To declare yourself financially independent and go running jubilantly through the streets, you have to hit your target number in investments. How do you come up with your target number?
- You figure out your annual expenses and
- You pick a safe withdrawal rate (SWR) that gives you the warm fuzzies
You put these two things together, stir, bring to a boil, and voila, you have a target number.
If your SWR is 4%, your target number is 25x your annual expenses.
If your SWR is 3.5%, your target number is approximately 28x your annual expenses.
If your SWR is 3%, your target number is 33x your annual expenses, etc.
But what if you, like us, are in the position of not knowing what your annual expenses are? How then does one set a target for early retirement? In this post we will cover why we have such trouble with our annual expenses, and the strategies we’ve come up with to set our target number.
Why We Don’t Know Our Annual Expenses
We use Mint. We use Personal Capital. We have spreadsheets coming out the wazoo, and yet I claim that we don’t have a handle on our annual expenses.
What I mean is that while we know exactly what our current annual expenses are, this information is less than useful given that we don’t plan to retire where we currently live. Add to that the fact that while we have a shortlist of places that might be our new home, we haven’t yet homed in on The One. And if that wasn’t quite enough ambiguity, three of our four possible new homes are in different countries than the one we currently live in. Yikes!
All of this adds an extra level of complexity to what is already not a particularly simple problem. It is all well and good to know what your current annual expenses are, but using your current expenses as a guide for your lifetime expenses is perhaps a wee bit short-sighted. All early retirees have to factor in things like ongoing health care costs, long term care in the twilight of our lives, our desire to pay for the weddings of our children, etc.
25x only works if you know the value of x. So how do you set yourself up for success if x is proving hard to nail down?
Planning in the Face of Uncertainty
When we first started planning our exit from the rat race, we had never tracked our expenses, so we had no idea how much we were spending. We had already decided that we would not continue to live in the Bay Area, but we had not decided where we would live – we didn’t even have the shortlist of four places that we currently have. We needed a target to aim for though, so we set ourselves a target of $100,000 a year, at a SWR of ~3.5%. What was our scientific method for choosing $100k?
- It is a nice round number.
- It is a comfortably large number. While 100K doesn’t go far in the pricey Bay Area, it is a fair chunk of change in most other places in the world.
With a target in place, we got serious about saving, but at the same time we worked on refining our target number. Here are some of the things we did to help us do better than “I pulled that number right out of my arse”.
Started Tracking Our Expenses
Now, nearly a year into our journey, we have been tracking and optimizing our expenses for 11 months. We have an idea of the areas where we can cut down without feeling miserable, and also which expenses we consider non-negotiable. This is powerful stuff, because it gives us an idea of how much flexibility we have in our budget, and what our bare-bones balls-to-the-wall expenses look like.
We can also use this information as a rough way to estimate our expenses in a different place. We can remove those line items that are specific to our location, and those that result from us working. For example, we can remove any expenses related to pool maintenance because we do not plan to buy another house with a pool, and we can discount income taxes and replace them with an estimate of long term capital gains taxes, or wealth tax in our new home, etc.
We’re taking advantage of a sort of global arbitrage here. We live in a very expensive area now, so if we use our budget here as a basis for living elsewhere, there is a good chance that we will end up with more than we actually need.
Researching our Potential New Home
We narrowed down the possibilities for our new home to four destinations. We then had conversations with people (friends and family) living in our target destinations about their annual spending. We have spent time on sites like The Earth Awaits (which uses Numbeo data for its budgeting projections) and on various expat forums. We’ve spent time researching how taxation works in each potential destination.
Cobbling Together a Target
Based on these inputs, we have come up with mock budgets for each of our target destinations. We started with the numbers based on actual budgets from folks who live in those places. We then tailored the budget based on what we know about ourselves and our current budget. e.g. if we know that we like to travel more often than the family we interviewed, we’ll pad that number. If we know we eat out less often than the budget described on a particular forum, we reduce that number accordingly. If we know that we will need to update our laptops every ‘n’ years, we budget for that.
We don’t consider our mock budgets to be set in stone – we are still collecting all the data we can. The more data points the better!
And The Final Number Is
We were pleasantly surprised to find that all our mock budgets worked out to be less than the $100,000 a year that we had used for our initial target calculations. We are now estimating we’ll need something more like $50,000 – $70,000 (depending on which of the four destinations we end up choosing) a year. At the SWR that makes us happy, this means that we need a Stash of close to $2 million dollars.
The Stash will not have to cover:
- Toddler BITA’s college fund. That is over and above the $2 million.
- The bulk of our housing costs. The equity in our current home will be used to cover most of our housing costs at our new location. We could use our equity to buy another home outright or, depending on interest rates at the time, add it to the $2 million stash, and take out another home loan.
We’re Closer To the Finish Line
We’ve reduced our target stash size, and the obvious side effect is that we could choose to move our dates in, thus making a mockery of the name of this website, since neither one of us will be 42 when we retire.
We have not yet decided if the dates are going to move, or if we’re going to stick to our original dates and heavily pad our Stash, or something in between. It is certainly a relief to know that we could choose to step off the treadmill even earlier than we had originally hoped for.
Cue celebratory music as the lights slowly dim and the curtain swings shut.