Over six years ago I wrote Key to Early Retirement: Margin of Safety.
I have referred to that post many times over the life of this site, and I thought it was time to share an update — where we stand these days on our margins of safety.
After all, things are a bit rocky in the market and economy and it’s times like these when you may need your margins of safety (if for nothing else than to make you feel better in rocky waters).
This post will hopefully serve a few purposes:
- Be a reminder to build margins of safety into your retirement plan.
- Give examples of what margins you might want to create.
- Serve as a real-life example of how one person has done it.
BTW, I am NOT saying that how I did it is how anyone else should set up their specific margins of safety. As you’ll see, mine are a bit overboard and frankly are too much. If I had backed off a bit I could have had lower but still solid levels of safety and have retired earlier.
That said, a lot of my margins were actually unexpected/by accident, so it wasn’t completely my fault. LOL.
Why Margins of Safety are Needed
Before we get to specifics, let’s do a bit of review from the original article. Here’s how I set up the need for margins of safety:
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 type of example is considered very normal for many in the early retirement community, but it has a couple inherent risks.
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.
In other words, the people in this example are living a spending lifestyle that’s too close to their income. So when (not if) an unexpected expense occurs, it becomes an issue.
This is the case no matter what you spend — it could be $40,000 a year, $100,000 a year, or even more. If your spending is close to your income, and especially if that spending is not discretionary (like a high mortgage payment), you need to have some margins of safety built in for times of trouble.
Margin of Safety Options
I went on in that post to list what my margins of safety were then, but instead of repeat those here (you can read the original post if you want to know them), I want to detail what the situation is today. And I want to do it as follows:
- Start with my actual (and projected) spending.
- List, in order, how I would likely address any issues above that level of spending (or any unplanned needs that arise).
So let’s get to it…
Our annual spending has been pretty steady over the past 7+ years of retirement. We’ve spent right around $100k per year give or take a bit here and there.
That’s a pretty healthy level of spending given that we have no mortgage and our giving (another large expense) is almost completely done from moving accumulated assets to our donor-advised fund and then giving from there. In other words, giving is not in our spending numbers, it’s just an asset withdrawal.
The largest expenses over these years have consistently been taxes (you’re welcome, Uncle Sam) and vacations. I’ll do a re-cap of our spending this year sometime in the new year, but I suspect the latter will be down big-time as we’re not taking $25k cruises any longer. Who needs to travel when you live in a resort? 😉
So we’re at $100k spending and likely will be for some time. Eventually inflation may get us or we may cut something we don’t like, but this number is certainly in the ballpark, so I’ll use it as the baseline.
Now, we have to ask…
- What would we do if a big expense hit us hard?
- How would we pay for it?
Current Margins of Safety
Here are our current margins of safety in order…
1. Pay it out of income.
The first margin of safety would be from income. We have multiple streams of income and currently make way more than what we spend.
The current sources of income include:
- Businesses (ESI Money and Millionaire Money Mentors)
- Real estate syndications
- Dividend stocks
- Interest on savings — Higher interest rates mean that we’re actually making decent returns on cash.
These are sources of income we have easy access to. I’ll count dividends from other investments below because they are in tax deferred accounts (and taking them would result in additional taxes).
This year income will be over twice our annual spending, so these options represent a good, first buffer.
2. Cash savings.
We currently have a large cash cushion — about 5x annual spending.
Yes, it’s a bit overkill, but I like having a large war-chest in case opportunities arise.
And with savings accounts paying 5%+, it’s not so hard to let it site for awhile.
Plus I have some things in the works and may need some cash, so stay tuned for that. 😉
BTW, even if the housing market crashed, I don’t think I’d buy rental real estate again…it’s just something I’m not interested in managing at this point in my life.
3. Asset withdrawal.
If the first two margins of safety fell apart or weren’t enough, I would then start withdrawing from assets.
Both my wife and I are over 59.5 now, so we can get funds from our tax deferred assets.
I would begin with just the dividends from our index funds which, believe it or not, are over 50% of our annual spending.
But if we needed more, we could withdraw more. In total, if we had to withdraw from just index fund assets at 4%, we’d be over 150% of our annual spend. If we added the assets from syndications in there (converting them to index funds once the deals go full cycle and counting no appreciation or loss from them — just at coast) we’d be at two times annual expenses.
This has been a HUGE increase in the past six years for a couple reasons:
- I sold my rental units and they had appreciated nicely.
- The stock market has been on fire, making our index funds soar.
These two things have grown our assets tremendously, even as we’ve pulled out a large chunk of them each year for giving.
And these two steps have been the main reasons our margins of safety have exploded so much (and turned into complete overkill). They weren’t planned (especially the market growth — who could have predicted), but were very fortunate events that happened a few years into retirement.
Our plan is to let them ride (and grow) for many more years to come, so they’ll likely end up being even more substantial when I update this post six years from now.
4. Cut spending.
So $100k is pretty lavish.
We aren’t living lifestyles of the rich and famous (anyone old enough to remember that show?), but we don’t have a spending worry when we spend.
I’d say we could pretty easily get our annual spending down to $60-$70k without a ton of pain. We are both naturally frugal and if we had to flip that switch back on, we’d crush it.
The truth is we are actually fighting the frugal gene most of the time these days and need to remember that we can spend more if we want to. That said, honestly there really isn’t much more we want that would make our lives better (and why buy something that makes your life worse?) This is why we’ve upped our giving — it makes us happy to make others’ lives better.
5. Sell stuff.
After three or four rounds of downsizing, moving, and cleaning out, I think we have our “stuff” close to a minimum, but if we had to we could sell some items (including a car) and likely raise at least $20-$30k.
Now if we sold my wife’s engagement ring, we could really be in the money. LOL!
And, of course, the biggest thing we could sell is…
6. Downsize our house.
Now that we’re at 1,900 square feet, we likely wouldn’t downsize to a smaller place (though we could).
But we’d downsize in cost of housing. We could move to a much less expensive part of the US (like my native Iowa) and bank 1-2 years of expenses (many more if we cut spending) and still buy a house.
Or we could sell our house and decide to rent. In that case we’d likely have enough to last several years.
And when you add in lower costs of taxes, utilities, etc., a move like this is really a pretty good margin of safety.
7. Go back to work/ramp up side hustle.
There’s a reason this one is last on the current list — we would have to be facing very desperate times before I’d go back to work (I would try the side hustle before going back to “working for the man.”)
But I have very marketable skills, good connections, and could go back to work if I needed. I wouldn’t make as much as I did back in the day because my skills and connections have deteriorated some, but I could certainly earn enough to cover expenses.
I could also try a new profession. The real estate agents down here in The Villages have it made (even in this economy.) Or I could get a job in Orlando selling timeshares. LOL!
Of course, I could send my wife to work instead, which would be my preferred first response during a crisis. I think she’d have other ideas. 🙂
8. Not available yet but coming: Social Security.
I spent most of my life planning for retirement without Social Security as I was uncertain what it would look like when I got to that age.
Now that “that age” is much closer it seems very likely that I’ll get something if not my full amount (which is what I expect). It’s still 10+ years down the road with my current plans of taking it at 70, but it could be claimed earlier if need be.
It will be pretty substantial as I paid the max amount of Social Security tax for most of my working years.
Again, I realize having so many margins of safety at such high levels is way over-the-top, and if I had to do it over again, I would have retired earlier with fewer assets. But I do like having options and flexibility. As time goes on, we may ramp up giving and reduce some of these, 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 into your finances? Or if you’re not retired, what margins of safety are you planning on building?