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{ in·deed·a·bly }

adverb: to competently express interest, surprise, disbelief, or contempt

Eudaimonia

What comes next, when you become independent of finance?

This is a thought experiment was proposed by SavingNinja. The one thing asked of participants is for a stream of consciousness outpouring of thoughts rather than a carefully polished article. Here goes…

Exam questions

Back in my high school days, one afternoon per week was reserved for vocational training.

The principal recognised that while few of his students were destined for tertiary education, a sizeable minority weren’t interested in mastering those subjects that the school was infamous for: applied reproduction, automobile ownership redistribution, or amateur pharmaceutical chemistry.

The school would ask the students to down their calculators, pens, joints, and knives to learn a trade.

Cooking. Motor mechanics. Sewing. Sports coaching. Technical drafting. Woodwork. And typing.

Trying their hand at each for roughly six weeks. Long enough to discern any aptitude or hidden talent.

In most subjects, the teenagers goofed off or played up, as is their wont.

However, in one surprising subject, everyone behaved: typing.

It was taught by a very angry man, with a brutal yet effective approach to education.

Students sat at an old school typewriter, with fingers poised over the keys. A sheet of blank paper was taped to the keyboard, resting over the back of their hands. This ensured the student could not see the keys while they typed. Touch typing is a mechanical skill, muscle memory learned through repetition.

The teacher would write a paragraph on the blackboard, for the students to type out. He would then prowl the room, wielding a metre-long blackboard ruler.

Every typo he spied was greeted with an almighty whack across the back of the offending student’s hands. Always delivered from behind. Always without warning.

To say that students were incentivised to excel would be an understatement! By the end of the six weeks, most students had gained the ability to touch type and developed a lifelong irrational fear of rulers.

When my final typing lesson rolled around, I was a competent touch typist. Figuring that the objective of the class was to learn the skill, I improvised by typing what I wanted to write, the 500 word English essay due by the end of the school day, rather than the set text.

Roughly two-thirds of the way through, I sensed the angry teacher hovering behind me. Fingers flying across the keys, I hammered out the essay’s conclusion. Perfect spelling. Grammar. Punctuation.

Excellent typing…” said the teacher, stepping away. I breathed a sigh of relief, thinking the threat had passed. I was mistaken. A swift breeze rushed past my ear, immediately followed by a sharp pain across the back of both my hands. Whack! “… but it fails to answer the exam question for this lesson.”

I was reminded of that lesson when I read back over my response to SavingNinja’s thought experiment. Just like an accomplished politician, I had answered the question I wanted to answer, rather than the one being asked. Such is the risk of writing via a stream of consciousness style.

SavingNinja had wanted to know how additional cash flow would be utilised once saving towards early retirement has been abandoned. Given I have never consciously saved towards early retirement, my lived experience is one possible answer. However, that would be a very brief and uninteresting story, so instead my subconscious mind tapped out what follows. Fingers crossed that SavingNinja does not have access to a blackboard ruler or a temper to rival my former typing teacher!

Eudaimonia

All financial tracking spreadsheets tell a story. Presenting a narrative that supports the creator’s viewpoint. Protecting their ego. Telling a feel-good story that helps them sleep soundly at night.

Choices made. Decisions consciously taken. Assumptions subconsciously baked in.

Our responses skewing the tale that our spreadsheets have to tell. A wise old management accountant once observed that far more lies were told in Excel than Word and PowerPoint combined!

Fundamental questions like what gets included and excluded from your net worth figure?

The value of your home furnishings or car? Sunk costs. Depreciating assets. Few capable of fetching a material sum on the secondary market. Many we would need to pay someone to haul away.

The provisional value of an expected future inheritance? Anticipated, not guaranteed. Amount and timing unknowable, except in hindsight. Yet potentially a life-changing sum of money.

The present value of a future state pension? An annuity by another name, guaranteed by law and underwritten by the government. Except politicians regularly change the rules of the game, making the outcome far from certain.

Endless potential permutations. With no definite right answer, but plenty of wrong ones. The personal part of personal finance.

What does your net worth number get used for? Bragging rights? Stroking your ego? The basis of future income stream projections, as part of retirement planning? Underpinning withdrawal rate calculations?

Issuing these types of challenges quickly focuses the mind. Cutting through the delusions and wishful thinking we may have baked into our spreadsheets. Distinguishing the substance from the noise.

Over the holidays, I invested some time challenging the premises behind my own financial tracking spreadsheet.

Was the narrative it tells still consistent with my current hopes, dreams, and priorities?

Could the assumptions and biases it contained withstand critical assessment and scrutiny?

Did it reflect the financial approach I follow? The learnings discovered as my experience evolved?

Were the questions it answered still the right questions? The questions I wished to answer today?

The results were mixed.

My spreadsheet did a passable job of tracking historical events, a far more reliable basis for anticipating future behaviours than any budget based upon good intentions and wishful thinking.

But it had several shortcomings.

First, it focussed on finances, not life. Money is merely an enabler, not a goal in its own right. Helping pay for those things that are important to us, but unable to provide them directly.

Second, it lacked context. Providing a brief vignette, but lacking the beginning or ending required to tell the whole story. Ignoring externalities that play such a major role in determining the outcome. Inflation. Interest rates. Life expectancy. Market rates. Purchasing power.

Third, many of the charts I had used to illustrate the story failed the “so what?” test. Interesting, but irrelevant. Neither a journal recounting how I got here nor a map leading to my desired destination.

Fourth, it painted a picture that no longer reflected my thinking. When I constructed the spreadsheet, I intended to live off my portfolio’s natural yield. However, in a world of overpriced assets and disappointing yields, I have learned that we should always focus on total returns. Free cash flows pay for the groceries, but real wealth is generated via capital growth!

Fifth, taxes are insanely complicated. Rates vary by asset class. Gains taxed more favourably than investment income, and in some jurisdictions varying by ownership duration. Investment income gets taxed more favourably than earned income. Yet investment income gets added on top of earned income, resulting in it being taxed at our highest marginal rates. My spreadsheet was a miserable failure on the taxation front.

Sixth, it served as a measuring engine but not as a prediction engine. While each chart should tell a distinct story, with a clear message, that is only the beginning. Each should also inform decisions about what happens next? Where is it leading? How might it end? Otherwise, what is their point?

I thought about the forward-looking problems my spreadsheet should be helping me to address.

How much is “enough”?

Are my winter working hibernations still required?

What standard of living can I sustainably afford? Distinguishing between economic inflation and lifestyle inflation.

How do best case, worst case, and most likely scenarios financially play out?

Armed with this newfound insight, I set about reworking my financial tracker spreadsheet.

The way I had chosen to visualise my numbers had painted some incomplete or misleading pictures.

Allocating passive income to offset living costs was a noble goal, but such a presentation only made sense had I first accounted for those investing expenses incurred while generating that income. A more useful measure would be passive income net of expenses.

Comparing dividend or rental income figures over an extended time series using nominal values made me feel good, but doing so told an ego flattering fairy tale. Consider a time series covering seven years, beginning with £100 annual dividend income and concluding with £110. Reading the nominal chart would induce victory dances and self-congratulatory cheers of joy as our figures climbed ever higher. However, the purchasing power of £100 seven years ago might have been 15% higher than £100 buys today. When viewed through a “real” (inflation adjusted) lens, the picture would tell a far different tale. This time it is a horror story, illustrating a relative decline in purchasing power. Bruising to the ego, but more realistic as it reflects how those amounts would feel at the cash register.

Probably the biggest challenge I faced was figuring out how to account for capital growth.

This is unpredictable, as markets go both up and down.

For the most part, capital gains are externally generated. Driven by Mr Market’s often irrational feelings about the future prospects of an asset, company, or the economy as a whole.

Yet capital gains have historically contributed the most growth to my portfolio.

Anyone who adopts a withdrawal rate based strategy for funding their retirement is betting on a certain level of capital growth occurring, on average, throughout their retirement.

Running a simple analysis of my own experience, over 30+ years I’ve averaged a simple annual capital growth rate of nearly 10.5% after inflation.

Which sounded pretty good, until I thought about all the things I once did, but do no longer, to actively manufacture capital growth. As opposed to what I do now, which is to passively sit back and hope.

A 10-year rolling average tells a very different story, my inflation-adjusted capital growth rate is now 5.48%, half what it had been just five years before. This being measured at the height of a bull market, where indices and house prices are said to be at all-time highs!

Looking at gross numbers is great for the ego, but sets the observer up for a lifetime of disappointment when those gains are realised and the tax authorities seek a cut of the proceeds. Making an allowance for an effective tax rate of 30%, this average annual capital growth measure further reduces to around 4%.

So which growth figure should my projections use?

The 10.5% lifetime average?

The 5.5% rolling 10-year average?

The 4% rolling 10-year average net of tax and brokerage fees?

Or none at all, because hope is not a sound basis for a financial plan?

These assumptions matter, because the potential decisions based upon them include whether or not a person believes they can afford to retire. Afford to trade money for happiness by changing roles, stepping down the career ladder, or adopting a part-time working lifestyle. Afford to help out family members in need, becoming a carer for elderly parents or babysitter for young grandchildren.

SavingNinja’s question could have been interpreted in several ways. The author may have conquered their fear of the unknown, and concluded they have acquired a sufficiently large net worth to comfortably coast into a sustainable retirement.

Alternatively, they may have decided it is all too hard, and opted to follow the default life script of working until they reach the point they are too old or their skills too dated for any employer to continue paying for their time.

Ultimately we should each maintain a financial planning spreadsheet to complement our financial tracking spreadsheet. Existing not to provide certainty or fact in the face of an unpredictable future, but to serve as a tool for validating assumptions and exploring options. Providing some measure of comfort that the thinking has been done, and the implications understood.

At which point focussing on the important things, happiness and well-being, rather than financial distractions becomes viable. A wise economics editor recently wrote that “happiness is a side effect of being too busy leading a fulfilling life to think about it“. I think he is onto something, a life independent of finance.

I’m no more inclined to save for early retirement than I ever was, but revisiting and validating my spreadsheet assumptions has proved to be a valuable thought experiment.


To hear some alternative points of view check out the other responses to SavingNinja’s thought experiment:


References
  • Gittins, R. (2021), ‘Prep for the new year: What I’ve learnt about happiness’, Sydney Morning Herald

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9 Comments

  1. SavingNinja 1 January 2022

    Eye-opening. Not thinking about inflation when looking at my net worth has crossed my mind a few times as I’ve apparently reached my ‘lean-FI number’, although I’ve quickly brushed the thought under the rug and taken some instant gratification instead, relying only on my budgeting spreadsheet. But then probably leads to most of my money anxiety; if I’m always trying to stay within a certain spending limit, without thinking about inflation, I’m setting myself up for deflating my life style and unhappiness in place of instant gratification for hitting a ‘number’.

    Another spreadsheet, focused on real life, happiness, and boasting a fulfilling, realistic spending figure that gets inflation adjusted, maybe even having a normalised number instead of a net worth until FI figure definitely sounds like the way to go. I think for our family, we need to get to the country / area we want to live in first, otherwise it’s too hard to calculate that real figure!

    Thanks for the food for thought as always 🙂

    • {in·deed·a·bly} 1 January 2022 — Post author

      Thanks SavingNinja.

      The “safe” withdrawal rate followers would tell you that the wisdom of Bengen takes care of inflation for you:

      FIRE number = Current annual expenditure * 1 / [preferred safe withdrawal rate]

      In the first year, that gives you a total FIRE income of

      Year 1 income = FIRE number * [preferred safe withdrawal rate]

      The second year, that income amount gets indexed by inflation:

      Year 2 income = Year 1 income * (1 + [annual inflation rate, e.g. CPI-H])

      So the general formula becomes:

      Year [n] income = Year [n-1] income * (1 + annual CPI-H)

      Of course that means two things:
      1. the starting point is a moving target until the FIRE-ee sets it in stone.
      2. once they’ve pulled the trigger on FIRE, they should never spend more than the income number from the formula, no lifestyle inflation for them.

      So if they forgot to budget for replacing their fridge every 10 years, or allocating money for dental treatment, or paying for their parents’ funerals, or whatever then they can’t afford any of that without belt tightening elsewhere or getting a job.

      The moral of the story is that if you’re not adjusting your numbers for inflation each year, you are living in the past, destined to become one of those clichéd old people who endlessly complains about how everything used to be cheaper back in their day!

  2. David Andrews 4 January 2022

    I suspect that we are all guilty of torturing the numbers to make them fit sometimes and discarding the elements we find problematic. There are so many variables that can potentially throw our best laid plans into disarray.

    I find it strange that even now when I’m at my highest ever net worth I’m probably at the same level of anxiety as when my net worth was considerably less.

    Having burned through my previous pension carryover and staring at a projected LTA breach before 55, I have some choices to make.

    Do those who don’t make the same elaborate plans as the FI crowd lead happier lives ? Is ignorance bliss …. at least for a while ?

    Anyway, this morning it’s likely that another of my colleagues will formally announce he’s leaving. That reduces my team from 6 to 3 and will mean we can barely meet our operational commitments – I’m glad I’m not in charge and technically FI.

    • {in·deed·a·bly} 4 January 2022 — Post author

      Very true, thanks David.

      I must confess I caught myself mentally explaining away historical spending spikes. One-off this. Short term recurring that. Whittling down the actual to what might be representative of “normal“, a homogenised view that smooths out the rollercoaster ride of real life.

      After mentally slapping myself upside the head, I challenged myself to find a year where there weren’t any unexpected or lumpy one-off costs. Of course, there wasn’t one! We can’t know what the specifics of what the unexpected will be, only that life is predictably unpredictable. Rolling up the gory details to the big picture level, and using the actuals as the baseline, provides a more realistic basis for projecting what may come.

      Unfortunately, it also blew up the nice chart I had been constructing. The homogenised numbers painted a predictable world of nice straight linear curves, showing I was (probably) comfortably financially independent and then some.

      Putting the warts and all data back into it shifted that line firmly into the stressful, pucker factor, sleep-loss-inducing “better get a second job” territory. Fortunately the issue (mostly) turned out to be an Excel formula error.

      Sounds like your work is about to get busier. Losing 3 out of 6 within such a short period suggests problems with management, perhaps there will be a re-org in your near future?

      • David Andrews 4 January 2022

        Thanks for your response. The mood amongst the remainers / left behind is rather sombre but I foresaw the team implosion alongside the toppling of the dominoes as soon as the first exit was announced.

        My previous incarnation would have gleefully scooped up all the overtime but my current self would rather have time than money and a less tense domestic life.

        Curiously I have a new 1 to 1 / annual review appointment for tomorrow which should be …. fun. Sadly all these movements have rather scuppered my plan to get rightsized with the associated severance.

        Does not leaving count as a milestone or achievement ??

        • {in·deed·a·bly} 4 January 2022 — Post author

          Does not leaving count as a milestone or achievement ??

          Perhaps. It does sound like there may be 3 performance bonuses that will have been budgeted for but which are looking for a new home. You could put your hand up, if you’re doing 2-3x the load, you could reasonably argue your remuneration could do with some topping up on return.

    • weenie 5 January 2022

      “Is ignorance bliss …. at least for a while “

      I’d say yes, but you could be sleepwalking into disaster as the majority of folk would like to stop working and retire at some point in their lives. If they only find out what they have in the pot on the day they want to leave, it’s probably a little too late then!

      Knowing is scary but at least you can make a plan and do something to make it less scary.

  3. weenie 5 January 2022

    I learned to touch type on a manual typewriter – I recall you had to have good finger strength to push down on the keys and occasionally, if you inadvertently pressed two keys at the same time, they got tangled up in the middle! Those were also the great days of Tippex!

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