My Dad once learned how to fly a microlight, a flying contraption that looks like a bit like a hang glider attached to a lawnmower.
It’s probably not the safest hobby you could choose.
He learned to fly this thing at a rustic airstrip which, by all accounts, was just a grass field with a hedge at the end.
The hedge marked the boundary of the field and the point by which you had to have achieved take off or crash headfirst into the hedge.
To get airborne, you needed to start from a standstill at the other end of the field and then go full throttle, bumping along gathering speed with the stick pulled back until you’d got up enough speed and enough altitude to achieve lift off and clear the hedge.
The moral of this story is that the more runway you have, the safer you are.
In your personal finances, you can think of “runway” as the length of time that you could go without working.
People that live paycheck to paycheck have no runway. They spend everything that comes in, go overdrawn at the end of every month and juggle credit cards. They end up paying interest at >20% on credit cards and >40% on overdrafts.
We’ve all done it at some point but it’s a terrible way to live. It makes you incredibly fragile: the smallest gust of wind can bring down the whole house of cards. If you are in debt, your compounding machine is stuck in reverse gear. This is how people can get trapped in poverty.
You need to have a margin of safety in your life. Just as engineers build bridges that would hold the weight not of an average car but of the heaviest truck, you need some room for error in your calculations. Some redundancy in your personal finances in case of redundancy in your career.
This is why a cash emergency fund (of say 3-6 months spending) sits as the base layer of a portfolio, the foundation of your financial fortress.
From The Psychology of Money by Morgan Housel:
A small amount of wealth means the ability to take a few days of work when you’re sick without breaking the bank. Gaining that ability is huge if you don’t have it.
A bit more means waiting for a good job to come around after you get laid off, rather than having to take the first one you find. That can be life changing.
Six months’ emergency expenses means not being terrified of your boss, because you know you won’t be ruined if you have to take some time off to find a new job.
More still means the ability to take a job with lower pay but flexible hours. Maybe one with a shorter commute. Or being able to deal with a medical emergency without the added burden of worrying about how you’ll pay for it.
Then there’s retiring when you want to instead of when you need to. Using your money to buy time and options has a lifestyle benefit few luxury goods can compete with.Morgan Housel in The Psychology of Money
What is your runway?
To calculate your “runway”, you first calculate your net worth. This is the total of your financial assets minus any debts. (If you wanted to be prudent you could exclude your house and pension from the calculation to arrive at accessible net worth).
Then you divide your net worth by your “burn rate”. Your burn rate is your non-discretionary spending. It’s the amount you need to keep the lights on, pay taxes, meet the mortgage payments, feed yourself and your family and generally keep the show on the road. This does not need to include holidays, luxuries or other stuff you have a choice over whether to spend or not.
So if you have savings of £100,000 and an annual burn rate of £20,000, you have a 5 year runway.
You get more runway (more financial security) either by getting more or spending less.
How much is enough? A runway of 25x annual spending is the classic rule of thumb for calculating how much is enough never to need work again. Reasonable people can debate the safe withdrawal rate and the exact way to calculate this, but it’s better to be roughly right than precisely wrong.
The more runway you have, the better…at least up to a point.
But the benefits of runway are non-linear. In other words, extra runway provides huge benefits in the early stages but the incremental benefits get smaller with more runway and things pretty much “level out” after 25x.
This is the law of diminishing returns. Just as one ice cream is fun to eat but you don’t get a lot of extra value from your 25th ice cream of the day.
It is HUGE to go from having no runway to having the ability to take a year off. It’s a big deal to go from zero to one year’s runway. But just going from 25x to 26x shouldn’t really change your life much.
This is why I say that once you have enough runway (whatever that might be for you) and are happy working on your own terms, you have won the game.
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