I was considering the difference between Flex FI and FI. The difference of course is two fold:
- the amount saved
- the withdrawal rate (SWR)
Flex FI vs FI
With Flex Fi you are only saving 20x your annual spend and for FI it is 25x your annual spend. In order to have a decent income from your FlexFi number you need a 5% withdrawal rate vs the 4% rate for FI. (For those approaching FIRE in their 30s and 40s a more appropriate SWR may be as low as 3.5%).
total yearly spend: $50k
Flex FI number = $1M @ 5% = $50K
FI number = $1.25M @ 4% = $50k
So given our more traditional retirement timeline, what is the concern here?
First of all we are not traditional retirees; we intend to retire at 60, not the usual 65 – 67. We believe that advances in medical technology and elder care, we might need 30-40 years of income, with the last 10 years potentially being the most expensive.
It all comes down to the percentage chance on how long the money will last. The chance of your money degrading to near zero is apparently dependent on your withdrawal rate and your equity/bond mix. Of course there are other factors (without going deep into the math which is something I feel unqualified to do).
Big Erns Math
Talking of the math, Big Ern of Early Retirement Now has an excellent and very in depth series on the SWR. The numbers that concern Cat and I specifically are the chances of success of making it to our deaths with a few bucks in the bank still. According to the tables Big Ern has, with the following parameters: 75% stock/25% bonds, and a 40 year timeline (final asset value of zero)
4% = 93% chance of success
5% = 69% chance of success
But Big Ern also charts out the following: A period of 30 & 60 years with 25% of capital left and a mix of 75% stock/25% bonds @ 4% SWR gives a 94% chance of success or 84% over a 60 year span. That’s pretty good odds. But this is all mathematics. There is also an emotional component to this. How do you feel about the odds?
This was discussed by ChooseFI on podcast 034 with JL Collins. There are two components to the Safe withdrawal Rate; emotional and mathematics. We tend to focus on the math but the emotional component must also be considered. One does not want to spend one’s final years shitting bricks about the money running out because life seems to keep going and you didn’t expire when you expected to.
So what we have to do is understand the math; understand that the outcome of all that math is not a red light / green light answer but a probability. That the answer is a probability value. This is because we have no idea what the future brings but based on past performance we can predict with some accuracy the long term future results.
And this is where our risk tolerance comes in. We can improve our odds a little according to Big Ern’s tables by moving to a 100% stock portfolio. However that makes for a more volatile portfolio, subject to the whims of the market. The addition of bonds to a portfolio does smooth things out in that regard. If we add more bonds to the portfolio, we must lower our SWR or we reduce the chances of making it 30-60 years without running out of money. Perusing Big Ern’s tables will give you an idea of how much the portfolio mix and time horizon can change the odds.
Finding the Balance
So now we have to balance our feelings about the volatility (mix) of the portfolio vs the percentage chance we get to make it to death with some cash to spare. Once we understand that all of this is based on odds we can start making smarter decisions. For instance; vary the SWR depending on needs as they change and as such, shifting the odds ever in our favor as they say.
So when we talk about risk aversion what we are really talking about is balancing several factors until we come to a point that we are most comfortable with. Those factors being SWR, portfolio mix, time horizon and capital preservation, and the chances of a satisfactory outcome.
Circling back to the original point, FI or Flex Fi? Cat and I are aiming for FI or even fat FI if we can, without having to work past our planned retirement dates. We are aiming to preserve our capital as we both figure we will need it. That’s our balance of factors, the last of which is our dignity in our final years.