How much is enough?

how much is enough

It was my last day at work. I was in a handover meeting with a client to introduce the new account handler.  The client was a private equity firm with offices in New York and London and a couple of billion of funds under management.

I was treated to a rare conversation with the Big Cheese, the Managing Partner of the firm.  This guy doesn’t get out of bed for less than a couple of million a year. If I had to guess his net worth, I’d reckon somewhere north of £30m.

When he asked me why I was leaving, I muttered something about financial independence. I was well aware how pitifully small my net worth was in comparison to his.  So his response baffled me….he said he was jealous and looked forward to the day when he could afford to do the same.

I almost choked on my coffee. It could just have been small talk or a joke…but the way he said it was like he was actually fucking serious.  He believed on some level that he couldn’t afford to quit yet. Perhaps he didn’t have this year’s Lear Jet or the right Carribean island…I don’t know. But I’m pretty sure a therapist would have a field day with him.

This reminded me of a true story from Winning the Losers Game. Two writers were at a party held on a billionaire’s island. The first was Kurt Vonnegut, the second Joseph Heller, author of Catch 22.  Kurt turned to Joe and said:  “How does it make you feel to know that our host only yesterday may have made more money than your novel Catch 22 has earned in its entire history?

Joe: “Ah, but I’ve got something he can never have

Kurt: “What on earth could that be, Joe?

Joe: “The knowledge that I’ve got enough”.

These stories illustrate a fundamental truth about FI. It is harder than you think to realise when you have enough.   Achieving FI not only entails the discipline to accumulate wealth for a number of years but then also having the self-awareness of your own emotional flaws and biases to know what’s enough.

This often gives rise to One More Year Syndrome (OMYS). People say they cant leave a job they don’t like because now is the wrong time, given my next salary increase / share options / incentive package / bonus / new fund / carried interest / whatever.

But if you are in a well paid job, you will always be forgoing huge future earnings when you quit.  That is not a good reason to stay. Should you should carry on until they find you dead in your cubicle with a heart attack, a Dilbert cartoon pinned up and this months employee morale questionnaire sadly unfinished?

Our time on this planet is short. The period when we are able to run, cycle up mountains, make love, raise children, snowboard and dance is even shorter. The clock is ticking and life is what happens while we are making other plans.

OMYS follows partly from the maths of compounding. If your career goes well, you get salary increases each year.  Anything that compounds over time produces a J curve effect where, after 10 years of so, the increases are spectacular. In my last years at work, I was getting annual pay rises bigger than my first salary when I started work.  This means it will always feel like this is not quite the time to quit the Prison Camp. The pot of gold is always just round the corner.

OMYS is powerful and can lead you to ignore warning signs that your relationships and health are suffering.  When I was in the Prison Camp, I had on my arm an area of skin inflammation that worked as a stress dashboard. If I had a big presentation to deliver, was hungover or was dealing with an obnoxious person it would flare up. It reminded me of a rev counter on a car, but for stress and unhappiness.  Because I had tunnel vision, I ignored it and ploughed on.

So we need to know how much is enough. The most widely quoted answer to this in the FI community is the 4% Safe Withdrawal Rate (SWR).  There are different views and definitions to mine but I think about the SWR as the amount you can take from a portfolio each year such that its real value will likely continue to be maintained indefinitely.

A 4% SWR implies that you have enough when you have a portfolio worth 25x your annual spending.  So if your annual spending is £25,000 then you need a portfolio of £625,000.  If your annual spending is £50,000 then you need a portfolio of £1,250,000. And so on.

In order to answer the question “How much is enough?” you first need to answer the question: “What are my actual spending needs?”.  There is no one magic £ / $ number that is needed by everyone. It depends on how much you can live comfortably on.

A 4% SWR means every £1 you cut from your annual spending reduces the pot you need to accumulate by £25.

Cutting spending is doubly important:

1) You need to slash spending to maximise savings in the wealth accumulation phase; and

2) If you can eliminate wasteful spending then “the number” for enough becomes much lower.

Step 1 is to disregard all background noise from the media and the consumer suckers around you. Remember that your ancestors lived for most of the last 100,000 years without money.

Step 2 is to quantify and analyse your recent spending. Spend a few months measuring where every pound goes. This is simple – just do all of your spending from one bank account. At the end of each month download all your account transactions to a spreadsheet so each item can be classified and the data analysed. This is a powerful exercise. What gets measured gets managed and your spending will fall naturally.

Step 3 is to understand the safe withdrawal rate.  The 4% “rule” is a simplification. It is based on a number of studies, the most widely cited of which is the Trinity Study (as updated). The Trinity Study showed how, over a range of time periods and market conditions, how portfolios reacted to differing levels of withdrawals.

In the Trinity Study, with a 75% equities : 25% fixed income portfolio (which is my current asset allocation) and 4% inflation adjusted withdrawals, the portfolio success rate (under their definition i.e. not running out of money before death) was 100%.

The study shows a range of withdrawal rates and what’s striking is the number of scenarios where the portfolio held or grew its value over the long term. The study illustrates using starting portfolio values of $1,000. For a 75% equities : 25% fixed income portfolio the median value of the portfolio after 30 years was $5,968 with a 4% withdrawal rate.

On this basis, a 4% withdrawal rate is not the answer to “Whats the most I can take from the portfolio each year such that I probably won’t run out of money before I die?” Remember you are not immortal. So there is a margin of safety built in to the 4% “rule”. Do you really care if the actual SWR turns out to be less than 4%?…this probably just means you will eat into your capital before you die, not that you will necessarily run out of money.

Ask yourself whether you really want to keep working into old age to leave behind a portfolio large enough to support your adult children into perpetuity? This risks screwing up your children’s ability to function as independent adults when you are no longer around to support them.

There are other conservative assumptions implicit in the 4% “rule”:

  • You never do any paid work again
  • You never receive any state benefits (e.g. child benefit, state pension)
  • You never downsize your house
  • You never benefit from any windfalls or inherit any money
  • Your spending will not fall over time (in real terms)

Can you see how unlikely these assumptions are?  The first in particular deserves our attention. If you have the drive and discipline to get anywhere near FI by say 50, then you are unusual. You’re the sort of person that can earn some income in almost any state of the economy. Even if that means flipping burgers or working in the local supermarket (my preferred plan Z).  More likely, you will develop your interests and passions and end up getting paid something for these.

I used to worry that I’d be too old / too under-qualified / too over-qualified to get another job or start a business.  But as it turned out, the gap between my last pay cheque from my former employer and my first earned income from financial coaching was less than 1 week.  It is possible to be recklessly over-conservative. Trust me on this.

There are plenty of posts out there in the blogosphere that will tell you that the 4% rate is too optimistic. These are often written by emotionally damaged men in their 40s and 50s who’ve unfortunately become suspicious and pessimistic. This is unnecessary and counter-productive.  I suggest you cultivate rational optimism and gratitude instead.

Money accumulation can not ward off all bad things.  Money is great for buying kitchen units but not so effective at staving off your inevitable human mortality. Or the slim but real possibilities of war, the collapse of capitalism or alien invasions. If these things happen, neither your portfolio nor your cubicle job will save you.

Read the Trinity study and give some thought to your own view of the SWR. Many people assume the “withdrawal rate” cant be more than the current level of portfolio income generated.  For these people, it feels reckless to spend more than the income and eat into capital.  Personally, I think this is too conservative.  The stash is there to serve you, not the other way around. For me, its more important to focus on total return (i.e. including capital growth) than income and to avoid “reaching for yield” when investing.

Ultimately the question you need to ask yourself is: do you understand what you are spending and why? Then, do you have 25x the spending you need.  If so, that’s probably enough.

Image credit: http://www.getrichslowly.org

29 comments

  1. Really good post – food for thought for us all.
    Many thanks

  2. Ray Prince · · Reply

    Totally spot on! I work as a CFP and my experience is that whilst individuals have a collection of ‘stuff’ (investments, policies etc), the missing link is that they don’t have a long term financial plan that will provide them with the answer to ‘how much is enough?’

    The ones that have gone through this process often retire earlier as they have already achieved FI (which they usually weren’t aware of). And if they haven’t arrived at FI yet, they know what steps they need to take to achieve it.

  3. Julie Knox · · Reply

    I’m so excited to read this properly. Congrats on your official ‘retirement’ and apologies for not having engaged properly with the blog yet. Suffice to say I just know this article below is Right On The Money, if you’ll pardon the pun.

  4. How much is enough is indeed a tricky one and one my wife often asks me!

    It’s also one that to date I’ve avoided calculating as an exact amount, though in my head I have a rough idea of average monthly income required.

    You are spot on stating that the margin of safety that most of us on the FI journey want is probably far too high and more than will be required in reality. Seeing as you ARE now FI, this point is advice that those of us still on the journey should give some serious ear time to.

  5. I haven’t done any paid work since retiring two and a bit years ago. And even then I figured I would flatline about 9 months ago. My spending was lower, and I still have savings left, enough to defer my pension another year.

    And yet the one more year syndrome is always there. I’ve lost count of the number of people I’ve heard switch to ‘I want to leave loads of money to my kids’ once they come across the 4% rule and think about what it means if they are above the line. Which is fine if that’s what they mean, unless it’s being used as a way of avoiding the uncomfortable thought that they can earn more money. But they can’t earn more life time…

    I never realised that the SWR was when you start to run down your capital, I had always thought it meant when the balance is 0.

  6. “I think about the SWR as the amount you can take from a portfolio each year such that its real value will likely continue to be maintained indefinitely.”

    I believe most people think it is the rate that doesn’t reduce your portfolio to zero.

    e.g.

    http://www.bogleheads.org/wiki/Safe_withdrawal_rates

    “A safe withdrawal rate is defined as the quantity of money, expressed as a percentage of the initial investment, which can be withdrawn per year for a given quantity of time, including adjustments for inflation, and not lead to portfolio failure; failure being defined as a 95% probability of depletion to zero at any time within the specified period.”

    I think there are reasons to be cautious about assuming any SWR, especially the commonly mentioned 4% SWR. The 4% SWR doesn’t take account of costs, and is based on historic US data. Future investment performance may be worse, and the SWR for other stock markets has in the main not been as good as that for the US.

    Looking at median portfolio values after 30 years, is not really that useful. Yes, it does show that most portfolios are worth more than they were initially but the problem is that a number of them were worth nothing before the end of the retirement period. That sort of failure is what the SWR is trying to avoid.

  7. saudisimon · · Reply

    Excellent article and blog, I think you’re doing good work. What do you think are the implications of a portfolio largely based on rental income from property? If you’ve got enough to retire on today, will it be enough in the future? That’s my little dilemma.
    Congratulations on jumping, it takes guts!

    1. Saudisimon. Thanks for your question and kind words. There is less data on property and its more idiosyncratic than a diversified portfolio of international equities. Owning property direct means you hold a local asset whose value depends on what’s happening in the local area. But a FI strategy based on property is perfectly sensible and many people do incredibly well from it.

      From the studies I’ve seen, property in the UK has outpaced inflation and delivered returns broadly similar to equities over the long haul. Be careful of markets where supply is less constrained – its booms and over-supply that you need to watch for.

      All the best with your portfolio and getting comfortable with what’s “enough” for you!

  8. BeatTheSystem · · Reply

    emotionally damaged men in their 40s and 50s

    Yep, that’s me.

    Your article resonates perfectly though. I bet you don’t have kids?

    I agree that kids on financial life support is not good, but how could I enjoy my (potentially) substantial wealth and retire before 50 and let them each rack up 50 grand of student debt with absolutely no hope of getting a place of their own would be equally irresponsible. The opportunities are just not there and it is only natural to want to help them, whilst I still have earning potential, in this life or the next…

    For me 4% is way too high, more like 2.5%, but I take your point, having just read monkey with a pin, and your casino article, the odds are stacked so heavily against me making any kind of decent return in this new world order I have to be ultra conservative. Anyone considering 4% as SWR is planning for capital drawdown whether they realise it or not, except for you who can get double digit returns. My returns have been crap this year and my IFA is bleeding me dry but that’s another topic.

    1. BTS

      Thanks for your comment. I have 3 kids and no IFA.

      TEA

      1. BeatTheSystem · ·

        TEA, Apologies, I assumed wrong, which is pretty much me all over (when it comes to investment decisions LOL). So are you planning to leave your kids a tidy sum or is it up to them?

        Yes you have no IFA and sadly I do. I was good at creating wealth but not very good at looking after it.

        I do need to get a grip of my finances. During some good years as an owner of a small business I put all my salary and bonuses into pensions over many years and built a tidy sum, paying little or no tax legally – hence the name ‘Beat The System’. During this time of large inputs the IFA fees were masked somewhat and also where injected at a time of good growth, now growth is not so good the IFA charges alone are more than to the 1% YOY gross increase this year on a 7 figure sum! My ‘situation’ has changed with little prospect of any decent money for the foreseeable future so I have to now rely on investment performance going forwards.

        Its a bit complex with factors I cant go into otherwise I would be giving you a call. Time is also a major problem, hence going down the IFA route.

  9. Anyway, further to my previous comment, which upon re-reading seems excessively negative. Thanks for this article, your story about the conversation with the Big Cheese shows how much the main barrier is a self-imposed mental one rather than anything to do with quibbling over the details of SWRs.

    The allure of one more year is strangely compelling to me, even though I have reached the point where I am financially independent. I have more than the 25x spending I need and have interests that I’d prefer to pursue instead of working, but I’m still reluctant to quit. Currently I’m very tempted by the idea of quitting in the next year or so, but that is exactly the one more year syndrome you describe.

    Why not now? As you say, my time on this planet is short and the longer I delay retirement the less I will be able to with it. I think my reasons are procrastination, fear of change and loss of (probably unnecessary) income. None of which are very good reasons.

    1. Andy – Thank you for the follow up… a fantastic response to your own earlier comment. I could not have put it better. It looks like you are asking yourself the right questions. Congratulations on getting to FI and all the best with your decision making!

  10. @BeatTheSystem

    Worrying about 50 grand of student debt each seems like you you have assumed the worst case scenario. If you allow 27 grand for 3 years of tuition fees, then what are the other costs that are really necessary? Students can live at home while they study and work in the holidays and even during term time. Also remember that student loans are really more of a graduate tax on higher earners, rather than a debt.

    Yes, it is natural to want to help your children, but do they really want or need this help once they become adults? Would they prefer you to work until you drop dead so that they could enjoy a comfortable life supported by you, or would they prefer you to live your own life? How much have you considered the opposite view that feather-bedding your kids may be equally irresponsible?

    > Anyone considering 4% as SWR is planning for capital drawdown

    Not necessarily, even though I think the 4% SWR may be high as I mentioned previously, it is quite possible that a hypothetical retirement portfolio starting today could succeed with a 4% withdrawal rate. Any SWR figure is merely a starting point for planning. Failure is not guaranteed and depends on the sequence of returns.

    Also why are you allowing your IFA to bleed you dry? Clearly you have above average knowledge of personal finance – you know about SWRs and are reading financial independence blogs. You must be in the top few percent of the population in terms of financial knowledge (not actually a difficult task), and you aware of the fact that you are being bled dry and are getting poor returns.

    1. BeatTheSystem · · Reply

      3 kids, #1 will be studying in a London uni. Accommodation for 1st year is 220 per week!!!! Fees and accommodation over 3 years will equal 53K and that’s without eating. #1 will take max loans and get a part time job, I will have to fund the shortfall so I suppose its not 50K out of my back pocket, more like 20K or so over 3 years but that is times 3 for 3 kids so 60K for all of them.

      #2 and #3 will most likely study far from home too.

      Yes I agree, it should be considered more of a graduate tax rather than a debt in the true sense of the word. Best save my dosh for a house deposit.

      ‘Would they prefer you to work until you drop dead so that they could enjoy a comfortable life supported by you, or would they prefer you to live your own life?’

      No I don’t think they want me dead, but I have a bit of a protestant work ethic (without being religious at all I hastily add) and see it my duty to help them whilst I have the capacity, or at least until they do have the ability to self sustain. But I do want to stop and look after ,myself as soon as they are settled in the chosen path and hope that is as soon as possible. Maybe that is a starter home each – I don’t know, bam 450K required before I can tell them to #uck off and leave me to die in peace!

      ‘Also why are you allowing your IFA to bleed you dry?’

      Excellent question. I think because

      Time!
      Lack of knowledge
      Fear of making a mistake
      Analysis Paralysis when I do look at it
      The belief that buying an index tracker is complete pants, it just doesn’t feel right.

      My best performers are actually VCT’s which I pushed, which links into my not afraid to take risks business brain.

      I have created some modest wealth that if managed correctly should allow me to retire before I get too old – I am just crap at looking after it and delegated responsibility to an IFA.

      1. BeatTheSystem · ·

        The point I wanted to make which I forgot to was that even though I have in theory enough already to be FI I am so pessimistic of investment performance I am downgrading the 4% to a much lower level. I am a similar age to the TEA and it has to last a very long time!

        I also have a financial sword of Damocles situation affecting 50% of my wealth which is too complex to go into here and wont be resolved for a few years.

        I read somewhere, but cant think where that 4% was hopelessly optimistic.

      2. Of course, how much you want to do for your kids is entirely up to you. I do feel that you aren’t really obliged to buy them all starter homes after supporting them through Uni. Do many parents do this?

        The IFA situation worries me, with a 7 figure sum, you are probably supporting your IFA more than you are supporting any of your children. Presumably you will also be paying fund fees on top of you IFA’s charges, so I guess you are probably losing about 1.5% or more a year. In comparison you could have a diversified low cost portfolio with Vanguard Lifestrategy for 0.25%. It’s difficult to control performance but easy to control charges.

        Time? It probably doesn’t really take a great deal of time to ditch your IFA if you are clear what you want to do, but perhaps the problem is more not knowing what to do due to Lack of Knowledge, leading to Analysis Paralysis?

        Lack of knowledge? There are some excellent books which don’t take too long to read if you haven’t already read them. See The Escape Artist’s list of life changing books, especially Tim Hale. Also A Random Walk Down Wall Street or Winning the Loser’s game might help to convince you that index trackers aren’t complete pants. A couple of weeks of reading might help to clarify what investment choices are best for you.

        Regarding the 4% withdrawal rate, there are valid arguments for considering it both overly optimistic and pessimistic. There is never going to be a definitive answer, maybe 2% is very safe, 5% is probably too optimistic if you have a long retirement. If you are paying 1.5% or more to your IFA and the financial services industry then you probably need to be revise it down by that amount. In reality you can monitor your progress and adjust your spending. You may find some other source of income that you enjoy, you will probably have a state pension starting at some point. You could downsize your house once the kids leave or take in a lodger. You have more options that the simple constant withdrawal year on year that is assumed in the SWR calculations.

  11. Another excellent and thought provoking post from TEA keep up the good work !!

    I like many others i;m sure have spent a lot of time trying to work out how much is enough for my own circumstances, I really like the simplicity of the desired/required income x 25 calculation because assuming you know what you need annually its easy to come up with a supposedly safe number to aim for.

    However the question of whether your comfortable burning down your capital through a hopefully long and active retirement, or whether you want to preserve that capital as far as possible intact to distribute to those you leave behind, appears to me to have a significant impact on what that initial target number needs to be. If you want to leave the capital behind your number needs to be a pot large enough to generate the income (dividends/interest) you need to live on every year without depleting the capital, if on the other hand your able to supplement the income your portfolio generates by drawing down a small amount of capital each year the number your aiming at for FI would I think be somewhat lower.

    A related and interesting read from a US based Financial adviser Kitces can be found on this link
    http://bit.ly/1ruSQxX what i like in this post is the idea of having identified a target “cash flow” that should sustain you throughout the withdrawal phase providing your willing and able to make any required adjustments along the way.

    Thanks again for this blog its really encouraging to learn how you got to your own FI moment and follow the new journey that you have embarked on

  12. Enjoyed the article. Couldn’t agree more about OMYS. Once you have your “enough” in mind it’s important to actually execute toward that end and escape the cave once the chains are freed. I imagine it’s fear of the unknown that keeps people working towards the goal instead of enjoying the fruits of past labor. I personally couldn’t imagine being so complacent with an employer running most of my waking hours, but that’s just me.

    Keep on fighting for freedom!

  13. I understand the desire to feather nest children. I have two young girls, and I too want to set them up as best as I can. My parents helped me with my current house, and I would like to do the same for them.

    I’m thinking about saving a significant deposit and investing in two ‘but to let’ modest homes. E.g 2 bed terrace somewhere reasonable (Cambridge?). If I buy before the children are 10 years old then by the time they are in their mid twenties they will have the option to (I) enjoy the rental income, (ii) live there, or (iii) sell it and buy somewhere they want.

    I think it’s a good plan. Maybe equities will provide a higher rate of return, but this BTL approach seems to match assets and liabilities nicely.

    What do you think?

    1. I think you should read this

  14. marine_life · · Reply

    Interesting read and a good summary.

    A couple of observations.

    The 4% rule is made to sound simple but it isn’t. what happens when you factor in various public pensions, private pensions etc. etc. I think for any potential early retiree there is a tendency to build in a huge buffer in order to both cope with uncertainty but also because of an inherent mistrust as to whether the 4% rule really is right. Most of the historical models of whether this is the right or wrong rate are based on historical returns which may turn out to be considerably above what we see ove the next 10 years (i.e. in an environment of close to deflation). Who knows.

    I can definitely identify with the OMYS but for me this is not so much about OMYS as about the no going back. At my age once you are gone you are gone and the chances (at age 50) of finding alternative employment at the same rate of pay are as close to zero as makes no difference. But that isn’t what really holds us in place. what holds us in place is the fact that we become institutionalised by The Man. We know we can get out but we are almost scared to do so because The Man might not let us, we are subconsciously scared that he might shout at us and tell us not to be so stupid and go back to our office. And we just might. We’re scared that our colleague will look at us with a little pity, an incredulous look and small shake of the head…and we might start to wonder whether we are doing the right thing.

    But I can add a little rationalization to all this, i don’t think we are scared of what we know, I think we are scared of what we don’t know. Scared that our funds won’t last or that The Firm who is responsible for paying our pensions might disappear before we get there. In our mind’s eye we see retirement as an endless procession of sunny days sitting on the patio sipping cocktails but our Inner Chimp tells us that actually it might rain every day.

    So what’s the secret? What’s the answer? You need to give your inner chimp a good talking to!

    1. Absolutely right, Marine Life

  15. Rowan Tree · · Reply

    I discovered your blog right at the start, and loved your name – The Escape Artist! I too was planning to escape from the prison camp and did it in the summer (otherwise I might have been found slumped over the wheel of my company car, dead with a heart attack, as you say!) People were surprised and jealous, even though I’m not young. The only support was from the FI blogs like Ermine SLIS, yourself and others. And my DH of course. We are now planning his escape, when I finally get a proper handle on the pensions and savings.

    1. Thanks for the comment and congratulations on your escape….we’ve just got to get your other half through the tunnel next.

      p.s. I love all my readers…but I especially love the early readers of the blog that signed up to follow it before I was world famous;-)

  16. John Smith · · Reply

    I know this is probably a dumb question but there doesn’t seem to be any mention in all of this talk of 25 x annual spend etc. of the age at which one “retires”. Surely the total portfolio needed to retire is just as dependant on retirement age as annual withdrawal rates? I’m sure I’ve missed something here? What might be the “correct” multiplier for someone retiring at age 50?

    1. Its a good question. The way the maths works is that the longer the time horizon, the more the SWR depends on the annual return generated by the portfolio rather than the initial principal amount. 4% is a rule of thumb based on 30+ year retirements. If we knew we aint gonna last 30 years, then the withdrawal rate could be somewhat higher. For example, if you were 70 and knew you’d only last 20 years, you could obviously withdraw a higher annual amount than 4%.

  17. Enough is when you get enough investment income to live the life that makes you happy, plus a little bit extra. A relatively easy way to do this is to live off your proposed retirement income as a test. I use a ‘laddering’ technique for my living expenses. I’ve got four six monthly blocks of $ in term deposits. Every six months I use investment income to create the next block. I’ve been doing this for three years now. The investment income over the has always been higher than the amount I’ve spent.

  18. […] someone who is almost definitely on a high London salary already. He either hasn’t worked out the concept of enough just yet, or is running a very spendy budget and so could therefore do with the extra income gain […]

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