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Net Worth and Income in Retirement
Old 07-30-2010, 11:42 AM   #1
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Net Worth and Income in Retirement

I am trying to determine whether I am looking at this the right way. If I save $25,000, or if my net worth otherwise increases by $25,000, have I, in effect, created a $1,000 annual annuity income stream. If this is the case, it will help me to better understand how much my net worth will need to be in order to retire early and have the annual income I will need in early retirement. I am basing these numbers on a 4 percent safe withddrawal rate (SWR).

Also, would I be able to increase that $1,000 annual income periodically to keep up with inflation?

I am assuming that if this premise is accurate, then I would need to have the $25,000 invested in a way that would, on average, earn at least 7 percent interest (4% for the drawn down and 3% for the inflation factor).

Does this sound right to you? Thanks for your insight.
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Old 07-30-2010, 11:44 AM   #2
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Quote:
Originally Posted by midnighter777 View Post
I am trying to determine whether I am looking at this the right way. If I save $25,000, or if my net worth otherwise increases by $25,000, have I, in effect, created a $1,000 annual annuity income stream. If this is the case, it will help me to better understand how much my net worth will need to be in order to retire early and have the annual income I will need in early retirement. I am basing these numbers on a 4 percent safe withddrawal rate (SWR).

Also, would I be able to increase that $1,000 annual income periodically to keep up with inflation?

I am assuming that if this premise is accurate, then I would need to have the $25,000 invested in a way that would, on average, earn at least 7 percent interest (4% for the drawn down and 3% for the inflation factor).

Does this sound right to you? Thanks for your insight.
providing that your $25k net worth increase is in real terms (ie not nominal, ie after inflation) then you have it.
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Old 07-30-2010, 12:36 PM   #3
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yes, that's about right. It's a very useful rule of thumb, but be sure that, if you are using it to plan, that you know roughly what the small print is:

4% before expenses (broker fees, fund fees, taxes, etc.)

4% is a rough long-run average based on historic returns. Your future may vary. Wildly. Especially on any time scale not long-term.

Don't forget that it can cost you to unlock some of your net worth (cost of selling a house to downgrade to a smaller place and free up equity is non-trival, cost of cashing out short-term investment returns in higher taxes, etc.)

A lot of the small print, on a longer-term scale fades into the uncertainty level of a rough rule like this, and 4% (or rule of 25, same thing) is easy to calculate. Just remember to factor in some costs to your 4% (for instance, i figure my spending will only be able to get up to aobut 3.6% after costs), but for your basic planning, it's a good 1st order rule.
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Old 07-30-2010, 08:41 PM   #4
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the 25X (or 4% SWR) is a "rule of thumb". Please read the literature that led to it so that you have a good understanding of the parameters. The most relevant are a) it is based on historical performance, b) it is true for 30 years and c) it is based on at least 50% equity allocation & d) investment expenses & taxes are not taken into account.

The FAQ section should have a link to either Bengen's papers or the Trinity papers. If you can't find them, pm me.

All the best.
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