Join Early Retirement Today
Reply
 
Thread Tools Search this Thread Display Modes
FIREcalc's handling of TIPS
Old 04-01-2004, 07:31 AM   #1
Thinks s/he gets paid by the post
wabmester's Avatar
 
Join Date: Dec 2003
Posts: 4,459
FIREcalc's handling of TIPS

I remember reading that FIREcalc handled TIPS a little oddly, but what exactly does it do?

I ran a sanity check:

withdraw $20,000/yr from a $1,000,000 port (i.e., 2% inflation adjusted)
assume 100% TIPS real yield is 2%, expenses 0, inflation = CPI

My naive expected results were that the portfolio value would remain constant in inflation-adjusted dollars, since I was just withdrawing 2% of the inflation adjusted principal.

However, FIREcalc had the remaining portfolio value fluctuating wildly with values as low as $500K and as high as $10M. * What's up?
__________________

__________________
wabmester is offline   Reply With Quote
Join the #1 Early Retirement and Financial Independence Forum Today - It's Totally Free!

Are you planning to be financially independent as early as possible so you can live life on your own terms? Discuss successful investing strategies, asset allocation models, tax strategies and other related topics in our online forum community. Our members range from young folks just starting their journey to financial independence, military retirees and even multimillionaires. No matter where you fit in you'll find that Early-Retirement.org is a great community to join. Best of all it's totally FREE!

You are currently viewing our boards as a guest so you have limited access to our community. Please take the time to register and you will gain a lot of great new features including; the ability to participate in discussions, network with our members, see fewer ads, upload photographs, create a retirement blog, send private messages and so much, much more!

Re: FIREcalc's handling of TIPS
Old 04-01-2004, 08:40 AM   #2
Recycles dryer sheets
 
Join Date: Dec 2002
Posts: 290
Re: FIREcalc's handling of TIPS

I don't know for sure. It is not unique to FIRECalc. It also happens with the Retire Early Safe Withdrawal Calculator.

I think that you are seeing a timing mismatch in terms of the TIPS and the adjustments in withdrawal amounts. [The same CPI is used for both the TIPS and withdrawal amounts. The TIPS interest rate is a fixed percentage of its principal (which increases with inflation).]

As a practical matter, I think that a real retiree would live off the interest coupon when he receives it (possibly with some sales if needed). That would get rid of any timing mismatch unless he went out of his way to look up the CPI.

Have fun.

John R.
__________________

__________________
JWR1945 is offline   Reply With Quote
Re: FIREcalc's handling of TIPS
Old 04-01-2004, 08:27 PM   #3
Thinks s/he gets paid by the post
wabmester's Avatar
 
Join Date: Dec 2003
Posts: 4,459
Re: FIREcalc's handling of TIPS

Hmm, after looking at the data, I discovered a couple of things:

1) 1874 would have been a very bad time to buy TIPS. *I didn't realize there were such long periods of deflation in US history.

2) The terminal value given by FIREcalc is inflation-adjusted (nominal). * This renders the value meaningless since each sequence has a different set of inflation factors. *It seems to me that the terminal value would be more useful if given in real dollars.
__________________
wabmester is offline   Reply With Quote
Re: FIREcalc's handling of TIPS
Old 04-01-2004, 08:58 PM   #4
Thinks s/he gets paid by the post
wabmester's Avatar
 
Join Date: Dec 2003
Posts: 4,459
Re: FIREcalc's handling of TIPS

Eh, there is still something weird going on beyond the effects of deflation.

By default, FIREcalc makes the coupon payment and inflation adjustment at the end of the year and then subtracts the inflation adjusted withdraw from principal. In theory, it shouldn't be possible to run out of money if you're withdrawing 2% from a portfolio of 100% TIPS with a 2% coupon.

Somehow, FIREcalc runs out of money after 92 years in this scenario.
__________________
wabmester is offline   Reply With Quote
Re: FIREcalc's handling of TIPS
Old 04-01-2004, 09:07 PM   #5
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
cute fuzzy bunny's Avatar
 
Join Date: Dec 2003
Location: Losing my whump
Posts: 22,697
Re: FIREcalc's handling of TIPS

SWAG, and in this case the S stands for stupid.

These bonds adjust inflation by the pricing of the bond, and you have to pay taxes on that repricing, although you dont get the benefit until you sell the bond or it matures.

Hence during times of high inflation, your 2% would shrivel to nothing or less, but you'd get the inflation adjustment back when the bond matured and was sold or given back for its inflation adjusted face value.

Certainly makes modeling these things a little entertaining.
__________________
Be fearful when others are greedy, and greedy when others are fearful. Just another form of "buy low, sell high" for those who have trouble with things. This rule is not universal. Do not buy a 1973 Pinto because everyone else is afraid of it.
cute fuzzy bunny is offline   Reply With Quote
Re: FIREcalc's handling of TIPS
Old 04-01-2004, 09:13 PM   #6
Thinks s/he gets paid by the post
wabmester's Avatar
 
Join Date: Dec 2003
Posts: 4,459
Re: FIREcalc's handling of TIPS

As far as I know, there are no taxes in FIREcalc-world. You're supposed to include taxes as part of your withdrawal, which I didn't for this sanity test.
__________________
wabmester is offline   Reply With Quote
Re: FIREcalc's handling of TIPS
Old 04-01-2004, 11:29 PM   #7
Recycles dryer sheets
 
Join Date: Dec 2002
Posts: 290
Re: FIREcalc's handling of TIPS

I cannot look at the FIRECalc's code, nor can I read it. I can look at the code in the Retire Early Safe Withdrawal Calculator and I can understand it. It is in an Excel spreadsheet.

Here is what happens:
1) Row 190 has the inflation index numbers. The ratio of two adjacent years equals (1+inflation).
2) Row 180 calculates [the TIPS interest rate*(1+inflation)+inflation]. That is, it multiplies the number in cell H8 (written as $H$8 ) and the ratio of two index numbers in row 190 and adds the inflation rate. The code looks awkward at this point. Inflation equals the ratio minus 1. In the first part, the code calculates [1+(the ratio-1)]. The number in cell H8 is a percentage. In the second part, the code converts the inflation to a percentage. It takes the ratio, subtracts 1 and then multiplies by 100%.
3) Row 183 has the interest rate of the fixed income component. It is the same as row 180 when TIPS is selected.
4) Reported balances are those for December 31st. It is at the bottom row for a specified sequence. The January 1st balance of the following year is the identical. It appears in the next column. It is at the top row of the same sequence.
5) The first withdrawal is calculated from the calculator inputs. With FIRECalc, you would enter the dollar amount. With the Retire Early Safe Withdrawal Calculator, it multiplies the withdrawal rate by the initial balance. [And it allocates the withdrawal into two parts according to the user specified input. One part is applied at the beginning of a year and the other at the end, after all portfolio gains and losses for that year.]
6) The first withdrawal has no adjustment for inflation from December 31st of the first year to January 1st of the following year. The withdrawal amount is multiplied by ratio of the index numbers found in row 190 in subsequent years, but not in the first year.
7) The TIPS interest rate includes an inflation adjustment from the first year to the second. That is, it does not know about January 1st or December 31st. It only knows about the inflation index numbers.

For example, in the 1871 sequence, the inflation rate for 1872 is 1.53% (as seen in row 187). With 2% interest, the TIPS interest for 1872 is 3.56% as seen in row 180 (and in row 183 if TIPS has been selected). The TIPS interest for 1872 is 3.56% times the (TIPS) bond balance on January 1st, after the first withdrawal and after allocating the balance between stocks and bonds. The withdrawal amount for 1872 is calculated based on the initial balance, which is the December 31, 1871 balance. It is also the January 1, 1872 balance. If you withdraw the TIPS interest rate, you withdraw 2%, not 3.56%. [It is then applied in two parts, one in January and the other in December.]

I think that FIRECalc treats TIPS the same. [However, it does not break withdrawals into two parts.]

Have fun.

John R.
__________________
JWR1945 is offline   Reply With Quote
Re: FIREcalc's handling of TIPS
Old 04-02-2004, 02:55 AM   #8
Early-Retirement.org Founder
Developer of FIRECalc
dory36's Avatar
 
Join Date: Jun 2002
Posts: 1,826
Re: FIREcalc's handling of TIPS

FWIW, Firecalc uses the same approach as the Excel calculator on REHP.
__________________

__________________
Often uninformed, seldom undecided.

Twenty years from now you will be more disappointed by the things you didn't do than by the ones you did do. So throw off the bowlines. Sail away from the safe harbor. Catch the trade winds in your sails. Explore. Dream. Discover. Mark Twain
dory36 is offline   Reply With Quote
Reply


Currently Active Users Viewing This Thread: 1 (0 members and 1 guests)
 
Thread Tools Search this Thread
Search this Thread:

Advanced Search
Display Modes

Posting Rules
You may not post new threads
You may not post replies
You may not post attachments
You may not edit your posts

BB code is On
Smilies are On
[IMG] code is On
HTML code is Off
Trackbacks are Off
Pingbacks are Off
Refbacks are Off


Similar Threads
Thread Thread Starter Forum Replies Last Post
Income from TIPS? Gearhead Jim FIRE and Money 6 04-05-2007 03:52 PM
TIPS vs. Vanguard TIPS Fund Cut-Throat FIRE and Money 16 08-15-2006 06:32 AM
TIPS funds: FIREcalc inputs, withdrawal strategy.. Cb FIRE and Money 2 09-28-2004 02:13 PM
SWR, terminal values, TIPS, I-bnds & comm paper sgeeeee FIRE and Money 144 02-25-2004 04:35 PM
TIPS vs. Mutual Fund with TIPS? Telly FIRE and Money 12 07-16-2003 12:21 PM

 

 
All times are GMT -6. The time now is 11:27 AM.
 
Powered by vBulletin® Version 3.8.8 Beta 1
Copyright ©2000 - 2017, vBulletin Solutions, Inc.