January 26, 2019
Let’s face it. Sometimes our hope of a perfectly smooth future turns out to be a little misguided.
This applies to those in the workforce as well as those who retire early. All of us need backup plans in place for times when things get a little rocky.
For example, Australia is bound to go through a recession in the future. Although you’d be forgiven for thinking they don’t occur anymore, given it’s been almost 30 years since the last one!
Either way, we need to know what we’ll do in such a scenario. Specifically, how will we sustain our Financial Independence?
There are three factors at play here – our investments, our spending, and probably the most important of all… ourselves. So let’s dive in and find some concrete ways to make sure we make it through to the sunshine and green grass on the other side!
Before we start, I don’t think there’s any bulletproof investment plan out there.
You can use history as a guide to see how reliable an asset class is at delivering long term returns. You can even pair investments that zig when others zag. But it still doesn’t tell you the future.
Investment markets are always uncertain. So we can’t perfectly predict how smooth, or otherwise, our income will be in early retirement. Therefore, we need a plan.
A word of warning: I’m about to pull a bunch of numbers from my backside and create a totally made-up scenario.
Let’s imagine we have a nasty recession. And the sharemarket drops by a very ugly 60%. Historically that’s extremely rare, but not impossible.
In that case, it’s possible that dividends paid by companies would drop by 40%. So we’ll make this our scenario for today.
Since many market participants don’t care about dividends, there’s little long term data available. But history and common sense suggests that dividends, on average, tend to be less volatile than share prices.
So for us, if our dividends and spending were roughly equal – $45,000 per year – our income would drop by $18,000. Our new retirement income would be $27,000 per year – a bit of a cut!
Our FI life is ruined, right? This whole thing blows up because we retired too soon with too little?
Are we completely unprepared and already living too frugally to cope on this lower income?
Let’s find out…
The first logical solution to a drop in income, is spending less money. Just like you’d need to if you got a pay cut at work.
Given we’re already somewhat frugal, you might think this isn’t an option. Indeed, my buddy Aussie HIFIRE just wrote a post about this here. And I know many people feel the same.
The main argument being, for low to moderate spenders, most living costs are fixed and unable to be adjusted down.
While I understand this viewpoint, I simply don’t believe that’s the case at all.
The issue I have, is with the often used term ‘fixed costs’. In my view, there’s no such thing as fixed costs.
Now, certain costs may be fixed in your mind, I get that. But not in reality. There’s no written contract for your household spending which runs in perpetuity.
Of course, there is such a thing as fixed needs.
Housing: You need a roof over your head. But you don’t need the house you’re living in.
Food: You need food to eat. But you don’t need the food you’re currently eating.
Transport: You need to go places sometimes. But you don’t need to own a vehicle (or 2) to do that.
You get the idea.
Our needs are very real. But nowhere are you forced to spend $X on these things. So while the need is fixed, the cost is not.
And if you’ve been around this blog a while, you’ll know I put most sweet perks of Western life in the ‘wants’ bucket, not the ‘needs’ bucket.
Hell, even though some consider it frugal, a good portion of our own spending is optional.
Therefore, I maintain that lowering our spending is entirely within our control, if we want it to be.
Because when you break it down, we need very little to live a good life. For the average Aussie, the fact that you’re reading this means you’re among the wealthiest people in the world, at any time in history.
Yes, I know it doesn’t feel like that – more on this later.
We live incredible lives in modern developed society. The kind that would be unbelievable to folks just a few generations ago.
So we need to stop and think for a minute to gain some perspective. We have to realise how lucky we are. And how everyone managed to live perfectly well without most of the things we have today.
Only then can we truly recognise the difference between ‘wants’ and ‘needs’.
Let’s use our recently published annual spending, so you can see this in action with real numbers.
If things got tough in retirement, how much could we reduce our spending? Let’s have a look…
Well, we currently live in a 4 bedroom house which backs out onto a gigantic regional park. Given there’s only 2 of us and the odd guest staying here, there’s no way this type of house is needed.
We could easily move into a 2-3 bedroom house in a regular neighbourhood and save $3,000 per year. We could even move out a little further and spend $300 per week instead of the current $400. Remember, no need to live near work, this is retirement after all. Total saving: $5,000.
You could argue this entire category is optional. But if we wound this back, you could easily more than halve this expense. Total saving: $3,000.
Again, all entirely optional. To continue to enjoy social outings, we could still spend $400 or so. Total saving: $500.
We could definitely be more selective about our spending on supplies here and start planting only cost-effective crops. Total saving: $500.
Currently this cost is entirely for Mrs SMA’s part time work, so this would be zero in an early retirement disaster scenario. Total saving: $800.
Sorry everyone, but this is also entirely optional. Adults exchanging gifts is nice and all, but it’s not exactly a need. Bonding with others is better done through helping each other and being there for one another – not swapping products from Westfield. Maybe we’ll do small gifts for each other, and continue small gifts for others, spending $500 in total. Total saving: $1,000.
Obviously we’ll be driving around less if we’re buying less stuff, taking less trips and trying to optimise. Total saving: $200.
We can ramp this back up later when things get back on track. But this is not an immediate need, more like a lifelong goal. Total saving: $400.
We’ll obviously be watching the ‘random’ expenses closely. And if we’re honest, the clothes we have now are probably fine for the next 5 years. Maintaining our independence is more important than staying ‘on trend’ – ha! Total saving: $600.
That’ll probably do for now, even though I can see way more options in there.
In fact, I reckon we could come up with a way to plug the entire gap, through lower spending alone – and I’m one of those sick, twisted people who’d probably enjoy the challenge!
But we’ll leave it there to remain ‘reasonable’ 🙂
The premise of these savings is based on the fact that if something is not a necessity, then by definition, it’s an optional extra – a luxury.
Most of those optimisations simply give us a slightly more frugal lifestyle than we have now. We still get to do pretty much all the same stuff, just a little less, or in a more cost-effective way.
Adding this up, the total made-up savings come to $12,000.
And notice we haven’t yet resorted to using both sides of toilet paper or drinking rainwater through our socks! Not bad!
Remember, our ravaged retirement income dropped by $18,000. This means these savings ideas cover two-thirds of that spending gap.
Our lower retirement income falls to $27,000. And our optimised spending falls to $33,000. Honestly, that’s pretty good.
So our investment cashflow drops 40% and there’s only a $6,000 per year shortfall. All because we’re adaptable and able to flex our frugality muscles when the time calls for it!
Remember, this is in a pretty terrible and scary situation – likely a global economic meltdown and an Aussie recession. So, it’s unlikely you’ll feel comfortable spending as much as before, even if you wanted to!
Our only ‘job’ is to make it work and sustain our Financial Independence. Why would we not do this?
Now, some people say they own their home so you can’t optimise that. Not quite true.
If we owned the rental we’re in, we also have the opportunity to downsize. Given this place is probably worth around $450,000, we could move to a lower cost house a little further out for $100,000 less.
And guess what?
If you live in more expensive housing, your opportunity for savings is greater.
After taking costs into account, we’d still be left with something like $60,000-$75,000 in hand. That could either be used to top up our income shortfall, or buy some now higher yielding shares, given the market crash/recessionary conditions.
The move also means lower council and water rates going forward, since those are roughly based on the land or rental value of your property. Similar to the rental scenario, we’d be better off by thousands of dollars per year.
Given many of us live in homes bigger than we need (we’re a prime example), moving house to reduce your footprint shouldn’t be off the cards. So the house excuse is out.
As I’ve said before, there’s almost always a way to find spending improvements in every category, if you really want to.
So I hope my point is clear. Reducing spending can easily be done, even for those people with low or moderate spending like us. It’s a simple matter of separating your wants from your needs, and being okay to change things up.
Calling them ‘fixed costs’ certainly makes things easier. Because this implies there’s nothing we can do about them.
But that’s simply not true. And framing it like this only creates a restrictive and somewhat pampered mindset, which isn’t helpful.
Again, there’s no contract in place which says those costs must remain exactly the same, should things get a bit rocky in our early retirement.
Now here’s an argument I can’t win, since I don’t have kids. And some of you will probably hate me for it! But I have to comment.
Why? Because it’s just too convenient an excuse! So let’s dive in.
The comments I’ve seen from people is that it would be terrible to have to cut back on spending or alter your lifestyle because of your children.
That sounds fair enough. But here’s the thing…
Are our standards so damn high as a society that we think it’s a disaster or a failure to our children if we spend less money or move to a smaller house?
Teaching our kids to be open to change and learning to be adaptable is an incredibly important life skill, that for some reason, they’re not allowed to learn anymore.
Instead, we cater to their every whim and try to protect them from any hardship or pain. Which all sounds reasonable. Only that it’s counter-productive.
A young person who grows up learning that sometimes things get a little harder so you need to adapt, and it’s not always puppies and rainbows, will be far better equipped for adult life, than those who are coddled and made to feel like they’re entitled to everything they have and it’s somehow painful without it.
Whether we mean to or not, this is the message we’re often sending.
Alternatively, teach your kids that it’s perfectly possible to live a good life without half the lifestyle we have today.
How do you do that?
By learning how people live in other countries. How Australia has some of the highest living standards globally. How pretty much all of us right now are in the richest 1% of the entire world’s population.
And finally, by recognising how much our incomes have grown over the decades, and we simply decide to spend it all on completely optional luxuries, when the cost of our necessities as a percentage of our income, is lower than ever before.
That’s not a matter of opinion. It’s a fact.
Sometimes this comes back to whether you feel your job is to give (spoil) your kids as much as possible. Or whether you think your job is to teach your kids as much as possible.
The first one does them long term harm and robs them of learning valuable life skills. The second is far more positive – it equips them with a basic fundamental knowledge of the world and their (very fortunate) place in it, which will stay with your kids and help them throughout life.
A good example is funding your child’s first car or their house deposit. Sounds like a big help, doesn’t it? Best parent ever, check!
But that young adult is robbed of the chance of learning to work hard, manage money efficiently and save up to accomplish goals through their own efforts.
That great sense of achievement they’ll feel, and pride in their own ability has been taken away.
See the difference between what feels like helping and what actually helps?
So the ‘providing the best life for my child’ excuse is out! Teaching them lifelong skills like resilience, adaptability, money management, gratitude and perspective is in!
Here’s where people differ.
This all sounds perfectly reasonable, or absolutely insane, depending on who you are.
But if you think it’s crazy, stop and think for a minute why that is? Is it because you think it’s not possible to live a happy life with less money?
Have you simply become accustomed to your cushy lifestyle and can’t imagine life any other way?
Don’t feel bad. Most of us do it!
But it’s important to recognise that people lived perfectly satisfying lives before an iPhone was invented. Before overseas holidays were a thing. And before all of the niceties we see around us in a modern Aussie life.
The fact is, our happiness does not scale up with luxury. Therefore, it doesn’t scale down with simplicity.
Think about it. Older Aussies lived perfectly happy lives without half the crap we have today. And people in many parts of the world still do.
Hell, people in other countries would kill to live the way we do!
So we need to stop comparing to our peers, which is a small and incredibly biased subset of people. Or worse, those living more exotic lifestyles than us, like celebrities.
That’s in no way an accurate representation of the typical human life experience. Not even close. So it shouldn’t be our benchmark.
I hear what you’re saying, “yeah but we just live an ordinary Aussie life, it’s not luxurious at all.”
That’s exactly my point! An average Aussie life IS luxurious, when we put things in perspective!
Because we should be considering the many billions of people who don’t have it as good as us. And all the generations that came before us. Not just a couple of friends at work who are ‘living it up’, or a few ultra-rich personalities on TV.
Even the most basic modern life is amazing, so open your eyes and learn to be grateful.
It’s often said Australia is a lucky country. And there’s lots of reasons for that.
No recession for almost 30 years is one. And that statistic is pretty damn impressive – a world record in fact. But even that has drawbacks.
One being, most of us have never known hard times. Now that actually sounds like a good thing. But I don’t think it is.
We’ve grown accustomed to a relatively smooth economy and a healthy jobs market. So we tend to think it’ll always be this good, and promptly spend all our money, as there’s always more where that came from!
I think many of us have lost the ability, or at least, the willingness, to live through a bit of hardship. We either think it won’t happen, or it’s up to the government to protect us.
But hardship and change are actually good for us. It strengthens our character and makes us more resilient people.
By implying that our standard of living is deserved, necessary, and should be protected at all costs, we’re convincing ourselves that we can’t cope with less money and that a less luxurious life is bad.
This mindset will bring us great pain if we’re forced to live through any lifestyle that is less expensive than the one we live now.
In short, if we can’t imagine spending less because we feel entitled to everything we have – that’s a weakness and there’s no question, we’re spoiled!
By now you can tell I believe the most important factor here is our mindset.
When the shit hits the Financial Independence fan, we need to adapt. So that means focusing on what we can control.
We can’t control the sharemarket. But we can control our personal flexibility and spending. And as you can see, even those of us with lower spending can comfortably adjust to any new reality we find ourselves in.
By keeping a global and historical perspective, we can remind ourselves how incredibly lucky we are, that so much of our spending is optional, and even a simple life in Australia is amazing and puts us firmly among the global elite.
If you’re still unwilling to reduce your spending should retirement get a little rocky, that’s perfectly fine.
But that’s not because our costs are fixed. It’s because our mindset is fixed. And it’s not because it can’t be done. It’s because we don’t want to do it. There’s a big difference!
So far we’ve only covered one Financial Independence backup plan – our spending. We’ll dive into investments, cash buffers, extra income and other things in Part Two.
I’ll also share how we’ll plug that $6,000 cashflow gap (and larger), in case you’re still wondering about that! Stay tuned and thanks for reading!