Guest post from ‘Humbug’ the investor in The Great British Trade Off and of www.seekingfinancialindependence.com
Hum, first of all what is the definition of myth? The Oxford Dictionary definition is: a widely held but false idea, a misrepresentation of the truth, a fictitious or imaginary thing. Oh Err.
So is Financial Independence a myth in my opinion? Nah, I’m certain it isn’t. But I’m also almost as certain that its not so easy to achieve as many of the blogs out there would have us believe.
Unless someone plans to simply go and live on the streets and become a beggar money needs to be involved, because the central point of Financial Independence is receiving enough unearned or passive income to cover all living costs.
The safer the Financial Independence is, the greater the money pot, or capital to use a better definition, needs to be.
Now that capital has to come from somewhere. It could come from winning the national lottery I suppose, although given the odds here in the UK are 13,983,816 to 1 (call it 14 million to 1) the chances aren’t that great.
the central point of Financial Independence is receiving enough unearned or passive income to cover all living costs
It could come from the money fairy, although I personally have never seen one and don’t think they exist and it could come from the magic money tree.
Again I’ve never seen one and don’t know anybody who’s grown one. I do know someone who’s currently on police bail for growing weed, but whilst that does sell for money (allegedly) its not quite the same as a magic money tree.
The capital could I suppose come from an inheritance, but the most likely source is from someones own earned income saved and invested either in the financial markets or property or better still both and compounded up over time.
As I recently posted under the semi-retire early tab, twenty years ago the capital that enabled me to semi-retire in my early fifties came from ruthlessly downsizing and cutting expenses to the bone for a few years and renovating two broken down old houses whilst I lived in them.
And let me tell you that’s not an exercise for those with a faint heart. The novelty of having a shower by going out into the garden and tipping a bucket of water over your head wears off fairly quickly, particularly in the winter.
But as a way of legally giving yourself a fairly large tax free capital boost, buying a wreck of a house, living in it while you do it up and then selling it on when all the work is done has much to commend it.
So, back to the plot and is Financial Independence a myth. Its certainly a wonderful dream. The idea that you never need to work another day in your life and you can do anything you want, when you want has ‘kerb appeal’ for sure.
But you’re going to need a huge amount of capital to really achieve that state are you not?
I just do not see the logic in flogging yourself half to death for say twenty years earning as much as you possibly can and at the same time depriving yourself and living a super frugal life in what are probably the best years of your life. The time when you’re young, full of energy and with a real jest for living and want to enjoy yourself, albeit as well as having one eye on the future.
Being sensible with your money and not just splashing the cash for the sake of it certainly makes sense, saving money in those big (hopefully) earning years likewise, I mean saving a decent percentage of income is logic but screwing yourself into the ground to save 60% of your money so you can retire with your idea of Financial Independence in your late thirties or early forties seems (and seemed to me personally at the time) too much deprivation.
Not least because suddenly stopping working hard to fully retire may not be as fulfilling or as much fun as you thought it would be. Grass is always greener and all that.
Also I think it would be so easy for the dream to get in the way of the reality and for someone to stop before they actually have enough money. This idea that’s widely out there that Financial Independence is arrived at when you have enough capital to cover your current living expenses 25 times over and that its safe to withdraw 4% of capital to live on every year is I think dangerous if the possible draw down period is four or five decades.
Because the problems are if you retire in say your late thirties or early forties with what you think is enough money, you may well live another fifty years and not only does your capital have to last, it has to cope with inflation and a number of stock market collapses along the way.
Right now inflation is very low both in the UK and the US. But I clearly remember the 1970’s when it was over 20% a year. Could that happen again? Answer, who knows.
I think a much safer way of judging when you’ve become truly Financially Independent, rather than taking 4% a year regardless, is when the natural yield from your investment portfolio is at least 150% higher than your total expected living expenses. Further I think the calculation of the living expenses should assume that there will be regular one off costs for things that go wrong. Because things will break, need replacing and generally stuff will happen.
when the natural yield from your investment portfolio is at least 150% higher than your total expected living expenses
Once anybody has that level of cover or better still 175%, then yes my view is that they have Financial Independence and well done them. They should be set up for life.
If someone hasn’t got that level of cover however, a great half way house for when they ‘run out of steam’ with the corporate grind is once their house is bought and paid for and mortgage free and once all other debts are history and the investment portfolio is building nicely is to semi-retire to run a business that they enjoy.
If the business is structured so there is very little financial downside risk (this will be the subject of a separate posting soon) then this is a brilliant way for someone to keep earning to live while they enjoy what their doing and at the save time allowing them to hopefully continue saving, albeit perhaps at a slower rate whilst the natural compounding effect continues with their investments not least because their not needing to take the yield out.
I didn’t have enough capital to consider myself Financially Independent back in the day, so I choose to do just that and semi-retire to run a small business. Its worked out really well, I love what I do, I’m my own boss and I decide what I do, don’t do and when I do it. More to the point I live comfortably and still have money to save and the investment portfolio continues to compound up.
So whilst I don’t think Financial Independence is a myth, I think that its not as easy to achieve as some would have us believe and that before anyone decides they have enough money for it to totally look after them for the rest of their days they need to do the sums very carefully.
Yours, aye Humbug