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What am I missing?
Old 12-06-2011, 08:44 AM   #1
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What am I missing?

I'm trying to figure out how much I need to retire which has proved more complicated than I expected. This is mainly due to the fact that I don't agree with many "how much do you need" calculators online.

All of them run calculations that take my savings to $0 by the last year of estimated retirement. I've always figured and planned that I would run a strategy to never or hardly ever touch the lump sum amount and only use it to create an income stream. If I can earn 6% of say a $1 Million portfolio, but only take a stream of 3% or $30,000, that remaining 3% gets reinvested at the same rate, adding $20K to the portofio for a next year income of $30,900 or a 3% raise to account for inflation. How would this ever diminish if my rate of return and distribution stay the same?

What am I missing?
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Old 12-06-2011, 08:53 AM   #2
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I'm trying to figure out how much I need to retire which has proved more complicated than I expected. This is mainly due to the fact that I don't agree with many "how much do you need" calculators online.

All of them run calculations that take my savings to $0 by the last year of estimated retirement. I've always figured and planned that I would run a strategy to never or hardly ever touch the lump sum amount and only use it to create an income stream. If I can earn 6% of say a $1 Million portfolio, but only take a stream of 3% or $30,000, that remaining 3% gets reinvested at the same rate, adding $20K to the portofio for a next year income of $30,900 or a 3% raise to account for inflation. How would this ever diminish if my rate of return and distribution stay the same?

What am I missing?
Well, FIRcalc doesn't run your portfolio to 0, it estimates the likelihood that your portfolio will survive based on your input values. Your scenario - a 3% withdrawal rate - sounds reasonable. The trick is in how to execute so you get the 6% without risk of asset loss or risk of inflation.
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Old 12-06-2011, 08:54 AM   #3
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I think the main factor is, can you guarantee that you'll always have that 6% income stream? If so, then there shouldn't be a problem, but things can change all the time. Companies can cut or even stop dividends. Stock prices can go down, etc. And if you're pulling out your 3%+ inflation in a down year, you're going to take out a bigger chunk of your principal.
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Old 12-06-2011, 08:57 AM   #4
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Your math is fine. There may be an assumption problem. IF I could earn an inflation-adjusted 6%, I could retire with .....

10 year TIPS seem to be yielding around 0% real these days. Getting 6% requires moving a ways out on the risk curve. That means more volatility, and hence more chance that you just happen to retire right before a bad stretch that eats your nest egg. (see FireCalc)

If you've got a long period before retirement, your guess is as good as anybody's on long term yields. Nothing wrong with assuming 6% today if you understand that it's an assumption, not a guarantee.
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Old 12-06-2011, 08:58 AM   #5
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Perhaps the OP does not know about FIREcalc.

Here it is again:
http://www.firecalc.com

Play with it. The Truth is Out There.
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Old 12-06-2011, 09:53 AM   #6
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Perhaps the OP does not know about FIREcalc.

Here it is again:
http://www.firecalc.com

Play with it. The Truth is Out There.
+1.
Be sure you understand the impact of volatility. I'm sure you know you won't get 6% return every year. What is often less clear is that you might go a LONG time with very low or negative returns, and this, together with your withdrawals, can bring your portfolio to zero before the returns go higher. It doesn't matter that your asset allocation returns 25% in the year 2022 if you went broke in 2021.

FIRECalc is your friend.
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Old 12-06-2011, 11:20 AM   #7
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All of them run calculations that take my savings to $0 by the last year of estimated retirement. I've always figured and planned that I would run a strategy to never or hardly ever touch the lump sum amount and only use it to create an income stream.
In theory, if you die when you get to $0, you win! You got to spend every last dollar and you left nothing on the table. That's probably not a rational way to plan, but at least you can see the potential upside, I assume. More practically, why would you set up a plan that assumes you never spend down your nest egg? Unless you have a specific desire to leave all/most of your nest egg to someone else, there is nothing sacred about your "stash". The only trick is to be relatively certain that you don't get to $0 before you die. That's what FIRECalc is attempting to deal with. It helps you plan such that the various ups and downs of the market (and your stash) still allow you to live out your life with a more or less constant standard of living.

Now, having said all that, I'm the first to admit that cutting into the stash is a problem to me. The only way to insure that it never happens is to save so much in your stash that you can continue to grow it or at least not dip into it no matter what your returns are. That would mean delaying your FIRE date a very long time (or hitting the lottery). So, what some of us do (like me) is take less from our nest egg than FIRECalc says is safe. That tends to preserve the stash yet allows for earlier retirement than having no plan at all.

Play around with FIRECalc for a while and see if doesn't help you orient your thinking toward FIRE. Good luck and don't forget: YMMV.
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Old 12-06-2011, 11:31 AM   #8
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My portfolio is nominally 100% equities. Although my average return should be good, there's no way it comes close to a steady 6% a year. If I get a series of down years after I start making withdrawals, like starting in 2000 or 2007, my portfolio could quickly shrink. Assuming a constant yearly return equal to the average is dangerous. FIREcalc uses historical returns to test your portfolio, which should be as realistic as you can be.

And then there's the bigger problem of just predicting the future. That means there is no simple answer to how much money you need to save and how it should be invested. You might look at an inflation-adjusted immediate annuity from a few top companies as a baseline and work from there, though that would be very conservative. Most of us keep a margin of safety over and above what the retirement calculators tell us, in an amount the lets us sleep at night. But that will be different for everyone.
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Old 12-06-2011, 11:38 AM   #9
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What am I missing?
Just to be redundant, you are not missing anything if your assumptions held true (consistent 6% return with 3% withdrawal). But those assumptions will not hold true.

Think of one scenario where you got 15% returns for the first five years of ER. You would be in great shape and could rethink your spending limits. Now think of a nasty scenario with a US double dip causing a 30% drop in year 1, followed by a EU collapse causing another 30% drop in year 2, followed by 3 years of -5% returns. You would be in terrible shape and might need to rethink your spending ceiling.
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Old 12-06-2011, 11:55 AM   #10
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+1

What you need to factor into your thinking is that the 6% return is an average. I might be -10% in some years to +30% in other years, and as others have pointed out, the sequence of returns make all the difference.
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Old 12-08-2011, 10:56 AM   #11
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You could do a bucket of cash (or MMFs or TIPS or bonds or CDs) into which you put all your dividends from your equities. Then, only take 3% (of your total pot) out of the bucket every year. How big should the bucket be? 5 to 10 years of spending at 3%, which is as long as a bear market gets. Of course, if you are using dividends only and not selling your equities, your bucket should never run dry. If you take 4% and the bucket is 10 years of spending, you have a 60/40 portfolio of equities/bonds (or equivalents). Have you heard of this ratio before?
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