Why I’m Going for FIO – Financial Independence with Options

The math behind financial independence isn’t rocket surgery. In my interactive guide, you can calculate the amount you’ll need to be FI – which will generally be around 25x to 33x your current yearly spending if you invest your savings. This number has always seemed incomplete to me. It’s a snapshot of what life would be like if you spent a known amount.

What about for those of us who aren’t sure what they want their future to be? For that, you need to add in a measure of uncertainty in your estimates. I’m calling that my FIO number – Financial Independence with options. This post is why I think this is a more accurate measure of my ongoing spending.

Making Estimates About The Future

If you head to Google and type “estimates are…”, one of the autocomplete responses is “estimates are evil”. As a software developer, making estimates can strike fear into hearts. If you make an estimate too high, there is concern people could think you unqualified, untrustworthy or stupid. If you make an estimate too low you risk not delivering and taking a hit to your credibility. I’ve worked with people who will do everything they can not to give an estimate because with the wrong people it can be a lose-lose situation.

As a software developer at a handful of companies – I’ve made many estimates over the years. Some of these were ones I executed on, while some were co-created with teams where we were all accountable. I’ve made more bad estimates than I care to admit. Even still, I’m a huge proponent of learning how to make great estimates. I’m here to tell you there’s a trick to making better estimates.

How to Make Better Estimates

The secret to good estimates is to switch from thinking about estimates as having a single point and thinking about estimates as ranges. There’s a low point and a high point in any given range – and you could include a “best guess” point that’s somewhere within that range for clarity. The beauty of ranges is that you don’t need to be precisely right.

Imagine you’re were playing The Price is Right and were given the option to guess the price of a car. For this game, the estimate is a single point estimate – the most brittle kind. What if you were allowed to give a range for your estimate instead? This would be a superpower! Think about how wide you could make your range:

Somewhere between $5,000 and $1,000,000!

Even without knowing what kind of car you were bidding on, you can be pretty sure it’s going to be in that range. You might be thinking that’s quite a huge range. The important part is winning the car, not to give the smallest range possible.

An Estimate Exercise

Let’s try an experiment. Try to make an estimate in your head that solves the following question:

How many gallons of water are in Lake Superior?

Make sure your estimate for this is a range rather than a specific number.

• Did you feel the need to make the range small?
• Do you feel stupid making a gigantic range?
• Do you feel confident that your range is large enough that you’re correct?
• Does it feel constricting to make your estimate too small and be wrong?

All of these are limiting beliefs about estimates. With estimates, it’s better to be accurate than to boost your own ego by being precise. This is something that I’ve struggled with. Giving small estimates implies that you are very sure that the answer is in that range. If you’re giving an estimate and you have no confidence that the answer is in that range, you’re making a guess rather than giving an estimate.

Back to Financial Independence

When it comes to Financial Independence spending, giving a single number implies you are sure you’ll spend that amount going forward. What if you instead used a range? How could that impact your estimates?

Don’t Artificially Reduce Your Range

If Drew Carey (the host of The Price is Right – in case you’re wondering) requested you to focus your estimate and make it smaller, what would you do? I’d hope you’d do absolutely nothing. There is no reason for you to reduce your estimate unless you have new knowledge. If you’re going to focus the estimate, then you’re going to need more data — maybe the make and model of the car, and the year. The more information you have, the better an estimate you can provide.

The term for this is the cone of uncertainty. You’ve probably seen this before in the 3-day and 5-day paths of a hurricane. It’s normal for there to be built in uncertainty.

The idea is that the more knowledge you have, the more you can reduce the range of your estimate. At the beginning, it’s not uncommon for estimates to be off by a factor of 4 — either 1/4 of the actual number or 4x the actual number. This is a huge range! The more knowledge you know the more you can refine your estimate and move it closer to the actual number.

Spending Estimates For Financial Independence

Let’s try this out with a FI spending estimate. I’m going to use my own numbers for this exercise, but the idea should work for yours too. Our yearly household spending is right around $60,000/yr now. The potential cone of uncertainty could be from $15,000/yr to $240,000/yr. The trick is to use this range as a starting point, then refine it with more data.

I’m assuming you have some data to help refine this estimate. You probably know how much you’ve made in the past and how much you’re making now. You may also know how much you’re spending now (if you don’t I’d recommend you start tracking that). With that data, you could know the lower bound of the estimate – the minimum amount you could possibly FI with. That might give you a baseline that you know the lower bound that you’d possibly spend.

I know that if we went super-lean we could cut out $60,000 spending down to $40,000 and still be very happy. This lower boundary isn’t a “I could survive on this”, but more of a realistic number that you could happily live on. I’ll choose $40,000 for my lower end of my estimate.

But what about the high end of this estimate? How do you calculate the maximum amount you want to spend in any given year going forward? I do this by calculating out some “what-ifs” and adding them together. The idea of having options and planning around them has had some great posts elsewhere recently.  Here are some of my “what-ifs” that would be nice to try someday in the future, even if they aren’t a core part of our lifestyle.

What if: I move to a super-expensive city? +15k

If I were to move to a much more expensive city than I’m in now, then my rent might be another $15k on top of what I’m currently paying. I’d also rope in the option that we buy a more expensive house in this number.

What if: I have to pay the maximum out of pocket on health insurance? +15k

Health care is in a very difficult spot to predict right now. There is one thing we can predict currently though — the ACA yearly out of pocket maximum. That number is around $15,000 right now for a family plan. This is the amount I’d pay if things went seriously wrong.

What if: We travel in style? +25k

Traveling cheap doesn’t mean skimping on luxury. You can do a lot with travel hacking, credit card points, and good planning and even hit some expensive places. With our current travel budget around $6k/yr, the idea of drastically increasing this sounds like a lot of fun. I’d love to just pick up and go when friends invite us on a trip or leave on a whim without months of points planning. Building this option into my FI number seems helpful.

What if: We donate more to worthy causes? +25k

Hearing Physician on FIRE and Our Next Life mention donor-advised funds it started to click with me how the charity side would work on a technical level. Having the ability to do this would be an amazing way to stay close to our communities.

What if: We support family? +10k

We’re lucky enough to have family that is also fortunate. But what if that’s not always the case?

What if: We eat out more (in the US)? +15k

Our spending for restaurants and groceries is about $600/mo so far in 2017. I’ll admit now that we spent that much on a single meal in November. I won’t lie – I’d love to do that much more often. Despite it being unhealthy, unsustainable and outright decadent, doing this every once in a while is memorable. I love the idea that we could live outside the US and eat out more only to see our spending go down.

What if: We decide to have kids? +0k

We’ve decided not to have kids, and are sure enough to put the estimate of this one at $0. If you’re following along and are considering this, it might be a good one to include on your what-if list with a number that makes sense for you.

What if: I go back to school? +0k

I don’t see this in the cards. I’d rather learn on my own. My mom went back to school for a law degree when she was 40, just a few years older than I am. Thinking about that now puts that achievement into perspective and makes me respect her that much more.

What if: We decide to upgrade our cars? +10k

We drive cheap cars. I’ve never been one to fawn over the latest and greatest, but the idea of an energy-efficient self-driving car is fascinating. I’ve been invested in Tesla for years and may consider changing to one someday down the line. There is a chance this could even lower the amount rather than raise it, but I’ll be safe and include it.

What if: I decided to start skiing in Utah and really love it? +10k

With our recent move to Utah, one of the things I’m looking forward to the most is skiing. I haven’t been skiing too many times in my life, but I’ve always loved it. It’s a 38-minute drive from our apartment Park City (I might’ve mapped it once or twice).

FI With Options

If you add all of these”what-ifs” up, it totals $125,000. Add to that the original $60,000 spending, and we have a high estimate of $185,000. The idea of spending $185k/yr is absolutely insane to me, but there it is in black in white how I could do it. Even looking at that list, it’s not a list of things I want to do every year. It’s a wishlist of things to have the option to do on years when they make sense.

Based on that, my FI number would be somewhere between $40,000 and $185,000, with $60,000 being my best guess based on current spending. In the estimation world there’s a handy formula for creating estimates that factor in uncertainty:

The beauty of this formula is that it shifts the result based on the uncertainty. I can plug in my numbers now and come up with a clearer estimate:

And here it is, my FI with options number! $77,500 is over $100,000 less than my maximum estimate, but since my “best guess” number is $60k it’s the one that makes the most difference. When I ran this formula 10 years ago, the “maximum” estimate would have been even higher since it incorporated additional “what ifs” for having kids, going back to school, buying a house, marrying someone who wasn’t frugal and more.

What is Your FIO Number?

Try making a list of all of your “what-ifs” and coming up with a maximum size of the estimate. When you have one in mind, plug it in and find out your FIO number!

Why is this Number Useful?

The minimum estimate for FI is helpful for understanding the earliest possible moment when you could be FI. The maximum estimate can help understand what FI would look like if you added an outrageous amount of lifestyle inflation to your life. I think the common ground, and the number that I’d happily want to plan for is somewhere in the middle of the FIO number.

What are your thoughts on a FIO number? How do you include flexibility in your future estimates? Do you budget for “what-ifs”?