If you have been reading this blog for a while, you know that I have been spending a lot of time writing about Financial Independence Retire Early (FIRE). Since our financial epiphany, we have been slowly building our passive income streams so one day the passive income can exceed our expenses.
You may be wondering, how much passive income do we need to cover our annual expenses?
Per our financial independence assumptions, I had made some estimates on how much we need to be financially independent.
Core expenses per month estimate
- House property taxes $350
- House maintenance $50
- House insurance $100
- Utilities $100 – water, electricity, and natural gas
- Internet & cellphones $100
- Groceries $800 – two growing kids
- Healthcare $150 – based on current BC MSP premium.
- Household supplies $100
- Clothing $100 – mostly for the growing kids. Mrs. T and I buy new clothes very rarely.
- Car insurance for 1 vehicle $120
- Gas for 1 vehicle $50
- Car maintenance $50
- Buffer $200
Our core expenses do not include expenses like eating out, charity donation, entertainment, side-business expenses, vacation, and education saving for the kids.
We estimated about $950 per month to cover non-core expenses.
So that means a total of $3,220 per month in expenses or $38,640 per year. We’ll round the number up to $40,000 per year for easiness sake.
Annual Spending from the past
If we look at our historical spending from the past few years, you’ll notice that the $40,000 estimate is way lower than what we have been spending. I do believe that when we are financially independent and I stop working full time (note: today we’re a single income family), our expenses will be lower than what we have today.
|Total Necessities Spending
|Core Necessities Spending per Month
|Total Annual Spending
|Total Spending per Month
If we average out the annual spending from 2012 to 2017, this leads us to an average of slightly over $47,000. Let’s be on the safe side and say we need $48,000 per year.
Therefore, we need anywhere from $40,000 to $48,000 per year of passive income to be financially independent. At 4% yield rate (or 25x the expenses), that means we need between $1M to $1.2M in portfolio value.
I have no doubt that our dividend portfolio value will reach $1.2 million one day. It’s just a matter of time. So in my mind, being financially independent is an event that will eventually happen. Mrs. T and I both know that we will get there one day, we are just not in a hurry to get there yet.
But what happens if we decide to retire early by stop working completely so we are no longer generating any active income?
That means we have to live off our investment portfolio and other assets.
What happens if things go wrong? What happens if FIRE doesn’t work out?
When the economy is going down the toilet
In many people’s minds, FIRE means you are not working at all and you are living off your passive income stream. If I look at people that are FIRE’d already, many of them rely on the two items below as their main passive income streams:
- Equity investments – portfolio withdrawals, dividend income, term deposits
- Real estates – rental income
Both of these are highly susceptible to a market correction. If there a bear market, that typically means a hit in your portfolio value, which reduces the amount of money you can withdraw. When the economy is bad, some companies suspend or reduce their dividend payout, so your dividend income may reduce. And finally, governments usually lower interest rates to stimulate the economy during a recession, so term deposit interest rates could be lowered which reduces your term deposit income.
The majority of our passive income comes from our dividend portfolio. Although many of the companies have solid dividend payout history and have raised dividend for many years, it doesn’t mean they can’t cut or suspend dividends during an economic downturn. We could be getting $48,000 in dividend income one year, then 40% less one year because some of the companies aren’t doing well. It’s unlikely to see such a drastic drop, but it certainly can happen and many long-time dividend growth investors have encountered dividend cuts and/or suspensions during the financial crisis.
On the other hand, when people lose their jobs due to an economic downturn, they may decide to reduce their living cost by renting a smaller place or move to a different city with better job opportunities. This can lead to an increase in the vacancy rate, making it harder to rent out your rental properties and reducing your rental income.
When the economy goes down the toilet, it can certainly lead to a lower passive income from your portfolio. At some point, your passive income may get so low that it no longer covers your expenses. When that happens, you’re in trouble. You are no longer financially independent. FIRE has failed!
Time to freak out!!!
Other freak out factors
In addition to an economic downturn, there are other factors that may cause FIRE to fail.
In the US, health care cost is a big unknown for many people that are FIRE’d due to US politics. Thanks to the universal health care system in Canada, this is something us Canadians don’t have to worry about. For that, I am very grateful. But still, it begs the question – what happens if you get sick and you need to be taken care of? What happens if you have to pay out of pocket for some medical expenses? The medical bills will start adding up quickly, causing your annual spending number to skyrocket.
What happens if your ageing parents need more caring and financial support than you previously anticipated? By looking after your ageing parents, you could incur additional expenses, causing your annual spending number to increase.
Another unplanned expense might be kids’ education and living expenses. What happens if your kids go to a university that cost way more you originally planned? What happens if your kids become a boomerang and keep returning back home to live with you?
All these factors could cause the sky to fall and cause you run out of money!
What to do when FIRE fails?
When I think about it, life is all about risk management. There are so many unknowns that we encounter on a daily basis. When you wake up in the morning, you certainly can’t predict that you might step on that LEGO block one of your kids left on the floor (damn that hurts!!!), or predict running into someone around the corner while carrying a hot cup of coffee and spilling hot coffee all over the both of you, or predict your car breaking down in the middle of a bridge, or predict losing that shiny new phone you just purchased a few weeks ago, and so on and so on.
Sh!t happens and you deal with it.
It’s the same thing when it comes to FIRE.
Catastrophes happen, you change and adapt.
The way I see it, financial independence (and the idea of retire early) simply sets you up so you are in a better place to handle things financially. But no amount of money can prepare any of us for every single possible disaster.
By reaching financial independence and perhaps retire early, that means you know how to save and invest money and you are responsible financially. You know which buttons to push when things get tough financially. You know which insurance to buy to cover yourself. And hopefully, along the FIRE journey, you have found your personal balance between saving for tomorrow and enjoy your life today.
So if Mrs. T and I are FIRE’d and we found ourselves running out of money, what do we do?
I think the solution is pretty simple. Swallow my pride, roll up my sleeves, and get back to the workforce, and start earning active income again. Mrs. T would do exactly the same. This way, we can start building up our passive income streams again.
Or maybe when we retire, we aren’t retired in the traditional sense. Instead of working for the sake of working, we are now working on something that we love and enjoy and we are getting paid. The money might not be great, but it creates a cushion.
Therefore, earning some sort of income from work that you enjoy doing when you’re FIRE’d is a great way to prevent a complete FIRE failure!
In the end, who cares if you are FIRE’d and you end up having to go back to a 9-5 job? I sure wouldn’t feel ashamed if I “retire” for 10 years then have to go back to the workforce. At least I can look at myself in the mirror and said: “I’m proud of myself that I have been able to determine my own schedule for the last 10 years, live the way I dream of, and spent quality time with my family and friends.”
FIRE does not exclude working and making income. They are not mutually exclusive.
Remember, life is not static, it’s fluid. So we all need to remain fluid and dynamic even in FIRE.