Firewalls of Financial Defence

With a baby on the way we are, for the first time, assessing how safe our lifestyle is. What would happen should we be hit with unexpected bills? What would the plan be if something unexpected comes at us?

Financial firewalls provide defence against the unexpected

10 years ago we didn’t consider this all that much – we had been teachers for just a couple of years and were still living in the U.K. We had little in the way of income (who starts a career in education for the money??) and almost no savings. We did have some potential sources of support through our parents. We also had credit cards, although not all would see debt as a viable defence in the face of sudden adversity! We could could be somewhat flexible in our lifestyle, although our mindset at the time put a lot of emphasis on possessions. Moving abroad really affected that mindset (in a good way!). We certainly could not have taken on extra work; teaching in the U.K takes over your life.

In essence, 10 years ago we had very little defence if something unexpected came our way. I remember our first holiday together exemplified how precarious our position was. We had only booked a few days to Morocco. When we arrived at the guest house we had booked, we were informed that we hadn’t paid for it online yet. We had to stump up about half of the money we had with us to pay for the room. This made us pretty anxious for the next few days – not something you want on holiday! On the final day we went to the airport to find that our plane was not scheduled at the right time. We were a bit confused…until we realised that the flight we had booked was the day before! We had completely missed it. I still remember the deep sense of panic which hit my stomach when I realised it might be difficult to get home. I didn’t have the money for a ticket and I wasn’t sure Shortbread did either. I didn’t actually have a credit card at the time so access to further cash was going to be challenging. I wandered if we could ring Shortbread’s parents to get some cash transferred (I couldn’t ring mine – there was no way they would have it!).

Shortbread had a couple of credit cards and we managed to grab two seats on a Thompson holidays flight back home. I remember their staff being helpful despite us not being on a Thompson holiday. The thing is, we spent the next couple of months seriously broke as a result of that holiday. Obviously a lesson learned for the future, but that feeling of panic is memorable. Ten years later we have worked ourselves into a different position, although I’d be lying if I said it was a direct result of the aforementioned story.

We see our defence as being a bit like firewalls – each form a barrier to protect us from ruin! Writing them out like this has been quite therapeutic given how anxious we have been at times following the news that baby was on the way. Here they are:

Level 1 – Income

We are both employed and live on considerably less than we earn. Thus, our first firewall of protection is our earned income. We have tracked our spending using Firefly iii for a few years now which has allowed us to accurately see how much money we need every month. We didn’t start with a budget based on a vague notion of what we thought we should be spending to live. This has allowed us to be really intentional and realistic with our incomes. Every dollar gets a job! Being in control of our spending has made it far easier to ensure there is slack in our finances.

Level 2 – Cash reserves

Further to our first firewall, we have an emergency fund for anything that our incomes can’t take care of. We have kept this quite low in the past compared to our portfolio (it’s about 5% held in cash). However, we felt that the liquidity of ETFs combined with the fact that markets tend to be up more than they are down meant we could just sell a few shares if needed. We’ve changed our minds a little now with a baby on the way. Cash reserves are hugely important if you have few other firewalls (or just get really anxious). For us it makes sense for a couple of years while we figure out how much babies cost. We will be targeting six months to a years living expenses for now.

Level 3 – Lifestyle flexibility

This is one of the FIRE superpowers. Should this firewall be reached we could slash our budget (well, a bit anyway. We’re already pretty frugal), we could find a cheap apartment, we could leave our current employment or even pick another expat destination. By combining lifestyle flexibility with, potentially, some geographic arbitrage we would be fine. We eat more locally and cheaply than many fellow expats, but we could go even further with this if we wanted to. Food and rent are our biggest outlays each month and it would be absolutely possible to address these if we needed to.

Level 4 – Relatively liquid investment in low cost index fund ETFs

Our portfolio currently includes property for family to live in, but the rest is in Vanguard ETFs. These were chosen not only for the indices they track, but also their liquidity. They are relatively high volume investments, so unlocking value from them is a straightforward and rapid process. If we have reached this firewall something quite drastic has happened in our lives! During the accumulation phase of our financial journey we do not wish to sell anything, especially under duress. This allows compounding returns a chance to grow the value of the investments.

As an aside, dividends should also be considered a small part of this firewall. Currently our dividends collected are modest and quarterly. They are reinvested (although we have a dividend day celebration every quarter), but could potentially be utilised for emergencies if absolutely needed.

Level 5 – Credit, extra work, downsizing

Our lives would have taken a seriously surprising turn if this firewall is reached. Credit is not a great strategy for getting yourself out of a financial emergency lest it become the emergency itself. However, if all else has failed, we have the option as long as we still have an income.

Additionally, there is a big market across Asia for tutors so picking up extra work would be a possibility. Failing that, it’s time to sell some posessions. Frankly this would actually make our lives easier as the next step is having to leave Asia and hightail it back to the motherland for Level 6 anyway…

Level 6 – Parents and support network, Benefits in the UK, Skills

The final backstop before homelessness, rack and ruin. We are fortunate that we could stay with Shortbread’s parents if we suddenly had to leave Asia. For all its faults, the U.K still offers some benefits (or welfare to North Americans) to help people in need, plus healthcare is free. If headlines are to be believed, there is a growing teacher shortage too so getting some work is likely.

We’ve been building these firewalls for a decade, so it’s hard to imagine what events could transpire to bring us to Level 6. This would really be a starting over from nothing. Obviously never say never, but it’s a priviledge to be in a position where this has become unlikely.

Other firewalls

Our firewalls will change as we continue our journey, and they certainly will when we move from the accumulation to the withdrawal phase. There are other firewalls we could look towards; rental income is a popular source for many FIRE devotees. We could potentially diversify away from our stock portfolio in the future to add this. Additionally, expats should be more than comfortable with geographic arbitrage. Some people choose to start businesses – it’s not something we’re particularly interested in, but successful enterprises can act as a firewall too.

Writing up our firewall defences makes us a feel a bit more secure. In some ways it can act as a plan against the unexpected difficulties life can throw up. It’s something we’re likely to come back to in the future.

What are your firewalls of financial defence?