FIRE Safety – FIRE Breaks

One of the major concerns for me with FIRE is the possibility of something going wrong with our plans which would affect myself and my family.  In particularly this is a concern once my wife and I have both retired because as frustrating as it might be to have to work a few years longer, it would be even worse to have to go back to work after retiring.  Even worse jobs are least likely to be available right when we’re most likely to need them.  The cause of something going wrong could be as inevitable as a stock or property market crash, less predictable like changes to legislation, or something out of the blue like an accident.  It’s impossible to get rid of all of these risks, but some of them at least can be mitigated.  And because I like clever wordplay even if I’m no good at it myself, I decided to call these risk mitigation strategies FIRE breaks! These are some of the FIRE breaks I plan on having in place.

HIFIRE/Fat FIRE

Aiming for a high income in retirement inherently gives you a bit of a safety net because you can easily tighten your belt a bit.  I would very much prefer that I manage to hit my FIRE Goals the whole way through retirement, but in reality I could live a very comfortable life on a lot less money.  In fact if my planned income in retirement were to drop by a third then I would still have more income than my current living costs, and it’s not as though I feel like I’m depriving myself of anything right now.  Sure I’m certainly looking forward to plenty of travel and all the rest of it, but it’s not going to be the end of the world if I take an overseas trip once every two years instead of once or twice a year.  So I’ve already got a very big safety net in place just by planning for a higher income than necessary.

A market crash/sequencing risk 

One of the biggest perceived risks for FIRE is a market crash.  I’ve written about this both when preparing for FIRE  as well as after you’ve already retired.  The reality is that investment markets have crashes on a fairly frequent basis.  We see it a lot more with the stockmarket and bond markets but it’s also an issue with the property market, albeit we haven’t had a country wide one here in Australia for a long time.  Having said that anyone who has invested in Perth or some of the mining towns can certainly tell you all about it.

There are ways of mitigating this risk directly for stocks and bonds, to me the most obvious one would be buying put options (If you don’t know what put options are then just skip this bit because I’m not doing it and wouldn’t recommend it to most people anyway). The trouble with that is that if I buy puts to correct against any fall in the market then it will cost me a lot of money, and if I try to make it cheaper by buying puts allowing for some fall in the market then I have to accept that fall before my protection starts kicking in.  Plus I need to keep buying puts over time as each one expires which means extra cost.  So it’s far from a perfect solution and as I said I don’t plan on using it.

This mean I have to accept that I will be subject to market crashes from time to time.  This is actually ok for me because I don’t plan on selling down my investments over time and instead will be relying on dividends from them for income.  Dividends tend to be a lot more stable over time than share prices, but there have been cuts in the past.  I can’t seem to find data as to how much they were cut in the GFC but from a look at this report from the RBA it appears to me to be about a 10% or 20% drop at most just from eyeballing it.  Now there’s no guarantees that this is all that would happen in the future, but given dividends do tend be less volatile than share prices I would like to hope that relying on these rather than selling down shares makes me a little safer.

Using the 3% rule

I’ve written previously about the 4% rule and pointed out some of the issues with the assumptions in it including that most people aren’t using the portfolios that the assumptions are based on, that the study is based on US performance rather than Australia etc.  I think that the basic idea of it is fine but it’s not a guarantee, although in fairness nothing is. 

The actual safe maximum drawdown rate for Australia over a 30 year period is 2.96% for a 50/50 stock/bond portfolio according to this paper, and although I’m not planning on using a 50/50 stock/bond portfolio it’s hopefully a pretty decent  proxy.  In any case 2.96% is pretty close to 3% and like everyone else I like nice round numbers so I plan on using that as a backup plan.  Looking at my projections a 3% drawdown rate on my portfolio would be more than enough for a very comfortable retirement, albeit not as comfortable as I would have liked.

I’ve also written about how much longer it would take to get to a portfolio that would give you the income you desire at a 3% withdrawal rate, and the answer generally is not that much longer.

Diversifying into Fixed Income

Diversification is the only free lunch in finance according to Harry Markowitz.  He’s also known as the father of Modern Portfolio Theory and won a Nobel Prize for his efforts, so who am I to argue with the guy?  I must confess that I’m not planning on investing in FI for the reason he would have envisaged, but then we have different goals in mind.  I want to have a nice steady income stream which ideally grows over time and am prepared to accept that the value of my portfolio will go up and down, so shares are the way to go for me.  But I also want a safety net of knowing that I have enough money to cover a reasonable amount of time with reduced or even no dividends, which is where fixed income comes in. 

The plan therefore is that a year or two out from hitting my FIRE number I want to be putting a lot of my excess money from then on into fixed income.  This may be in the form of bonds, it may be in the form of term deposits or High Interest Savings Accounts (HISAs) or it may be a combination of any or all of the above.  On the Reddit Australia FIRE forum I was pointed towards this article on bond tents which is quite interesting.  Looking at my calculations even just a year of using all my dividends and contributions pre-retirement would buy me about two full years of what I want to have as my annual spending in retirement.  So if dividends got cut by half then I could top that up by selling my FI holdings and would have 4 years that I could go through before I would have spent that money.  If It got cut by a quarter then I’ve got 8 years to figure out a backup plan.  It’s not a perfect safety net, but it certainly makes me feel a lot more secure.

Retiring later

Starting my journey to FIRE later than a lot of other people has a couple of advantages in terms of safety, although it does mean that I won’t get as much time in retirement as those who started earlier.  I have less time before I’ll be able to access my superannuation than most which is why it’s incorporated into my plans more than it is for others, but I also will have the safety net of the age pension available a lot sooner if necessary as well.  The plan is very much that I won’t actually ever get any age pension or even get close to it given I want to build up my assets over time rather than draw down on them, but it’s there as a backup plan and given our living costs are pretty low it would actually cover our expenses anyway. 

Other sources of income

Personally I don’t plan on doing much if any work when I retire, but it’s possible I may continue to do some sort of part time work for a while depending on how things are going.  The only other likely source of income for my wife and I are part UK pensions as we lived in the UK for long enough and contributed to the state pension over there for a sufficient number of years that we would be entitled to a partial UK pension.  The good news is that unlike the Australian age pension there is no means testing for the UK one so that might be a nice source of additional income in retirement.  I’m actually not factoring this pension into my FIRE plans at all because I’m convinced that by the time I’m eligible in about 25 years or so they will likely have brought in means testing or some other measure to ensure I don’t actually get any.  But if it all goes pear shaped with the rest of my investments then it makes it more likely that I will be eligible for the UK age pension as well as the Australian one, we’ll see how it goes!

Personal Insurance

I’ve written about FIRE and personal insurance previously so I won’t go into it in too much detail but I’ll certainly be keeping some of my insurances in place even after I retire to make sure that if something were to happen to myself or my wife then there would be plenty of money coming in.

Emergency Fund

On top of whatever Fixed Income investments I have part of the plan is also to have at least 3-6 months of expenses in a HISA.  Most people love the peace of mind of having $20,000 or so on hand whenever they need just in case of emergency and I’m no different which is why I already have this in place.  This gives me a bit more of a safety net before I have to consider selling down any expenses, as well as being a decent place to park money if it’s building up which would obviously be a nice problem to have! 

Edit: I’ve written this post about emergency funds now.

Legislative risk

There really isn’t a lot that I can do to eliminate this risk entirely.  Different political parties have different policies which will affect FIRE, an obvious example being the Labor party policy to get rid of cash refunds on excess franking credits which I wrote about here.  They are also proposing that family trusts be taxed at the company tax rate, and given establishing a family trust is something I’m thinking about this would have an impact on me as well.  The Liberal party also recently made a number of retrospective changes to superannuation so it’s not as though it’s just one side of politics changing the rules or at least proposing to do so.  Anyone who doesn’t think that there will be more changes to superannuation in the future wants their head read in my opinion because it is absolutely unfathomable to me that a government of any type won’t be falling over themselves to get their hands on more of that money.

My presumption therefore with both major political parties (and at least some of the minor ones) is that they will keep on raising taxes and trying to take as much of my money as they can in whatever way possible.  Because of this I try not to lock myself into relying on just one type of investment holding structure so that it’s hopefully unlikely that I’ll get totally screwed over whenever they decide to make changes to the system.  As an example of this when I run the numbers on my income stream from shares I ignore the franking credits as it seems likely to me that these will be gone sooner or later.  Similarly with the money in my super, I assume that sooner or later it will be taxed in pension phase and/or be treated as ordinary income so I don’t include any potential tax benefits.  I do still maximise my personal pre-tax contributions to super because the tax savings are pretty attractive, but I don’t put any post tax money in apart from whatever gets me tax offsets, deductions or co-contributions. 

Being flexible

One of the biggest things you can do to make FIRE safer is to be flexible.  If there are changes to the tax system then I’ll make changes to how I structure my investments.  If there are changes to super then I’ll change what I do based on the new rules.  If I have to work an extra year or two to reach FIRE then so be it, I haven’t decided ten years in advance that I’m absolutely retiring on some specific date.  If there are big changes to the attractiveness of different asset classes then I’ll take that into account and invest accordingly.  I buy investments, I don’t marry them so if it makes sense to sell then hasta la vista baby.  I’m not locked in to any one way of doing things, I’m happy to go with what makes the most sense for my circumstances.  This doesn’t guarantee that everything will go smoothly, but hopefully it means that the risks are lower.

Conclusion

I’ve talked about a lot of different risks and hopefully I’ve made it clear that I can’t eliminate all of them.  Pursuing FIRE gives you a lot more options than the average person if things go wrong, but there are no guarantees unfortunately.  I do a lot to minimise the risks as I’ve detailed above, but there are limits to the tradeoffs I’m willing to make because otherwise I’d never be able to quit working.  I certainly don’t plan on pulling the pin on work completely until I’m pretty confident that things will be ok, but there isn’t any certainty with these things so maybe things will go wrong.  I’m pretty hopeful that even if things do go wrong though that I’m still going to lead a very comfortable retirement!

What FIRE breaks have you incorporated into your plan to make FIRE safer?  If you liked this post and would like to read more like it then please subscribe using the link on the right!