25 X Expenses

[marko]

Not to further complicate the discussion, but for fun I'll sometimes take my current annual spending and divide it by 4% to see how much cushion my portfolio balance has.

IOW, how low would my portfolio have to go before I'd have to consider cutting back on spending. Same math, different angle to it.

 

[pj.mask]

Sorry I wasn't clear - to me the earnings referred to how much money I want to take in per year in retirement. For me this isn't tied to expenses now but the inflated lifestyle I would like

 

[HappyMinimalist]

You've provided very few details, but I notice you want to retire at 57.

Carve out enough money to cover the gap from retirement to start of social security. The rest of your assets "should" (with all the caveats on the 4% "rule") be 25x the rest of your spending.

Example: Want to spend $40k per year. SS at 66 is $15k. Have $785k assets.

Carve out (66-57) x $15k = $135k. That will provide $15k per year for the 9 years between retirement and SS.

This leaves ($785k-$135k)= $650k.

You still need $40k - $15k = $25k every year from savings.

So the 25x says you "should" have 25 x $25k = $625k in savings.
In this example, you'd have a pretty slim cushion.

Out of curiosity I'm working out my numbers using your method-

Couple's annual Budget $80K, local SS equivalent CPF Life 32K, have at least 3 mio mostly invested in rental properties. We intend to live off rental income for as long as possible without drawing down.
DH will retire at 54, I will be 52 at that time. I will use a median age 53 for calculation

Carve out (65-53)x 32K= $384k
We still need $80k-32k= $48k from savings

At 25x we will need 48kx25= $1.2 mio
Add back carved out amount we need 1.2+384k= $1.584 Mio
One question, Independent, how do I factor in inflation?

 

[pj.mask]

Inflation should be accounted for In 4% model.

Run a simulation like firecalc. You can use the tabs to add in Pension/social security, rental income, and spending.

On the first page enter amounts invested in stocks/bonds. You can even plan to sell your rental property and add a lump sum to account in 15 or whenever years.

 

[ShokWaveRider]

So I guess our 45x is overkill and we need to spend more?

 

[Independent]

Out of curiosity I'm working out my numbers using your method-

Couple's annual Budget $80K, local SS equivalent CPF Life 32K, have at least 3 mio mostly invested in rental properties. We intend to live off rental income for as long as possible without drawing down.
DH will retire at 54, I will be 52 at that time. I will use a median age 53 for calculation

Carve out (65-53)x 32K= $384k
We still need $80k-32k= $48k from savings

At 25x we will need 48kx25= $1.2 mio
Add back carved out amount we need 1.2+384k= $1.584 Mio
One question, Independent, how do I factor in inflation?

The people who backtested the 4% assumed that annual withdrawals would grow with inflation. So, inflation is "covered" (to the extent that anything is in that process) for the annual $48k.

The question is how to handle inflation on the $32k annual income for the first 9 years? We earmarked assets specifically for this period. They were fixed income - a mix of CDs for the earlier years and I-Bonds for the later years. My calculation assumes that I believe the inflation rate equals the interest rate on my assets. When I retired, that was "close enough" for this type of work.

Someone else, using the same process, might feel that inflation is going to outrun interest and go through an explicit calculation. I'd explicitly set up a ladder, look at the annual cash flows from interest and maturities, and plan for a pattern that follows my assumed (probably conservatively assumed) inflation rate.

I expect that if you do the math, you'll discover it's not a lot of extra money.

Of course, this is a quick and dirty, gut feel calculation. You can put the numbers into a calculator and see what it says. Note that if you want to go the earmarked assets route, you may need to set them aside outside the calculator.

------------------------

That said, I don't know how to interpret your comment on rental properties, whether they are in the $1.2 million and producing the $48k, or whether they are in addition to the $1.2 million. Part of my confusion is that you say you can live off the rents in the early years - that implies your rental properties by themselves are generating $80k of net income.

 

[pj.mask]

So I guess our 45x is overkill and we need to spend more?

I would say 45x is overkill for maintaining that level of spending. However it may not be overkill for providing you needed income.

What I mean is if your annual spend is 30k, what is the chance you could have some events that push you up to 50k? Especially with our medical risk in the US. This could quickly drop you to 27x where you may risk sustainability with long retirement timeline.

However if you spend like 150k/yr and 45x you have the same risk of an overspend result but if that moves you from 150 to 170, that only drops you to 40x - still a very safe level.

Edit: also depends if you are investing for your kids/people you will leave your estate to.

 

[HappyMinimalist]

The people who backtested the 4% assumed that annual withdrawals would grow with inflation. So, inflation is "covered" (to the extent that anything is in that process) for the annual $48k.

The question is how to handle inflation on the $32k annual income for the first 9 years? We earmarked assets specifically for this period. They were fixed income - a mix of CDs for the earlier years and I-Bonds for the later years. My calculation assumes that I believe the inflation rate equals the interest rate on my assets. When I retired, that was "close enough" for this type of work.

Someone else, using the same process, might feel that inflation is going to outrun interest and go through an explicit calculation. I'd explicitly set up a ladder, look at the annual cash flows from interest and maturities, and plan for a pattern that follows my assumed (probably conservatively assumed) inflation rate.

I expect that if you do the math, you'll discover it's not a lot of extra money.

Of course, this is a quick and dirty, gut feel calculation. You can put the numbers into a calculator and see what it says. Note that if you want to go the earmarked assets route, you may need to set them aside outside the calculator.

------------------------

That said, I don't know how to interpret your comment on rental properties, whether they are in the $1.2 million and producing the $48k, or whether they are in addition to the $1.2 million. Part of my confusion is that you say you can live off the rents in the early years - that implies your rental properties by themselves are generating $80k of net income.

Thanks , Independent, for taking the time craft a reply to my newbie question, it's folks like you who make this site such a wonderful resource.

I understand about the assumption that the interest from my instruments will need to be 4% or higher to cover inflation. As for withdrawal, does it mean I have to adjust my annual amount every year? 48kx1.04=49920 for year 2 and so forth?

The rental properties we hold will produce part of the 1.2 million. At this moment I estimate rentals to contribute 60k to my 80k annual budget . The remaining 20k will come from income from REITs, stocks and our cash float. We envision having to liquidate a property to get a lump sum only if say my DH's mother meets with a catastrophic health event or if DD wants to take a PhD.

 

[Independent]

Thanks , Independent, for taking the time craft a reply to my newbie question, it's folks like you who make this site such a wonderful resource.

I understand about the assumption that the interest from my instruments will need to be 4% or higher to cover inflation.

I had suggested splitting assets into two buckets - one to cover $32k for 9 years, the other to cover $48k for all years. I think you're talking about the first 9 years here?
If so, I don't think there is any magic in 4%. Inflation could be anything over the first 9 years. We can get a consensus expectation from bond yields, but the herd doesn't know either. When I retired, we had CDs for the first 5 years, and I-Bonds for the next 7. The I-Bonds are CPI indexed, so I didn't need to worry about inflation with them, and I just took the inflation risk on the CDs for the first 5 years.

As for withdrawal, does it mean I have to adjust my annual amount every year? 48kx1.04=49920 for year 2 and so forth?

Now I think we're talking about the $1.2 million bucket that would provide the $48k.

The backtesting that supports the 4% withdrawal idea assumed that withdrawals would go up with the actual CPI.
So, if your first year withdrawal is $48,000, and actual CPI growth is 5%, you'd withdraw $48k x 1.05 = $50,400 in the second year.
OTOH, if the actual CPI growth is 2%, you'd withdraw $48,000 x 1.02 = $48,960 in the second year.

The rental properties we hold will produce part of the 1.2 million. At this moment I estimate rentals to contribute 60k to my 80k annual budget . The remaining 20k will come from income from REITs, stocks and our cash float. We envision having to liquidate a property to get a lump sum only if say my DH's mother meets with a catastrophic health event or if DD wants to take a PhD.

Okay, the rentals are included in the $1.2 million, and seem to make up the bulk of it.

In that case, the 4% "rule", or the equivalent 25x in the first post, may not be relevant to your situation. That number was developed to allow for the volatility of common stocks and the order of returns risk. I expect real estate is noticeably different.

You're the expert on how much net income you can expect from your rentals, how stable it is, whether you expect it to go up as fast as your living costs, and how much market risk you are taking in some future sale. I can say that those seem to be the types of things one would consider, but then I run out of things to say.

 

[HappyMinimalist]

I had suggested splitting assets into two buckets - one to cover $32k for 9 years, the other to cover $48k for all years. I think you're talking about the first 9 years here?
If so, I don't think there is any magic in 4%. Inflation could be anything over the first 9 years. We can get a consensus expectation from bond yields, but the herd doesn't know either. When I retired, we had CDs for the first 5 years, and I-Bonds for the next 7. The I-Bonds are CPI indexed, so I didn't need to worry about inflation with them, and I just took the inflation risk on the CDs for the first 5 years.

Now I think we're talking about the $1.2 million bucket that would provide the $48k.

The backtesting that supports the 4% withdrawal idea assumed that withdrawals would go up with the actual CPI.
So, if your first year withdrawal is $48,000, and actual CPI growth is 5%, you'd withdraw $48k x 1.05 = $50,400 in the second year.
OTOH, if the actual CPI growth is 2%, you'd withdraw $48,000 x 1.02 = $48,960 in the second year.

Okay, the rentals are included in the $1.2 million, and seem to make up the bulk of it.

In that case, the 4% "rule", or the equivalent 25x in the first post, may not be relevant to your situation. That number was developed to allow for the volatility of common stocks and the order of returns risk. I expect real estate is noticeably different.

You're the expert on how much net income you can expect from your rentals, how stable it is, whether you expect it to go up as fast as your living costs, and how much market risk you are taking in some future sale. I can say that those seem to be the types of things one would consider, but then I run out of things to say.

I get what you mean about the 4% and 25x expenses not being relevant to me now. What matters to me would be the rental yields, repair costs and vacancy rate. It would be much easier to park funds in index funds and bond funds and draw down on them but Asian stock markets are not as robust as US.

 

[GravitySucks]

I get what you mean about the 4% and 25x expenses not being relevant to me now. What matters to me would be the rental yields, repair costs and vacancy rate. It would be much easier to park funds in index funds and bond funds and draw down on them but Asian stock markets are not as robust as US.

The 4% - 25X guidelines were based on US stocks and bonds. If you're mostly invested in other markets and devices you probably should not use that guideline. I think FireCalc and RIP are based on US markets too.