Key to Early Retirement: Margin of Safety

One of the things I worry about for extreme early financial independence retirees is that they play the numbers too close.

In other words, I think some would be in trouble if something unexpected and costly pops up. And as we know, we should expect the unexpected when it comes to money emergencies.

For example, let’s say a 30-year-old has $1 million saved. Using the 4% rule, they should be able to take out $40k each year and be reasonably sure their money will last. Let’s also assume that $40k is just what they need to make their budget work.

This sort of set-up is considered very normal for many in the early retirement community, but it has a couple inherent risks.

Potential Money Problems in Early Retirement

There are the problems that could pop up given this scenario:

  • The 4% “rule” is not a “rule” in the same way a “law” is a “law” in science. A law has been proven to be true. The 4% rule has been “proven” to the extent that it’s been back-tested but as we all know, “past performance is no guarantee of future results.” So basing your entire life on something that is probably true but may not actually happen in your lifetime is risky.
  • Their savings withdrawal and expenses match. So if a big expense pops out of nowhere, like let’s say your furnace stops working when it’s zero degrees outside, life starts to get very tough.

What these people lack is something I always try to bake into any of my financial plans: a margin of safety.

Margin of Safety Options

I’m a fairly conservative money manager and thus prefer several, significant margins of safety.

You never know what could hit and how severe it will be, so I think it’s best to have lots of plans/safety/”insurance” in case circumstances conspire against me.

Here’s a list of the margins of safety we have in early retirement:

  • Not having to withdraw from assets. I think I’ve been clear about the fact that we are living on the income generated by our assets, not actually spending the assets themselves. So if I wanted/needed, I could take an additional $120k in assets each year (using the 4% rule) to supplement our income. That’s a pretty good cushion.
  • Relying on a portion of my assets. Our current income is actually generated by half of our assets. So, in theory, we could spend the other half and not reduce our lifestyle. Big cushion here too.
  • Multiple streams of income. I have one really strong income stream (rental properties), a few couple ones (P2P lending and dividends), and one decent and growing (blog income). The last one has the potential to be really significant. Eventually it may be able to rival the rental properties to give me yet another strong margin of safety.
  • Large cash cushion. We currently have about two years’ living expenses in cash — and it’s growing. There are actually two reasons for so much cash: 1) provide a margin of safety, of course and 2) be ready for the next real estate downturn. 🙂 I would like to buy a few more places if the prices are right.
  • Cut spending. Our current annual budget is $85k. As you might imagine, that affords us a pretty high standard of living, especially since we are no longer saving and have no debt. We could cut $30k or so from the budget if worse came to worse.
  • Downsize house. Our current home is awesome: 5 bedrooms, 4 1/2 baths, 3,500 square feet, etc. It has plenty of room for us and frequent visitors, which we get often since we live in the AWESOME state of Colorado. It’s in a great location too, near our gym, grocery store, and a handful of shops (we walk to all these places). If we had to, we could sell it and pay rent for roughly 25 years from the house’s proceeds alone (assuming the proceeds didn’t grow one penny). When you factor in the lower costs (maintenance, taxes, etc.) of living in an apartment that gives us even more margin.
  • Going back to work. I hate to think about it, but I have very marketable skills, good connections, and could go back to work if I needed. Of course, I could send my wife to work instead, which would be my preferred first response during a crisis. 🙂
  • New ways to earn. If I had to, I could implement several money-making ideas I have been tossing around.
  • Social Security. I spent my life planning for retirement without Social Security and I’m not really counting on it now. But odds are, I’ll get something. That’s 15 years down the road, but is at least a minor margin of safety.
  • Sell stuff. We have tried to keep our “stuff” to a minimum, but if we had to we could sell some items (including a car or two) and likely raise a good amount of money.

I realize having so many margins of safety could be considered a bit over-the-top, but I like having options and flexibility. Perhaps as time goes on, we’ll loosen up a bit and spend, eliminate, or reduce some of them, but for now I’m happy to have lots of choices. To me it’s a key part of early retirement and certainly helps me sleep better at night.

How about you? Do you have any margins of safety built in to your finances?

 


Originally posted at https://esimoney.com/key-early-retirement-margin-safety/

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