Investment Moats

A couple of months ago, someone asked on Reddit about how our experience these few months living in financial independence.

He was also curious if our friends are more open-minded about pursuing financial independence, retiring early (FIRE) than a lot of his peers.

That is how I first got to know BOCH. We went out for coffee one afternoon and chatted for over two hours about financial independence, work, and life in general.

I decided to explore whether BOCH is open to sharing his experiences with my readers because of a few things.

The first reason is that I want you to hear a perspective that is not mine. Some may find that after hearing what I said, the FIRE process might be very hard to achieve. So other perspective may help.

The second reason is that BOCH took the plunge, cut away from his job, with his family depending on his accumulated wealth. There is the emotional side of FIRE that is seldom discussed. In my conversation with BOCH, I do pick up that living without your job as a fall-back plan, having your portfolio value go up and down with the market is something not to be discounted.

The final reason is to give him, whom I now considered as a friend, room to pen his thoughts and exercise his creativity and storytelling. If you enjoy what he has written, leave a note below and maybe he would write something to address your query in the future.

In this article, BOCH will share with you how he determines whether he has accumulated enough to be financially independent. He would also share how he deals with the uncertainties of life in his plan (which is definitely going to happen). Finally, he shared how he lived through his first big test without a job, living with portfolio volatility and the “self-talk” that got him through things.

I will come back and round off this article with my personal thoughts.

Way back in March and early April this year (2020 as of this writing), which seems like a lifetime ago, the COVID case counts continued to rise, and the markets around the world seemed to be going through an unending rollercoaster ride on a daily basis. 

The volatility did not seem to want to end. Ever.  The stock index graph seems to have lost its vitality and have been perpetually pointing south, unable to turn the corner.  Doom and gloom was everywhere as you turned to the news. 

Non-stop. 

Et tu, Bane? (You too, Bane?)

At the time, I was having this nagging feeling of uncertainty, percolating, and permeating with its ebbs and flows throughout the days.  I am sure I am not alone.  It was like an unseen phantom that sucker-punched in your stomach every time you caught a glance of a stock index graph.

This sensation is familiar to me, a la 2008 global financial crisis or the 1999 dot-com bust, yet this time it felt very different.  It felt more personal.  The dread of the market crash is like the relentless Bane, in the Batman movie, going after the Dark Crusader, only I am far from being like Batman, and more like a skinny nerdy chap going into a cage fight over my retirement nest egg. 

You see, this time is different for me.

This time, I am no longer working, unlike the other crises, I have experienced. This means my portfolio will be my main source of income, rather than having income from employment. 

In the other crises, I saw my portfolio drop in a similar, spectacular fashion as the index.  As gut-wrenching as it may be, it was comforting to continue to be employed, knowing you have income coming through. 

This time, it felt like all your cumulative investment decisions leading up to this point in your life are being tested.  Did I make the right choices, the voice in the back of my mind asked?

Through the Looking Glass

Let me backtrack a bit. 

I left the company I worked for, an MNC that is a leader within its chosen industry, in September in the previous year. 

I worked as the CFO for the region and helped it grow over a number of years.  As the company grew, so did my responsibilities and my paycheck. 

However, with the growth, it also brought along with more politics, disagreements about the direction of the company, and treatment of employees.

This is no different than other roles I had previously, nor my bosses or colleagues any better or worse than my previous companies.  However, at this stage in my life, I was fortunate and grateful to be able to have saved a nest egg and grew my financial resources over the years. 

At the time when I left, I was 48 years old. 

I started strategizing my exit a little more than a year before I took the plunge.  I have a loving family with a young child in Singapore, and a widowed mother living in a different country.  Spending more time with them became a higher priority as I aged. 

I am sure some of you can relate to the dilemma and thoughts about the question of time versus money and the preciousness of seeing a young child growing up versus earning more financial resources. I was extremely fortunate to come to a point in my life where I can ponder making such a choice. 

However, being naturally risk-averse, making this choice cannot be a sporadic, “at the moment” consideration out of frustration, but rather it must be a deliberate, methodical choice for me. 

Being a numbers guy, the very first thing I turned to in order to make such a choice is my plethora of tools (spreadsheets, retirement calculators, Monte Carlo simulations, etc.) that I have accumulated and refined over the years. 

The question I was seeking an answer to at that time was this:

If I leave the workplace now, is my nest egg financially feasible to last an extended long time horizon, without unduly downgrade of lifestyle, and with sufficient financial buffer to counteract unforeseeable or unexpected life circumstances?

There is no easy answer to this.  For one, whatever tools and analysis you choose to use, will not give you a definitive “yes” or “no” answer.  It may, at most, gives you a confidence level, or a probability.

Even that is probably guesswork at best, given the uncertainty relating to forecasting for a long period of time.

Is a failure of 1 out of 10 chances good enough for you? How about 1 out of 20? 

YOU are still the one who can make the decision that you are happy with, living within a certain confidence level or probability, and bear the consequences of the decision.  However, it is still a chance, which means it is not completely fool-proof.  To make this assessment, I need to have a set of consistent criteria that I can come back to and revisit periodically, and especially when times are bad.

How Do I Determine Whether I am Financially Independent and Ready to Retire?

My financial criteria were relatively simple.

You can find some of these terms and definitions within Investment Moats or other websites on the internet.  The range within these criteria is a personal choice based on my own risk tolerance. 

You can have a higher or lower range within the metric than mine depending on your own tolerance. 

Here are my personal metrics or formula:

1. Does my nest egg (or total portfolio) generate sufficient cash flow to support my annual expenses?
   • Guideline: (Dividends + Interest + Capital Gain – Expenses)>0
   • My spending should not be greater than the dividends, interests, and capital gain
2. Is my safe withdrawal rate (SWR) over the projected long haul within a limit that I am comfortable with?
   • Guideline: Safe Withdrawal Rate between 3.2% – 3.8%
3. Does my nest egg have sufficient cash resources, in terms of the number of years’ worth of expenses to spend, such that I don’t need to divest my invested portfolio if there is a multi-year market downturn?
   • Guideline: “Convertible cash” / annual expenses is between 3-5 years
   • “convertible cash” is in instruments that will unlikely to subject to probability to lose value when converted to cash.
4. Does my nest egg have sufficient “buffer”, in terms of percentage, compared to a required amount based on meeting reasonable essential expenses at a standard SWR? (Admittedly, this is a little theoretical with will need further explanation later)
   • Guideline: Reasonable excess of Current Nest Egg over Annual Essential Expenses (such as rent, tuition, etc) divided by 4%

The first two criteria are really answering the question of whether I have enough money to live on over a long-term period

The last two criteria are really answering the question of whether I have enough buffer if bad things happen.

Allow me to clarify each of the above four personal criteria and to provide each a bit of a context.

1. Does my nest egg (or total portfolio) generate sufficient cash flow to support my annual expenses?

This one is simple enough.  If my total portfolio is generating sufficient cash flow to support my household expenses, I feel I am in good shape.  The key question is “what are my household expenses?” 

If you do not keep track of it, you will have no idea.  One thing to note is that your household expenses will likely have some “one-off” that you may be tempted to take out in your calculation. 

But if you have different kinds of “one-off” every year, you really have a recurring expense so I would not remove it.  I have been tracking my household expense for a very, very long time so I have a very good idea what it is. 

Another item to note is that I use total return (dividends + interests + capital gain) as a gauge, not just dividends and interests.  This is because in reality, the dividend is just part of the reduction of capital (i.e. accounting mumbo jumbo) and I expect to have annual rebalancing to sell a small portion of my portion to support my living, so I would include capital gain.  You don’t have to. 

But if you don’t, your nest egg will likely need to be much larger and you will likely leave a large bequest to your heirs.  This is not my intent and I plan to use up a good portion of my nest egg before I go.  I value my time and enjoyment over the accumulation phase. 

However, I would only plan to support my son for a bit of a leg up in education or seed money.  Rather, I would like to teach him the skills so he can fight his own battles in life rather than living off the inheritance.  As an aside, when I was young, I read a book called The Millionaire Next Door by Thomas J. Stanley.  It has a profound impact on my views on money.  It has a chapter on raising kids and I highly recommend this book for nuggets about having the right mindset for wealth creation.

2. Is my safe withdrawal rate (SWR) over the projected time horizon within a limit that I am comfortable with?

There is a very wide body of literature on the discussion of safe withdrawal rate so I am not going to go through them. 

There is a range of what an ideal rate is (but they are debatable in many cases)

• The consensus seems to be 4% for a retirement time horizon of about 30 years.
• Given the depressed inflation experienced globally in recent years, the original author (William Bengen) who developed the SWR concept has now come out and suggested 5% will be the new 4%. 
• However, for someone like me who has a longer time horizon, I have dialed down my range to 3.2% to 3.8%. 

Some may say I should have a lower SWR just to be truly safe.  While this is likely true, my view on this is about a tradeoff of two different risks. 

While I can save more with a higher nest egg and enjoy a lower SWR, I would see that with each additional year of work I would likely incur a bit of higher health risks and risk of death.  

To me, life would totally suck if you get to a comfortable SWR, and then you only get to enjoy it for a very, very short time.  In other words, I am comparing two opposing risks:

• The risks of running out of funds or living a lower standard of living if I leave sooner and accumulate less versus
• The risks of higher health risks or mortality risks if I stay longer and accumulate more funds

While the health or dying sooner risks has a much smaller quantum of risks than, say, running out of money, the issue for me is not about the size of the risks, but more about the willingness to accept the risks.  For me, even the health risks are smaller, by comparison, I am more willing to accept the risks of a lower standard of living than having all the money but have no sanity, health, or relationship to enjoy it.

The risk of over accumulation and passing on early has not been studied thoroughly, but I am convinced it is real, given the stress that we accumulate in our modern lifestyle.  Your range of values will be a matter of personal choice in alignment with your risk tolerance.

3. Does my nest egg have sufficient cash resources, in terms of the number of years’ worth of expenses, to spend such that I don’t need to divest my invested portfolio if there is a multi-year market downturn?

This metric is my measurement of how long I can “ride” out a market correction and let the investment portfolio recover without a significant drawdown on my nest egg. 

There is much research out there on the length of recovery versus the depth of a market correction. 

• When the market corrects over 30% of its value, it may take over 6 years or more to recover. 
• When market correction with a lesser degree, its recovery tends to be quicker (1/2 year to 3 years). 

The correction we see back in March while recovering in the U.S. has yet been fully recovered to its former height in many markets around the world.  It’s a good example to have sufficient cash to ride out a down market.  There were many who panic and sold on the crash. 

There were a lot of professional managers who incurred losses when they sold during the crash and were unable to get back into the market quickly when it snapped back for recovery.  Timing the market is hard and I am quite terrible at it.  I think the cash buffer I have built prior to leaving my workplace helps me to sleep a lot better at night. 

Not all my buffer is sitting in cash.  I would say, cash or cash equivalent makes sense where the instruments can be redeemed without losing value.  Singapore Saving Bonds is very safe, and fairly liquid, as are cash or fixed deposits. 

I have at least 1 year worth of “true cash” for my day to day spending and a few years of convertible cash to ride out the market crash.

4. Does my nest egg have sufficient “buffer”, in terms of percentage, compared to a required amount based on meeting a reasonable essential expense at a standard SWR?

This part gets a little more theoretical but it is not too bad. 

This metric also allows me to assess how much shock my portfolio can absorb.  In the beginning, the key item to know is what is your true essential expenses within your household expenses.  So again, tracking expenses is important and I have over two decades of data to analyze my spending patterns. You don’t need that much data to come up with a reasonable projection, but you have to be factual and honest with yourself about what is truly deemed to be essential expenses.  Data simply allows you to have more precision, but not a prerequisite. 

For me, all the household spend such as rent, cellphone, internet, grocery, insurance, tuition, etc. are essential. 

My discretionary spending is on travel, hobbies, gym membership, etc.  Your definitions may vary. 

Having a contractual commitment may be a non-discretionary for the short-term but nothing is fixed for the long-term.  One of the key success factor I felt it is important to emphasize is the following:

You have to know what your basic standard of living is without going crazy and feeling depressed, and this is different for everyone. 

We also know that the standard FIRE SWR is 4% based on a huge body of literatures out there. 

So if you divide the essential expenses by 4% (or a rate you feel more comfortable with), you can get a theoretical size of a nest egg that you will need to minimally retire. 

Of course, you can add a little more or less to make it livable, but the idea is to get to a minimum spend and a minimum portfolio size for your retirement. 

Whatever that number is, I can then compare against my current portfolio size and see how much excess I have against this minimum number.  This excess, as a percentage, is also the percentage of market correction my portfolio can absorb before I cry “uncle”.  Simply put, if you have a buffer of 50% or more, you will likely be able to withstand a significant market correction. 

What this reasonable excess as a buffer over a minimum portfolio size differs for everyone. It depends on how much you want your portfolio to absorb a market correction.  Personally, I believe this buffer should be at least a minimum of 20% to 30% because a market correction can easily be of this size.  I am risk-averse so I am looking towards a buffer great than 50% and beyond. 

However, please keep in mind that the accumulation of more capital is not the only way to keep the buffer size up.  Lowering your essential spending is a way to reduce the minimum portfolio size, and this can be accomplished by various means, such as redefining the meaning of “essential” or move to a lower cost of living country, if such opportunity is available.

Let’s have an example:

If you spend $50K a year and your “hardwire” essential expense is about 30K (or 60% of your total spend), at a 4% Safe Withdrawal Rate, your theoretical minimum portfolio size is $30K/4%, of $750K. 

So, if your current portfolio is $1M, at your current spend of $50K, you have an SWR of 5%.  It is a little on the risky side or not egregiously bad. In this example, your buffer against a theoretic minimum nest egg is a 33% buffer ($1M less $750K divided by 750K). 

Is this good or bad?  Let’s say the equity market corrected by 25%.  However, assuming your investment portfolio is well-diversified and not everything is in equity, so your portfolio may be reduced by only 20%, not 25%. 

Now you have $800K, rather than $1M (20% off).  If you cut out your discretionary spending and only spend 30K of the non-discretionary, you are still okay for a good while. 

Your new SWR is $30K/800K or 3.75%.  However, life may not be as comfortable but you still have a roof over your head and food to eat, assuming you have properly tracked and classified what is non-discretionary spending and you are not overly depressed with your new frugal lifestyle. 

This will still give you time for your portfolio to recover.

How I Incorporate Life Uncertainties into My F.I.R.E Plan

All plans would come with a set of assumptions. These assumptions define the conditions where my plan would succeed and unsuccessfully work.

I should be comfortable with these assumptions. They should also fall within my risk tolerance.

Life can be uncertain. There are chances something bad will happen or something good will happen.

I could budget a number of “bad things” into what my nest egg could withstand. However, the nest egg needed would be so big that the amount needed would be very substantial.

With all the good intentions, you may still fail without any interventions. 

I use this concept of “Good guys” and “Bad guys” to explain how I frame the remedies to uncertainties in the plan.

1. “Good guys”. A set of potential action steps that I can implement to improve unforseen financial situation
2. “Bad guys”. A set of unforseen financial situations that may derail your plan

The way that my mind works is that if I have interventions (or “good guys” actions I can take to offset the “bad guys”) readily available when bad things happen, I feel more comfortable in taking more risks in the first place.

Risk tolerance does come into play and whether you have other “good guys” (or positive factors) that you can count on to offset the “bad guys” (or negative factors) you experience along your post-retirement journey. 

So when it was time to assess the “stay or go” decision, I used the criterion above to assess the viability of taking the plunge of leaving a company I have worked with for quite a number of years. 

There is always this nagging feeling of “work just one more year and you will have $X dollar” or “Are you insane? You are leaving $X on the table if you leave!?” 

Yes, these thoughts went through my mind and it was pretty insane. 

Being a numbers guy, who is rational and risk-averse, this was certainly one of the tougher life choices I have made and it also came back to nag on me during the onset of the pandemic. 

While my nest egg met the above criteria I set up, I want to also anticipate some of the “bad guys” scenarios where I have appropriate “good guys” actions to counteract them. 

I asked myself, “What are the bad things that can negatively impact my finances and what can I do about them?” So, these are the “bad guys” I can come up with at the time:

1. My nest egg experiences a sequence of return risks (this is the “Bane” of every early retiree and you can google the term)
2. There is some unexpected permanent decline in value in the investments of my nest egg
3. I have unexpected expenses that I need to pay
4. I experience a significant health issue
5. My family members experience significant health issues

If I can boil down the above, they are really about two buckets of risks in financial terms:

1. A declined in value in my nest egg, so it will have less funds to “dip” into for spending, and also it has decreased in its ability to generate future income
2. More spending to cover (like unexpected health expenses) but this could be recurring or non-recurring expenses

Rationally, these two buckets can be offset by some of the assumptions that you have “baked in” while accumulating the nest egg. 

For example, the amount of buffer I have in the nest egg should be an answer to the risk of permanent declined in the value of the nest egg.  Or the number of expenses that would be considered as “discretionary” or “luxury” should be an answer to offset some of the unexpected spendings.

However, I want to identify further actionable items I can do when the “bad guys” strike.  I.e. If I know I will be locked into a cage fight with the proverbial “Bane”, what can I do now before I leave the workplace and what options will I have when the time comes?  At the time, I consider the following to be the items I can action on:

1. When it comes to health or health-related risks, I will take the time I “bought” from retirement to exercise, eat better, sleep better to enhance my health outcome. Preventive actions are better than dealing with the fallout afterward.
2. I will purchase the proper insurance for my family in case of an emergency prior to leaving my workplace.
3. I will go back to work if things are dire.  This means I should continue to keep up the relevance of my skills
4. I can also move to a different location or countries where there may be better health care or better cost advantage if required
5. I will restructure my portfolio such that it will minimize the sequence of return risks and have better diversifications through a “Bond tent” prior to leaving the workplace.

All of these things are discrete and actionable prior to my big plunge.  They can be acted on or prepared or researched within the year prior to leaving the workplace or shortly after.  Having said that, I did not expect the need to revisit these thoughts and the financial criteria I outlined above so soon at the time of the COVID market correction!

The first half of retirement, while fulfilling in many aspects, was also full of adjustments. 

I managed to teach a course at a local university about personal financial planning.  Teaching has always been something I wanted to do so I am very happy I got that “fill” and gave something back to the community. 

I have also spent some quality time traveling with my mother and we were able to communicate a lot more since my father passed away a few years back.  We caught up on a lot of lost time and were able to build a more robust relationship. 

I slept more, but not necessarily better, and was able to catch up with some of my favorite TV shows and movies.  I read more books than in the past three years combined. My son and I have made a bunch of silly faced photos which he loved so much that his official greetings to me now is “My Ugly Daddy”. 

In addition, some of my work contacts in a niche industry reached out to me to do some contract consulting work and I happily obliged, knowing that I control my own time and this is an option rather than a necessity.

The Ongoing Questions I Asked About My Financial Model from Time to Time

Oh yeah, remember my proverbial Bane?

Well, all is well for my retirement plan until it is not. 

The COVID-induced market volatility has made me questioned some of the assumptions I have used, and also questioned the timing of the life choices I have made. 

It shows that while everyone can talk a good game about not selling into your emotions when it comes to managing your investments, it is another thing when your money is on the line and you have to put your money where your mouth is.

Luckily, being decades in the financial business, I have developed a relatively rational head on my shoulder when it comes to investments.

Having dealt with more than my share of fire drills in my finance role at work has helped me to be clear-headed in times like this.  Nevertheless, the emotion is still there and it is a matter of managing the emotions when it comes to making investment decisions. 

I have also developed tools in my pre-retirement phase to analyze the sensitivity of my plan’s success against various assumptions (ie from bad case scenarios to really bad case scenarios).  These tools have helped me during the volatility back in 1999 and 2008. 

My tools have evolved over time, but nevertheless, the usage at this time as a sounding board is similar.

Around April and May this year, when the market was moving like a rollercoaster ride, I have gone back to my models and tools and revisited the assumptions I have made. 

Some of the questions and scenarios I have plugged into the model we’re trying to answer the following:

1. If the nest egg remains at this current depressed valuation, can the investment return of my nest egg support my lifestyle? For how long? What is the incremental probability of running out of money before my time horizon given the current reduction of the size of the nest egg?
2. How much can your nest decline further without hitting a “red zone”?
3. How much buffer does my nest egg still have? Has the buffer run out?
4. How many years of cash, in terms of expenses, exists without forcing a sale of investments at this current depressed value?
5. How many expenses can be trimmed, without impacting life style unduly? Does it require any reduction of discretionary expenses, and if so, how much?

With the market volatility came a new set of data on the market and my portfolio for analysis.  I dutifully plugged in the data to see where I am at.  This is where you have some kind of objective measurements to validate against your emotions and see what actions can be taken to ride out the uncertain times. 

I found that I am satisfied with most of the outcomes of the analysis. Using the four criteria I mentioned above helped me have a more rational view of where my tolerance level is.  In particular, I know where I can trim my expenses if required, and also what is the “red line” of the market decline before I should consider other more drastic actions. In addition, I also know from an emotional point of view how the market volatility impacted my mood and whether the emotions are rational or not.  I came away with a better sense of understanding my own risk tolerance and the actions I can take (or avoid) to manage my investments that are more aligned with my long-term goals. 

I ended up not selling into fear and also kept buying into the market on a selected, broadly diversified basis to maintain my intended asset allocations.

After all, I have discussed the importance of diversification, portfolio construction, and rebalancing in my course.  It would be hypocritical of me to not follow my own advice.  I can say that as of this writing my portfolio is healthy and was able to earn me a living in a consistent, predictable manner.

You Will Only Know if You Have a Successful FIRE When You Die

Is this a happy ending and did I make the right decision last September?

Yes, a definitely “maybe”. 

As someone has once asked me, “How do you know you can retire?” My answer was “I don’t!” and I continued, “I don’t think anyone will know until the day they pass away for pure certainty, because there will always be the unknown unknowns!”

The COVID experience taught me about being prepared before the “big plunge” of leaving the workforce, having the right tools to rationally assess my portfolio, and have the right set of realistic questions and criteria ahead of time to assess the healthiness of the portfolio when there is a big change in the market.

The experience allows me to know myself better, in particular, what my risk tolerance is. 

The criteria I have outlined above is what I used when I am unsure about the market, or when I am rebalancing my portfolio in my periodic review. I hope the above thought process helps you to develop your own metrics and guidelines that you can revisit during your pre-retirement planning and also in the time of financial uncertainty. 

In my next post, I am happy to share about what are some of the hits and misses in my accumulation phase and in my career that have led up to this point.  Thank you for reading!

There are a few things I wish to bring to your attention to what BOCH shared.

The first thing is that there is a similarity between how he goes about figuring out his FI number and how I would go about figuring how much is enough for a person’s financial independence or financial security.

But he has a different way of computing how much is enough for him to pull the plug. In a way, in order to be able to pull the plug from your job and live on your portfolio, I think your plan needs to have a certain degree of robustness.

If our plan is less robust, either we realize too late that things are blowing up, or that we get overly anxious.

The second thing is that, even with all the preparation work, it does not mean that you will sail through your retirement and not worry about anything.

Some of us are naturally anxious but that can be reduced if you have a certain degree of confidence you have taken care of the important things about retirement that you need to think about. But you can never wipe out the cautiousness. BOCH and I tend to lean closer to more cautious people.

But I think it’s also irrational that we do not review whether our plan is still ok once in a while. The ongoing questions BOCH talked about are necessary because he shared that he doesn’t check things so often. For sure, he does check on his portfolio occasionally. However, he does not check the current withdrawal rate, his buffer, expenses that often.

The key to a retirement plan is not just about working out if you are ready to retire, what you need to take care of upfront. The important part is what happens when your life, your portfolio, your family deviates from the original assumptions.

Those deviation will certainly come, and you need a way to navigate them.

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