Being the bossiest personal finance role model on the Internet, Adm Karpinsk receives quite a few challenges on the accuracy of his math and assumptions. It is with a palpable sense of glee that some people hold up a perceived inaccuracy in my calculations, and deduce that therefore my entire status as Adm Karpinsk and all the principles of Mustachianism are therefore invalid!
And I will admit that I do make mistakes sometimes, both plain old typos, and even overly simplified assumptions. This is because it is not easy to model something as complicated as a Human Life into a series of income and spending equations – especially when the income portion is derived from investments, which in turn further depend on the activities of other unpredictable humans.
But yet I am incredibly confident in the future – my family and I will lead a happy life, and we will almost certainly have a growing surplus of money for the rest of our lives. We started the clock on retirement about six years ago, and despite a negative stock market performance, and even some expensive business and legal problems a few years ago, we have still done just fine and are ending up further ahead each year.
What is causing all of this good fortune? Baby Angels? Envy-inspiring Luck? Smugness?
Nope, it’s actually just another example of math and statistics playing out behind the scenes, in the form of something most of us know as the Safety Margin.
Back in Engineering school, they used to teach us that every piece of real-world information comes along with an unspoken “Error Range”. By testing a sample of soil upon which you want to build a bridge, you might find that the soil can support a load of about 2000 pounds per square foot. But because you don’t know what is hiding deeper inside the Earth, the real value could range between 1000 and 3000 PSF (based on what the other bridge builders before you have measured and recorded around the world). So you design your bridge strong enough to survive even on 1000 PSF soil.
You will be using concrete that can withstand 5000 pounds of pressure per square inch. But because there could be an error at the cement factory, the real range is between 4000 and 6000 PSI. So you design the bridge even stronger, to survive even if it was made of 4000PSI concrete on 1000PSF soil.
If you continue the chain of calculations, you end up with a longer and longer list of error ranges, and you can adjust your design to accommodate all of them. If you use the most pessimistic number for all possible decisions, you’ll end up with a bridge that is incredibly strong. On the other hand, if you design the bridge to withstand exactly the expected amount of stress, it will collapse as soon as something unexpected happens to it. Somewhere in between is a happy medium where your bridge is statistically very safe, yet not nearly as expensive as a worst-of-all-cases design.
In my old field of Software Engineering, the same principles applied when estimating how long it would take to develop a big product which took the cooperation of many people to build. Each stage of the project might be estimated to take five days, but in reality it could take between 2-10 days depending on unforeseen hardships in working with the new technology.
The most pointy-haired managers would create what they liked to call “aggressive” schedules that would assume each stage would get done in 4 days (a brilliant idea often accompanied by the suggestion that we all put in some nice unpaid overtime to accomplish this). Sometimes work would fly along without any problems even on the shortened schedule. But then the inevitable unforeseen hardships would occur, and there would be no slack in the schedule to allow the designers to catch up. This would in turn cause delays and stress, which in turn would compound, causing people to get flustered and create low-quality work that took months to clean up… (or sometimes which never got cleaned up and would eventually destroy the company in the form of buggy products.).
Wiser managers with knowledge of the Safety Margin principle would schedule 6-8 days for each component. On average, some would go more quickly. But then the engineers would also have time to solve the problems in the more difficult parts. In the end, everything would be completed just a little bit ahead of schedule, most of the time, leaving everyone feeling good about their jobs and creating a higher quality product as well. Once I learned this trick, I started running my own group’s projects this way, much to the amazement and scorn of the pointyhairs.
But the safety margin isn’t just for engineers. I had a friend once who was late for almost 100% of his appointments. It was because he planned them like this: “OK.. I need to meet with MMM at noon. But I also want to pick up some deck screws at Lowe’s first. So, 5 minutes to drive to Lowe’s, 5 minutes to buy the screws, 5 more minutes to drive to the meeting. So I’ll leave my house at 11:45PM”.
All of these times might be accurate in ideal conditions. But with no safety margin, they don’t leave time for a line up at the checkout counter, or a freight train crossing the road, or a conversation with someone you meet in the parking lot.
On the opposite end of the spectrum, I’m a compulsively cautious planner. I’d leave my house at 11:00 AM, allowing 15 minutes to get to the store, 15 minutes to shop, 15 minutes to travel to the appointment, and then a further 15 minute safety margin just in case anything else goes wrong and also in case the other person shows up early for the appointment. My own slogan for timeliness is “If I’m not at least 5 minutes early, I’m late”. By never packing too much into my day, I was always able to commit full effort to the things I did schedule.
Now we can finally bring it all back to financial planning. When a young lad graduates from college and gets a new job and an apartment or house-with-roommates, he is implicitly choosing a safety margin. If his job pays $2000 per month, and his food and rent is $800 per month, the margin is fairly reasonable. If he signs up for a car loan at $300/month, the margin shrinks considerably. As more services and especially loans are added, the margin can approach zero or even become negative. And even with a small positive margin, the slightest change in life situation – like a medical bill, a job loss, or a partner or spouse losing their job, can tip the whole balancing act quickly into the shitter.
Modern life also creates the the issue of a time safety margin. When people design a long double-income commute into their lives, add kids, and schedule an Olympic Roster of events for everyone involved, they have eliminated their time safety margin. With no slack in their schedule, they feel overwhelmed when the prospect of change is suggested to them, and many of them complained violently on Hacker News and Metafilter when an MMM article pointing out the fact that most long car commutes are in fact self-imposed and ridiculous went somewhat viral on the Internet last week.
Because of all this, I would suggest that modern life works best if you design in at least a 50% safety margin. In other words, find a way to live on no more than 50% of your take-home pay, and keep plenty of your non-work time open for freestyle learning and new experiences. If this means living with parents, family, or in a nice house with roommates initially, so be it. On average, the 50% that you save will build up rapidly and start providing an income stream of its own, and also on average, the take-home pay of many recent graduates will tend to rise over time. So a lifestyle of increasing luxury is still available as time goes on. But the safety margin will always be there for you, preventing financial disasters as well as giving you a vastly wider range of choices in your life!
I think I may have been born with too much of a love of the safety margin. As a kid, I was afraid to try new things until I was sure I could master them on the first day of trying. As a teenager, when I played real-time strategy video games I would always amass a ridiculously overpowering army before swooping in to destroy the opponent – I was too cautious to risk an earlier attack. And as a planner for early retirement, I built up a ‘Stash of savings that was big enough to live on, as well as several backup systems that could also provide a living if anything went wrong with the primary system.
So let’s review what I view as my own financial safety margin. Doubters and Anti-Mustachian complainypantses should pay close attention, because it is this network of flexible parts that allows me to safely brush off minor details like “what if your health insurance premiums rise?”, or “how will you pay for your kid’s university education?”. All told, the safety margin represents a 500-1000% flexibility in the income to expenses ratio that can be adjusted to meet any situation. And in all reasonably probable cases, Adm Karpinsk will both retain and further entrench the status his doubters on the other discussion boards so happily like to question.
First level of safety: a primary income. Right now, this is a rental house that provides an income of $24,000 after expenses – just a bit more than our family’s spending last year. If the rental house happens to go up in value faster than general inflation by the time we sell it (aka, a housing market recovery), this would be an unbudgeted additional safety margin.
Second level of safety: a backup income. We also have some index funds in taxable accounts that provide capital appreciation (admittedly negligible recent years), and a strong level of dividends that are just building up for eventual future use.
Third level of safety: optional part-time work. Levels #1 and #2 are paying the bills and continuing to build a larger safety margin, but Mr. and Mrs. Money Mustache also have some free time during school days, and we love to accomplish things during that time. We happen to get paid for some of these things – financial and real estate work on her side, construction and internet-related things on my side. This income gets saved as well.
Fourth level of safety: 401(k) plans. We stashed away quite a few years worth of maximum-level 401k savings back in the working days, and they will collect dividends and appreciate until we can crack into them at age 59.5. Assuming a reasonable level of stock appreciation over the coming decades, these funds alone will be enough to live off from that age forwards – despite the fact that we aren’t even planning to spend the Level 1, 2, or 3 money before then!
Fifth level of safety: Social Security! This is an unpredictable benefit due to the political questions surrounding the program, but it will very likely still provide a substantial portion of our living expenses, since even $600 per month in today’s dollars is a substantial portion. All of the first four levels of safety don’t even assume any support from Social Security.
Sixth level of safety: lifestyle flexibility. The MMM family currently spends about $24,000 per year, but there is plenty of room for improvement if money ever became tight. All of the safety systems above have been built assuming a level of spending even higher than our current $24,000 rate. We could easily move to a much smaller house, take fewer month-long trips, go car-free, stop buying organic food, and more. And, I also assumed that our child-related expenses will never go away, which in fact they probably will in less than 20 years as Junior ‘Stash grows up to forge his own way in the world.
Seventh level of safety: Work Flexibility. I could start building more stuff for people, and earn three times our living expenses from that alone. Or I could go back into software and earn even easier money. Mrs. M. could probably out-earn me by using her golden reputation among the people she used to work with to get a new job. Or she could just start rustling up real estate work. I have a huge fancy finished basement suite in my house that we could rent out for about $8000 per year with only minor modifications. I could buy a multi-unit apartment building for thousands per month in cashflow. I could start peddling “Mustachian Wear” clothing and e-books on this website. Or we could start some sort of entirely new business!
It all seems a bit excessive when you type it out in a big list like that. And indeed, it could be said that Adm Karpinsk is actually a bit of an overcautious wimp when it comes to financial planning, not the reckless chronic optimist that many people accuse me of being.
But I just wanted to share the thinking process that goes into retiring confidently. By building a large safety margin into everything you do, you open up a whole new world of options for yourself, and the resulting reduction in stress and increase in happiness tends to feed back into more energy, trying more new things, and opening up even more options.
And since in real life, it is very unlikely for every single thing to go wrong in a well-protected system, you will tend to have ever-increasing safety margins throughout your life. Six years into retirement, I already see this happening at an increasing rate.
So what is the lesson? Save your current income, even as you build complementary skills like frugality, adaptability, and the ability to earn money in more than one way. Then you’ll be ready to retire much earlier, because the sum of your safety margins will be enough to make you feel comfortable taking the leap. And most importantly, stop worrying!