Positive Cash Flow: An Open Secret In Early Retirement

It’s been six months since the stock market touched a bottom in the coronavirus crash. It recovered nicely and fast. When the 2008 financial crisis started, I followed a path of overbalancing. After the stock market dropped 20%, I increased my allocation to stocks by five percentage points, and I increased it again by another five percentage points for each additional 10% drop. Whether the moves were right or wrong in theory, they were successful in the end. I was able to buy more stocks at low prices. Even at the bottom of the market in March 2020, the prices were still so much higher than the prices I paid in 2008 and 2009.

I didn’t overbalance again in March 2020. It wasn’t because I thought the market would never recover this time around. Overbalancing would’ve worked equally well in 2020, perhaps even better than in 2008. I didn’t do it because I’m different than I was in 2008.

I had a good-paying job in 2008. Although some people lost their jobs in the great recession, the industry I was in wasn’t hit hard. The company I worked for had a layoff, which affected 5% of the employees. The laid-off employees were able to find other jobs in short order. My salary was more than enough to cover our expenses. In other words, I had a positive cash flow outside my portfolio. My portfolio was also smaller back then. Although the percentage loss in 2008-2009 was larger than in March 2020, my loss-to-income ratio was much lower last time. Because I wasn’t relying on my investment portfolio and I could make up the loss relatively quickly with my income, I had no problem being greedy when others were fearful.

I don’t have that luxury anymore in 2020. While I still have some income from my blog and my advisor search and screening service, my income is far less than my previous salary. It doesn’t cover our expenses. While our withdrawal rate is still low, it feels a lot different than having a positive cashflow outside your portfolio and covering all your expenses with it.

Having a positive cash flow outside the portfolio is an open secret in the Financial Independence Retire Early (FIRE) circles. Despite all the headlines talking about saving 25x or 30x of annual expenses, it’s more for confidence than actually using the savings to cover expenses post-FIRE. The smart FIRE leaders don’t rely on their investment portfolio for their day-to-day spending. In theory, they can cover their expenses by withdrawing from their investment portfolio, but in reality, they don’t. They cover their expenses by their current income while leaving their portfolio untouched. Those who questioned whether FIRE will survive when the stock market crashed in March simply didn’t know how the game is played. The 4% rule doesn’t matter when you don’t withdraw at all.

This isn’t to argue whether the FIRE leaders really retired or not. It’s a lesson on how to insulate yourself from bear markets. If you have a positive cash flow outside your portfolio, you don’t worry much about bear markets. So how do you keep a positive cash flow after FIRE? Multiple ways.

Spouse’s Employment

Some couples keep one person working after FIRE. The working spouse’s employment covers the expenses and provides health insurance. Government statistics show that among working couples, 1/3 of them only have one spouse employed. When my wife quit her job in 2015, I was still working. If a bear market came but I kept my job, we wouldn’t have to worry.

Pension

Some had a pension when they retired. Doug Nordman at The Military Guide had it from the military. Fritz at The Retirement Manifesto had it from a private employer. Some employers also provide health insurance to retirees receiving a pension. Even if the pension doesn’t cover all the expenses, it still provides a nice cushion. Living lean in a bear market is also an option.

Part-Time Job

Some keep their job and only drop down to part-time. The part-time job can provide income and health insurance. Bianca planned to do that in her flight attendant job (This flight attendant has enough money saved to retire at 44, but she wants to keep working, MarketWatch).

Rental Properties

Living on income from rental properties is another popular option. Chad Carson has a book and a course teaching people how to retire early on rental properties.

Self-Employment

The most famous early retiree Mr Money Mustache arguably never withdrew from his investment portfolio after he retired at 30. He used self-employment income, first from fixing and flipping houses, then from blogging. Leif at Physician On FIRE just posted his 2019 tax return. He had a negative withdrawal rate because his self-employment income covered his expenses. He didn’t worry when the value of his investment portfolio dropped by $1 million in March. That’s the power of having a positive cash flow outside the portfolio.

If you only have a job, you’re vulnerable to recessions and unemployment, as many have experienced in the COVID-19 pandemic. If you only have an investment portfolio, you’re vulnerable to prolonged bear markets. When you have both an investment portfolio and a positive cash flow outside the portfolio, you’re financially more secure. That’s the smart way to do FIRE.

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[Update] Long-time blogger J.D. Roth wrote this note when he shared this post on Apex Money:

As a FIRE insider, I can say that this is generally 100% true. Except for me and Doug Nordman, most FIRE folks support themselves with actual income.

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