Catching FIDough - Get a Plan!
The Basics of Catching FIDough.
To develop a basic plan for catching FIDough, you must figure out two things: 1. how much money you will need to become financially independent (your Catching FIDough Number), and 2. how you will reach your Catching FIDough Number. Easy, right?
Step 1 – Determine your Catching FIDough Number
To determine your Catching FIDough Number, you need some idea about how much you want to be able to spend the rest of your life without running out of money, presumably while pursuing your non-paying FI interests. (If you have paying FI interests, that’s a bonus!) In other words, how much income would you like to live on in retirement?
If you expect to have other sources of income while retired (like a pension), you only need to worry about generating the additional income you desire from your FIDough. Your FIDough Income Number is the annual amount of income you would like your FIDough to generate. To determine your Catching FIDough Number, a good place to start is by multiplying your FIDough Income Number by twenty five (or thirty).
Catching FIDough Number = your FIDough Income Number X 25.
This number is in today’s dollars, and must be inflation adjusted into the future based on the number of years remaining before you become financially independent. Although more than 25 times is even better, if your savings is roughly 25 times larger than the amount you will need to withdraw from your retirement portfolio in your first year of retirement, you should be in pretty good shape (especially if you are willing to make spending adjustments late if necessary).
There are other complexities and nuances discussed in the tabs and resources below to help you determine more precisely your Catching FIDough Number, and that number is only a rough guide. It also assumes you plan to have a broadly diversified portfolio, that includes a fairly sizable equity allocation. In any event, having some rough idea about your Catching FIDough Number is a great place to start with your own FIDough Plan.
Step 2 – Figure out how to reach your Catching FIDough number
To determine how to reach your Catching FIDough Number (to catch FIDough), you need to determine the number of years remaining before you want to catch FIDough (your target date for Catching FIDough). You must then determine the remaining amount you need to save/invest to get your FI number within your timeframe goal. So, if you want to catch FIDough in 5 years, and you are $100,000 short of your Catching FIDough Number, you must grow your saving an average of $20,000 per year for the next five years.
Here too there are some complexities and nuances due to things like expected investment returns, etc., but you now have the basic framework to begin building your plan to catch FIDough. And, fortunately there are now many awesome tools available to make building your plan easier than ever!
What Is Your FIDough Income Number?
As explained in the previous tab, your FIDough Income Number is the annual income you would like your FIDough to generate. This number is used by virtually all retirement calculators (usually called “expenses”), and is also used for simple retirement formulas like the “25 times” rule of thumb. But often in these tools there is no explanation about what you should and should not include in that number.
What to include in your FIDough Income Number
Your usual spending
Your FIDough Income Number must, of course, cover your usual spending. If you already track your spending and have done so for several years, that’s a great start. If you do not already track your spending, start doing so now to help guide your FIDough Income Number. Mr. FIDough’s budget article gives you the basics to get started with tracking your spending and saving (and how to improve your saving results). As noted there, FIDough’s Favorite spending tacker is Personal Capital.
Expected spending, and goal spending
Your FIDough Income Number should also include the spending you can reasonably anticipate, such as health care costs. It should also include anything that your employer currently pays for (e.g., a cell phone) that you will need to cover. Also include monies for any goal spending such as additional travel.
Yuck, I know, it takes all the fun out of it but your FIDough Plan must consider taxes. To account for taxes, you should consider some best and worst case scenarios and make sure you are comfortable with what you might face. So, for example, what would your tax bill look like if you withdrew all of your FIDough in a given year from an IRA subject to ordinary income tax? What if some of the income came from ordinary dividends or long-term capital gains? As explained in Spending FIDough, you ideally will have some control over your taxes, but it is better to plan for the worst and hope for the best.
Infrequent big ticket items
Not all spending occurs evenly each year. If you own a home, you will likely need to replace your roof every ten years and your air conditioning/heating units every 7-10 years. If you own one or more cars, those also need periodic replacement. Include in your FIDough Income Number an amount that will allow you to, in effect, save enough to pay for these infrequent big-ticket items. For example, if you plan to replace a $30,000 car car every 10 years, make sure you build in enough ($3k/year) to permit you to have that extra money after 10years.
Ideally, you are planning well in advance of your goal date for catching FIDough, meaning that you will need to adjust your FIDough Income Number for the inflation that will occur between now and the time you plan to catch FIDough. This, of course, requires some guess work. Most retirement calculators account for this, and you can also use a simple inflation calculator with some estimates based on past inflation. (Most folks today are assuming 3% inflation going forward, but who knows what it will actually be.) The good news is you can adjust this number as you get closer to your target date, and it will increasingly become more accurate.
Include some cushion for life’s unexpected events, but recognize in real life you can also adjust spending in other areas if need by.
What to exclude in your FIDough Income Number
Other sources of income
If you expect that other sources of income will cover some or all of your FI spending, you may exclude these from your FIDough Income Number. Examples include pensions, annuities, and social security (but not interest or dividend income). You should only exclude these other income sources from your FIDough Income Number if you are confident you can rely upon them. Additionally, if some of these other sources will not keep up with inflation (e.g., the annuity amount will not change over time), build into your FIDough Income Number an amount to, in effect, provide a cost-of-living inflation adjustment to those other income sources that do not already include that benefit. The better retirement calculators take that into account.
Expenses you will no longer incur
If there are work related expenses that you will no longer incur (e.g., dry cleaning, commuting expenses, etc.), you should exclude those from your FIDough Income Number. You should exclude items such as 401K/IRA contributions that you no longer intend to make.
What Is Your Catching FIDough number?
Your Catching FIDough Number = Your FIDough Income Number X 25
You need to save roughly 25-30 times Your FIDough Income Number (i.e., the amount you would like to be able to spend in retirement from your FIDough). This is known as the the “25 times” rule of thumb.
There is currently much debate about whether this number still works, and as explained here it comes with some built in assumptions. But as Mr. Money Mustache has elegantly explained, it remains a useful heuristic in the real world.