My Early Retirement Financial Strategy and Portfolio

With FIRE now on the doorstep it’s time to finalise what my early retirement drawdown strategy and portfolio is going to look like.

Firstly, let’s look at the strategy and portfolio that has put me where I am today.  I first published it in detail in 2009 and then polished it slightly in 2012.  In brief it was about building significant wealth (at least for me) in quick time.  Quick time was less than 10 years which meant I needed to be accruing wealth in relation to My Number at just a little less than 1% per month.  A very aggressive target when I look at it that way in hindsight but one which provided Mr Market behaves for just a few more months looks real.

By living frugally while focusing on earning more I believed I could Save Hard.  To date my Savings Rate has averaged around 52% of Gross Earnings so that has played out.  This then advantaged me when it came to investing as I didn’t have to take great investment risk giving me an increased probability of success.  I called it Investing Wisely.  As it turns out since starting my annualised investment return has been 5.9% which is 3.3% after inflation.

When I came out I stated that at the point of Early Retirement I wanted wealth of £1 million (it was actually £1,011,000).  Today my trusty Excel spreadsheet is telling me that once I hit £1,023,000 I’m good to retire.  At this point it’s then no longer about building wealth but instead the simple problem of ensuring I outlive my wealth which will be drawn on as I’ll have no other earnings.  I suspect it may require a slightly different strategy and investment portfolio to that which I have today.  That said the principles of tax efficiency, low expenses and a diversified investment portfolio, with a key decision of what Bond to Equity Allocation Percentage at its core, I intend to keep.

Given the seriousness of this topic it’s about now that I have to pop in a wealth warning:  History is not a predictor of the future, this is not financial advice, I’m not a financial planner and I’m just an average person who’s made investment mistakes on a DIY Investment journey to Financial Independence.  The post is also just for educational purposes only and is not a recommendation of any type.  Ok let’s move on...

My current estimates, based on my forecast FIRE date, suggest I’ll actually overshoot my FIRE wealth Number with circa £1,117,000.  A Mediterranean life will then mean a life priced in Euro’s.  The average exchange rate with the £ since the Euro’s inception has been 1.3742.  I’m not going to bank on that.  Instead, I’m going to use the worst average year since inception, which was 2009, with its rate of 1.123.  That gives me EUR1,254,000 of wealth to buy a home with and live from for the rest of my life.  I’m going to assume a 40 year retirement period.

Some behind the scenes work leads me to believe that our (initial) dream Mediterranean home in FIRE will cost EUR350,000 plus stamp duty.  So all of a sudden my wealth is down to EUR889,000.  This is the amount that will stay invested and from which I will drawdown as I do not intend to buy any type of annuity.

From a spending perspective I’ll then need my wealth to sweat EUR24,708 per annum which includes all family basic running costs, fun money for me (my better half will self fund her fun money), some holiday money, money for home repairs and money for a car replacement every 10 years or so.  That’s a drawdown rate of 2.8% which is greater than the 2.5% I have been planning.  Assuming 0.27% investment expenses it still looks ok against Pfau’s analysis which was for a 30 year retirement (as mentioned above I’m planning on 40 years) and which looked at a portfolio which was either 50% Domestic Equities to 50% Domestic Bonds or 50% Global Equities to 50% Global Bonds.   Assuming the average Euro to £ exchange rate since inception it would be 2.1%.

I could just leave my Equities to Bond Allocation there or I could even use one of a number of rules of thumb.  This is important for me so I won’t.  Instead let’s continue with some more analysis.

I’ve used the excellent cFIREsim for analysis previously and I’m going to use it again.  It’s important to note that it uses historic US based datasets for its analysis which according to the Pfau research above makes it more bullish for a UK based investor.  Another note is that at this point I’m still going to treat myself as a UK based investor but will try to ensure Mediterranean success with what I hope is a conservative £ to EUR exchange rate.  This gives me a get out of jail card if the Mediterranean dream turns into a nightmare.  If it doesn’t then in a few years it shouldn’t be too daunting to reallocate to that home base gradually.

The problem I want to solve with cFIREsim is to give myself the best chance I can of outliving my wealth while drawing down on it.  This is very different to trying to maximise my wealth.  So with that in mind let’s plug my data of EUR889,000 (wealth), EUR24,708 (annual spending which could be increased by inflation annually), a 40 year investing horizon and expenses of 0.27% per annum.  Let’s now vary the Equity to Bond percentages which gives this chart:

Click to enlarge, Probability of FIRE (financially independent, retired early) Drawdown Success

So far so good with this history lesson.  As long as I have at least 30% Equities my probability of success would have been 100%.  Let’s now look at the nominal ending portfolio values at the end of my 40 years:

Click to enlarge, Nominal ending FIRE (financially independent, retired early) portfolio value after 40 years

This tells me that if history repeats with its best sequence of returns and I invested aggressively I could end up with a portfolio value of EUR23,800,000 and on average could end up with EUR5,754,000.  Interesting sound bites but completely irrelevant for what I’m trying to do.  I’m interested in that blue minimum portfolio value curve so let’s zoom in:

Click to enlarge, Nominal minimum ending FIRE (financially independent, retired early) portfolio value after 40 years

That’s telling me that historically (and remember it’s US based) I would have been best off with an 80% Equities to 20% Bonds portfolio.  Now let’s also bring the knowledge that 30% Equities would have been good enough, the Pfau UK research which used 50% Equities and the rules of thumb back in.

Like when I was trying to build my wealth I appear to again just not need to be that aggressive and so why take the risk of a different sequence of returns putting me into trouble.  It’s of course not an exact science but weighing it all up I’m going to start with 65% “Equities” and 35% “Bonds”.

Now I need to add my portfolio diversifiers.  Here I’ll use the rules and percentages I’ve consistently used up until now and written about ad infinitum.

Firstly some property investments where I’m going to load in 10%.  I’ll assume that the risk of property is between that of Equities and Bonds.  As I do today I’m therefore going to split the property allocation 50% to UK commercial/industrial and 50% Europe ex UK.  This now makes my portfolio:

• 30% “Bonds”
• 60% “Equities”
• 10% Property

Next I’ll add some commodities.  I’m going to stick with this being physical gold in ETC form and I’ll grab 5%.  As gold prices can be extremely volatile I’ll take the allocation from “Equities”.  This makes my portfolio:

• 30% “Bonds”
• 55% “Equities”
• 10% Property
• 5% Gold

Now I’ve written previously that I intend to try and live of dividends alone which means I need 3 years of cash around.  While above I said I intended to spend an inflation adjusted EUR24,708 in reality I would guarantee I would cut back during periods like the Global Financial Crisis.  To plan for it I could imagine halving my fun money spending and only spending to keep the home operational.  So I’d replace a failed boiler but not install a new kitchen during the down times.  In those times I estimate I’ll be spending EUR18,358 per annum.  It’d be easy to know when to cut back also.  When dividends no longer cover spending switch to the lower spending level.  So that’s EUR18,358 x 3 = EUR55,075 I need to have down the ‘back of the sofa’ or 6% of total wealth.  I’ll take that from “Bonds” so the portfolio is now:

• 24% “Bonds”
• 55% “Equities”
• 10% Property
• 5% Gold
• 6% Cash

As I do today my Bonds will be a mixture of UK Index Linked Gilts and Global but predominantly UK Corporate Bonds.

On the Equities front I’ll stick with my base being FTSE All Share, FTSE250 and a bit of HYP (high yield portfolio).  On top of that I’ll stay with 20% International (40% US, 40% Europe, 20% Japan) and 5% Emerging.  I’ll try and dispose of my Australian mistake with time and replace with UK Equities.  So that’s the portfolio at a top level done and it looks like this:

Click to enlarge,  My early retirement investment portfolio

On a topic like this it would be great to get readers thoughts here which includes your strategy as the sum of our collective knowledge is far more powerful than just mine.

As always DYOR.