If you are trudging along determinedly towards financial independence, and possible early retirement, it is safe to say that you have a target number in mind. It is also a pretty safe bet that you came up with that target number by calculating your annual expenses and then multiplying that number by 25 (for a 4% withdrawal rate) or 33 (for a 3% withdrawal rate), or something in between.
While the 25x rule is elegant, if you diligently sock away 25 times your annual expenses and then sail away into the sunset, chances are that the day will come when you will find yourself digging through your pockets and wishing that they were just a little bit deeper. Why? Because while 25x works most excellently for annual expenses, it falters when it comes to sporadic expenses.
When 25x is not enough
25x works well enough for expenses that recur, and for expenses that you expect to have your whole life. Groceries? Check. A Phone Bill? Check.
Sporadic expenses? Those are a whole different ballgame. Sporadic expenses don’t play nice with the 25x rule of thumb. For the purposes of this article I am defining sporadic expenses as:
- Large expenses. The kind of expenses that you can’t just find room in your budget for by cutting down on other categories temporarily.
- Expenses that occur only once or expenses that recur, but only a few times, such that applying the 25x multiplier to them would be overkill.
- Expenses that are not unexpected. Sporadic expenses are not emergencies. They are expenses that one can foresee.
Here are some examples of kinds of expenses that you might not account for if you only employ the 25x method of calculating what you need.
Once in a Lifetime Gifts
In this category I include things like paying for the wedding of a child or celebrating your parents’ 50th wedding anniversary in style. Maybe you would like to help your child with the down payment for their first house. Perhaps you want to make a significant contribution to your grandchild’s 529 (college saving plan), and not just in the scenario where your portfolio happens to have thrived.
End of Life Care For Pets
Much like your own, your pet’s medical bills in their old age will likely bear little resemblance to their bills when they were young and spry. In the last year or two of your pet’s life you could end up having to shell out a few thousand dollars a year in vet bills.
When I was just yea high, my teeth were the stuff of nightmares. My baby teeth refused to fall out and my permanent teeth were determined to make an appearance in a mouth that had no room for them. My milk teeth and one permanent tooth needed to be extracted, and then I needed years of braces before I could smile and not cause people to run away humming the theme song from Jaws as they receded into the distance. Mr. BITA is blessed with a perfect set of pearly whites. If my genes won the battle, in a few years Toddler BITA’s mouth is going to help put some dentist’s child through college.
Oh and also, when my mother was around 55 she needed to have about half her teeth replaced with implants, and oh boy that was not cheap.
A Luxury Purchase
Mr. 1500 recently bought himself a very expensive Honda. Perhaps you have your eye on something similar, something that you may want to splurge on, truly splurge, just once in your life?
If Not 25x, Then What?
So how is one to deal with life’s sporadic expenses?
What we are planning to do is to modify our retirement formula a little bit. We are planning to use a 3.5% withdrawal rate, so our multiplier is 28 (instead of 25). Instead of:
Stash Size = 28 * annual expenses
Our formula is:
Stash Size = 28 * annual expenses + sporadic expenses
We have an excel sheet that lists as many sporadic expenses as we can think of, and an estimated budget for each. We then add a 15% buffer to the total and plug it into the formula above to yield our target Stash Size. Obviously, this isn’t foolproof. There may be sporadic expenses out there that we have not taken into consideration. The hope though, is that we have thought of enough of them and that the buffer will help cover for the ones we have forgotten.
For example, assume that our annual expenses are $60,000, and our excel sheet tells us that we want to plan for $70,000 worth of sporadic expenses. Here is how we would compute our target for early retirement:
Sample Stash Size = 28 * 60,000 + 70,000 = $1,750,000.
In this example, when we do have $1.57 million dollars saved, we don’t start drawing down 3.5% of $1.75 million. We draw down 3.5% of $1.68 million, because that is what we need for our regular annual expenses. When one of the sporadic events occur, we withdraw what we need for it, and that withdrawal is not based on the 3.5% withdrawal rate .
A final note about the Sporadic Expense Stash
It is important to note that as far as asset allocation and investments go, we treat our sporadic expense money like the rest of the money in our stash. It isn’t sitting isolated in an account somewhere. It is just a way of coming up with a target Stash Size that is based on more than just the 25x rule of thumb. Just as the 4% number is a rule of thumb that cannot be applied blindly irrespective of market conditions, similarly we can’t blindly withdraw for sporadic expenses either. We must take the overall health of the portfolio and market conditions into account before we make a big withdrawal.
What is your plan for sporadic expenses in early retirement? What kinds of sporadic expenses are you planning and saving for?