As our financial independence date draws closer, I have found the idea of taking the plunge into early retirement an interesting exploration of my risk tolerance. Although information and education can influence one’s thinking, I believe a person’s tolerance for risk is very much a function of who you are. Some people are natural risk takers, while others, like me, at least when it comes to money, tend to err on the side of caution when given the opportunity.
In the early years of our journey to financial independence and retiring early (FIRE), it has been easy for Mrs. Zero and I to put the “retire early” part of our plan on the back burner, thinking of it only in terms of how great it will be to finally be free to spend our time any way we choose. Yes, besides my incessant researching of used sailboat prices, most of our energy has been focused the simple principles of becoming financially independent (1. Increase income, 2. Minimize spending, 3. Be patient).
As it turns out, being risk averse is a huge asset in building wealth. Do I really want to invest in that hot new equity, or would it be smarter to put that dough in a boring, low cost, highly diversified mutual fund? Chalk one up for Mr. and Mrs. Zero.
Preparing Yourself to Manage Risk in Retirement
That is not to say that I haven’t spent a great deal of time planning for the day that we finally pull the plug. I have crunched our FIRE numbers to the point that I know they are solid. But I also know they are decidedly not fool-proof. Shit happens – Significant health issues for myself, Mrs. Zero, or god forbid one of our little Zeroes, getting sued, a major and extended change in the state of the world economies, etc..
These risks are real and have the potential to derail even the best laid early retirement plans.
Although there are no guarantees in life, proactively tackling the potential problems within a plan can improve the odds for success. This is an approach on which I am well-schooled.
One of the reasons that I believe I have been successful in my career as an engineer is that when faced with a decision, my internal dialogue kicks into high gear. I naturally look at the issue from multiple angles and challenge the assumptions that go into the decision process. This probably stems from insecurity and a fear of being wrong, but in my field of work, where the wrong decision can result in a multi-million dollar impact to the corporation’s bottom line, a good imagination for what can go wrong is a strength.
Engineers at my company are trained in various methodologies to assess and manage risk (which provides structure to my neuroses). We are encouraged to document the results of these assessments because “putting it on paper” tends to sharpen the focus and also acts as a way to cover our asses if we make the wrong decision (which everyone does if given enough opportunities).
We most often use the Kepner Tregoe Potential Problem Analysis (PPA) methodology, which first requires identifying potential problems associated with a planned action and then developing preventative and contingent actions to reduce the probability and/or impact these potential problems create.
Since we are now roughly 20 months from reaching financial independence and retiring early, I thought a PPA might further increase my comfort with our plan. Below is a simplified version of the results.
So what did we learn from the PPA?
Besides learning that Mrs. Zero thinks we need contingencies in the event I someday get arrested, the results of the PPA do not contain any potential problems that I hadn’t already considered. That said, it was helpful to perform this exercise jointly with Mrs. Zero, as it was a way to non-judgmentally get all our concerns out in the open.
The PPA was also helpful in forcing us to talk about just what we would do in the event things don’t go according to plan. As you can see, many of the preventative and contingent actions revolve around either going back to work in some capacity or cutting expenses.
The reality is that it would not take much movement in either area to offset a major hit to our net worth.
For example, using the 4% rule, a drop of $500,000 in our net worth would require a cut in spending or an increase in income of $20,000 to offset. Cutting expenditures by 1/3rd would be uncomfortable, but still above our estimated rock bottom spending requirement of $35,000 per year.
I also don’t think it would be difficult for each of us to earn $10,000 per year. Not that it would be my first choice, but a 35 hour per week minimum wage job earns more than $10,000 per year. Additionally, even though I don’t include it in our planning, I think it is highly likely that one or both of us will ultimately end up making some money in our retirement. We both have many interests, hobbies and work experiences that could easily lead to opportunities to make a little money.
Having adequate insurance coverage is another action item that appeared frequently in the PPA. I have already started to research health insurance options, but due to the state of affairs in the US now, it has been a frustrating endeavor. Based on what I have learned and depending on the fate of the ACA, we can expect to pay between $2,500 and $25,000 per year to cover our family of five. Talk about uncertainty! Of all the potential problems with our plan, this is the one that worries me the most. For now, I am watching and waiting to see where Republicans take our health care system.
I haven’t put a lot of thought into the area of liability insurance (car, home, etc..), but given our aversion to risk, I suspect we will approach this conservatively. I would rather cut spending a bit for the peace of mind that high quality liability insurance provides. The cost-benefit of insuring the replacement cost of our belongings is a math problem. Spending my hard earned retirement worrying about the neighbor’s kid breaking their neck in my front yard is a peace of mind problem.
Finally, what makes me most comfortable with our plan is that we will have the benefit of a very large financial buffer between us and the poor house. Even if our net worth was suddenly cut in half, we would still have more than 10 years worth of savings to figure a way out of the mess. Because we are risk averse, you can bet we will trigger contingencies much faster than we probably need to.
“Whatever course you decide upon, there is always someone to tell you that you are wrong.” – Emerson
But seriously, what do you think? What potential problems, preventative and contingent actions would you add to my list?