What Does Your “Year 2” Look Like?

For most folks in the FIRE community, part of what motivates us is the free time we hope to have once we hit our “number.” Time to pursue other goals, hobbies, time with family & friends, etc. We look at the future and imagine all sorts of things we would be doing once the need for money is taken care of. Often this involves extensive travel (both in the home country and throughout the world). It can be very exciting.

Most folks have a long list of what they intend to do in their first year – but what are your plans for year 2? Once you have checked off all the immediate ideas and needs, and you are starting towards the long, daily “grind” of being financially independent, what is your life going to look like. It is this part of planning that many FIRE folks fall a little short of – yet it is here where we will be spending the vast majority of our time. How do we plan for year 2?

What are you passionate about?

One way is to ask yourself what are you really passionate about? What gets you out of bed in the morning, gets your blood flowing when you get the chance to do it. It may be volunteer work, working on your house or garden, a specific hobby, or spending time with your family. Take  the time to sit down and ponder/meditate on what you are passionate about and use that as a basis to plan your year 2 activities.

Not a race, not one answer

One of the mistakes folks make when they think about this is to believe that it is a one-time decision, and once they start down the road towards activities for year 2+, they will be stuck in it. Nothing is further from the truth. Almost everyone will have changing interests/passions over the next 10, 20, 30 years – as their life experiences change them. Look at what you want to do now, but don’t beat yourself up that you might change your mind. In the engineering world, its called “paralysis by analysis” where you keep analyzing without actually acting. Feel free to make a decision with the full knowledge that it isn’t going to commit you for the rest of your life.

Learn to enjoy the present

Typically, year 1 of FIRE is a frantic time, running around and doing all the things you’ve always wanted to do. Year 2 and beyond is much more about relaxing and enjoying the present in a more unstructured manner. Make sure that while planning year 2, that you don’t “over-plan” year 2. Leave yourself plenty of time to relax and just “enjoy the present.”

In the end, the primary benefit of hitting FIRE is you are given the “Gift of Time.” You should make some serious considerations of how you intend to use that time, once the initial “bloom” of retiring early is done. While you don’t need to being too crazy about analyzing it, take the opportunity to look into it.

Mr. 39 months

Friends

Came home the other day from work, and Mrs. 39 Months met me with the news. “John is in the hospital.”

John is one of our close friends in the area, and someone I have known for almost 30 years. We are the same age, and have many of the same interests, though lately his crafts and interests have tended to mirror more of what Mrs. 39 Months enjoys making.

John has been married for 20+ years, and while it has its difficulties, you can tell he loves his wife. Unfortunately, her health has deteriorated over the last five years to the point that she can barely walk for any length of time. This precludes a lot of activities and forces John to do a lot more work around the house, just to take care of her. She is under a doctor’s care for her ailments, and she does work to get better, but it is a struggle. John is a “giver” and while he complains about it at time, I think he enjoys the role of “white knight.”

Recently John’s allergies kicked up and got rather bad. He ended up overextending himself, and in the end, had to go to the hospital because he had come down with a severe case of bronchitis. This left him so weak he could barely move, and at the same time, he was not around to take care of his wife (her daughter assisted a bit).

We took the opportunity to go visit him for a couple of hours last night. He was still weak, and was probably going to be in the hospital for at least 2-3 more days. He knew he needed to rest, but worried that when he went home, he would end up exhausting himself with taking care of his wife. All we could do was volunteer to help, and let him know we were there for him.

It is interesting, as you get older. You realize that friends and family are the most important thing in your life. With FI, you can try to find more time for them, especially if they need it.

Mr. 39 months

Investment Update Sep 2019 – The benefits of Asset Allocation

One of the key aspects of working towards Financial Independence is the asset allocation of our investments as we move towards FI, and after we have reached it. For many of the investment advisors we have talked with, their area of expertise is on the “accumulation” phase of investments, i.e. gaining the most and growing your investments.  This results in a larger weight towards stocks and reduced use of bonds and other fixed investments. The key with this is that if you have time, then ‘swing for the fences” and get the highest return.

But what happens as you close in on FI, or once you hit it? In some cases, folks continue to work, and so they don’t mind remaining heavily invested in stocks – as they can withstand a market correction like 2008/2009 – they just keep working and accumulating, and eventually it comes back.

However, as you get to the point in your FI journey where you are looking at the full “FIRE” reality (retire early) you start having to look at protecting what you have, and dialing back some of the stock investments. I don’t believe you should dial it back completely (after all, you could have 4+ decades to go before you pass away). This is where “asset allocation” becomes a part of your life.

For asset allocation, you determine the level of risk you are comfortable with at this time (it changes obviously as you move towards full retirement) and then determine the percentage of your investments you want in stocks, bonds, savings, and other assets. The objective is to maximize returns, while at the same time keeping your risk of major losses in line with what you are comfortable with.

As many of you know, the allocation for my retirement accounts (IRAs, 401K, etc) is pretty much index funds, spread out between the  S&P 500, small-cap, international, REITs and bonds.

Retirement Accounts: Remember, my allocation for these is:

  • 30% Bond Index Fund
  • 17.5% S&P500 Index Fund
  • 17.5% International Index Fund
  • 17.5% Small Cap Index Fund
  • 17.5% REIT Index Fund

My 401K doesn’t have REIT option, so its just 25% for each.

The folks more heavily invested in stocks have done better than me for 2019 (other than international stocks), though they did worse in 2018.

For the month of August, stocks were down (-1.6% for S&P500, 2% for international, and 4% for small cap) yet my REITS and bonds were up (+1.6% and +2.8%), so the end result for my accounts was only a -0.3%.

My dividend account allocation is:

  • 25% Dividend Stocks
  • 25% REITs
  • 50% Bond Index Funds

So as you can guess, it actually was up 1.3%

Overall, I’m just down -0.3% for August, and still trending at +13.3% for the year. My asset allocation may not be as “speedy” as some, but it allows me to sleep as night as I close in on FI. Only 10 Months left to go!

I hope you had a good August, and your journey continues to go well!

Mr. 39 Months

The Rent vs. Buy Decision for Housing

There has been a lot of talk lately about renting housing vs. buying lately, especially in light of the article from folks in Dallas who said they lost about $60K by buying vs. renting and re-investing the difference. Some key points in reference to that article:

  • Their time to own was very short (about 43 months). The general rule is only buy if you are planning to be there for 5+ years
  • They are assuming that they would have invested the extra money, but you can’t always assume that. Many folks find other ways to spend the money they save on renting instead of buying rather than investing it.
  • They are “backward looking” in regards to the amount they could have made. When they purchased in late 2015, nobody could predict the markets would shoot up like they did. In fact, many people were expecting a recession in 2017. If they had bought before the 2000 market crash, then they’d be patting themselves on the back.

An important update to most rent vs. buy is the 2018 tax reform act, which got rid of a lot of tax write-offs for home ownership (property taxes, mortgage interest. Etc.) for a generic $12K single/$24K for married couple. The result is that it gives that same benefit whether you buy or rent – so it makes renting more cost effective than before.

To do a real analysis on whether you should rent or buy, you are going to have to dig into the numbers and make some assumptions. Based on how those assumptions bear out, Its possible your numbers might come out differently, but they shouldn’t be too far off – provided no major market crashes or dot.com fueled jumps up in value.

This example comes from Focus on Personal Finance, by Kapoor, Dlabay, Hughes & Hart. I’ve shown the pre- and post-2018 tax reform.

  • Apartment has rent of $1,250/month
  • Home costs $200,000
Rental Cost Before Tax reform 2018   After Tax reform 2018
  Annual Rent payments $15,000   $15,000
  Renter’s Insurance $210   $210
  Interest Lost on security deposti (amount of security deost times after-tax savings account interest rate) $36   $36
Total Annual Cost of Renting $15,246   $15,246
Buying Cost
  Annual mortgage payments $15,168   $15,168
  Property taxes (annual) $4,800   $4,800
  Homeowner’s insurance (annual) $600   $600
  Estimated maintenance & repairs (1%) $2,000   $2,000
  After-tax interest lost on down payment & closing costs $750   $750
Less      
  Growth in equity ($1,120)   ($1,120)
  Tax savings for mortage interest (annual mortgate interest times tax rate) ($3,048)   $0
  Tax savings for property taxes (annual property tax times tax rate) ($1,344)   $0
  Estimated annual appreciation (1.5%) ($3,000)   ($3,000)
Total annual cost of buying $14,806   $19,198

As I stated, the tax reform act certainy makes it look like renting is better. Another thing to throw in here are the purchasing costs. Typically, you are going to spend 5%-8% of the home costs ($10-$16Kk if above home) for fees, points, commission, etc. to purchase. To evaluate this, you would spread these costs over the lifetime of the home (i.e. the longer you stay in, the less it will be per year).

Is it any wonder why fewer people are buying homes, and more people are renting in this society?

Mr. 39 Months

Social Security Fixes in the United States

A lot of ink has been spilled over the last 10 years on the state of the United States’ social security program. For those outside the US, this is the base retirement investment program, which takes 6.2% of someone’s salary, and another 6.2% of the salary from the employer, and uses this tax to pay for current retirees. Most folks think they are paying into an “account” for themselves, but it is actually sort of a giant Ponzi scheme, where current tax money is used to pay off outstanding bills. For folks in the FI community, Social Security is a part of the program, but probably not a major part.

Like so many Ponzi schemes, it is predicated on getting more and more people/taxpayers to pay into it in order to keep it rolling. Unfortunately, the folks in the US have not been having 3+ kids to help defer this, and the bill for the “Baby Boomers” is coming due. The taxes taken in are now not enough to pay current beneficiaries, and so the system is spending up the excess it has built up over the past decades. Depending on which accounting system you use, the year it goes “belly up” is around 2032. Unless something is done, benefits will be cut to 75%, which could be very serious for the ones who most depend on social security.

This happened previously, and the two sides of the political aisle got together in the 1980s and came up with a series of items (extend retirement age, tax benefits, etc.) to fix it, at least for the next several decades. Well, we are fast approaching the time when we need to do something similar, but both sides of the US political aisle seem to not want to even discuss it. Probably because it has been called the “third rail” (i.e. the electrical rail for trains) for politics – to touch it means death.

Which is sad, because the closer we get to the magical date, the more severe the changes that will need to be made in order to keep it solvent.  I recently read a report from the Society of Actuaries (an accounting field that specializes in longevity, insurance, etc.) on potential fixes, and what percentage they could go to in fixing the problem.

  1. Raise the retirement age to 70. Life expectancy is longer, but it could be hard on people with physically demanding jobs or who are disabled. +68% of fix
  2. Reduce the cost-of-living-allowance (COLA) by a certain percentage. A congressional commission felt the consumer price index (CPI) was overstated by 1.1%, meaning the COLA was too high. However, these would be cumulative, so as retirees get older, they fall further behind in purchasing power. +37% fix
  3. Reduce benefits by 5% for future retirees: Puts everyone in the same boat, but would hit low income the hardest. +26%
  4. Increase the number of years used to calculate average wage from 35 to 40 years. This would encourage people to work longer, but would hurt folks who work less than 40 years, especially mothers. +24%
  5. Affluence test: Reduce benefits for those whose total retirement income exceeds $50k/year. This preserves the benefits for most, but discourages savings and encourages people to hide assets. It also changes Social Security from a universal, “all in this together” program, to one of need. Would hurt support for program. +75%
  6. Raise payroll taxes from 12.4% to 13.4%. Would not hurt because real wages are going up, but we may also have to increase Medicare payroll tax (it is in even worse shape) so total taxation would be burdensome. +53%
  7. Increase wages to social security tax: Currently capped at , this would make Social Security a worse deal for higher incomes, further eroding universal support
  8. Invest 40% of Social Security Trust Fund in private investments. Could boost returns with less risk to individuals, but this would be 5% of private market. Stock voting and selection could be politicized. +48%

While there does not seem to be one single answer, the best way to do this is with a series of 3-5 of these, and this will get us over the 2032 “hump.” All we have to do is have the political will to do it.

That is the problem.

Sorry to be a bit of a bummer, but we all need to be planning on our financial future, and for those in the US, this is an important part of it.

Mr. 39 months

Timing the Market – Update for Aug 2019

Back two years ago, I reviewed Ben Stein’s & Phil DeMuth’s book “Yes You can time the Market” in which they discussed ways  to time the market over the long term, using various signals signs to determine the long term (15 year trend) of the market. They definitely did not believe in short-term timing, but they did present a good case for how to look at the current state and make long-term determinations.

I followed up with several other posts in which I looked at short-term timing, and at what Stein/DeMuth’s strategy would have resulted if I had followed it since graduating college in 1986 (answer, I would have been 5% – 10% richer over a 30 year period, including the dot.com crash).

I thought I’d provide a slight update to folks in case they were interested.

If you remember, Stein/DeMuth had four key measurements to determine the long-term direction of the market:

  1. Price vs 15-year average
  2. Price-to-earnings ratio vs. 15-year average
  3. Dividend yield vs. 15-year average
  4. Bond yeld vs Dividend yield

For Jan 1, 2018, the numbers showed:

  • Price (adjusted for inflation) of $2,883 vs 15 year avg of $1,789 – don’t buy stock
  • P/E ratio: 24.97 vs 15-year average of 23.2 – don’t buy stock
  • Dividend Yield: 1.83% vs. 15-year average of 1.99% – don’t buy stock
  • Earnings Yield (inverse of P/E) vs. AAA bond yield: 4.0% vs 3.5% – buy stock

So three out of the four metrics said don’t buy. The S&P 500 for 2018 was down -6.2% (source CNBC). A lot of folks paid money for stocks that were overpriced at the beginning of 2018.

So what did Jan 2019 look like?

  • Price (adjusted for inflation) of $2,654 vs 15 year avg of $1,862 – don’t buy stock
  • P/E ratio: 19.6 vs 15-year average of 23.0 – Buy Stock
  • Dividend Yield: 2.14% vs. 15-year average of 2.03% – Buy Stock
  • Earnings Yield (inverse of P/E) vs. AAA bond yield: 5.1% vs 3.98% – Buy Stock

So three out of the four metrics say “buy stocks” – and the market is up 15.23% year-to-date

Does this prove that Ben Stein and Phil DeMuth’s market timing strategy is still valid. It appears to be still going well.

Anybody out there with an interesting market timing strategy?

Mr. 39 months