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Wednesday, 13 November 2019

My Early Retirement Plan - Version 2.0

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Previous plan downgraded to
junk status. 
The imminent arrival of Stealthy Junior version 2.0 means that our original early retirement plan is quite simply not going to cut it anymore.

Junior 2.0 => Early Retirement Plan 2.0.

Back in 2016 when I put together the original early retirement plan we had a target date of 2030. But that was with expenses of the 1 child variety (and a little naivety around what a child actually costs).

So I am keen to see how a second child is going to affect our plan, and if I can still achieve Financial Freedom in 2030 at age 45 (satisfying both my original goal and my round number fetish).

This post will also serve as a good example for anyone else who wants to achieve FIRE and is looking to put together a financial freedom plan of their own. I will be breaking down the process step by step.

Okay, let’s go!

The 4% Rule

The first important question around financial freedom is how much do you need? In fact this is the question that drives everything else. Luckily the answer is not that difficult to calculate, and that’s thanks to the beautiful simplicity of the Rule of 300 (otherwise known as the 4% Rule).

In short, the rule says:
Amount needed for Financial Freedom = Monthly Expenses x 300

So, as you can see, the only thing you need to know in order to calculate how much you need for financial freedom, is the value of your monthly expenses.

Important caveat – the monthly expense number is not your current monthly expenses, but rather your monthly expenses at the time you plan to be financially free/retire. This is important because while things like a bond payment might fall away, there could be other additional expenses (for example, travel).

Okay, so the first thing I need to do, is to estimate what our cost of living will be when we are financially free.

Estimating Our Financial Freedom Cost Of Living

I first took a stab at this number back in this 2016 blog post. And this leads me to an interesting little side track...

For my original plan, I used an inflation rate of 6.28% based on South Africa’s long term inflation data. Recently, the official inflation figures have been a few percentage points below that, but my own estimated personal inflation rate in retirement is estimated to be around 1% more than the long term data.

So I was keen to see if the numbers I projected from the start of 2016, tie up with the actual numbers here at the end of 2019/start of 2020 (4 years later).

The table below summarises my financial freedom cost of living as estimated at the beginning of 2016, the projected 2020 values, and the actual 2020 values.

Expense
2016 Estimate
2020 Projected
2020 Actual
Stealthville Levies
 R         1 646.00
 R           2 100.08
 R          2 024.00
Stealthville Rates
 R            410.00
 R              523.11
 R             610.00
Petrol
 R            800.00
 R           1 020.70
 R          1 200.00
Bank Fees
 R            100.00
 R              127.59
 R             110.00
Medical Aid
 R         3 365.00
 R           4 293.30
 R          4 277.00
Medical Savings
 R            500.00
 R              637.93
 R          1 000.00
Electricity
 R            500.00
 R              637.93
 R             800.00
Groceries
 R         5 000.00
 R           6 379.35
 R          6 500.00
Toiletries
 R            200.00
 R              255.17
 R             500.00
Schooling
 R         3 000.00
 R           3 827.61
 R          3 820.00
Entertainment
 R         1 000.00
 R           1 275.87
 R          1 200.00
Miscellaneous
 R            700.00
 R              893.11
 R             900.00
Cellphones
 R            500.00
 R              637.93
 R             500.00
Short Term insurance
 R            400.00
 R              510.35
 R             450.00
Internet
 R            200.00
 R              255.17
 R             400.00
Clothing
 R            400.00
 R              510.35
 R             400.00
Stealthy Junior Savings
 R            600.00
 R              765.52
 R             650.00
Car Savings
 R            800.00
 R           1 020.70
 R             800.00
Household Maintenance
 R            400.00
 R              510.35
 R             500.00
Memberships
 R            300.00
 R              382.76
 R             400.00
Holiday Savings
 R            800.00
 R           1 020.70
 R          1 200.00
TOTAL
 R      21 621.00
 R        27 585.57
 R       28 241.00

So, as you can see, the projection using inflation at 6.28% falls a little short - around R27,600 versus our actual figure of around R28,200.

So the first change I want to make on this updated early retirement plan is to bump up our inflation rate from 6.28%, to 7% (which is also around the number I came up with using the spreadsheet in this article on calculating your own inflation rate).

Applying 7% inflation to our 2016 expenses gives us a 2020 estimate which is much more aligned to our actual experience. Let's note this change in input to the plan (and I will do the same for all the other changes going forward, for easy record keeping)

Change 1
Inflation = 6.28% 7.0%


Okay, so that’s the scenario sorted for one child, now time to throw Junior 2.0 into the mix…

Here is my best guess.

Expense
2020 Expenses with second child
Stealthville Levies
 R     2 024.00
Stealthville Rates
 R        610.00
Petrol
 R     1 400.00
Bank Fees
 R        110.00
Medical Aid
 R    5 060.00
Medical Savings
 R     1 400.00
Electricity
 R        900.00
Groceries
 R     7 500.00
Toiletries
 R        600.00
Schooling
 R     7 640.00
Entertainment
 R     1 500.00
Miscellaneous
 R     1 200.00
Cellphones
 R        650.00
Short Term insurance
 R        450.00
Internet
 R        400.00
Clothing
 R        500.00
Stealthy Junior Savings
 R     1 300.00
Car Savings
 R        800.00
Household Maintenance
 R        500.00
Memberships
 R        400.00
Holiday Savings
 R     1 400.00
TOTAL
 R   36 344.00

We come out at let’s call it R36,300. Seems an extra child is going to be costing us around R8k/month extra... Have kids they said, it would be fun they said...

Calculating Our Financial Freedom Number

Right, so now that we have our estimated expenses, we just plug them into the formula given by the Rule of 300 (and of course round off to something easier on the eye)

Amount needed for Financial Freedom = Monthly Expenses x 300
Amount needed for Financial Freedom = (R36,300 x 300)
Amount needed for Financial Freedom ≈ R10.9 Million

Wowziz! We into 8 digits!

Now I must admit that this number depressed me a little. It’s monstrous! And when I plugged it into the rest of the plan, I was incredibly disappointed to see that financial freedom by 2030 was going to be a pipe dream. Our retirement expenses were just too high. I was pretty bleak.

But then I realised something…

The expenses I was looking at applied to our household while it consisted of two school-going children. And while this would be the case for the first few years after 2030, the majority of our financial freedom would consist of us living in a nest void of our two chicks.

In fact, it would be only 4 years until our first child would hit University age, and then just another 4 until the second child got there. And since their University fees would be covered by separate investments I have set up it meant that there would be no more education related costs to pay after 2038.

And then there is also the saving we will get from not having our children as dependants on our medical aid once they leave varsity and start their own careers.

So I reran our estimated expenses for the scenario where both children had left the house – i.e. excluding education costs and their portion of the medical aid. (Yes there will be some other small savings too, but medical and education are the big ones). Our total monthly expenses now came out at a little under R26k/month (more than R10k a month less!)

I excitedly plugged that into the Rule of 300 and was delighted to find we were back in the 7 digit range!

Amount needed for Financial Freedom = Monthly Expenses x 300
Amount needed for Financial Freedom = (R26,000 x 300)
Amount needed for Financial Freedom = R7.8 Million

But of course I can’t just ignore the years where we will still have to fund their education and medical. So what I did was total up those costs (estimated at around R1.1 Million) and just added that as a lumpsum to the value we got above.

Amount needed for Financial Freedom = R7.8 Million + (Education and Medical Costs)
Amount needed for Financial Freedom = R7.8 Million + R1.1 Million
Amount needed for Financial Freedom = R8.9 Million

And finally, I am left with a required final financial freedom fund (a FFFF?) of R8.9 Million.

Still a monster number, but considerably better than the over R10 Million I initially calculated.

Adjust For Inflation

Okay, so we would need 8.9 Million in today’s money if we wanted to call it quits in 2030. But today’s money is only good for today (and maybe tomorrow). By next year, everything would have gone up in price (damn that sneaky inflation monster) and that means my R8.9 Million won’t be enough anymore – I need to adjust it a little higher. And for each year after that, as inflation slowly nibbles away at my rands, the value I am going to need for financial freedom will inch a little higher.

So let me project this number forward at our estimated inflation rate of 7%, to see what the required R8.9 Million will look like as the years roll on.

2020
 R    8 900 000.00
2021
 R    9 523 000.00
2022
 R  10 189 610.00
2023
 R  10 902 882.70
2024
 R  11 666 084.49
2025
 R  12 482 710.40
2026
 R  13 356 500.13
2027
 R  14 291 455.14
2028
 R  15 291 857.00
2029
 R  16 362 286.99
2030
 R  17 507 647.08

As you can see our freedom number becomes a moving target – and by 2030 it would have grown to over R17.5 Million. Scary! The only way I am going to be able to chase down a number like that is by investing in something that can grow faster than inflation.

A bank account is not going to cut it. I need my money to multiply like bunnies.

Investing For Financial Freedom

The best chance of me achieving inflation beating returns over the long term, is by investing in equities/shares/stocks. Historically this asset class has given around 15% per annum in South Africa, and since a financial freedom plan necessitates an estimate on the annual return you will get, I decided to go with the historical +-15% when I put my initial plan together.

However there are two aspects which I did not consider in the initial plan.
  1. The cost of the products used to invest in equities. The ETFs I use to invest in are unfortunately not free (although they are a hell of a lot cheaper than Unit Trusts). They have a TER (or annual fee) associated with them, and this means that even if the market does deliver 15% returns, I will not see all of that 15%.
  2. Buying an ETF is not free – there is brokerage, STRATE and a number of other one off fees whenever you buy something on the stock exchange.
So for these reasons, I have decided to use a growth rate of 14.5% instead of the previous 15%. I think this will better reflect the actual returns I should see if the market delivers around 15% (as it has done over the long term in the past).

Change 2
Equity Returns = 15% 14.5%


Other than investment performance, there are two other levers which can be pulled with regards to investing – time and contributions. Now if I fix our time period to 2030 (our targeted financial freedom date) then the only other input I can play around with is the contribution amount, and how much I increase that by each year.

In my original plan, I took the amount we were currently investing, and increased that by inflation for each passing year. If I stick with that approach (and increase the monthly investment amount by the new 7% inflation) I estimate that we will be short by around R2 Million when 2030 rolls around.

So I tinkered with the monthly contribution annual increase value until I found something that would sneak us into financial freedom by 2030. This number turned out to be 13%. For our new plan, we were going to need to be far more aggressive with our contributions if we were going to make it work

Change 3
Annual increase in investment amount = 6.28% 13%


And now to put it everything together...

Here is what the plan looks like now. (The grey line is the required investment amount for financial freedom, and the blue line is the estimated value of our investments. Freedom is when the blue line crosses the grey line. You can click for a larger image.)

No prizes for guessing when baby number 2 arrives...

Make no mistake, baby number 2 has put a bit of a spanner in the works, and increasing our investment contribution by 13% per year is going to be an immense ask!

The higher expenses of a second child also means we are hit with a cruel combo of needing to invest more, while having less available to invest.

And then there is more bad news…

My Early Retirement Plan - The Bad News

There are two more factors counting against us making this new plan work.

1. Bigger Target, Less Ammo

Two of the new changes (using a higher inflation rate, and reducing the expected returns) work in perfect harmony to try derail our ambitions. The higher inflation rate means our financial freedom number now grows much faster than initially projected, and the lower projected return means that our investment growth is going to be slower – so effectively we have a bigger target to shoot down, and less ammo to do it with.

2. We Are Already Behind

Even by the standards of our original early retirement plan, we still find ourselves a fair way behind where we’d hoped to be. A combination of a few years of below inflation salary increases at my work, and us deciding to allow my wife to become a stay at home mom for a few years, has meant we have not invested as much as I had hoped.

And then when we throw in some lousy local market returns (which the majority of our investments are still in) we find ourselves around 28% behind (at the time of writing this).

This new plan picks up our investment value as if our actual investment matched our original projected investment. So we already find ourselves a fair way behind before this new plan even kicks off.

However, even in light of all of the bad news, I am still cautiously optimistic we will still be able to make our 2030 date. Now before you think I am smoking my socks, allow me to present to you a secret weapon or two…

My Two Trump Cards

Despite a lot of stuff counting against our Financial Freedom 2030 dream, I have two tricks up my sleeve which might just tip the odds back in our favour.

The first is our investment property. I haven’t factored in it's value into this plan. In a few years’ time, this property will (in theory) either be generating a decent amount of additional income, or (more likely) we will sell it to help squash our bond. Either of these outcomes will allow us to up our monthly investment contribution and that will hopefully go a long way towards making up the additional investment required.

Secondly, there is the chance that we would be able to get free Tertiary education for our children by hacking the system a little. If the current scheme remains in place, it will be mean that the investments we have set up to fund our children’s tertiary education can be reallocated. That will certainly take some of the pressure off.

So, Will We Make It?

The theory is simple. If the following holds true:
  • Personal inflation of 7%
  • Our investments return 14.5%
  • We increase our investment contribution by 13% per year
Then everything will work out just fine.

I guess the problem is that in theory, everything that works in theory works in practice, but in practice it doesn’t!

It is going to be extremely tough, make no mistake! But I remain hopeful, and think that our two trump cards might just be enough to get us over the line.

But you know what, even if we don’t quite make it, and take a few years longer, we will still be miles ahead than if we didn’t try at all. So there really is no downside in any of this.

No matter what ends up happening, I am excited to continue on this journey, and our 2030 goal still motivates and inspires me.

And then finally, for those of you who are interested in monitoring our progress, I will continue to update our journey every month on the Tracker Page (which should be updated to our new plan from early next year.)





Till next time, Stay Stealthy!
 - ~ - ~

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