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Why You Need A Budget

You Need A Budget – It’s About Time!

In a previous post, I mentioned that I need just over $3 million in order to achieve Financial Independence and maintain my current lifestyle. This equates to $7,000/month in today’s dollars at a 3.75% Safe Withdrawal Rate (SWR). This is a rate I feel will be able to sustain me for a long retirement as compared to the traditional 4% SWR, especially in this low interest rate environment.

But how did I actually know my expenses would be about $7,000/month? By budgeting of course! Budgeting allows me to track my expenses so I know exactly where each dollar is going and allows me to make an accurate forecast of what I’ll need in retirement. It also allows me to identify unnecessary spending and identify areas that can be cut. If you don’t have a budget and rely on “mental accounting” to get you by, I’m afraid I have bad news: you won’t be able to achieve FI. At least, not easily since you’re just guessing and that’s no way to plan.

You won’t be able to achieve FIRE without a budget.

To start budgeting accurately, you’ll need to track where your money is going. You can certainly do this by hand or in an Excel spreadsheet, tracking and categorizing where every expense goes. But this is tedious. I highly recommend that you take advantage of tools that allow you to do this automatically. Two free tools to help you here would be Personal Capital or Mint. They allow you to link up your checking account & credit card accounts and pull in transactions automatically. Then it’s a trivial matter to build a budget off it. Yes, you do give up some privacy for this but I think it’s well worth it. Of course, you can pay for budgeting tools that may alleviate any privacy concerns you may have but for me, the free tools are fine. I would personally suggest Personal Capital over Mint as I’ve had issues with linking & syncing on Mint.

For most people, their expenses will naturally fall into several big categories: housing + associated expenses, utilities & recurring monthly bills, insurance (auto, life insurance, long term care insurance, and most importantly health insurance), food costs, and lastly other expenses. How you group these expenses is completely up to you. As a single person, I put food in the “Other” category and kept travel as a separate category altogether so I can easily track it. I would suggest these major categories and sub-categories:

Main CategorySub-Category
HousingMortgage or Rent
Property Tax
Homeowner’s or Renter’s Insurance
Maintenance, HOA + other fees
Bills & UtilitiesElectric & Gas
Water & Sewer Fees
Trash Fees
Mobile Phone plan
Cable & Internet
Netflix + other streaming services
InsuranceHealth Insurance
Auto Insurance
Life Insurance
Long Term Care Insurance
OtherTravel
Food/Groceries
Auto Related Expenses
Clothing
Eating Out
Entertainment
Education
Personal Care
Other Services + Spending
Suggested Budget Categories
Downtown San Diego Skyline – Raychel Sanner

The main reason that I need a comparatively large nest egg is that I live in a High Cost of Living Area (HCOL) in San Diego, CA. According to Kiplinger in July 2020, San Diego is the 7th most expensive city in the United States, ahead of cities like Los Angeles, San Francisco, Boston & New York. You can argue with their methodology but I suspect they’re taking account not just raw cost but also income. San Diegans call this the “sunshine tax”. You’re going to pay to live here!

By far, the largest cost you’ll have to bear is housing cost. While San Diego is rated as the 7th most expensive city, in terms of median home price, it stands at 15th. According to Zillow, the median home price in San Diego, CA is $644,000 as of August 2020. That factors heavily into my budget. Housing prices have a direct influence on rent, so the more expensive houses are in a city, the more rent will be as well. My caution here is to make sure that you include all costs associated with owning a home if that’s your plan. Big ticket costs will be property taxes and maintenance. You’ll have these costs even if your mortgage is paid off.

Riccardo Annandale

Next would be your utilities and recurring monthly bills. Expenses in this section would include electricity & natural gas, water and sewer fees, mobile phone plan, cable & home internet, Netflix & other streaming services, and any other recurring expenses you think you’ll incur. Astute readers will note that my electricity & gas cost is low. The reason for this is that I have a paid for solar system that generates all the electricity I need.

Insurance would be my next major category. Within this, I only have auto insurance and health insurance. Others may wish to include life insurance and long term insurance as well. A note here on health insurance: as we’re part of the FIRE movement, there is a desire to retire early, whether it’s one year or one decade. If you do truly retire early without part time work that may provide health coverage, you’ll have to buy your own. Health insurance when purchased without any subsidy is expensive. Plan on paying at least $1,000 per person per month. This includes premium cost as well as out of pocket costs. Healthcare is broken in America and will only go up. It’s better to overestimate here than underestimate.

Sergey Pesterev

My next major category only has one item: travel. The reason for this is my desire to retire early so that I have the physical ability to be active and do what I’d like. One of these activities is to travel. It’s another category where you should not underestimate the cost. I’m budgeting $750/month or $9,000/year. That’s a lot but when you take a step back and realize that a trip to Europe can easily be $3,000 – $5,000, this will afford you 2-3 trips a year. Domestic traveling will be cheaper of course and you can hack your way to cheaper traveling, but it won’t be cheap. This is another area as you’re doing your own budget that can be cut down if can’t afford it. My expectation is that travel costs can be quite large the first 5-10 years of my own retirement and should then subside as I get the travel bug out of my system.

Last but not least is my catch-all category – Other. I did something here that may look odd: I put food/groceries in other. It works for me since I’m single, but for couples or those with dependents for one reason or another, groceries may be a big expense and may warrant its own main category. Aside from this caveat, other expenses that would go here include auto expenses (maintenance reserve + gasoline), clothing, eating out, entertainment, personal care, online services (cloud subscriptions for example), and any other expenses.

Here’s my actual budget based on carefully tracking my spending over many years and building an accurate budget off it. Only once you have an accurate picture of your expenses can you then calculate the nest egg that would generate the income need to cover these expenses.

My retirement budget

Once you have a reasonable idea of what expenses you’ll incur in retirement, then you can go about calculating your nest egg. You’ll most often hear about the “4% Rule” or as I like to call it, the “4% Rule of Thumb”. This would suggest multiplying your annual expenses by 25 in order to get to be able to withdrawal 4% a year and hopefully have your money last your entire retirement. Some argue you can go higher and others say you should go lower to be safe. One of the biggest risks you can face once you’ve accumulated a nest egg and begin withdrawing from it is sequence of return risk. It basically says that if you’re unlucky enough, you’ll encounter a number of dramatically lower return years early in your retirement. This will make it very difficult to sustain that 4% withdrawal rate. But it’s a personal decision you’ll have to make yourself. I’ll write about it in detail at some point in the future. For me personally, I’m aiming for a 3.50% Safe Withdrawal Rate and that would require a 29 times multiplier. Here’s a table outlining some SWR and their multipliers. Just select the rate you’re comfortable with and multiply your annual expense by the multiplier:

Safe Withdrawal Rate (SWR)Nest Egg Multiplier
5.00%20.0 x
4.75%21.0 x
4.50%22.2 x
4.25%23.5 x
4.00%25.0 x
3.75%26.7 x
3.50%28.6 x
3.25%30.8 x
3.00%33.3 x
Safe Withdrawal Rate and their Nest Egg Multiplier

I hope that I’ve convinced you that you need a budget and have given you some ideas on how to go about it. If you’ve hesitated previously on establishing a budget, you should take the opportunity to set up one as an essential step on your FIRE journey. If you have any questions, feel free to drop me a note. Good luck!

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Investments I’m Currently Holding

Last time I promised to share my individual holdings and here we are! Many people in the FIRE movement choose to invest in index funds which is essentially a “set it and forget it” process. That is fine for most individuals who are not willing to put in the time to select individual securities. I opt to do the extra legwork in hopes of a better return. Without further ado, here is my current allocation by investments (as of the close of market on September 4, 2020):

Courtesy of Dmitry Demidko

Cash
As before, my largest holding remains cash or cash equivalent (e.g. federally backed money market funds) at 40%. I would love to increase this to 50+% but am unable to do so at this moment due to trading restrictions. Holding cash in a time where equities are over valued is smart and allows me the resources to make a move when opportunities arise. When they come is anyone’s guess but I’ll be ready when they do!

MSFT – Microsoft Corp.
Microsoft is my next largest holding at 18%. This is higher than I would like to be given that tech has had a tremendous run up and are trading at stratospheric valuations. Microsoft has done well for me, returning over 500% since I’ve bought it as Steve Ballmer was turning the reins over to Satya Nadella. Everyone was down on it at the time for no good reason and I was able to pick it up cheap.

AAPL – Apple Inc.
Apple remains a core holding in my portfolio even after its tremendous run up and some profit taking by yours truly. Still, it forms 8% of my portfolio. I bought it cheap, it has a lot of cash on hand, almost no debt, and despite being very expensive at the moment, it remains a long term hold for me.

ABBV – AbbVie Inc.
Aside from Tech, I’m big on healthcare and AbbVie makes up a big portion of that. They have great valuations, good drugs (Humira), and a healthy dividend that I re-invest along with a lot of capital growth. It has done very well for me and I continue to hold it at this valuation level, making up 8% of my portfolio.

XLE – S&P Energy Select Sector
This ETF tracks the S&P Energy sector and has a lot of oil companies such as Exxon Mobil, Chevron, BP, etc. Oil has been beaten down a lot in 2020 and I think it’s a great buy. I doubled up on my holdings and it makes up another 6% of the portfolio.

BTI – British American Tobacco
It’s a sin stock but generates a lot of cash. I used to hold other tobacco stocks as well but now it’s down to just BTI at 5% of the portfolio. I came to it via RJR when BTI bought it out. At some point I may move out of this sector completely but at the moment it’s cheap, pays a great dividend, and does provide me with non-U.S. exposure.

REM – iShares Mortgage Real Estate Capped ETF
REM is a REIT holding company and comprises a bunch of REIT’s. I had wanted more exposure to real assets and decided to pick up REM before the COVID-19 crash. It has not recovered, unlike other sectors but I’ll continue to hold it since I see no reason to sell. It makes up 5% of my portfolio.

JNJ – Johnson & Johnson
Another pharmaceutical stock, this one has also done very well for me. Despite a setback in court in regards to an opioid judgment, I still think it’s a good stock for the long run. The company is sound and continues to generate profits. It contributes 3% to my portfolio.

Other
The rest are too small to mention individually, but for the sake of completeness, I’ll list them out here. They include: PFE, TLT, COP, NRZ, and OMC. Of these, I’d like to get out of OMC, COP, and PFE at some point but now is not that point.

So there you have it. Those are all of the individual holdings that I have in my portfolio. The count is currently 12 holdings (aside from cash) and that’s not quite enough to be well diversified, but it’ll have to do for now. Previously I had other stocks in the mix before I liquidated to cash to take advantage of high valuations to rebalance. Those stocks included issues such as Baidu, Facebook, and others. I will re-deploy my cash into the market when I can find companies that a value to buy. There are none that fits my criteria at the moment but perhaps when the NASDAQ/S&P 500 corrects by another 30% from these levels, I’ll move back in.

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My Portfolio Allocation for August 2020

In the beginning of August, I made a pretty drastic change to my portfolio’s allocation. The main result of this move is that I’m now 40% in cash, with the rest of the portfolio spread across big tech, healthcare, energy, REITs, and consumer staples. I would have preferred to be 50+% in cash, but due to certain restrictions, I couldn’t quite get there. But this is close enough. Previously I was 100% invested in equities, so this was a pretty big move for me.

Unlike most of the people pursuing FIRE, I’m not in index funds but own individual stocks. I find that with a little work and the right opportunity, you can get superior returns. Some of my big wins have been in Apple and Microsoft, both of which I bought a few years ago when short term bad news made them bargains. Additionally, I focus my allocation on sectors rather how much I should be in stocks vs. bonds, large vs. small caps, domestic vs. international.

Apple Logo – Laurenz Heymann

At the time, they made up 5% – 7% of my portfolio, which was a very reasonable amount for an individual stock. Over the past few years though, they’ve gained some 400% and 500% respectively. Along with more modest gains from other stocks, I found that my tech stocks were now making up a much larger percentage of my portfolio. Apple and Microsoft alone made up over 50% of my portfolio. That introduces a new risk, called concentration risk. It’s similar to putting all of your eggs into one basket. After the move, my portfolio looks like this:

Even though I’ve liquidated most of my tech holdings plus a few other stocks, 26% of my portfolio is still in tech stocks. Coincidentally, this mirrors the tech stock % in the S&P 500 (although to be fair, some stocks like Google are not considered tech by the S&P folks but rather communications services companies).

Microsoft – Matthew Manuel

I’ve not abandoned tech at all, as I do believe that it’s the next revolution to drive us forward. Rather, this move was to get things back into balance. Since I also think we’re long overdue for a correction, I want to have cash on hand to move back in when the opportunity presents itself. I’m also a believer in the healthcare sector as I think it will continue to grow.

In future posts, I’ll discuss the individual positions I’m currently holding and what will make me move back into equities 100%. Stay tuned!