Thursday, November 25, 2004

Don't talk too much about your plan

When I first started this blog, I tried to publicize it a little bit by posting on some forums. I did receive three kinds of comments:
  • "go for it", "good luck", "I do the same", "Hope you'll succeed"
  • "you're full of s***!", "do your homework!", "you surely haven't considered inflation!"

In a post in which I said that when I tell relatives about my plan, they doubt much, someone told me not to talk about my ER plan to relatives (unless they do also have such a plan). More recently, another person on a forum told me I would have to fight naysayers. I agree with them.

Don't talk about your plan too much to your relatives. Some reasons:

  • They'll try to make you believe that your lifestyle is ludicrous. On the other hand, if you don't tell about your ER plan, they might never notice your frugal lifestyle.
  • If you fail and must retire a year later, they'll be happy to ensure you remember when they told you it couldn't work.
  • Some people can even laugh at you and tell about your plan to other people. You would need even more courage to try to convincing them your plan can work.

So stick to your plan, don't be discouraged if, from time to time, the figures doesn't work as planned, make adjustements, don't talk about too much people around you about your plan and good luck!

Friday, November 19, 2004

Inflation is the early retiree’s biggest enemy

As time goes, the cost of living increases. Actually, this is not really true: prices are increasing, but wages generally increases at the same rate or, hopefully, at a higher rate (when this occurs in a society, it is getting richer).

As prices are increasing, you will need to withdraw more money from your portfolio after retirement. How much more? It is difficult to tell. It depends upon many factors: health of the economy, interest rates, natural disasters, international events, etc.

Year to year, indexes permit the assessment of the increase of the cost of living: these are averages taking into account a basket of goods and services. The most common one is the CPI: the Consumer Price Index. Typically, in the US and in Canada, the CPI increase between 2-3% each year.

However, be aware that this CPI is for a basket of goods and services that does not reflect your own expenses. For instance, the CPI is calculated using many components that are weighted to reflect their relative importance. Thus, food price weighs more in the CPI than travel fares. For instance, in this document: http://www.bls.gov/cpi/cpiri2003.pdf, each CPI’s component is provided along with their weight in the index for many US cities.

How to deal with inflation in your retirement plan
To plan how much money you need to save in order to retire, you need to take inflation into account. Most calculators suggest entering an average value for inflation (say 3%). Thus, each year, you would withdraw 3% more than the previous year.

However, the real inflation that is relevant for you is the annual increase of your budget. It doesn’t matter if, for instance, cigarettes price has increased 10% that year if you don’t smoke.

Personal inflation assessment technique #1
To assess how much prices have increased *for you*, I think the best way is to compare your actual budget with that of the previous year. There are two components in your budget changes:

· Inflation (same items or services cost more than before)
· Increase or decrease in expenses (for instance, you travel more than before).

While you don’t have any control over inflation, you have some control over your expenses. Thus, try to make sure that your budget doesn’t increase more than what you planned in terms of inflation.

Personal inflation assessment technique #2
Technique #1 has some benefits: it really takes into account the increase of your expenses from one year to another. However, it has a major drawback: your budget may be quite different year to year for many reasons. For instance, you may have to replace your old car. You may also have some home repairs. For this reason, I think that you should also use the CPI. For instance, if a given year the CPI has increased 3% from the previous year and that your budget has increased 4%, you can estimate that you spent an additional 1% “new money” that year. If it is the case and if you planned a lower increase in your retirement plan, you’ll need to make some adjustments the following year.

The best estimate of your personal inflation would be to split your budget into CPI components, along with their respective weights in your budget and to calculate your own CPI based on the data provided by the government for each component. Thus, if electricity makes 5% of your budget, you will be able to reflect the inflation for this component into your budget. The overall CPI provided by the government is a much more general measure which might not reflect your consumption habits. However, doing that is quite complicated and you need to be much disciplined to use it. At least, if you use the official CPI, use the figure for your geographical area.

Bottom line
Inflation should be taken into account in your ER plan. Actually, it is the most important pitfall that could break down your plan. If some year your expenses increase faster than what was planned, make adjustments (remember, you don’t have control over inflation, but you do over your expenses).

Saturday, November 06, 2004

Determine a date on which you plan to retire

How many years before you retire?
So you’ve decided to take the leap. You plan to retire early. First, I think you should set a date for this. Setting a date for your retirement plan will have you adjust budget, savings, investments, etc., in order to be able to get retired by that date. If you don’t do it, you might be tempted to procrastinate. For your plan to succeed, you need to stick to it.

Be conservative; add an additional year of work to your plan. If things go as planned, you will be able to retire even sooner, giving you satisfaction and reward. If things go wrong, this extra-year will allow you to make some adjustments by adding up to a year of savings instead of a year of withdrawal, which is why one year make such a large difference in a retirement plan.

Stick to your plan
It is important to stick to your plan. It is possible that the stock markets are going to skyrocket two or three years before you retirement date and that you would be tempted to retire sooner. Don’t. Many of those who retired sooner when the market was high in 2000 had the bad surprise of seeing the value of their nest-egg decrease much (if they held stocks or stock-like investments) in 2001. Don’t forget that the investment return estimates are based over a long period of time, so don’t feel too rich if for some years your portfolio gets higher than expected. First rule: retire at the date you planned, if you can. Second rule: if you don’t apply first rule, retire when the market is low. Thus, you are more likely to really have enough money to retire and there are some chances the market will get back on track when you will start withdrawing money from your portfolio.

Choosing the best part of the year for you to retire
Now that you’ve decided in how many years you want to retire, you have to choose a date. Is it better to retire in December or in June? My suggestion: retire at the beginning of the summer, say June 1st.

First, retiring during the summer will have you enjoy summer days as your first retirement days. This might have an important benefit on your moral, since retiring will be a major change in your life. It can be very stressful for many people. Retiring in the summer will also allow you to have time to be with your relatives (who will have job vacations). Take some good time, thinking about your projects to come, enjoying your new life, etc. Reward yourself for the frugal lifestyle that led you to this achievement.

Many projects you might have will likely begin at the end of the summer / beginning of fall: going back to school, getting a part-time job, volunteering, etc. Retiring during the summer will let you with time to prepare these projects and to decide what you want to do.

There may be a fiscal benefit by retiring June 1st. In the US, Canada and many other countries, tax rates are progressive: the more you gain, the more you pay as a percentage of your personal income. Each progressive step in the tax rate system is named a bracket. For instance, the first $0-$20k you earn might be taxed at 20%, while the part over $100k could be at 35%. The actual value depends where you live (country and state or province).

If you retire in December, you’ll have worked the full fiscal year, thus your personal income for that fiscal year will be that of your salary, say $60k (plus investments returns not tax-protected). However, if you retire in June and don’t withdraw from your IRA or RRSP, your income for the year will be less than $30k. Instead of being taxed at the higher bracket, you will be taxed at a lower bracket. Thus, instead of working for the government, you will have worked a little bit more for yourself. Instead of earning a net $20/hour after taxes, for instance, you will earn a net $30/hour that year.

In Quebec (Canada), people get an additional benefit if they retire halfway during the year. This might also apply to you if you have an employer plan (401k). In Quebec, RRQ is a public Pension Plan. All workers must contribute to the plan if they earn more than $3500. The contribution is set as a percentage of income, up to a maximum. This year, the maximum is $40k. How much you will get from the Pension Plan depends upon the number of years you have contributed to the plan and your average income. But for any year, the income calculated in the average cannot be over $40k. That is, if you earn $80k in a given year, only $40k will be used in the average. Thus, if you retire in June, you’ll add almost a full year of contribution to the plan (depending upon your annual wages), increasing the amount you will obtain when you reach 65, even if you work only a few months that year.