Mrs. FIFam

To pay off the mortgage or not, the essential question all early retirees (except renters) must ask themselves. The folks that want to pay off their mortgage argue that no early retiree ever regretted NOT having a mortgage. I love the idea of not having a mortgage. And who wants to pay the extra hundreds of thousands on mortgage interest? 

Those that do not want to pay off their mortgage in early retirement base their decision purely on the math. If you are paying 3 or 4% interest, you could be making 6-10% with that money invested. Not to mention, you have a way better shot at itemizing your taxes with that interest deduction (I know rules have changed, but it is still more likely with the interest than without). 

Mr. FIF firmly believes we should not pay off the sub 3% mortgage. I want the lower monthly and annual expenses that come with not having a mortgage to pay for. 

The compromise? I account for the mortgage separately from our FI Spending, with a different “bucket” of money. I don’t have a separate fund specifically dedicated to the mortgage, I just earmark part of the portfolio to pay the mortgage payment and don’t count the mortgage payment as part of my annual spending. This is probably more complex than it needs to be, but it makes me sleep better at night.

Ever since Mr. FIF took a stand on paying off the mortgage, I’ve been researching what approach to use to account for our mortgage in retirement. I’ll show you the math behind multiple approaches, run them through firecalc.com (online retirement calculator that I run most of my scenarios through), and then I’ll share which approach I’m using for my planning purposes. 

We are about a year into a $463,518 mortgage. Holy cow you say, how does anyone pursuing FI have over a $400,000 mortgage? I thought we were supposed to be frugal? Well folks, there are six of us plus a dog and the one place in my budget that I haven’t been frugal is the house. We have never house hacked, nor do we ever plan to. I fully support house hacking if you are in a season of life that allows that. Housing is a huge expense, our biggest in fact. On the bright side, we got a damn good 2.875% interest rate on this mortgage. So our principal and interest payments are $1923/mo. Remember, real estate taxes and homeowner’s insurance aren’t going away even if the house is paid off, so we keep those expenses solidly in our annual expenses when calculating our FI number.

Other details we’ll need to compare our strategies are that we plan for a 3.5% safe withdrawal rate (SWR) and assume a portfolio return of 6.0%. For our $463,518 mortgage at 2.875%, we’ll pay a total of $692,316 in principal and interest over the life of the loan if we pay the mortgage as scheduled.  

Strategy 1: Include in FI #

Now, the first and most conservative strategy is to act like you’ll be paying the principal and interest of a 30-year loan forever and add it to the expenses side of your FI calculation.

$1,923 x 12 = $23,076

$23,076/.035 = $659,314

The problems with this strategy are that the loan won’t be around forever AND my mortgage payment is inflation-protected. If I include the $23,076 in my annual expenses, the safe withdrawal rate assumes that those expenses will inflate.

Strategy 2: Payoff Set Aside

Another simple strategy, though not as conservative is to just add the balance of the mortgage to your portfolio. So the payoff set aside here is $463,518, or whatever the balance of the mortgage is at the time you FIRE.

This money could be used to pay off our loan anytime, but this strategy doesn’t account for the interest we are still paying every month when we don’t pay it off. We just assume that the payoff set aside portfolio will make at least 2.875% (which is pretty safe considering our safe withdrawal rate is higher than that). So is this amount still too conservative for our FI planning? 

Strategy 3: Drawdown

The last strategy is to set aside a portfolio value large enough that you can draw down the portfolio to zero over the life of the mortgage. I came across this reddit/financial independence page, How to Calculate Your FIRE Number When You Have a Mortgage (with Spreadsheet!).

The drawdown strategy is planning an investment amount that you can draw down to zero over the life of the mortgage. 

To get a value for this strategy, use a “present value” formula in your favorite spreadsheet. This one works in either Excel or Sheets: PV(rate, number of periods, monthly payment, payment made at beginning or end of period). 

Just remember to make sure your periods are consistent. Since we will use monthly payments, the rate and number of periods should also be by month. Our interest rate is an annual rate, so we divide by 12 to get the monthly rate. Staying consistent, we multiply our 30-year mortgage by 12 for a 360 period. 

PV(2.875%/12, 360, -$1923, 0) = $320,757

That is less than half of the portfolio needed for strategy 1! When I first dug into the reddit post, I was ecstatic. It took years off of my FI projections. I wanted to believe it so badly. As I sat with it and turned it over in my head, it began to feel too good to be true. Enter FIRECalc, one of my favorite online retirement calculators.  

I used the $320,757 as my portfolio value with no spending. Any spending entered on the first tab will be adjusted for inflation based on what options you choose on the “Spending Models” tab. Instead, I enter the annual mortgage payments in the “Other Income/Spending” tab so I can remove the inflation adjustment to our spending. The Off Chart Spending is the annual expense of the mortgage, and the Pension Income is used to reduce the off chart spending when the mortgage is paid off. I also adjusted the “Your Portfolio” tab to match my stock weight (85%) and fees (0.13%).

FIRECalc looked at the 120 possible 30-year periods in the available data, starting with a portfolio of $320,757 and found a success rate of 67.8%! I don’t know about you, but I can’t sleep at night with a 67.8% chance that I’ll be able to afford to continue paying my mortgage. I don’t know how FIRECalc does it, but the output graph looks exactly like how I feel with a 67.8% success rate. 

Now that we’ve explored all of these strategies, thanks to FIRECalc, we have come around to the strategy I currently use to account for my mortgage in my FIRE calculations.

Strategy 4: Estimate Based on Historical Returns

Close to a 33% failure rate makes me pretty uncomfortable. I decided that maybe my 6% market return assumption (that got me to my original $320,757 drawdown amount) may have been too optimistic. So I ran the following numbers through the calculator to get a drawdown estimate I was comfortable with.

Assumed Market Return	Starting Portfolio Value	FIRECalc Success Rate
6%	$320,757	67.8%
5%	$358,238	85.1%
4%	$402,815	96.7%
N/A	$400,000	95.9%

I’m shooting for a 95% success rate, but I also like big round numbers. So when I saw $402,815 overshot 95%, I rounded down to $400,000 and put it in FIRECalc to make sure I liked what I saw. 

$400,000 is the portfolio value I set aside to cover our mortgage for early retirement. 

What do you think, is my number too conservative, too risky or just right?

The golden rule in the financial independence/retire early (FIRE) space is to amass investable assets worth 25 times your annual expenses, that is, you live off 4% of your investments, adjusted for inflation. So, during the first year of retirement, you withdraw 4%, during the second year, 3% plus the amount needed to cover inflation, and so on.  

The original financial planner that introduced this idea was William P. Bengen. If you want to dig into his article, Determining Withdrawal Rates Using Historical Data. His work in 1964 was followed up in 1998, by three professors of finance in the Department of Business Administration, Trinity University, San Antonio, Texas, affectionately nicknamed the Trinity Study.

The Trinity Study analyzed withdrawal periods up to 30 years. While it did not account for taxes and transaction fees, the study did account for inflation. The Study concluded that stock-dominated portfolios (75% stock/25% bonds) would last 30 years 98% of the time based on all historical data.  

Plus, the math is easy with the 4% rule. Examples are often represented by showing someone that can live on $40,000/year (though in most places, I would consider that EXTREMELY frugal). They just need to make it to the 2 comma club for a nest egg of $1,000,000 to FIRE.  

$40,000 / 4% = $1,000,000

Or as it is more commonly stated

 $40,000 x 25 = $1,000,000

In the second year of FIRE, adjust for 3% inflation and you would withdraw:

$40,000 x 1.03 = $41,200

Should I trust the 4% rule?

When you are starting from a negative net worth (more debt than assets), or you’re socking away your first $100,000, your FIRE number is just a concept to move you to action. It doesn’t really need to be that accurate. But the closer you get, the more comfortable you need to be with that number.

The key finding from the Trinity study that keeps me from blindly following the 4% rule is the very first conclusion they draw,

“Early retirees who anticipate long payout periods should plan on lower withdrawal rates.”

I’m looking at 45-50 years here and FIRE is no longer an abstract concept. I don’t feel like abstract generalizations are good enough anymore, so my FIRE number has become more complicated. I use a more conservative 3.5% withdrawal rate for my planning purposes. 

Our income in retirement will come from a pension for Mr. FIF and assets invested primarily in low cost index funds. We will also keep our mortgage with a rate of 2.875%. It is unusual for early retirees to keep the mortgage, but it is our only debt and that rate is amazing! 

In order for us to feel confident in our financial independence, I have broken out our FIRE plan into these four components:

FIRE Component	Annual Expense	The Explanation	FIRE #
Kid’s College (529s)		Present Value of $25K/yr for 8 yrs	$175,000
Mortgage	$22,000	Estimate 100% success based on historical returns	$400,000
Spending over Pension (not including mortgage)	$28,000	Using a safe withdrawal rate of 3.5% or $28,000/3.5%	$800,000
Cash Cushion		2x Annual expense of mortgage and spending over pension or ($22,000+$28,000)*2	$100,000
Total			$1,475,000
Total w/o 529’s			$1,300,000

Expenses, the real key to FIRE

I’ve tracked our net worth since 2010 because I’m a money nerd. I used Microsoft Money originally, but Microsoft quit supporting it, so then I used Quicken for many years, but then I got very annoyed with their insistence on forcing me to update (read: PAY) for a new version every 2 years, or they would no longer support importing my account balances. Enter Mint, Personal Capital, and so many spreadsheets. I’ve settled on a single spreadsheet, the FI Family Google Sheet, plus Personal Capital.

Mint is ok for tracking expenses, but Personal Capital does that too and so much more. I love the dashboard. It offers a snapshot of my net worth (to the extent I’ve loaded all my accounts into it). It also shows a budget widget that compares how much I’ve spent to last month. I only have two complaints for Personal Capital. One is that two-factor authentication (the additional annoying step of needing to get a code texted to you) for my bank and investment accounts often break the import. Sometimes it fixes itself and sometimes I have to spend too much time figuring out why it doesn’t work. The second annoyance is that once you have $100,000, they offer a “free” call with one of their advisors. Remember, as the saying goes, if the product is free; you’re the product. Have no doubt, with Personal Capital; you are the product. I still look at it almost every day though for a quick and easy estimate.  

I ended up building a Google Sheet that tracks my annual net worth as in the above picture. It also tracks monthly net worth for the current year, monthly income and spending, and all of my quirky FI calculations. I still need to clean it up and put some dummy numbers and instructions in it, and then I’ll offer it to the masses or the three of you reading one of my first posts.

Where are we on our FIRE journey?

*Updated as of April 24, 2021

For the sake of consistency, I’ll only report on my invested assets in order to track the family’s journey towards financial independence. I also won’t include the 529 balances since I won’t be able to withdraw from those investments for living expenses in early retirement. What we’re left with are Financial Independence (FI) Assets. 

April 1, 2021, FI Assets $989,937  

I assume a 6% real return, with $6000 monthly investment contributions.

Date	Contributions	Real Returns	Estimated FI Assets
4/1/2021			$989,937
4/1/2022	$72,000	$59,396	$1,121,333
4/1/2023	$72,000	$67,280	$1,260,613
Monthly
5/1/2023	$6,000	$6,303	$1,272,916
6/1/2023	$6,000	$6,365	$1,285,281
7/1/2023	$6,000	$6,426	$1,297,707
8/1/2023	$6,000	$6,489	$1,310,196

While there are general rounding errors in the above table due to switching from annual to monthly calculations, it is good enough to illustrate how we come to the FIRE date of 2 years and 4 months left to early retirement.

Let’s be honest… I spend a lot of money. And I don’t even mean “my family”. I mean I spend a lot of money. Mr. FIF spends very little. He’s picked up our grocery shopping task (to lower the bill because I spend too much) and he does the home improvement spending as well. 

Not the best way to hold myself up as an example for the FI community.  Now in my defense, we are family of 6 and it takes a lot of food, clothes, and utilities to keep us running (or at least that is what I tell myself). 

Of the variables I have control over in my Financial Independence journey, one of them is absolutely EXPENSES.  If you can live off of less, you hit FI faster!

So Mr. FIF and I decided we would try out an experiment. An experiment that we forced our kids to participate in too. 

NO SPEND SEPTEMBER

The kids were not very excited about No Spend September, but we tried to make it fun.

Here were the rules:

1. Necessary spending still allowed, but try not to spend more than REALLY necessary, no extra splurges at the grocery store, just groceries
2. Kids were not allowed to spend from their saved allowance, but still earned their allowance for the month
3. We COULD SPEND the cash in our pockets (it doesn’t count if Personal Capital doesn’t see it)
4. We COULD SELL things to put more cash in our pockets
5. Kids could do extra chores for CASH payments that could be spent

The spending cash stipulation was made for a few reasons. We wanted to soften the sacrifice, see what we really were probably spending too much on, and increase the kid’s motivation for doing work around the house and getting rid of things we don’t need that are just sitting around the house.

So we still ate out a few times in the month because I sold a dresser that has been sitting in the hallway of our new home for months because I just hadn’t gotten to it. But I really needed a cheeseburger. 

My teenager, FIF Jr. painted the neighbor’s fence for over a hundred bucks! He also helped with a variety of outdoor chores we needed help with. He now has a one year subscription to his PlayStation (he was saving for the annual subscription because it was cheaper than the monthly subscription, I’m so proud!).

So, how’d we do?

	12 Mo. Average	No Spend September	Money Saved
Necessary Spending	$5,477	$4,814	$663
Discretionary Spending	$3,003	$1737	$1,266
Total Spending	$8,480	$6,551	$1,929

Necessary Spending went down mostly in gas and home maintenance/improvement categories. Mr. FIF really limited his Home Depot and Lowes trips to those that were necessary. As for gas, I’m not sure why it dropped, maybe we weren’t driving around to spend our money? 

You may wonder why Discretionary Spending didn’t go to $0 during a no spend month. Some of the categories I mark as discretionary are really only discretionary for an emergency, like the kid’s college fund. If one of us lost our job, we could cut that, but not just for a no spend challenge. As I already mentioned, liquor is tracked as discretionary, but we weren’t willing to sacrifice it for this challenge. 

 You may be asking SO WHAT?!

The real impact of lowering expenses if you can sustain it looks like this:

$1,929 x 12 = $23,148 / annual expenses

$23,148 x 25 = $578,700 (using the 4% rule)

So if I could keep it up, I could reduce my investible FI assets by a whopping $578,700! I don’t really expect every month to be a no-spend month. But it did illuminate some categories we could cut back on without feeling like we’re missing out or sacrificing too much like eating out.

I was raised by a solidly middle-class couple. They were living the American dream. They bought a house, both worked, and had 2.5 kids (ok just 2). I remember always having whatever I needed, never feeling like there wasn’t enough – true privilege. My mom handled the finances for the family and credit cards were a normal part of paying for our lifestyle. Many Christmases were paid for on credit cards; back to school shopping, credit cards; birthdays, credit cards. My mom refinanced the house several times to pay off credit cards, and now 45 years after building a very modest home, she still has a mortgage to pay.  Now all that being said, if we had money problems, I didn’t know it.  Nobody really talked about money. 

My parents had always told me that they did not save any money for college (or retirement for that matter, but we’ll get to that in other posts I’m sure).  So I went into my high school guidance counselor’s office and asked what the cheapest college was.  Her response, “Well, the United States Air Force Academy is free.”  Wait, what?!  Ok, that sounded a little crazy, is there anything less hard core? “If you got an Air Force ROTC scholarship, college could be free and you could go anywhere.”  Where do I sign up?  I applied and ended up getting a three year scholarship.  Thus, with some help from my parents, I graduated with very little student loan debt and had it paid off in the first year of active duty military service.   

Now by the time I stuck out on my own, I had formed the opinion that credit cards were evil. I was about to go off to military technical training after graduation and I was going to do it with a clean (credit card) slate. I had one visa card and a store-branded credit card that I paid off AND CANCELED before I left. What I soon learned is that it is hard to rent hotel rooms (where we had to stay during technical training) without a credit card. Cue misty-eyed call to parents.  Mom put that room on HER credit card until I could get the military travel card (which took time because I was brand-spanking-new.  So, maybe credit cards weren’t so evil. 

Now, Mr. FIF has a completely different money upbringing that I. He was raised by loving parents who were also faithful Catholics. They had very modest incomes and we’re also the same age as my grandparents. What that meant was they both lived through the great depression as part of their childhood. So they knew what it felt like to not have enough. They taught my husband serious lessons in frugality. For birthdays, they got to choose between going out to eat or a gift.  Not both, one or the other. I only point this out to call attention to the start difference between our childhoods. Though, like mine, his parents were not able to set aside money for college and he received a full four year AF ROTC scholarship. 

Mr. FIF and I balance each other out. I have learned to weigh how much a thing is needed or valued before spending money on it and Mr. FIF has learned that people things can bring people joy even if the thing does not have objective value to him. Needless to say, I handle Christmas shopping in our family.