Each year I have the privilege of joining ~25 readers for a week in Ecuador at our now annual Chautauqua event. During the week I get to meet one-on-one with several of these folks to privately discuss their situations and to answer their questions. Cheryl, the owner of Above the Clouds Retreats, once said to me, “They all look so happy afterwards!”
The reason is pretty simple. As often as not, I’ve been able to tell them: “Yes! You are financially independent.”
Now these are all very smart people who have a clear sense of their assets. (They rarely have liabilities.) But having worked for some time and with great focus on their goal, they frequently have crossed the finish line without noticing. I then have the distinct honor and privilege of being the one who gets to point it out. Great fun, that. And smiles all around.
So too with today’s Case Study. John reached out in the Ask jlcollinsnh section a little while back and, in laying out his situation and questions, I was reminded of several of those one-on-one sessions. Here too was a guy who has worked hard, lived frugally and built his assets; and now I get to tell him he has arrived. Whoo Hoo!
This despite an unfortunate and fairly large at-risk investment with a relative.
Which reminds me of an important fact: The single most important factor that will determine your success in reaching financial independence is your savings rate.**
Certainly investing well is important, and that’s mostly what I talk about here on the blog. But you can make a lot of investing mistakes and, if your savings rate is robust enough, you’ll still get there. The truth is, I got there myself along a great trail of investing blunders and before ever investing in my first index fund.
That’s what a powerful savings rate will do for you. Of course, if I’d accepted the simplicity and power of indexing sooner, I would have gotten there far more quickly and with far less grief along the way. But then, I’m a slow learner.
But now let’s meet John, see where he is at the moment and see what adjustments he might make for the future.
John’s note:
Jim,
I’ve really enjoyed reading your website, blogs, etc., your outlook on investments, business, life, etc., make a lot of sense to me. If you could give me your input I would be so grateful.
Background
I know that all decisions are mine and I am responsible solely for their outcomes.
I am in midlife change. I am 56, single, no children, owned a small business for many years so I wanted to stay as liquid as possible.
I rent a 1 bedroom apt. in the Northeastern U.S. and live a simple, frugal, life, and love being outdoors cycling, hiking, and walking.
Not actually John
I left a job in 2014, and am looking at options currently ranging from possibly not working, to working part time in the business world.
My living expenses are about $1,600 monthly or $20,000 annually, and I don’t have any debt.
I am not sure at what age I will stop working; anywhere from now until 70 years old, I don’t plan on taking social security until 70 years old.
Investments
- Retirement $190,000 in Vanguard, (includes $6,000 in individual stocks, a small amount in the Vanguard target date 2025 fund, but in total 9% in stocks, 3% in bonds, 88% in money market)
- Non-retirement Cash $410,000 in bank account receiving 1.05 % interest
- Emergency Fund $5500
- Small Business investments $275,000
This is a total of roughly $880,000.
Questions
1. Retirement. Obviously I need to put the Vanguard retirement money into action. I’m thinking about putting it into the Vanguard total stock market index fund, and the vanguard total bond market index fund, the allocation maybe at 70/30 between stocks and bonds, using admiral shares.
I’ve read that you like putting it in as a lump sum rather than DCA (dollar cost averaging), but I’ve felt that we’re due for a correction, and, yes, I know that you don’t believe that one can successfully time the market. What would you do with the $190,000?
Where do you think the market is headed?
2. Can I afford to stop working now? Would you advise that? What should I do with the $410,000 in cash if I stop working? It seems that whether I stop working or start to work on my own now, I need revenue to pay my current monthly expenses, or I start drawing down on my savings.
3. What would you do with the $410,000 in cash if I go back to work and start earning money? Buy a home? Do nothing and stay liquid? Put it in the same Vanguard funds but in a taxable account (?)-seems like duplication. Make loans in lending club, betterment, etc.? Invest in T-bills, tax-free bonds, or a vanguard dividend paying stock fund? This probably would be short-term money, 0-5 years.
4. The $275,000 is investments in businesses with a close relative, I am nervous about being paid back, and this has caused me worry and stress. Any thoughts?
5. The property that I live in was sold recently, it is a 3 family built in the mid-1800’s, including an apt that I live in, and a large garage that can be rented out. I could have paid cash for it. I decided not to because of its age, I would not do the bigger repairs myself, and I was nervous about buying this before getting paid back on my business investments. If they went south I could be stressed financially, and I also wasn’t sure if I wanted to be a landlord. It is likely that it would have thrown off positive cash flow immediately. The fact that I passed on the acquisition has been bothering me, wondering about your opinion on this?
6. I live in what I call a “stupidly expensive” part of the country (the Northeast), due to the housing prices and cost of living. It doesn’t seem worth it, but maybe I’m just mad that I didn’t make a ton of money in the housing market!! I have some family here but other than that there really is nothing keeping me here. I’m considering looking at other parts of the country, where I can enjoy the outdoors more, either the mountains or the ocean. I’m tired of the “grey” winters and early darkness here, maybe I should go somewhere else for the winters, at least initially. I am considering Tucson, Albuquerque, Sedona, Santa Fe, Pueblo, Co., I have enjoyed not working, and spending days hiking and cycling in the desert southwest sounds appealing.
Any thoughts?
7. I like a simple life, and feel that there is value in that. I’ve read your opinion on renting vs. buying, but long term do you think I should look to purchase a home?
Finally, I know that these are questions that are personal choices, and it isn’t even fair to ask for your input, but any opinions that you have would be greatly appreciated.
John
jlcollinsnh replies:
Welcome John…
Let me start by saying “thank you” for your kind words but, even more, for your clear understanding of the limits of my inputs and the personal responsibility you bear for any and all actions you take.
I make this abundantly clear on my Disclaimers Page, but it is an important reminder. It is only when this is understood that I can offer any thoughts and advice to the best of my abilities and my understanding of any given situation.
Next, let me offer kudos for having constructed what sounds like a joyful life that has avoided the consumer spending traps that too often are substituted for happiness. Your simple, frugal lifestyle embracing such healthy and free activities as hiking, cycling and walking has, as we’ll see, put you in a strong and financially free position. Although, given your focus on outdoor activities, I can see why you have an interest in getting away from the Northeast’s winters. (In fact, there is a major blizzard closing in as I type this!)
Since you’ve also done a great job of laying out your situation and questions, let’s just walk through them one at a time, but a little out of order: 1, 3, 4, 2, 5, 7 and 6.
1. If you want your investments to grow and keep pace with inflation, you have far too much held in cash. While most see cash as ultra-safe, the truth is that it is a guaranteed long-term loser. Each year inflation erodes its spending power a little more. Death by a thousand cuts, if you will.
Stocks are, of course, far more volatile but they offer the growth needed to power a successful portfolio over the decades. In fact, the more stocks held in your portfolio, the more likely your investments will last.
Bonds, in turn, diminish growth but we hold them to smooth out the volatility of stocks. So in determining your asset allocation a key question is how big a price are you prepared to pay for that v. how important is growth.
You are also correct in that I am not a fan of Dollar Cost Averaging, nor can anyone time the market. Jack Bogle is fond of saying that in his 60+ year investing career not only has he never met anyone who can time the market, he’s never met anyone who has met anyone who can time the market.
I certainly can’t, although each year I make predictions in my annual contest designed to mock the very idea. If you want my predictions for 2015, you’ll find them there. Just remember that any resemblance to my predictions and what actually happens is pure chance. This, by the way, is true of EVERY expert out there making such forecasts. No matter how credentialed they may be.
That said, I would take $190,000 you have in Vanguard retirement accounts and the $410,000 in the taxable bank accounts and look at them as a whole for allocation purposes.
Your proposed allocation of 70/30 stocks and bonds sounds reasonable to me and I like the idea of using VTSAX (Vanguard’s Total Stock Market Fund) and VBTLX (Vanguard’s Total Bond Market Fund) as the investments.
But if you are very nervous about the market, you can increase your bond allocation. This is the better strategy than trying to time your entry into the market. Your allocation, not timing, is the right tool for mitigating risk.
Finally, because it is less tax-efficient, hold your VBTLX in your tax-advantaged retirement account. That said, your allocation design comes first. This means it is OK to have some VTSAX in your tax-advantaged account or some VBTLX in your taxable account if required.
3. In this question you asked about investing your $410,000 but, as you can see, I’ve already deployed it in the VTSAX/VBTLX allocation above.
You emphasize your desire for simplicity and I strongly second that. Those two funds are really all you need and, in owning them, you are very broadly invested in a diverse range of stocks and bonds.
You really don’t need to concern yourself with lending clubs, Betterment, T-bills, tax-free bonds or sector funds such as dividend paying stock funds.
4. The $275,000 you have invested with your relative has me worried, too. If you are not comfortable with the situation you should seek to get cashed out, even if it means taking a loss.
If you are unable or unwilling to do so, you need to make a clear, hard-nosed assessment of how much of that $275,000 is really secure. This is the number you should use in figuring your net worth and you should err on the conservative side.
Since I have no idea about the situation or how to value it, for the purposes of the rest of this Case Study I’m going to subtract it from your $880,000 total and work with $605,000 as your net worth.
2. Using $605,000 and the 4% rule (which should work nicely with your 70/30 allocation) your portfolio can support ~$24,200 a year. Since your annual expenses are only $20,000, the great news is that you are fully FI and with a withdrawal rate of only 3.3%. Congratulations!
Pulling the 4% is my post on how to go about doing this.
Continuing to work is now entirely optional and the decision should be based on what gives you the most joy.
As for Social Security, your plan to wait until 70 years old to take it is a good one, provided you are in excellent health. The break-even for delaying payment is ~82-86 years old. Die before that and you would have been better off taking it at 66. The longer you live past that, the better your decision to wait until age 70 becomes.
Further, despite all the scary talk, Social Security is secure. It will be especially nice to have those larger checks as we become very old and our mental capacities diminish.
Personally, I too plan to wait till I’m 70. Actually, I will be surprised to live to be 82, but my wife is very likely to live well into her 90s and she’ll benefit from my larger checks. And, of course, I might get lucky!
5. I think you dodged a bullet in not buying the three-family house.
Courtesy of Chow Hon Lam
Investing in real estate can be profitable, but it is also a part-time job and a very specialized one at that. It is not something to be done on a whim or without extensive research. If you are going to be a landlord, you had best become an expert in land-lording. Plus a building that old is likely to need an ongoing range of maintenance and repairs. I don’t read any desire for or interest in any of this in your note.
Here’s a cautionary tale, appropriately titled The Rental from Hell, written by a guy who also backed into it as you almost did. And, if you’re curious, here’s Part I of my own nightmare after doing the same.
If you want to invest in real estate, there will always be properties to buy. But first, spend the time needed to educate yourself as to what’s involved. Only then can you make a sound decision and a profitable investment.
7. If you like the simple life, I certainly wouldn’t buy a home. Especially given that you are uncertain as to where you want to live.
Most often, houses are an expensive indulgence. Expensive indulgences are fine, if you can afford them and if they are really what you want. It is fairly easy to run the numbers and see where you stand, but it is worth remembering that houses are almost always terrible investments.*
Renting is likely to be cheaper, more flexible and more likely to permit you to continue living on $20,000 per year as you currently are.
Here’s an idea. Perhaps once you extract whatever money you can from that business venture with your relative, you can use some of that to buy a house if you’ve decided you really want one. Presuming that happens a few years down the line, you should also have a better idea where you want that house to be. Which brings us to…
6. Where to live. Like you, we live in the Northeast but here in New Hampshire things are slightly less “stupidly expensive” than in many other parts.
New Hampshire
While we’ve loved it here, sometime in the next couple of years we might very well move. We’ve been here awhile and we like change.
And, like you, we are closely considering the Southwest, specifically New Mexico. We’ve traveled there many times and have friends in the state. We find it stunningly beautiful and the endless visas are amazing. While NH is equally beautiful, the type of beauty is entirely different and, as I say, change is one of our motivations. We also prefer a dry climate.
New Mexico
That said, we do know people who have moved there from the more lush and verdant areas east of the Mississippi and who grew to hate the relentless browns, dust and lack of water. Will that be us? Who knows? But one of the beauties of renting is that it is easy to move on. Another reason to be slow to buy a house.
My pal Darrow recently made the move out there and he and his wife are thriving. You might be interested in his story on finding The Ideal Retirement Location.
You also mentioned liking the ocean and, of course, living on the water in the US is very expensive. But if you are willing to look to Latin America, all kinds of ocean side living options open up.
San Clemente Beach
I’m personally partial to Ecuador and I’ve enjoyed the time I’ve spent in the little fishing village of San Clemente. But there are many others.
Once you are no longer tied to a job, the world opens up and the limits are only your imagination.
You are in a great position to create the rest of your life as you see fit. Good luck, keep us posted and maybe I’ll see you out there!
*Just this week I was interviewed on Why your house is a terrible investment with Mike & Lauren YouTube. In the Q&A we also discuss asset allocation, bonds and even dating.
**If reaching financial independence is important to you, the chart below will give you a good idea as to just how powerful your savings rate can be.
The chart assumes an 8% annual investment return and that you’ll live on the classic 4% withdrawal rate, which implies assets of 25 times your annual needs. So, this is not a gospel, but a guideline.
The chart is taken from my pal Darrow’s (Can I Retire Yet?) book:
