Saturday, March 10, 2007

Early Retirement and the Cash Flow

Over at Common Sense Financial Wisdom From My Wife, there was an interesting post about early retirement being more about having a cash flow to cover your expenses rather than drawing down your nest egg. I believe the point of the article was to point out that if you have the cash flow to retire early it doesn't matter how long you are retired since you won't run out of money.

This is a bit of dangerous idea when it comes to early retirement planning. Yes you can retire that way, but I'll explain what I mean about dangerous. If you assume that your spending will stay the same for your entire retirement your ignoring some studies which seem to indicate this isn't true. Actually it seems your spending goes down in phases in your retirement years. During your initial retirement you will burn through more cash as you travel and do all those things you been waiting to try. Yet as you get older you can't travel as easy and start to want to spend more time with the family, so your spending drops off. After all how many 80 year olds do you know whom still travel around the world every year?

So your asking, how is the cash flow model dangerous? Well it makes you saving up enough to fund your entire retirement like it's your early retirement phase, you will be grossly over saving compared to your entire retirement spending. The net result, you actually spend more time working than you needed to. After all isn't early retirement, about getting started early?

PS: You might notice that I'm posting on a Sat. when I normally don't do this. Well the fact is I'm generating ideas faster than I can write about them at the moment. So I'm going to give Sat. posts a try for a while and see how it works out. Yet a word of caution about this, I can't tell you when the post will be up on a Sat, since I don't set an alarm on the weekend. -CD

9 comments: said...

Mr. Dream, a Saturday post?? Awesome!

Regarding your post, yes, if you want cash flow to pay for the retirement without touching your capital like Mr. Hubby states, you'll need a very LARGE nest egg.

Perhaps i'll write an analysis on it.


the money diva said...

Good point about changing needs. I always worry more about the cash flow needing to rise, due to inflation. But you are correct in pointing out that expenses do drop due to lifestyle changes, or major events such as paying off a mortgage. The hardest part about planning an early retirement is that the sheer length of it means there are so many variables and unknowns. Some sort of adaptability has to be built in, but I haven't figured out how yet. I think that the answer is hidden in Monte Carlo simluation....

Happy Saturday!

Canadian Dream said...


I'm glad you enjoyed the post.

M. Diva,

That is the true problem with early retirement. Your trying to predict something that by its very nature can't be predicted. It's hard to work with this many variables and it gets worse over a 40 year retirement window.

By the way, the Monte Carlo won't help entirely. It will give you an idea of how you will do based on the past, but it can't reflect the future.

So in the end, you do your best, but your still jumping off a cliff.


Investoid said...

I think the perpetual retirement model is psychologically attractive, from both a safety and a 'live forever' perspective. I agree it isn't the most practical for most people though.

Money Diva: Monte Carlo simulations can help you quantify the risk of falling short of money at certain times, the unpredictability in various factors, etc. but must be done with care (it follows the garbage in garbage out model). Purchasing a program like @Risk is a good place to start if you're a do-it-yourself type of person.

Here's another wrench in the machine, what if you plan not on retiring early, but rather slowly reducing your paid work well into your later years?

Recently Retired said...

Interesting discussion.

There are lots of variables. A fexible plan is also a good stategy. One of the advantages of "early retirement" is that because you are younger you have more potential to go back to work if you find things aren't going according to the plan.

An ideal plan might be one where you continue working part-time at the same salary level and ease into it.

The hubby said...

In the United States, medical costs are much higher than in Canada, so a million dollar nest egg gets burned up quickly in retirement.

And so what if you have too much money in the end? Isn't that the whole point?

And the cash flow model is really not that hard. If you have 200k in stocks, and your stocks grew by 10% every year, you can skim off 20k from your portfolio every year. If you have 2 houses, and you rent out one house for 2200 a month and another house for 1400 a month, and if your house is all paid off, you can net 43k a year off of rent. Add another self perpetual business that generates 3k a month, and you can generate 36k per year. That's a total of 99k per year.

The problem with retiring now is that I have increasing expenses, and I need to keep on generating income. When the expenses start decreasing, that's when the cash flows in. When cash flows in, assets grow. Only then can I retire early.

Middle Class Millionaire said...

“After all isn't early retirement, about getting started early?”

CD – couldn’t agree more…. In my opinion the extra years of freedom/time flexibility that you’ll get from early retirement is worth far more than anything you could buy if you worked an extra 10 or 20 years. (who know in early retirement you might even start posting on Sundays too…)


Canadian Dream said...


You do have a point that medical expense does change the US/Canada model.

But I totally disagree with your point about having too much money being ok. I want to have my cheque for my funeral to bounce. I earned that money, I want to spend it, not have my kid spend it.


Sunday posts?!? No. I like to have at least one day computer free if I can manage it. I spend far too much time in front of these damn things as is.


The hubby said...

I'm not talking about really working. I'm talking more about earning passive income, and not the regular 9 to 5 rat race job. I talking more about collecting rent, earning appreciation, collecting money from your businesses. Even when you retire you still have those as income.

The hubby.