It’s About the Long-Term Average

This week I thought we would talk about long-term averages, mostly about how occasionally deviating isn’t necessarily the end of the world.

Outside of Personal Finance

To start, let’s talk about working out. Even if it is a tired analogy for personal finance. I try to work out five days a week, even if it’s just a simple walk every day. Although I do try to do more difficult workouts every day, more on that in a future post.

But what happens if I miss one workout every month? Is everything thrown off and I might as well just quit trying to workout? I’d say no. Now if that changes to one a week, then two, and so on then it’s taking things off track but its not worth tossing everything out

Blacksmithing is really hard. It’s a skill, and one that has to be honed to a high degree of competency. I am nowhere near that level of competency. But, if I keep working at it and working at specific weak points I’ll improve. My first knife was terrible; it doesn’t keep an edge, the design makes it essentially useless as a tool, and the handle doesn’t fit comfortably in the hand (all from poor planning). My second knife was arguably even worse, I messed up my planning and forged it too thin before I tried to forge the cleft point (although it does a better job holding an edge and I was able to salvage it into at least a usable shape, although it needs a handle). It doesn’t get better yet, I ignited what would have been my third knife about halfway through and it delaminated.

But I didn’t get discouraged, my fourth project, a hatchet turned out pretty well, it could have been better. I learned useful skills from each knife I made; plan the knife first, make the basic shape (point, tang, decorative elements) before getting too far into sizing it, control the heat (as well as other lessons). At this point in time, the bladesmithing club I ran was meeting twice a week and over the summers I was blacksmithing several times a week. It was a habit and it had benefits that led to my improvement.

The habit and keeping at it is the important part. I’ve known people before who stumble once, say a knife that doesn’t come out well, and use that as an excuse to throw their hands up and quit, be it working out or other things they want to do.

Onto Finance

While I’m basically beating you over the head with the point here, and I’m sure you get it, let’s connect this back to finance, that is the point of this blog after all.

A similar mindset can be applied to personal finance. My goal with working out is to stay in shape and to reach and maintain a good baseline physical fitness. My goal with saving is to have the option to leave my job at any time for any reason, even if I decide not to take that option.

For smaller expenses I may stumble from month to month. I may go over my grocery budget one month and spend closer to $400 rather than $300. Does that mean that this whole trying to retire early thing is over and I should toss the whole thing out the window? No, it just means I’ll need to take a look at why I went over budget in that category and what I can do going forward to improve that. What were the most expensive groceries I bought? Can I substitute that for something else?

Taking a look at it through that lens lets me improve my budget and get closer to my goal even if I didn’t hit it for that month. Maybe I have to go back to the drawing board and my initial goal of $300 was too high and instead I should shoot for $350 or something similar.

Something similar can be done for larger expenses. One of the longer term goals that I’m considering is to start a fund to cover the purchase of a home in the current price range I’m looking at (roughly adjusted for inflation of course). In total, saving that amount will push my FIRE date out by about 1-2 years. At some point I’ll need to find a way to set aside some extra cash for this, maybe it’ll be out of future raises. But I’ll need to weigh the time to that purchase with the time to FIRE, maybe I let compounding do some more heavy lifting for me and push that goal out by a few years so that the amount I have to set aside is lower and then spend a year or two after retirement spending less to account for this difference or in a different living arrangement, I have a few options as I’m already working out the details now and planning for it.

Taking the above two examples into a more nebulous realm, let’s think about market returns. If we go into a bear market or recession does that mean I should sell all my stocks and quit? If you’re a reader of this blog, you should know better than to sell. What if this drop happens ten or twenty years from now? There will be market downturns we’ll all have to endure one day. The question is did you include the assumption of a drop in your projections? I’ve tried to by using the long-term average return which includes the down years to arrive at those numbers such as my withdrawal rate.

On the other hand, lower than expected expenses don’t really change my plan much either (unless they were a crazy large drop in my expenses). For instance if I managed to spend only $200 on groceries for a few months, that would make it easier and speed things up to FIRE, but it wouldn’t move the needle much, especially once my spending trended back towards its average.

I think this plays into a lot of the ideas I advocate for on this blog. In this case I think the one it meshes the best with is robust planning. If your plan requires such a high degree of accuracy to your assumptions that any higher than anticipated expense completely derails your plan, it sounds like you need to adjust your plan.

Even more so, how can you plan for the future if you can’t plan for the long-term. If you have an idea of what your expenses are on average, that can allow you to plan for the future and take account of where you can improve.

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