The world is too much with us; late and soonGetting and spending, we lay waste our powersLittle we see in nature that is oursWordsworth The World is Too Much With Us
Reading the signal flags
As the journey progresses, some questions are increasingly pushing themselves forward. Questions such as: what does achieved financial independence look like in practical day-to-day terms? Will I recognise it when I see it? The answers to these questions will help recognise the length of the journey still to travel, and the signposts of arrival.
Over the last few years I have been recording my credit card expenditure, and more recently, have started comparing this against the income produced by the portfolio. This is on the theory that if my investment income matches or exceeds average credit card charges each month, then at one level some variant of FI has been achieved (is “credit card FI” copyrighted?). In July I mentioned this, and provided a snapshot. This post seeks to dig deeper into this data, to better understand where I am from a different perspective.
The portfolio goals I am working to are built from target incomes, which are then translated into lump sum targets, using an assumed average return (of 3.92%). Each month I report a percentage progress towards these goals. Currently I’m about 95 per cent of the way to Objective #1 and 70 per cent of the way to Objective #2.
There are some interesting subtleties to bear in mind in using a percentage based measure of progress, that are well discussed here. The goals also have a time frame based on progress to date, which means, for example, that I noticed the other day I was officially only around 100 days from Objective #1.
Each of these are useful measures for understanding progress, but at its most basic, financial independence is having a steady passive income sufficient to meet required daily expenses. There are different variants of this concept, with ‘leanFIRE’ and ‘FATfire’ referring respectively to a capacity to meet a modest, if not minimal lifestyle, or the capacity to live a relatively unconstrained, comfortable lifestyle from passive income.
Constant bearing, decreasing range
To better understand the answers to the questions above, I have stepped beyond credit card expenses records, to look at total expenditure from all sources. This includes items such as rates, energy and utility costs, day to day cash, as well as contributions to irregular major expenses such as holidays, house and car repairs, as well as eventual car replacement. It does not include income taxes.
This record has never focused on frugality of living expenses, or detailed expense analysis to a significant degree, and will not start doing so now. Rather, what I sought to understand was an estimated total cost of maintenance of my current lifestyle. Over the past few years my total credit card expenses have averaged around $72 600 per year. Adding all other expenses not paid by credit card ($24 300) gives a total current expenses of $96 972 (or around $8 081 per month). The figure below sets out a ‘credit card only’ and a ‘total expenses’ series against an averaged measure of monthly portfolio distributions. The green line effectively represents actual credit card expenses, added to an equal monthly contribution of other non-credit card expenses.
This shows that while on average portfolio distributions have been around equal to credit card expenses since the middle of 2017, there is still some further progress before portfolio distribution can regularly meet total current expenses. As that is a quite busy graph, I have produced a simplification of the same data, expressing instead the proportion of total expenses being met by portfolio distributions over time.
This data, and the trend line, shows steady progress through the last five years. Distributions have risen from meeting only around 20 per cent of expenses, to now meeting around 80 per cent. On current trends, it would appear that the next several months could see it passing the point at which annual distributions regularly fully meet my current lifestyle expenses.
Summary – Running before the wind
By definition, this log can only be a record of what has been. There are dangers in linear extrapolation on any course. For this moment, progress seems relatively steady and consistent beneath month to month market variations.
Yet there are a few cautionary points to observe:
- Right target? My current estimated total expenses are above those assumed in my portfolio goals ($96 000 compared to $80 000 per annum), potentially implying the latter need to be revisited.
- Irregular estimated expenses – The total expense estimate is influenced by some broad estimates of major but irregular spending requirements, which could turn out differently than expected.
- Both income and expenses are variables – while portfolio income has been mostly stable over the long-term, there can be large variations in half-yearly totals. It is not impossible for future periods of higher expenditure to coincide with lower portfolio income.
The answer to the questions I posed may well be that I will not immediately recognise the cross-over point, that I will need to actively monitor for it. In the immediate term, it’s possible I will drift into a position in which notionally my entirely ordinary salary income is available to add to the portfolio, increasing portfolio growth strongly. This is an intriguing and motivating part of the mathematics of long-term portfolio investment.
As the portfolio reaches towards full expense replacement, there is a duality. Amongst steady but small changes and weekly habits it feels as if an inflection point, or some form of phase transition is creeping upon the stage. The task is to measure, notice, reflect and act on the result.
Great write up, I always enjoy your visual representation of the data. I must say I was alarmed at your total annual expenses. Does this include paying down a mortgage or are you renting?
Also I am interested in your thoughts on using a credit card for all of your expenses. What is the logic behind this? I’ve seen others note a few reasons, such as:
– Using cash to generate additional interest income
– Providing a safety net against fraud (banks money not yours)
– Ease of tracking expenditure
– Points/rewards
For me this all makes sense but I would need to exercise greater self control than I have in the past to ensure I don’t over spend.
Thanks Path to Fire!
I’m not alarmed, it was essentially what I expected. It includes some housing costs, but expenses are quite specific to personal circumstances, and I’d rather focus my this blog elsewhere.
Good question on the credit card. I agree with those reasons, and have paid of my card automatically for a long-time. So it’s essentially an ease, and (small) incidental rewards from time to time driven decision.
Great post and a clear and practical way of reviewing your progress. Maybe a few months (6-12) of sustained performance (>100% of total expenses) is needed to ensure you have a sufficient buffer and able to sustain periods of low investment performance/higher expenses.
Thanks for the feedback Wildgoose! Yes, I agree. A dark part of me half wishes that GFC2.0 would just come already, so I could see the portfolio and distribution impacts and effects already (and potentially invest at a lower cost base). 🙂
Nice post as always. I like how you are aiming to maintain the same lifestyle however once FI are there things that might drop off your expenses? And if currently paying a mortgage or planning to buy has that also been taken into account in the above? Thanks
Thanks J.D! It has been taken into account, I’ll be in a ‘steady state’ assuming no housing change after.
It feels such an unknown. I can plausibly imagine day to day expenses going both up, or down, after FI…
Another great post, thanks for sharing!
With regards to the issues of using a percentage based measure of progress, presumably the goalposts shift from the absolute value of your portfolio to the dividends it produces? From your post I’m assuming that you’re calculating dividends based on a percentage of your portfolio, but in earlier posts you’ve mentioned that your realised dividend income is actually higher. Perhaps a better way of measuring progress toward your goals would therefore be to used realised income rather than deriving it from portfolio value? Or am I just making too many assumptions and over complicating things?
Also given the non linear nature of compound interest, although there is still a reasonable gap between your calculated income and target income, presumably you are actually only a few years at most from hitting both goals?
In any case, congratulations on doing so well with your FIRE goals! It’s an inspiration to me and presumably plenty of others!
Thanks for the kind thoughts and good questions AussieHIFIRE.
Yes, do read the linked article, there are some really useful and engaging concepts in there, for example, about an absolute target misleading through time, and fostering either complacency or undue worry, depending on market movements and timing.
Correct, I have typically calculated dividend income (median 4.4%) based on the average portfolio level over the period. Note that my portfolio is not fully invested in income producing assets (I’m looking at you, Bitcoin) so that is another thing to consider in terms of performance departures over time, i.e. misalignment between actual and assumed portfolio allocations. Ratesetter would be another asset that it producing higher than assumed in my benchmark allocations and returns estimates.
I agree, I think the last couple of posts have been me grappling with exactly the idea you’re discussing – measuring progress my actual passive income received, rather than total amounts. I do like the concreteness of a total “number” goal, but I will give this further thought. And I’ll have data point on the same issue in my Monthly Portfolio Report tomorrow! 🙂
I think it’s one of those things where there isn’t a correct answer, or at least not in all scenarios.
If you use income calculated from amount invested, it ignores non income producing assets. If you used realised income that’s maybe better, but how much of that is realised capital gains that you shouldn’t be counting on? Even if you go for just dividends from the underlying investments of LICs or ETFs some of those dividends are likely to be cut in a recesssion. How much would they be cut depends on what the cause of the recession. Is it a commodity price crash, is it a property crash, is it a credit squeeze, and so on and so forth. There’s just no way to know.
One of the good things is that dividends do tend to be less volatile than share prices, but they can and are still cut as per my posts on the 4% rule and on sequencing risk, dividends and retiring at the end of a bull market.
So as I said and as you’ve obviously realised, there isn’t a correct answer 100% of the time. If it makes you feel any better I’m planning on a pretty similar strategy to yourself so at least at some point in the future I’ll hopefully be in the same boat as you!