Monday, May 27, 2013

Concerns about Early Retirement


Dear Investor Juan,

I've been reading your blog and I find it entertaining and at the same time educational. I have a few questions for you but let me give you a little background about myself. I am 27 years old and single. Been working as a caregiver and my goal is to quit work by next year and follow my long time dream of becoming a lay missionary. I wasn't able to follow my dream coz my family needed me financially and now that I settled them already, it's time for me to follow my heart's desire.

Let me give you and idea on my financial life and please tell me if you think I can  follow my goal or if I should extend a year or two before quitting work for good.

Net worth: Php 4 Million
Mutual fund : Php 150k
Stocks:  Php 1M
Debt : 0
Other investments : Small land
Home: owned

I am a frugal person and live simply. I am also a minimalist and I don't dabble in consumerism. I'm planning on not touching my paper assets till I'm old. I also have emergency fund worth 6 months of living expenses. However, I don't have insurance and would like to avail one. Please take note that I'm single and with no beneficiary.

You think it's possible to quit work and "forget" about my paper assets and just move on with life without adding to it? How much you think my money would grow in 40 years considering inflation? I'm still investing 70-80 percent of my income as of the moment. How am I doing financially. I am a voluntary celibate and don't plan on marrying in the future so please consider that too esp with health care cost with no one to share the expenses when I'm old.

Sorry if I have tons of questions. I just needed some advice on where I stand financially or if I can quit work by next year coz I feel so empty. I keep thinking if next year is the time where I can say to myself that " My earning days are over. Time for me to follow my dream"

Good luck and thanks so much,


(Additional information in response to a follow-up email.)

4 million consist of emergency fund, mutual fund, stocks and the townhouse  in Cebu (subdivision) which actually appraised at 1.3M and its in use (that's where I will live once I get home). My other land is totally small and idle that I did not count it in my asset. I consider my townhouse an asset, though.

My expected expenses is P15k (scrimp) - P25k (splurge). I'm totally used to simple life and would like to live frugally. I am planning to live on my townhouse that I own when I grow old which is situated in Mactan, Cebu or I'll probably move somewhere quiet depending on the cost of living as long as its safe. I'm not maarte :) (Emphasis is mine. - IJ)

Thanks a bunch.


Dear Cory,

Choosing to retire early compounds the "retirement problem" because the longer retirement period increases funding requirement, and at the same time, the smaller earning window makes it harder to meet the higher retirement fund target. It's still possible, though, if one starts saving early enough and earns (and saves) high enough. And from the information you've provided, I think you meet both criteria to a certain degree, we just have to see if you meet the criteria well enough.

It's time to crunch some numbers (since we can't really use the 30-60-90 framework that I introduced a couple of posts back).

Let's start by assuming that your assets will earn just enough returns to be able to beat inflation so that the spending power of your assets is constant throughout the planning horizon. Speaking of planning horizons, the typical end-of-horizon age planners use is 90 years, so let's start with that.

Retirement period = 90 - 28 = 62 years * 12 = 744 months.

Net worth = 4,000,000/744 months = 5,376 pesos per month. Can you live on this amount?

Honestly, 90 years may be a bit conservative since it's well above the estimated life expectancy of Filipinos (or people living in the Philippines?) of around 68 years. If we use 80 years, we get:

Retirement period = 80 - 28 = 52 years * 12 = 624 months.

Net worth = 4,000,000/624 months = 6,410 pesos per month. Better, but maybe still not enough.

Things don't look so good given the above assumptions. But if you subscribe to the concept of long-term passive investing, something like Jeremy Siegel's "stocks for the long run" argument (to which I completely adhere, but that's for another post), then the returns on your assets should be able to reliably beat inflation year-on-year and give your assets more spending power. The question is: how much more?

Click to enlarge

Please consider the timeline at the top of the image above. Say you withdraw an amount X from your assets for your expenses on your first year of retirement. The following year, you withdraw a higher amount, X*(1+g), where g is the average annual inflation rate. You keep on doing this until age 89, where you withdraw an amount equal to X*(1+g)^61.

The sum of your withdrawals should of course be less than or equal to your total net worth of 4 million plus your investment returns, if your assets earn annual average return of i. Then, what would be the largest value of X given that you have 4 million in assets today, your assets can earn an annual return of i, and annual inflation is g? There are several approaches in solving for X, but the most straightforward is to get the present value of the withdrawals and equate it to 4 million using the formula:

The final equation is boxed in the image above.

The average annual inflation rate in the Philippines in the past 10 years is around 4.5% (I thought it would be lower for outside the NCR, but it's not. This figure is for the entire country), so let's use that for g. Let's assume that you'll invest your assets in a diversified portfolio of stocks such that you'll earn the average annual return of the PSEi. I don't have exact numbers at the moment, so let's just use i = 7%, which I believe is a conservative estimate (given that the S&P 500 has had an annualized return of close to 10% in the past 25 years). Solving for X as shown in the image above, we get:

@ g = 4.5%, i = 7%, X = 122,394 or 10,200 per month. More workable?

Of course, higher assumptions for i would further improve the situation.

@ g = 4.5%, i = 8%, X = 149,695 or 12,475 per month

@ g = 4.5%, i = 9%, X = 178,797 or 14,900 per month

You'll notice that this last estimate almost meets your "scrimp" budget, so I think your plan is workable. To make it really work, though, you would have to keep most of your assets in equities so that you'll have a higher chance of beating inflation every year, and beating it by a higher amount. Also, I still strongly encourage you to stick to the DRREW plan--particularly, always have some amount ready for unexpected expenses and get some form of private health insurance.

Finally, you may want to delay retirement for a few years and maybe build up your funds to 5 or 6 million. Try to play with the equation, change 4 million to a higher amount and instead of 60 change the exponent to years of retirement - 1, and see by how much X will increase.

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