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Old 06-21-2010, 12:05 PM   #21
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Return itself is secondary IMO, I plan in terms of real return (returns less inflation). For long term planning, I use a real return of 1%, I'm projecting from 0-2%. If inflation is lower than I expect and/or returns are better than I expect (which is hopefully possible) - wunderbar! But I'd rather be "disappointed" on the upside than the downside. YMMV
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Old 06-21-2010, 12:07 PM   #22
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For long term planning, I use a real return of 1%
You could load up on TIPS today and do better than that. Then again we're back to the argument over reported inflation and actual inflation...
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Old 06-21-2010, 12:13 PM   #23
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You could load up on TIPS today and do better than that. Then again we're back to the argument over reported inflation and actual inflation...
Sounds good on paper and you're more knowledgeable than I am, but TIPS haven't been around thru a period of high inflation yet, we'll see...
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Old 06-21-2010, 12:18 PM   #24
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Sounds good on paper and you're more knowledgeable than I am, but TIPS haven't been around thru a period of high inflation yet, we'll see...
True, and that goes back to the question of whether the CPI is a useful indicator of the inflation a typical household sees. Because as long as the CPI remains fairly close to being an indicator of the "true inflation" the average person feels, it will work fine whether there is 1% inflation or 11%. However, if there is a large disconnect with higher inflation rates, who knows?

The obvious conflict of interest the government has in underreporting real inflation is why I don't have more than about 20% of my portfolio in TIPS. Nothing would work out better for the Treasury than very high inflation which is signficantly underreported in the CPI. Still, the real 2.8% YTM with very low credit risk was too good to pass on at the time.
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Old 06-21-2010, 12:59 PM   #25
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I think all bets are off for any time period, except of course for December 21, 2012 when, as we all know, the world ends.
So, we're good with a perpetual 5% APY and one minor blip discontinuity, right?

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I'm just using the 5% number as a gauge to run some numbers and determine the day I could ER if I wanted. Hopefully that is sooner than the 5 year deadline I have set for myself. I realize no one can guess the right number, even over long periods of time. I'm just looking for something that may be realistic in order to run the numbers.
I am hoping to increase my bond percentage (working on it right now) to 40-45% by the time I exit.
The Gordon Equation comes up with numbers around 4-6%, which Bernstein considers reasonable for a "mature" economy, and which Buffett has also opined is a decent expectation. But they're very good at managing expectations.

2-3% over inflation might be a more reasonable goal. Hopefully that's a nominal return of 4-6%, not 18%.

There's nothing wrong with paying taxes on profits, but if you're changing your asset allocation in a taxable account you might want to consider the effect of taxes. When you ER you'll be in a lower (perhaps much lower) tax bracket and could adjust your AA during your first full year of ER with a much smaller tax bill. Of course you don't want to ER into a bear market that whacks your portfolio 50%, either, but there's perhaps a sweet spot between paying high 20% higher taxes to have the perfect ER AA and risking a 20% market drop while waiting until after you ER to adjust your AA.
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Old 06-21-2010, 01:36 PM   #26
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Well, I'll stick with the 5% then for projecting my "magic number" for the next 5 years.

I try to keep my portfolio tax efficient. All of my bonds and reits are in 401Ks or IRAs. I also have a chunk of stock index funds in an IRA that I could convert to bonds if needed.

Outside my 401k (in the taxable space) I have most of my stock, which is split between Fidelity's Total Market Index Fund and Vanguard's World Ex-US Fund. Also, I have started buying Vanguard's Intermediate Muni Fund, which is where I will put most of my purchases for the next few years, in order to get my bond % up.

Once the 2013 health care tax on investments kicks in, or before, I may have to consider converting more of the stock to munis in order to avoid the tax hit. I'll have to have someone do the numbers at that point.
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Old 06-21-2010, 05:46 PM   #27
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I have no idea either for the next 5 years or for the longer term. However, in order to plan for retirement I have to be confident that my portfolio will do well enough to maintain my inflation adjusted cost of living over the long term which more or less forces me to make an assumption about rates of return: I just assume (or hope) that the net of everything yield on real estate and equities will be the real return and the underlying assets will match inflation. If they do better than that - great. If not, I have over saved to some extent - hopefully enought.
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Old 06-21-2010, 07:03 PM   #28
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So, we're good with a perpetual 5% APY and one minor blip discontinuity, right?

I believe the proper term is "singularity" but not to worry. Everything begins anew afterwards, freshly scrubbed and so forth...
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Old 06-21-2010, 10:21 PM   #29
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I use different rates of return for the 6 funds I own. I own two muni bond funds and I happen to use the same rate of return for them. I own my "Big Bond Fund" which I assume a higher rate of return. I also own a stock mutual fund. In my IRA, I have a stock fund and another bond fund, each of which have their own rates of return comparable to those in the taxable accounts. The general range of rates of returns is from 4% to 6%.

For income-generating purposes (in my taxable accounts), I assume a certain amount of dividends (and cap gains, if applicable) per share per year so I can figure out how much of it will be needed to cover my expenses and how much can be reinvested and to which fund(s). If I have a projected deficit (about 10 years from now, possibly), I have to select a fund whose principal will be used to cover the shortfall.

On the expense side, I have different inflation rates for medical expenses (i.e. mostly health insurance) versus everything else. Tough to figure the HI inflation with the effects of the HI reform not yet known (not trying to get political here, just noting the uncertainty).
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Old 06-22-2010, 10:09 AM   #30
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You could load up on TIPS today and do better than that. Then again we're back to the argument over reported inflation and actual inflation...
I forgot to mention that I also use 4% as a personal rate of inflation.

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The Gordon Equation comes up with numbers around 4-6%, which Bernstein considers reasonable for a "mature" economy, and which Buffett has also opined is a decent expectation. But they're very good at managing expectations.

2-3% over inflation might be a more reasonable goal. Hopefully that's a nominal return of 4-6%, not 18%....
Yes so I guess my 7% portfolio growth is 3% over my inflation assumption. I use 4% inflation because that has been our personal experience and has nothing to do with official numbers. It includes travel which is substantially higher than before ER.
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Old 06-22-2010, 08:53 PM   #31
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Try zero percent, which might still be a generous number. Double dip recession - here we come (or not). I won't know and neither does anyone else. Don't just plan for the average/likely scenarios, but also around the margins.
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Old 06-22-2010, 09:29 PM   #32
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Try zero percent, which might still be a generous number.
Absolutely. A five year period can definitely be negative - we are ALL painfully aware of that.

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Old 06-22-2010, 09:46 PM   #33
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I use (1/pe) - costs for real stock return, about 5.5% for a mix of US and International. For bond real return its yield - cpi - costs, about 3% now.
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Old 06-22-2010, 11:42 PM   #34
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For the last 10 years before I retired (and the almost 4 years since), I was more interested in the dividends my portfolio generated rather than the market value, since that is what I planned to (and now actually) live on. I projected when my (after-tax/health insurance) dividend income would pass my (after tax/savings/401k/SS/mortgage) paycheck - this is when I considered myself FI. I found this a much more linear climb, and generally projectable within a few percent per year, much tighter than projecting market value. I generally projected 6-7% growth per year on my stocks which yield about 3%, and averaged somewhat higher.
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Old 06-22-2010, 11:47 PM   #35
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I'm just using the 5% number as a gauge to run some numbers and determine the day I could ER if I wanted. Hopefully that is sooner than the 5 year deadline I have set for myself. I realize no one can guess the right number, even over long periods of time. I'm just looking for something that may be realistic in order to run the numbers.

I am hoping to increase my bond percentage (working on it right now) to 40-45% by the time I exit.
Go back and re-read ERD50's post concerning using averages over short terms. You can't plug in one number to estimate returns for a short 5 yr period because the variability will be too large to make it meaningful for planning purposes.

For example, you might say the average return for your AA over the next 5 yrs will be 5% +/- 7%. That is, it will be between -2% and +12%, with 5% being the most likely and -2% and +12% being the least likely.

Don't make the mistake of planning with averages. Put together several different scenarios and assign probabilities to each. Try assuming your portfolio will have a small loss, a small gain and a larger gain (you plug the numbers) and see how each fits with your ER desires. Each of those outcomes is possible and should be considered.

I'd be very willing to bet that the 5 yr return for a portfolio with your AA will NOT be 5%.
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Old 06-23-2010, 12:57 AM   #36
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My assumptions:

Inflation 3%
Short-term savings 2%
Education inflation rate 6%
Long-term stock returns 10.7%

But these are all just spreadsheet inputs that I can change any time. My personal inflation rate is actually running slightly below 0% over the past 41 months of actual data, so if I get 7.7%, all other things being equal, my spreadsheet will be accurate and I will be FI on February 21, 2015. If I don't, then I'll be FI later than that.

I've been watching my projected FI date bounce around in my spreadsheet as I've update my account balances, assumptions, etc. It tends to stay around 45.5, or Christmas 2014ish. With the slop / bias towards being conservative overall, I am hopeful for around 45.

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