After more than nine years of early retirement, I realized I made a serious mistake that cost me $500,000+. Let me tell you what happened so you don't do the same. The biggest financial mistake early retirees make are often realized until way after the fact.
Estimated Passive Income In Retirement
When I left Corporate America at the age of 34, I thought I was done earning more money for good. Below is the income budget I put together in 2012 to support us for the rest of our lives. Expenses are not listed because we've never spent more than we've made.
Our base case retirement income scenario was to make $78,000 gross or $54,600 net a year in passive income and live a simple life back in Hawaii for the rest of our lives. If things went really well in the stock and real estate markets, we calculated an optimistic annual passive income scenario of $117,600 gross and $94,080 net.
Related: Which Is A Better Investment: Real Estate Or Stocks?
At the time, we were probably spending about $100,000 a year to live in high cost San Francisco. By moving to a paid off house in Honolulu, we'd have no problem living within our means with a child on a much lower income.
Flexibility To Earn More In Early Retirement
But if we did have a problem living on less or wanted to live it up more, we had fallback options through Active Income and Bonus Income. These were also divided into Base Case and Blue Sky with $15,000/month and $50,000+/month gross totals, respectively. It's always fun to dream about what could be.
If you're wondering about the line items in the Bonus Income column, those are all the things I already had, but didn't count on to make anything extra. For example, my Rich Hot Spouse was there to provide the love she has always provided. Anything more and I classified it as utopia. Aww.
Today, we still live in San Francisco and I've done all the things listed in the Active Income chart. Although my income grew in retirement, I did NOT change my investment risk profile. This was a major mistake because a major bull market ensued.
Early Retirees Should Invest With More Flexibility
If you retire early, know that you have the ability to make more money than you could ever imagine working a full-time job. This surprise is the biggest reason why the fear of running out of money in early retirement is completely overblown. If you have the wherewithal to retire early, you have the wherewithal to lock down your expenses or make a killing pursuing a dream.
From the years 2012 – 2014 I was stuck with a “4% mentality.” In other words, if all I could earn was 4% a year on my retirement nut, I'd be happy because at this rate, I'd never touch principal. By not touching principal, I could leave some money to people in need after I die.
Because of my complacency and fear of having to go back to work, I proceeded to invest much more conservatively than I should have. As a result, my public investment portfolios comprised of stocks and bonds underperformed the S&P 500 by several percentage points per year. For reference, the S&P 500 was up 13.5% in 2012, 29.5% in 2013, and 11.4% in 2014.
Therefore, my biggest financial mistake as an early retiree is investing to conservatively.
Yes, I know I shouldn't compare a stock/bond portfolio only to the S&P 500, but I like to compare my performance to the top performing asset class of the two to feel the pain. I always have a choice to go 100% stocks or bonds.
Despite my public investments comprising only ~25% of my net worth, I was still unable to invest aggressively like a 28 year old who has only seen a bull market. I kept reminding myself of the Asian Financial Crisis of 1997, the dotcom bubble of 2000, and the housing implosion of 2008-2009 as reasons to stay conservative. The first rule of financial freedom is to not lose money. The second rule of financial freedom is to not forget the first rule!
Lessons #1 From The Biggest Financial Mistake As An Early Retiree
Just because you close your eyes doesn't mean the world can't see you. When investing, try to think beyond your own financial situation. The stock market doesn't care if you are retired. What it cares about is corporate earnings growth and profitability. There are always companies to invest in which because of different phases in their growth cycles can offer much greater returns. Projecting your own financial situation onto other investments may adversely affect your returns.
In Spring 2014 a catalyst for change happened. My 7 year, 4.1% yielding CD was finally coming due and I had to put the money to work. Originally I was going to just reinvest the proceeds in another 7-year CD, but the best 7-year CD rate I could find at the time was about 2.2%. Disappointed, I decided to look elsewhere.
After seeing Blue Sky income growth, I realized that my base income assumption of $78,000 – $117,600 a year in retirement had been too conservative. Thus, I decided to do a 180 and aggressively leverage up. Specifically, I took on a $1 million mortgage to buy a $1.24M fixer upper in Golden Gate Heights while already carrying a $1 million mortgage for my primary residence.
Risk Exposure Is Off
Think about how egregious this move was from a risk management perspective. What I did was akin to buying $1.24M of one stock on $1M margin. If the stock went down 20%, I'd be wiped out. I suddenly believed I was some invincible hot shot who couldn't miss. Yet I had no job, just a feeling that my online business would stay at an elevated level.
The last time I made such a move was back in 2007. Not only did I lose all my vacation property equity a couple years later, but I also suffered through a 50% income haircut as company bonuses were slashed. It's funny how after a long enough period passes, we dismiss our mistakes.
With this new home purchase in 2014, I figured I could make up for my underperformance the previous three years. To do so, I'd take on leveraged single asset exposure risk. Meanwhile,I already had three other properties in the SF Bay Area.
It was only through luck, some self-published propaganda, and a bit of foresight that Golden Gate Heights and the western portion of San Francisco turned out to be a region in high demand three years later.
Lessons #2 From The Biggest Financial Mistake As An Early Retiree
When you finally admit that your investment strategy was suboptimal, try not to go crazy by over-investing to catch up. Taking on leverage to invest, co-mingling funds, putting up safe assets as collateral for riskier investment, and aggressively inflating your lifestyle are the main reasons for financial destruction.
Instead, slowly increase exposure through at least three tranches over a minimum six month period. Just note that even if you reach an “optimal” investment allocation, there will always be people who make even more.
I'm currently in the process of de-risking in order to make sure I don't lose all my gains. The three year double leveraged gamble feels like I went into a casino, found $30,000 worth of chips in a trash can, bet it all on black five times in a row and won each time. With these proceeds, I'm allocating a large chunk of capital towards 3% – 4% yielding, A-rated or better, tax free municipal bonds with 17 – 23 year maturity periods so that the money will be there to pay for my son's college education and then some.
But here's the thing. I'm going back to my same super conservative investing style despite my income now being able to easily make up for losses in riskier assets. There used to be a time when my investments made more money than my income. Not any more. Therefore, in a bull market with excess cash flow, I should take more risk and try and generate more income.
Lessons #3 From The Biggest Financial Mistake As An Early Retiree
You need to talk to someone about your investment plan. For example, Personal Capital offers a free financial consultation after you link up $100,000 in your free account.
Despite being an intelligent, rational human being, investing money is an incredibly emotional and sometimes completely irrational process. We are naturally guided by greed and fear to the point where we go from one extreme to another.
Over the long term, talking to a parent, friend, spouse or professional can help you make better investment decisions. Make sure you can properly explain your investment thesis to someone. If you can't, then chances are high you are not investing according to your risk tolerance.
If you want a wonderful life, you should share it with someone. Talk to people about your hopes and problems.
The Biggest Error For Retirees
Poor risk management is absolutely one of the biggest financial errors early retirees make. We often bet too big when we aren't supposed to, or invest too little when the opportunity is ripe. Steady recalibration is in order. See Financial SEER to learn how to quantify your risk tolerance.
I wish I could turn back the clock to 2012. I should have realized just because I was jobless, didn't mean that everybody else was in a precarious situation as well.
We need to set up an investing system similar to what I wrote in the post, A Better Dollar Cost Averaging Strategy. The problem is, even if you come up with an investing system that works for you, it still takes effort to follow your system.
Reduce Financial Stress
For three months in 1H2017, I was too stressed to think about anything other than my pregnant wife and newborn. As a result, I neglected to take advantage of any stock market sell offs and follow my asset allocation objective of 50% stocks, 50% bonds for the year. The biggest financial mistake left me somewhat paralyzed.
Instead, I focused mainly on paying down mortgage debt and buying municipal bonds at par value because I didn’t have to think as much. I had already invested $250,000 in a real estate crowdfunding fund in January. My lack of focus has already cost me ~3% of performance compared to the S&P 500 in just half a year.
Automation is one of the reasons why so many people have done so well investing in real estate. Come hell or high water, some principal will get paid down each month. Automation is why I have no problems paying a marginal fee to a robo advisor. Life is always getting in the way. Tenters who say they'll simply “invest the difference” hardly ever do.
If you don't follow any of the three lessons above, then let me offer one catchall guideline for retirees when it comes to investing your money:
Invest 90% of your capital as if your life depends on it, because it does. For the remaining 10%, invest as if you were a 28 year old whipper snapper with nothing to lose.
By following this guideline, you are protected from financial calamity. Further, you also potentially gaining exposure to higher performing assets that may supercharge your wealth in retirement.
Always Keep Building Passive Income
Perhaps above all else, always focus on building as much passive income as possible. This way, you'll also have various income streams to keep you afloat. In 2012, I had about $78,000 a year in passive income.
Today, I'm earning about $300,000 a year in passive income. Therefore, although my biggest financial mistake was investing too conservatively, I still made out OK.
Recommendation To Build Wealth
Sign up for Personal Capital, the web’s #1 free wealth management tool to get a better handle on your finances. In addition to better money oversight, run your investments through their award-winning Investment Checkup tool. It will show you exactly how much you are paying in fees. I was paying $1,700 a year in fees I had no idea I was paying.
After you link all your accounts, use their Retirement Planning calculator. It pulls your real data to give you as pure an estimation of your retirement future as possible. Don't let your biggest financial mistake be not carefully monitoring you're finances.
I’ve been using Personal Capital since 2012. Since then, I have seen my net worth skyrocket thanks to better money management.
Related: Stop Your Limited Beliefs About Making Money And Wealth Creation
My biggest mistake was fear. I was so afraid of my lack of safety net that I did not learn enough about investing early. Thankfully, I turned some of that fear-based cash savings into a business, but I missed out on some very good return years.
My current allocation is 95% stocks. I’m expecting an income doubling event in the near future. When that occurs, I will combine pumping up my cash reserves with paying down debt in the short term. Once that has stabilized, I want to allocate up to 98% stocks. I’m young and have many years ahead of me.
Sam, enjoy your post and articles. Are you going to write an article about digital coin currency? I am interested in getting your thoughts on it.
Probably not because I don’t fully understand the currency. But maybe I can get someone who has been investing in researching it for years to write a guest post.
I made an error many years ago by investing in a solar company in China that I didn’t know anything about. It was based on greed and positive news reports about its growth potential. Long story short I suffered. Now I realized that greed and finding value are different and am glad I made that error sooner in my life rather than later.
Sam, enjoy your writing and philosophy. I just turned 60, dreaming about retirement, we’ll see.
Net Worth: $2.67M (Annuity fund $675, Rollover IRA $500, Inherited IRA $130, new 401k $150, LT incentive $400, Real Estate 3 homes Net $700, cash $100)
Guaranteed income Age 62 $70k age 65 $90k
I have been much more conservative after the crash and reinvesting at the bottom, bought the annuity at Dow 18,500 in 2015 and now only $300k of net worth in stocks. I do agree with your 90/10 rule althought the 10% risky investments have all been losers for me and the Buffet way of investing has always been more successful “buy good companies cheap”. I do think it is important to remember that 20% losses require 25% returns, 33% require 50% returns and 50% requires 100%!! My goal is to earn minimum $180k per year without ever touching principal and leave at least $1M in today’s dollars to each of my 2 kids. I do find it fun to fiddle with the spreadsheet and look at all the scenarios! Cheers
Got to love guaranteed income until death! How does one ever lose with a guarantee?
I’ve been focused on building passive income since I’m not eligible for a pension, and I’m not buying an annuity.
Ranking The Best Passive Income Investments
Well the only loss on the guaranteed income I could potentially have is high inflation. Why don’t you like annuitiies? The fees are high, mine is about 2.2%, but guaranteed 6%/yr increase to Base investment used as calculator for 4% permanent payout. So, I saw it as protection against the next big dip which I will see before I retire in 3-5 yrs. The other option I might have taken is a solid dividend stock portfolio in the 3-4% range. Anyway, my annuity plus Soc Sec = $90k per guarantee starting age 65 plus return from real Estates and stocks should be total of $180-200k per year without touching principal
I am far far from being retired but the biggest mistake I made so far was leaving a job that provided pension. I was so ignorant and financially illiterate that I didn’t care about benefits/retirements back then. Luckily, now I have pension again, but if I stayed on the first job, I might be able to retire in 10 years (~47 or 48). I like what I do, so I don’t plan on retiring early, but do want to achieve FI in 10 years.
consider the rate-of-change of net worth. if we assume the utterly unrealistic model of uniform periodic contributions made to a constant rate interest-bearing account, we get a nice smooth exponential curve. (unrealistic, but useful for purposes of discussion.) at the moment of retirement the slope of this curve is maximal. Thus any perturbation in timing retirement will have its greatest effect on the size of the war chest at the beginning of retirement.
at retirement the curve changes to another familiar exponential. it gently curves downward at the outset (depending upon the ratio of war-chest size vs living expenses taken from it), and its slope inexorably increases reaching the maximum slope at epsilon minus the time the fund expires. i hope we all expire before our funds do, but the timing is known only to the grim reaper.
it seems that, in addition to the other factors cited introducing uncertainty into the retirement timing decision, the mathematics is conspiring against us.