I admit that I’m a fan of unconventional ideas. Whether it’s tiny houses, financial independence, no-car living, or any of the other unconventional lifestyles gaining popularity in recent years. They all interest me.
To be clear — I’m not necessarily going to dive off the deep-end and fully commit to another alternative lifestyle, but I do like how these unconventional ideas make me think.
Unconventional thinking is what helped me reach financial independence by the time I was 38. There’s lessons to be learned and freedom to be found in doing things differently.
Recently, I had one of these unconventional ideas I wanted to share — What if I said “screw the market!” and completely sold off all our assets? Effectively going 100% to cash…
Crazy idea right? This idea happened because I’ve been considering all manner of strategies to protect myself from the next inevitable down market. A downturn is going to happen at some point — stock returns have just been too good for too long!
There are a number of popular strategies I’ve seen people moving to, in order to “smooth out the ride” — Some are pivoting to bonds, while others are moving assets into real estate crowdfunding. All of these are good strategies, but they change the risk profile by exposing the investor to different areas of the economy.
The risk profiles are simply different, and not necessarily “risk free”.
So this crazy idea hit me — What if I completely uninvested every dollar from the market?
If we moved 100% of our liquid assets into cash and lived completely disconnected from the stock market, that’s about as “risk free” as I could possibly get.
Obviously being 100% in cash would protect us from a falling market… but would we have enough money?
Most ‘experts’ state that financial independence requires a portfolio 25 times your annual spending before you can call yourself financially independent. (25x is simply the 4% rule inverted.)
Let’s run my numbers, just to make sure I’m actually FI:
$73,000 annual spending / .04 = $1,825,000 million required for FI
By all the “conventional” definitions of financial independence, using our 2.6 million in liquid assets we could safely call ourselves ‘FI’. We have 36 times our annual spending in assets.
This means if the Tako family we went 100% into cash we would have 36 years worth of spending. Seeing how I’m 40 years old right now, this would get me to age 76. In days long past, that was considered a nice ripe old age.
But it’s no longer 1850. People are living much longer, and it’s very possible I could end-up living well past that age. In fact, I just had a relative die at age 102. It’s a possibile I could live that long.
As technology has improved, so have people’s life spans. I see no reason why this trend won’t continue over the next 30-50 years. Medical science is almost certain to improve while I live out my life.
But wait a minute! We’re forgetting some important facts! $27,240 of our annual spending is actually the cost of daycare. That expense will drop in-half once our oldest son starts kindergarten this fall, and then disappear entirely in two more years when our youngest starts school.
So really, our annual spending is going to look more like this:
2018 — $73,000
2019 — $59,380
2020 — $45,760
2021 — $45,760
Without the cost of daycare, our annual expenses drop to $45,760 in 2020. Considering this lower level of spending after two years, we’ll have enough cash to last us 56 years.
I’d be 96 years old before we ran out of cash! Most of my relatives haven’t lived longer than this, so it’s possible we could go to cash and live out the rest of our natural lives without stock market risk!
Problem #1: Inflation
If only life was that simple! As safe as this plan sounds, isn’t entirely perfect — I’ve completely ignored the fact that when our dollars are not invested they’re not keeping up with inflation.
Inflation has been relatively benign the last decade, averaging 1-2% annually in the United States. Just because inflation is low, doesn’t mean it should be ignored entirely. Inflation has a powerful compounding effect too — in the wrong direction!
If after I factor in inflation (at a constant 2% rate) our 2.6 million cash pile would only last 39 years. Not nearly long enough!
This terrible result is only with 2% inflation! If I consider higher historical inflation rates, there have been times in the past where inflation was MUCH higher. It’s very possible (at some point in the next 50 years) we’ll see inflation rise again.
Problem #2: Healthcare
The second big issue with this scheme is healthcare. Currently our healthcare costs are pretty non-existent. We’re healthy people, and spend very little on healthcare annually.
As far as actual health insurance coverage goes, Mrs. Tako’s employer covers our family… right now.
At some point, Mrs. Tako will eventually quit her job. Maybe in 5 years, maybe in 10… it will eventually happen. This means we’ll have to start purchasing health insurance. Our expenses will grow beyond the $45k point as a result.
(I explored this idea last year, just to determine what a health plan off the exchange would cost us.)
For the purposes of this blog post, let’s assume Mrs. Tako quits her job in 5 years. At that point, we’ll purchase health insurance on a exchange. and it might costs us $1000 per month (which is insanely high… but whatever… this is a thought exercise).
Our annual expenses would then grow to $57,760.
When inflation, healthcare (and the lack of daycare) are factored in, our cash pile only lasts 34 years. Technically that’s still considered financially independent using the 4% rule, but it doesn’t sound long enough to me.
Problem #3: Life Happens
The next big problem with the plan, is that life can be completely random. Big things can change. I have no idea if my expenses are going to be $45k or $73k in the next 20 years.
What if our roof needs replacing? That’s a huge expense (probably over $10,000) that would blow our estimated annual expenses in any given year. The same goes for the cost of a new car, or even emergency medical treatment.
I can’t predict when and where these random expenses are going to happen, but they will! So we saved extra to deal with it.
This, plus inflation and the cost of healthcare has us looking at only 30-ish years of expenses when living off cash.
That isn’t nearly enough if I consider the longevity advantages of financial independence…
So, I’m calling this “all cash” idea a bit of a bust!
What About Alternatives?
The point of exploring unconventional ideas like these, is really about learning. Under most circumstances I would never move my family into a 200 square foot ‘tiny’ house, completely give up our cars, or try to live out the rest of our lives with only cash.
But these kinds of questions lead to interesting possibilities — What if we moved into a smaller house? What if we sold one car? Or, what if we sold all of our stock investments and moved into a ‘safe’ asset class like bonds?
Bonds are touted as a safe alternative, and could be a good place to store our assets. Holding one of Vanguard’s bond funds for the next 30-50 years would probably earn us average annual returns in the range of 2%-4%. This might cover the devastating effects of inflation on our portfolio performance. But would it be enough?
Under most circumstances a low cost bond fund would probably get us close to 50 years worth of living expenses. That’s probably enough for most lifetimes.
After age 90, I don’t expect we’ll be spending a lot of money on travel, clothes, or even our kids. Life really slows down at that age.
While this thought exercise has been fun, I doubt we’ll shift our assets completely to cash. Despite having significantly more than the 4% rule requires, we probably don’t have enough assets to live out our lives without investment returns…
Even at 36 times our annual spending, our financial independence requires returns. They don’t need to be big returns, but they should exceed inflation. Will the stock market do that?
Most experts (including Jack Bogle) expect future stock market returns to be significantly lower than in past decades. (And let’s not forget that the past is where the 4% rule was written) These experts believe stock market returns of 4% are likely, which doesn’t leave a lot of room for compounding if you live off the 4% rule.
This is one of the reasons why I typically espouse withdrawal rates lower than 3%. Even if the market crashes tomorrow, as long as we can find a way to generate returns close to or exceeding our target withdraw rate of 3%, we’ll be able to live a comfortable life well into our 90’s.
What do you think? Is an all cash portfolio a viable way to cut market risk?
[Image Credit: Flickr]