3 Ways to Manage Downside Risk in pursuit of Financial Independence

Since the FIRE movement has been growing it has garnered increasing amounts of media attention from mainstream finance talking heads, much of it negative.  For some reason, these folks who have professed for years that their only goal is to help people with their finances often react negatively to a movement to put the power of financial planning and analysis into the hands of the individual.  In some cases, like Suze Ormond, her initial reaction was that everyone needs at least a $5 million dollar net worth to retire, which she then tempered with a follow on article that was slightly less risk averse.

Some FIRE writers, such as Tanja Hester have discussed their techniques for downside risk mitigation in FIRE by modifying their planned withdrawal rate below 4% which implicitly increases their savings amount to reach FI.  I am here to talk about some other strategies that can be implemented as appropriate to mitigate downside risk in your pursuit of FIRE.

1) Don't pay off your mortgage before RE if the remaining term is short enough to pay off in your lifetime.

This is a hot topic even in the FIRE community, so hear me out.  As long as your mortgage rate is below your expected stock market return (I typically go to 5 or 5.5% for an inflation adjusted return rate) and you are living in a larger house than what you plan to retire to, or are living in a house in a high cost of living country don't pay off your mortgage early!  This leaves a "wiggle factor" in your monthly expense estimation for future unanticipated costs.

For example, I am in my mid thirties and am a handful of years from achieving first world FI with my husband.  Our house is larger than we will need in retirement because we have two small children.  It is also in a more expensive area than we will necessarily need because we wanted to be zoned for some of the highest rated schools in our city (they still have the option of doing a lottery for some of the language immersion schools in our district, as I discuss in my earlier Parents on Fire blog).  We have a 30 year mortgage that if we do the minimum payment only we will pay off in my mid 60s.  At that point, since we will have already saved enough in our net worth nest egg to pay for the entire mortgage payment in our monthly expenses in perpetuity we will free up about $1,000 from our planned withdrawal rate to act as a cushion for medical expenses, travel or nonsense.

We could change that number even more by downsizing our property as we age, possibly to a condo or smaller lot, or moving to a different area.  This leads me to my next downside risk reduction strategy....

2) Exploit geographic arbitrage as needed.

I see my family's FIRE goal as downside risk averse because both my husband and I are open to the idea of living in other states, or even other countries.  We have our FIRE goal number set to support a lifestyle with a more expensive house than we need in one of the highest cost of living states in a high cost of living country.  This leaves us room to change any of those factors as needed further down the road.

I see setting a FIRE goal in a low cost of living country as inherently more risky, because there are fewer places in the world available for decreasing cost simply by moving.  Similarly, setting a FIRE goal at a 4% withdrawal rate while not having the flexibility of moving increases the probability that something could go awry.

3)  Keep potential income capacity, even if it isn't enough to meet your full cost of living.  

One of the aspects that I am really looking forward to in FI is the freedom to earn money in any way I enjoy at that time.  One adventure my husband and I had last summer was renting out our 1992 Eurovan weekender (pop top!) out to tourists in Alaska.  After the first renter I definitely revised the language in our ad around how clean the van needed to be upon return without incurring a cleaning fee!  We have neighbors who sell eggs, as another example of a small income stream that can help to lower your withdrawal rate - and in a pinch they can liquidate the chickens, enclosure and coop!

My main strategy in this vein is to pursue my PE license, so that I can offer engineering services as a contractor or consultant in Alaska after we reach FI.  This will not only generate some income, but give me a softer transition to retirement.  One of my concerns with retirement is losing the fulfillment I get from helping companies solve difficult problems, and devising innovative strategies to change their design of service to maximize the bottom line (while also increasing customer satisfaction, naturally).  Having a PE will quantify my skillset in a way that allows me to leverage it to accommodate other lifestyle goals such as travel and quality time with my daughters.

Mr. AF also does not intend to quit supporting his clients and bringing in some level of income after FI, because he runs his own business and is doing something he enjoys and believes in.

The point here is to recognize potential income capacity in the items you already own, hobbies you enjoy or identifying opportunities to frame your skillset in a way to work as you want on your terms for enjoyment and fulfillment.

What are other downside risk management strategies did you use or are you using in your FIRE lifestyle?


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