Playing with FIRE without getting burnt

Living your life with a FIRE strategy essentially means there are two phases. You'll first have to accumulate money to invest by spending less than you earn. At times this can be difficult as spending money can be a lot of fun. On top of that the markets can be turbulent at times (for instance, right now!) which makes you wonder even more why you are doing this to yourself. Luckily at the end of the rocky road you'll reach your FI number and enter the next phase; early retirement! Can you now relax and enjoy? Let's have a look at the numbers.

30 years of investing

Let's assume someone started a career at the age of 25. She starts pumping €500 into an ETF from day 1 and does so for 30 years. It is 2018 now, where does this leave her?

€500/month investment in VWRL using historical data.

Well, obviously in a much better place than someone who had mindlessly spend it all! Almost €700,000 in the bank. Let's assume this is 25 times her yearly post-retirement spending number (€28,000). Based on the 4% rule this is enough to pull the trigger and retire. The ride probably felt rocky with 2 major market crashes but hey, you made it, congrats! 

Retirement is nerve racking!

After early retirement you'll have to stay in the market. Otherwise you will run out of money. The dampening effect of buying low when markets are low is not available to you any more. You don't have the income to buy more stocks. Therefore it makes sense to not go for 100% stocks anymore. To partially avoid volatility you can go for 50/50 stocks and bonds. 

What will happen? Off course we don't know. Many scenarios have happened in the past, depending on when you retired and what the market did next. I used the Trinity study to produce the graph below.

After retirement volatility!

The volatile of the line from the first graph (accumulation phase) suddenly looks very stable. What happens afterwards (dots on the right) is where the scary volatility is. The median of what could happen to your €700,000 in the first 30 years after retirement is that it grows to almost 2 million. You could get lucky and end up with more than 3 million. Mind you, this is while using money from the stash every month even increasing your income with inflation.

You could be unlucky and run out of money after 20 years. Yikes! Not sure how relaxed I would be with the different scenarios being so, well, different in how they impact on the rest of your life. If you feel uncomfortable with the current minor market correction, imagine what you would feel like when your income fully depends on it!

A way out

If you think you might not be able to handle this insecurity and the vastly different outcomes your retirement might have, there is a way out. You can buy a traditional pension from your €700,000. Retiring at 55 like the lady in our example would mean you receive €2227/month (best offer I could find here). Not bad and fairly close to your 4% withdrawal rate. You get this amount guaranteed until you die. The catch? After that the money is gone. Nothing left, guaranteed! Peace of mind is expensive. But might be worth the money for some.

Subtle ways of unintended market timing

The basic idea of many people aiming for FIRE/HOT is to invest in low-cost ETFs that exactly track the performance of the world-wide stock market as a whole. Besides not picking winners, people keep the costs low and don't time the market. The latter one is most tricky. Even if you think you are not timing you might be timing after all. At least I am.

Why timing is bad

Our investment strategy is to buy the same amount (in euro's) of an ETF every month on the day our salaries arrive. This means there is no need to log into our account at any other point during the month. This keeps the psychological burden low and for me it is most easy to stick to the plan like this. 

My timing is not always bad, sometimes it is really good! See for instance here a post I wrote just before the recent market correction. I could have prevented a 7% drop of my portfolio by selling. The problem is that I have no clue whether the correction has now ended. Hence you would have to time correctly twice, not only to get out but also to get back in not to miss an upswing. 

Sometimes my timing would have been bad from the start. Five years ago I felt the markets were on the high side, considering the financial crisis was resolved with more debt. This had to go wrong! But it did not. Markets went up by a lot in the last five years. It still feels we are overbought at this point but I'll stay put.

Timing happens all the time

So that is clear, I should not time. Unfortunately it is not that simple and I am still doing it. Not the obvious way as described above but in more subtle ways.

With the markets down around 7% at the moment, I thought it was smart to buy an extra portion of our favorite ETF this month. Buying extra can never be bad as I also still stick to the plan, right? Wrong! Where does the extra money come from? Apparently our cash position is too large as I am happy to throw more into the market. This is a sneaky version of dollar cost averaging which the numbers tell you should not do. 

Dollar cost averaging is certainly better than not getting into the market at all. So if investing a lump sum scares the crap out of you by all means use dollar cost averaging. But be aware that you are, and that the numbers are against you. I only realized I am doing it after a recent discussion in the FireNL Slack group.

I don't see the point of having a bond position. Not because I feel I have balls of steal and can handle the full volatility of the stock market. No, it just feels the interest rates are so low that this has to end somewhere soon. As a consequence, bonds will go down. I prefer to keep cash instead of bonds. Darn, timing again! Who says interest rates cannot go down further or stay around 0 for another decade?

Any other sneaky versions of timing I am blatantly unaware of? Let me know, it might help me to avoid them!

Mind the gap; a remortgage hack

In the current low-interest environment many people are considering to pay an interest penalty fee ("boeterente") to remortgage. We recently did the same and I was surprised by the simplicity of the calculation by the bank. Many people in the FI community aim to pay off their mortgage early and in that case there is a substantial amount of additional money coming your way that the bank seems to ignore in their calculations. 

An example; what the bank does

Let's assume someone has a 30-year annuity mortgage. The interest is fixed for ten years. After five years the remaining mortgage is €200,000. The interest rates offered by the bank are substantially lower nowadays. This person goes to the bank to calculate the interest penalty fee to be paid. You can calculate your penalty fee here. Let's assume the penalty fee is €5000. If your new, lower interest rate decreases your monthly interest payment by €200, the bank will argue you earn the penalty fee back within 25 months. 

If you fix the interest rate for longer than 25 months you should go for it! If you would fix it for 15 years (up to 2033) you'll have 155 months to benefit from the lower interest rate after the break even point. It should be said (but never is) that there is also a scenario of even lower interest in the future. In that case you have paid a fine for nothing and are again stuck with a what-turns-out to be relatively high interest rate.

That being sad, people should really check out this option as it can save you a lot of money which you can invest. In our personal case our monthly interest payments went down to €325/month. This is before the tax benefit which brings it down to approximately €200. We felt this is a no-brainer and are happy to fix this ridiculously low amount for the coming ten years. Ten years might be enough to save up enough to pay off the rest of the mortgage!

What the bank does not tell you

Back to the example mortgage. There is nothing wrong with the bank's argumentation. But there is an additional advantage if you pay off your mortgage faster than the standard 30-year plan. And it is rather big. 

Debt left when paying off €200,000 in 25 years with a 2, 4 or 6% interest rate.

In the graph above the mindset off the bank is like the majority of their customers who will remortgage and struggle for 25 more years to pay their mortgage. Afterwards the full mortgage is paid off, regardless of the interest rate. No need to take this into account in the remortgage calculations as their is no difference at the end of the full mortgage period.

Many people in the FI community are paying of their houses much faster than the standard plan.  This is where the magic happens. If someone decides 15 years from now (in 2033) to pay off the remainder of the mortgage, there is a gap in what you owe the bank depending on the interest rate you paid along the way. This gap between 2 and 4% interest is €12,000 and that amount roughly doubles looking at 2 and 6%. 

This is awesome! By paying less interest for 15 years you end up in a situation where you owe the bank less. If this is not win-win I don't know what is!

Pension gate - paying fees for bad performance

My defined contribution (DC) pension has an option to invest in the passive ishares developed world index fund. This is what I obviously do but most of my colleagues have Nationale Nederlanden to actively manage their pension. This means they buy into the NN first class return fund. A fund with a name like that must surely outperform the market! Let’s have a look at the actual, shocking numbers.

Did they really underperform every year on record!?

I can’t go back further than 2014 as the NN fund became operational in that year. I used performance data from Morningstar and initially compared the NN fund to the ishares developed world index fund as these are the two options I have within my pension. The passive tracker outperformed the higher cost active fund each year. Simply investing in all stocks in the developed world resulted in a more than double yield (69.72% vs 32.82%) compared to “experts” picking stocks for you…

Performance (%) of NN active fund vs. passive strategies (1-10-2018).

You could argue I just got lucky as the developed world outperformed the developing world in the last 5 years. Bringing VWRL (passive whole world tracker) into the mix proves that argument wrong. The developing world is relatively small and only has a minor negative impact on the still impressive performance (66.62%), and still hugely outperforming the "experts".

You could also argue the NN fund is not only investing in stocks but also in different categories like real estate (stocks anyway), a hedge fund (mostly stocks again), as well as commodities and bonds. All these positions are acquired by buying into their own funds again, let’s at least hope they don’t charge fees again inside the NN first class return fund. 

Play it safe
Why they try to play “safe” by diversifying out of stocks is beyond me. While you get older they throw larger proportions of bonds into the mix anyway (via 3 separate funds to complicate things further). Plus if anyone can bare the risk of going 100% stock for young people it is pension funds, as the risk is shared with participants from all generations. 

Anyway, as 30% of their positions were outside stocks in the 2018 Q2 report, I added a VWRL:bond (70:30 mix) into the equation just to show it still outperforms the NN fund by quite a margin. I used the best performing bond NN has on offer (ishares core euro corporate bond) so this is as much help as I can offer them. 

The conclusion is NN heavily underperforms a passive strategy, whichever way you look at it.

Listen to Jim!

Jim Collins is the author of the legendary stock series posts and the book the simple path to wealth. In essence his advice is to avoid stock picking, market timing, and fees. Many people in the FI community follow his advice. NN is clearly trying to pick the winners which I show here is a fool’s game. Along the way they charge fees to keep the stock picking circus running. 

At least they are not timing the market, right? They simply invest the money that comes in from the salaries of their participants every month instantaneously. Or are they? I noticed cash funds are showing up in the investment list of the NN first class return fund lately. This implies they keep cash inside their fund. Effectively they are trying to time the next market crash. Three basic rules of investing, all broken!

Business as usual

NN did what any pension fund does, or in fact anyone offering active funds. After underperforming for a few years, you slightly tweak the fund and give it a new name. NN send everyone a letter explaining they tax-optimized the fund and added a “I” to the end of the name. 

This comes in handy as rating websites like Morningstar  cannot connect the dots anymore and your fund gets a fresh start. If you are lucky the first couple of years you can even start an ad campaign on TV showing off how much you outperform the market. 

Sadly, in the case of pensions, most people don’t have any choice but to play along and hope for the best. When investing in personal accounts, it should not be a surprise I avoid active funds like the plague.

Why Suze Orman loves the FIRE movement...outside the US

A recent "afford anything" podcast episode created a lot of buzz. Suze Orman hates the FIRE movement and thinks it is stupid to retire with anything less than $10,000,000. Here is why I am not bothered by her remarks.

Who is she anyway?

Suze Orman is a very successful personal finance guru in the US. Successful in the sense that she got rich out of doing it, I did not bother to check whether her clients feel the same. She has authored books and had a long-running TV show. She made a fortune out of her business.

Why does she hate the FI community?

She thinks we are stupid because we underestimate how much costs go up in life as we age. "When you get older things happen" she said. "You're hit by a car, you fall down the ice, you get sick, you get cancer. Things happen."

The rage goes on to even include full-time care of a disabled family member ($250,000/year). If you would spend another $100,000 yourself you would need $500,000 pre-tax income, hence the $10,000,000 as she seems to use a 5% withdrawal rate.

This is excellent news if you are not American! 

This is very good news for anyone from a country with a decent social system! Look at the rage above, it is all health care related! We don't need $250,000/year to take care of loved ones here in the Netherlands. Also I feel Suze could have a critical look at the $100,000 personal spending in this example, flying private jets and owning private islands are not exactly frugal. 

What is the alternative anyway?

You could say Suze has lost touch with reality. For the majority of us ever gathering ten million is so far out of reach we would give up trying and just spend all our money. Not really a viable alternative. Much better to safe what you can, anything is better than nothing. 

I get comforted by the table below. I used data on Dutch male life expectancy combined with the Trinity study data. Just use the 4% rule for withdrawal from your ridiculously small stash of money and the chance of dying is bigger than the chance you run out of money. Eat your heart out Suze if you can afford the surgery to have it put back in like us Europeans!

Millenials ain't seen nothing yet

More and more people blog on how they became financially independent or are doing great on the journey to get there. At this stage it starts to feel like only idiots still have to work for their money.

The raging bull

There has been a bull market for about a decade now. Blogging is popular with millenials and I much appreciate the fancy lay-outs and formats of their blogs as compared to the rather basic level this old fart is typing in. The longer the current bull market will continue to march on, the more people will be around that have never experienced a significant market drop. And also the more people that were hesitant at first, take the plunge and dip their toes into the stock market. 

Imagine you are 32 now, started working a decade ago and you were smart enough to start investing from the beginning. Or a bit later because you thought stocks were scary at first but it turned out everyone was making money except you. Here’s what your investment world looks like:

I am so smart; my investment tripled over a decade!

The old farts

So the last decade is exactly like all the older legends of the FI community have been telling you it will be, the market always goes up. This is in fact also true if you look at the 30 year time frame:

Fantastic, it went up 10-fold in the last 30 years!

Well, yes it did go up a lot. But look closer, there is two nasty drops of around 50% there. These represent the internet bubble bursting and the financial crisis. Sure, with hindsight everything worked out fine for your investments but trust me that is not what it feels like when the floodgates open.

The aging bull

I see a lot of people reporting monthly performances of their “young” portfolios reporting things like “we had a difficult first week of the month but it recovered nicely afterwards”. This 1-2% drop you experienced should really not be confused with the flood gates opening. We are talking -25% before you could blink an eye. And it is a given fact this will happen again at some point. It regularly does. We just don’t know when so we can't time it. And bear markets always move much faster than bull markets. We only know the turning point comes one day closer every day. 

Off course we are all confident we will just buy more stocks when this golden opportunity of low prices arrives. However, the people around me that are into Bitcoin all told me the same at the beginning of this year. “We'll see $50,000 later this year. If it first drops below $10,000 all systems will crash because of the great opportunity to buy more, everyone will flood in!”

Then the shit hit the fan. Only thing that happened was that people stopped reporting their daily double-digit gains at the coffee break and now tell me block chain is a long term investment. Market volumes have dropped dramatically. People bought high and do nothing now that prices are low.

Prepare yourself for the trouble ahead

Please don’t let the same happen to you wise, young, low-cost index fund investors. Stick to the plan. Buy low, sell high. Or even better, never sell. Have a few interviews with Jim Collins lined up in your playlist. Write a letter to yourself with the long-term plan. 

Once the shit hits the fan, listen to the soothing voice of Jim. Read what the plan was in the letter from your rational self to your panicky unstable current self. Do your breathing exercises. Calm your “I told you stocks are risky” spouse down. Buy more stocks every month. Celebrate the low prices as if there is a sale at your favorite clothing store.

The really long-term ride is not easy. You young investors just got a lucky start with your first decade. The road will be rocky but extremely rewarding if you do what you know you should do in the storm ahead. Don’t drop off the wagon, stick to the plan and prosper! I'll try to do the same on a -1.5% day like today. Because quite frankly, you'll never be experienced enough to get the mindfuck completely out of your game plan.

playing with FIRE; the documentary

The long awaited trailer of the documentary "playing with FIRE" is online!

The documentary includes footage from many legends of the American FI community. The idea is to get it mainstream and available on Netflix. This would obviously help a lot to make more people aware of the concept. To fund the full development of the documentary, a kickstarter initiative has been launched. Also find a podcast here in which the mad fientist interviews the director and executive producer of the documentary - Travis Shakespeare.

You can donate as little or as much as you want, $25 will give you early access to the documentary once it is finished. You can pay with AmEx, so at least it helped me a little in my travel hacking 😉 Hope you will help a little too to spread the FIRE!

UPDATE: We made it, fully funded within a couple of days!!