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Wealth accumulation phase rate of return
Old 08-27-2003, 02:12 PM   #1
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Wealth accumulation phase rate of return

Hello Folks,

What rates of return do you folks use for the wealth accumulation phase and why do you use that rate? I have been using the 11% historical S&P rate that I handicap by 3% for inflation. My current timeline is 15 years until ER/FI. My thrift plan (read 401k) is invested 90% in an S&P fund, 5% in Wilshire 4500 fund, and 5% in Barclays EAFE fund (developed international). It's been like that for quite some time. It was 100% S&P indexed previously. Even with the recent market, I'm perfectly happy with this mix and I haven't lost an hour of sleep. Hopefully this isn't a case of ignorance is bliss. Time will tell, I suppose.

I was thinking that I would move into a 75/25 split between stocks and treasuries around 5 years our from ER and keep that mix indefinitely.

Thanks,

Chris
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Re: Wealth accumulation phase rate of return
Old 08-27-2003, 02:40 PM   #2
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Re: Wealth accumulation phase rate of return

IF you are happy with the mix and can live with stock volatility by all means keep on dollar cost averaging into your 401K. 1977 - 1987 I went 50% GIC's at 9-11% and 50% index 500. After the 1987 stock crash = went 100% index 500 until 1993. 11% maybe High for a !5 year average given rolling 15 year returns from 1871 to now. You might want to to look at ranges from 6-12% and see how that affects your options.
BTY- The bulk of gain in our 401k/IRA occured in 90's - after ER because of History - the planing was maintaing an exposure to stocks/bonds-in 2003 age 60 we are 50/50 - maybe a tad too conservative.
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Re: Wealth accumulation phase rate of return
Old 08-27-2003, 03:15 PM   #3
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Re: Wealth accumulation phase rate of return

I am Er'd, but figure one has to contnue to accumulate (or appreciate?) to keep going for all the years to come with a long payout phase.

I am using 6% max, and 3% for inflation, for a 3% real. Early this year, I was plugging in some negative numbers till it turned up starting in March. About 50% stocks, not comfortable with going higher at this particular time. Wondering about valuation.
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Re: Wealth accumulation phase rate of return
Old 08-27-2003, 04:17 PM   #4
 
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Re: Wealth accumulation phase rate of return

I am ER'd also and I used to use the 8-11% numbers too. Since the economy is in the tank and the Stock Market seems overvalued to me. I have been using the 6% number also with 3% inflation.

Currently I am 50% in Cash and 50% mostly in the S&P 500. If the market drops in the next couple of years I'll invest, If it goes sideways I'll go the TIPS, Bond route, If the Market gains I'll be selling and holding cash waiting for an opportunity.

No Debt, House paid for, Just having a good time! Going fishing on the cheap next month in British Columbia!
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Re: Wealth accumulation phase rate of return
Old 08-27-2003, 04:22 PM   #5
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Re: Wealth accumulation phase rate of return

I am in favor of using very conservative estimated rates of return, since dividends are at an all time historic low. Dividends have been a major component of past market returns. A further caution is high lagging P/E ratios. Since the P/E ratios have been under 10 in the past, plans should allow for the possibility that they will be at that level again in our life times. This potential contraction of P/E ratios would act along with smaller total collected dividends to lower returns.
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Re: Wealth accumulation phase rate of return
Old 08-27-2003, 06:22 PM   #6
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Re: Wealth accumulation phase rate of return

Bogle and Buffet agree with the 6% rate of the last three posts - at least from what I've read on the net. As for dividends I tend to look at $ not yield - my Vanguard Retiremnt Planner ( a book!) only goes to 1994 but shows dividends outplacing inflation 4.5% vs 3.1%.Today's low dividend, high P/E envirnoment would make me lean toward the 6% rate in planning how much to be saving for ER - i.e. I agree with you guys.
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Re: Wealth accumulation phase rate of return
Old 08-28-2003, 08:05 AM   #7
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Re: Wealth accumulation phase rate of return

Wow, interesting replies. Thanks! Those replies took some time to digest! There doesn't seem to be much faith that the market will perform as well in the future as it has in the past. YIKES! I had been running a 8% real return (11-3% for inflation). A 6% return with 3% real return figures change the accumulation phase from an investing exercise to more of a savings exercise.

I re-ran the FIRE calcs with a 3% and 6% real return figure. All of the scenarios work and they range from Whoo-hoo party time to just plain nice. Thankfully, tube steaks, ramen noodles, and generic beer don't need to enter the equation at any of these rates of return. The 3% real rate would mean that going earlier than age 50 would be less comfortable than I desire (therefore I won't do it) and that my wife would need to hit her 30 and out age for the pension. Higher rates during the accumulation phase mean earlier FI for both of us, provided she wants to leave work.

The results of the FIRE calcs really make me question these low returns (3 and 6% real). In general, the withdrawal phase makes higher returns less likely since you still need to take money even in down markets. If someone trusts the FIRE calc to give you an inflation adjusted rate of return at 4-5% (for a real return of 7-8%), why wouldn't these same folks trust the market to return MORE than that during the accumulation phase since withdrawals in a down market aren't a factor? I don't get it.

Thanks,

Chris
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Re: Wealth accumulation phase rate of return
Old 08-28-2003, 08:22 AM   #8
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Re: Wealth accumulation phase rate of return

Hey - what's wrong with tube steaks and generic beer once in a while?? Isn't the `good life' worth a little sacrifice?

Similar to Cut Throat's admission in another area of this board (and I'm also 52 - fully retired since 99 and partially since 94), I too LOVE Mondays. Come to think of it, I also love the other 6 days as well.

I'm sure many of you other ER's have used this old cliche:

The worst part of being retired is that you really can't appreciate weekends or holidays the way you did when you worked.

The best part of being retired - Every day is like a weekend or vacation day.

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Re: Wealth accumulation phase rate of return
Old 08-28-2003, 08:59 AM   #9
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Re: Wealth accumulation phase rate of return

Do not panic - things change - Bogle and Buffet were talking about the coming decade starting from a high P/E, low dividend point. If you are dollar cost averaging over a long enough period you may beat 6%. You might want to read Bogle's 1994 book Common Sense on Mutal Funds - about tin and golden decades - and his thougts on price to dividend ratio (in contrast to P/E).
BTY- I don't start my 401K until 1977. I putzed around with stocks/mutual funds 1965 till now including the roughly 1968-1982 period when the DOW never broke 1000. The 401k is 90% of my portfolio in ER and stocks 10%. But I spent stocks along the way Two sports cars, two years penthouse living, a boat, two campers, a duplex, and a fish camp and I was lousy stock picker.- Oh the power of dollar cost averaging and the fact I couldn't spend the 401K , no loans in those days.
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If you'r: Wealth accumulation phase rate of return
Old 08-28-2003, 01:21 PM   #10
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If you'r: Wealth accumulation phase rate of return

From unclemick:
Quote:
If you are dollar cost averaging over a long enough period you may beat 6%.
Chris, be sure to collect the benefits of dollar cost averaging. In a sideways market it will reduce your average price per share purchased by 5% to 10% (or even more with high volatility). It is always best to buy at low prices. But unless you are thoroughly convinced that prices will be going down, dollar cost averaging (or something like it) is the way to go.

Have fun.

John R.
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Re: Wealth accumulation phase rate of return
Old 08-28-2003, 04:28 PM   #11
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Re: Wealth accumulation phase rate of return

Jack,

Thanks for the note. I don't know if the good life is worth a little sacrifice - but I will take your word that it is worth seriously considering. I do know that 2 of my 4 years at college were awash with tube steaks, ramen noodles, and $.49 frozen pizzas. As I type those words, my stomach is on the verge of flipping. I spent the first two years in the dorm with cafeteria plan. That I could do over again, chicken cosmo sandwiches, creamery ice cream, etc. Yummmmm. Seriously, my wife and I were just commenting the other night how we could go for a chicken cosmo.

I think I know what I'm going to miss when I leave work other than the 6-8 folks I actually consider to be friends. I'm going to miss the occasional business trip to a new location, the T-1 line for access to the internet, and lastly, the bi-weekly lump that gets EFTed to the credit union account. I think that Monday through Friday (less holidays) will become my weekend. Crowds aren't a favorite of mine and I look forward to having days off to do activities that are always clogged with way too many people on the weekends. Or as I refer to crowds - the Million Moron March.
--------------------------------
unclemick,

Thanks for the note. I wouldn't say I was panicked. Just surprised at the pessimism (realism?). The more I think about it, the 3% numbers don't sound too bad. The biggest drawback to these numbers is that my wife probably won't be comfortable joining me in ER until she gets her 30 and out pension. I'd like her to join me in ER earlier than this. The higher rates of return would simplify this outcome. I'll see if I can find the book at the local library. We are getting closer to reading season here in Michigan.

I had some stocks a while back. I'd get mad when they didn't go up in value because I knew they should and would get anxious when they did go up because I thought they went too high. I considered professional mental help, but it was cheaper to just sell the stocks and buy some mutuals. Haven't been mad or anxious about money issues since.

We sail and I fish among other things. Sounds like you have some toys to play with. I'm looking forward to playing with my toys a little more.
----------------------------------
John,

Thanks for the post. No question about it - we are dollar cost averaging. We probably wouldn't hit the max if we didn't. I'd be interested in hearing more about the 5-10% boost from DCA. Not sure how to figure that into the mix unless I just plus up the contribution figure by 5-10%. Maybe I answered my own question. Don't know.

Thanks to all for posting,

Chris
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Re: Wealth accumulation phase rate of return
Old 08-29-2003, 08:26 AM   #12
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Re: Wealth accumulation phase rate of return

For newellcr:
Here is a little write up about dollar cost averaging. It is highly mathematical, but I am sure that you will understand the more important points.

Definition
Dollar cost averaging consists of purchasing the same, fixed dollar amount of stocks periodically over a long time period. The number of shares varies with each purchase since share prices fluctuate.

The Numbers
1. The numerical accuracy of my analysis is not that good. Keep that in mind.
2. I approximate the price of a stock as following a triangle pattern. It starts from a minimum (MIN) and rises uniformly to a maximum (MAX) and then back to its initial minimum. The rates of increasing prices and decreasing prices are both constant and equal. I then make a series of purchases, each amounting to $1000, at equal intervals. For simplicity, I make one purchase at the minimum, one purchase at the maximum and two purchases at each intermediate price: one on the way up and a second on the way down. Because I am using a triangular pattern, the median price is equal to (MIN+MAX)/2.
3. First, consider a minimum price (MIN) of $50 per share and a maximum price (MAX) of $150 per share. We will purchase $1000 of stock at prices of $50, $70, $90, $110, $130, $150, $130, $110, $90 and $70 per share. The total amount that we invest is $10 000. The number of shares that we purchase are 20.00, 14.29, 11.11, 9.09, 7.69, 6.67, 7.69, 9.09, 11.11 and 14.29, respectively. We purchase a total of 111.03 shares. The average price per share is $10000/111.02 = $90.07 per share. The median price is (MIN+MAX)/2 = ($50+150)/2 = $200/2 = $100.00 per share. Our purchases average 90.07% of the median price. We get a 10% discount.
4. If we get very fancy and use calculus, we can derive a formula for the average price per share if we purchase shares continually. The formula is [(MAX-MIN)]/[ln (MAX/MIN)], where ln refers to the natural logarithm. It is found on scientific calculators. This formula results in an answer of $91.02 per share (when MIN = $50 and MAX = $150) or a 9% discount overall.
5. I introduce this formula only to indicate the effects of volatility.
6. Let us hold the difference between the maximum and minimum prices per share constant. Increasing the ratio MAX/MIN corresponds to increasing volatility. We can do that by decreasing the values MAX and MIN by the same amount. For example, if we subtracted $25 per share from each, then MAX = $125 per share, MIN = $25 per share and MAX/MIN = 5 (highly volatile). The median price is reduced to ($125+$25)/2 = $150/2 = $75 per share. The formula calculates an average price of $62.13 per share or 83% of the median price per share. That is an impressive 17% discount. But the volatility is much more impressive (MAX/MIN = 5).
7. Consider the effect of having prices MAX = $100 and MIN = $50 per share. The median price is $75 per share. The average price is $72.13 per share or 96.2% of the median. The volatility is MAX/MIN = 2 and the discount is 4%.

Conclusion
From these examples we see that a discount of 5% to 10% is reasonable. You should not expect to get a discount of 15%.

Have fun.

John R.
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Re: Wealth accumulation phase rate of return
Old 08-29-2003, 08:58 AM   #13
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Re: Wealth accumulation phase rate of return

I use a return of 6%. I get this from a 10% return minus 4% inflation. I am only 23 and have a 17 year accumulation phase so I am 100% into stocks. I use the 4% inflation number because my parents lived through times in which 3% inflation would have been a joke. So I am a little pessamistic that inflation will be 3% until I die(hopefully 60+ more year). My conservatism also extends in that I only plan on a 1.75% withdraw rate.
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Plus up from DCA
Old 08-29-2003, 05:10 PM   #14
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Plus up from DCA

John R.,

There is a practical use for calculus?! Just kidding. Thanks for the detailed explaination. I understand the discounting now. The more volitility - the greater the benefit for dollar cost averaging. Cool, a 5% discound could add another $40k or so to the lump.

Thanks for the thoughtful reply,

Chris
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Re: Wealth accumulation phase rate of return
Old 08-29-2003, 05:12 PM   #15
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Re: Wealth accumulation phase rate of return

Blazerjeremy,

Thanks for the post. I understand why you are using your accumulation rates, but I have a question for you. Are you using these withdrawal rates as a conservative ~estimate~ for the withdrawal or are you going to actually shoot for a 1.75 withdrawal rate?

Thanks,

Chris
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Re: Wealth accumulation phase rate of return
Old 09-02-2003, 07:49 AM   #16
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Re: Wealth accumulation phase rate of return

newellcr,

I actually shoot to only use the 1.75% withdrawal rate. This demands that I save more/longer before I can FIRE. Or live on less. I will choose to Save more so that I can have enough of a nest egg that I can get by on only 1.75%. The reason for this is that once I retire I want to move into less risky investments. While I am working and in the accumulation phase if the stock market drops and half of the nest egg vaporizes it won't be a problem cause I am living on my wage. But once FIRE and that happens I will be starving. This is a scenario I would like to avoid. I plan on retiring early at 40. I also plan to live until I am very old. Hopefully 100 or older!! So I need my money to last. One rule I have set for myself is if in one year I only withdraw 1.75% and my money grows faster, say 4%, I will not take the extra for 5 years. Then I will take the extra but not what that extra earned during those 5 years. It sounds stupid because I could have lots of money left over when I die. But being the conservative I am I like to miss by too much than by not enough.
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Re: Wealth accumulation phase rate of return
Old 09-02-2003, 08:58 AM   #17
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Re: Wealth accumulation phase rate of return

Blazerjeremy,

Thanks for the reply. A belt and suspenders approach, nothing wrong with that.

Thanks,

Chris
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