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Real Return and Risk
Old 05-04-2006, 10:44 AM   #1
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Real Return and Risk

Seems a slow day so I'm going to ask a newbe question. If infaltion is usually 3 - 4% and portfolio returns are 8 - 10% for 60% stock / 40% bond allocation this leaves us with a real return of 4% - 7%. Using the rule of 72 this means an average lump-sum balance portfolio will take as much as 18 years to double (conservative). If you increase your stock exposure to say 80% stock you can maybe get 1 or 2% more but are taking greater risk but will potentially double your money in 10 years. Is this logic correct and does it mean that many attempting to achive FIRE assume more risk to do it sooner rather then later?

Elroy
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Re: Real Return and Risk
Old 05-04-2006, 10:52 AM   #2
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Re: Real Return and Risk

Typically, a higher allocation of equities will increase the variability of your returns. Therefore, depending on the time period you're measuring, the period of time it takes to double your money could be longer or shorter. On average, it will be shorter. But few actually experience the average. Average is a descriptive statistic, not something that actually happens, except on rare occassion.

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Re: Real Return and Risk
Old 05-04-2006, 02:15 PM   #3
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Re: Real Return and Risk

Quote:
Originally Posted by elroy
Seems a slow day so I'm going to ask a newbe question.
... and portfolio returns are 8 - 10% for 60% stock / 40% bond allocation...
I'm having a little trouble getting past this assumption!

I'd say that after-inflation returns could be as little as 3-4%, and that's before paying taxes.

But if your assumptions are correct, then so is your math.

Quote:
Originally Posted by elroy
does it mean that many attempting to achive FIRE assume more risk to do it sooner rather then later?
But I disagree with this conclusion. Investors take more risk because they feel that they have a good prospect of remaining employed, or because they're living way below their means, or because they stumble across a 10-bagger, or because they feel that they have plenty of time to recover from a bear market, or because they just don't care about volatility if they don't have to sell assets when they're down.

If I was investing solely to accelerate FIRE then I'd be 100% in gold futures & naked stock options. Unfortunately I don't think I'd be doubling my money quicker just by quintupling my volatility risk.

It's much easier (and much more achievable) to cut down on your expenses or to raise your income than it is to find a low-volatility method to double your portfolio more quickly.
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Re: Real Return and Risk
Old 05-04-2006, 02:25 PM   #4
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Re: Real Return and Risk

Quote:
I'm having a little trouble getting past this assumption!

I'd say that after-inflation returns could be as little as 3-4%, and that's before paying taxes.
He probably assumed the use of tax advantaged vehicles like 401(k)s and IRAs.

Quote:
Seems a slow day so I'm going to ask a newbe question. If infaltion is usually 3 - 4% and portfolio returns are 8 - 10% for 60% stock / 40% bond allocation this leaves us with a real return of 4% - 7%. Using the rule of 72 this means an average lump-sum balance portfolio will take as much as 18 years to double (conservative). If you increase your stock exposure to say 80% stock you can maybe get 1 or 2% more but are taking greater risk but will potentially double your money in 10 years. Is this logic correct and does it mean that many attempting to achive FIRE assume more risk to do it sooner rather then later?

Elroy
Yes. Were you looking for something else?
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Re: Real Return and Risk
Old 05-04-2006, 03:53 PM   #5
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Re: Real Return and Risk

I decided on a relatively high-risk path to FIRE. 100% equities, no fixed income.

I'll probably get there in 7-10 years (pretty good chance). If the market takes a big extended dive, it might be a few years beyond that. Although while the market is down, I'll get to buy stocks "on the cheap".

I'm willing to take the risk that I may have to postpone FIRE a few years due to poor market returns in exchange for cutting off a few years from my expected FIRE date.

In other words, I'd rather work for 7 to 13 years, knowing it would be closer to 7. The alternative would be a less risky portfolio and being pretty certain to work for 11+ years.
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Re: Real Return and Risk
Old 05-04-2006, 06:19 PM   #6
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Re: Real Return and Risk

Thanks for the input. I guess what has me concerned is whenever I look into the future and adjust the variables in my retirement plan that I control the biggest change in outcomes is caused by how many years longer I work. My previous plan had me >95% (finacial engines) and 100% (firecalc) sure to FIRE at 60 (17 years) with ~80K a year. I wanted to see if I can RE earlier with a more aggesive protfolio but it didn't really have as big of an effect as I thought it would. Then I increased contributions to the point that I would have no discretionary spending with a only a 2 year earlier (age 58) effect. How many years saving had a overwelming effect. Finally settled for a plan that puts me at ~75% chance at 55. keeping a simialr 75% stock / 25% bond allocation and increasing by 20% the amount saved in my taxable account.

David
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