The Three Level Concept

J

JWR1945

Recycles dryer sheets
Joined
Dec 16, 2002
Messages
290
The Three Level Concept

I placed these posts originally on the FIRE board on the http://nofeeboards.com. I post them here to give you an idea of how wonderfully powerful the dory36 FIRECalc calculator is. I also wish for you to think creatively and come up with good suggestions so that dory36 can make it even better. He is currently asking for ideas.

Have fun.

John R.
 
FIRE The Three Level PoRe: The Three Level Concept

The Three Level Portfolio Concept

Part A. The Design
1. This looks into an early retirement approach that is suitable for younger people. It is centered on a semi-retirement approach such as *****'s. The three levels are those described by *****. The lowest level covers all necessities. It cannot be cut back. The second level covers your desired standard of living. The third level is for additional luxuries.
2. My design approach is to take the intermediate level of income and multiply it by 25. That is the total portfolio that is needed eventually. The intermediate level corresponds to the traditional, relatively safe 4% withdrawal rate identified by various studies.
3. The initial portfolio balance is taken to be 20 times the lowest level of income that covers all necessities. That income is a somewhat dangerous 5% of the initial balance.
4. I assume that the young retiree continues to add to his investment portfolio during the first decade or two. This does not necessarily mean that he puts new money in. It can mean that he withdraws less than the 5% based on his initial balance.
5. For purposes of analysis, I assume that he makes his cash infusion after ten years: That he contributes half of the needed amount after ten years and the other half after twenty years. In either case, I assume that he increases his withdrawals to his desired level (4% of his total investment) after the first ten years.
6. I do not specify where the young retiree gets his funds. The most likely source would be from working part time. But it would not necessarily be from a high-income job. Rather, it could be from working on something that he wishes to work on (something that might pay considerably less). It might be from something seasonal that produces good income but only for a very short time. It could be from an inheritance or some other windfall. It could be from a variety of sources.
7. The young retiree is not forced to live on $30K per year during the first decade. He is only restricted from withdrawing more than that amount. He can supplement his standard of living by working part time.

Continued John R.
 
Part B. My Investigations
1. I used round numbers suitable for calculators and studies. I used $1.0 million for the eventual total investment. The corresponding 4% withdrawal amount is $40K.
2. Based on previous investigations I selected $600K as the initial portfolio balance. It is among the lowest balances that have been successful (although many details and many qualifiers are different). It is a reasonable ballpark number and the corresponding $30K annual withdrawal amount (5% of $600K) is reasonable (and possibly a little bit high). Any conclusions are likely to be a little bit conservative, but not too much so.
3. I used the standard tricks that we have studied in the past. In particular, I used both standard and special thresholds. By using thresholds, I mean that you convert your portfolio into an inflation matched cash equivalent when the portfolio has grown sufficiently. An inflation matched cash equivalent would correspond to a Treasury Inflation Protected Security (TIPS) (or some other Treasury Inflation Indexed Security) at a 0.0% interest rate. When I refer to standard thresholds, I mean that any conversion is done in a particular year (such as year 20 or 30) after the retirement starts. Standard thresholds are convenient for data analysis when looking at calculator outputs. By special thresholds, I mean that the conversion takes place as soon as possible.
4. What is different is from my previous investigations is that I generally use thresholds and special thresholds to match the $40K per year desired income level, not the $30K per year basic level.
5. As for the remaining details, I used the dory36 FIRECalc calculator at http://capn-bill.com/fire/. I used a 50-year life span. I used a 50% stock allocation. I used commercial paper as my cash equivalent. I used the CPI for my inflation index. I used 0.20% for expenses. I used default settings for the other values.

Continued John R.
 
Part C. Results
1. My initial investigation looked at an initial portfolio balance of $600K with one cash infusion of $400K in year 11. I checked what happens if I withdraw $30K annually for the entire 50 years. It always succeeded. The more interesting condition is when you increase withdrawals to $40K in year 11. In that case, there would have been 12 years (starts of historical sequences) that failed. Thresholds at 20, 30 and 40 years reduce the number of failures to 4. Using special thresholds reduces that number to one. Even the portfolio that failed (with the start year of 1929) lasted until year 40. In addition, looking at portfolio balances, it is pretty obvious when your investments are not doing all that well. There is plenty of warning and there is plenty of time to react.
2. In my second investigation I pushed the envelope farther than I had before. In an earlier study, I had considered two cash infusions ($200K each from an initial balance of $600) but I had made the second at year 16. In this case, I made the cash infusions at years 11 and 21. But I balanced that out somewhat when I chose the initial withdrawal amount to be $30K (5% of the initial $600K balance) instead of $40K (4% of the $1.0 million final total investment).
3. The results of my second investigation are quite promising. Although there were 27 failures before considering thresholds, using thresholds at years 30 and 40 reduced that number to 11 and using special thresholds reduced it further to only 6. All portfolios lasted more than 36 years. Once again, portfolio deterioration was gradual. There was plenty of warning. There was plenty of time to react.
4. I made a cursory examination of what the results of reacting to a poorly performing portfolio might look like. I assumed that the retiree cuts back his annual withdrawals to $30K at year 31. That would still be sufficient for meeting his needs. The result was that there were 14 failures before using thresholds (compared to 27 when the retiree continued to withdraw $40K per year) and 4 failures when he used standard thresholds or special thresholds (compared to 11 with standard thresholds and 6 with special thresholds).
5. This final comparison is quite interesting. By using special thresholds a retiree is able to maintain his desired standard of living ($40K per year) almost as well as by cutting back to his lowest level ($30K per year) and using thresholds.
6. It is also worth remembering that (when using thresholds) the portfolio is converted to inflation matched cash equivalents. That is exceedingly conservative. TIPS and ibonds do better.
Part D. Summary
1. I am quite pleased with these results. I think that we have a viable approach for looking at early retirement finances.
2. There are, of course, a host of qualifiers. Most of them apply to any projection. What I especially like about this approach is that it provides early warning when your portfolio is in danger.

Have fun.

John R.
 
One of the things I liked about my FIREcalc results
was that they confirmed what I had learned from my manual
number crunching, i.e. under a "worst case" scenario
my money will likely last as long as I do. When I
semiretired in 1993, it was quite skinny and based
mostly on "smoke and mirrors". Ten years later,
with obsessive attention to details, and some luck
I know I will never have to go back to work. It's a nice
feeling.
 
Let me help:

Look at stock valuations through a single measurement metric that not everyone will agree with.

Decide stocks are too expensive and dont buy any.

Assume you have a crystal ball and can determine the future of investing and the directions of markets.

Buy 100% tips assuming they will provide full inflation protection when they wont.

Eat your portfolio principal in conjunction with the tips interest.

Hope you dont outlive the portfolio you're consuming, even though medical advances are improving and lifespans are increasing.

End up eating dog food and washing out tin foil when you're in your eighties and cant work.

Good asset allocation, evenly spread and occasionally adjusted, is your best friend.
 
Tommy_Dolittle
Hey....educate me on your analysis. I didn't quite follow everything.
Click to expand...
This analysis has an error in it relating to thresholds and special thresholds. It turns out that the balances in FIRECalc are all in nominal dollars. That is, they do not include an adjustment for inflation.

The idea behind thresholds is that, if your portfolio does exceedingly well, go ahead and convert (at least, some of) it to TIPS and/or ibonds because they provide true safety. For example, if you need $40000 per year for 30 years (but not more) and you already have a portfolio balance of $1 200 000, why not lock in success? Or if you need it for another 40 years and you have a balance of $1 600 000, why not lock in success?

If you were just starting out, you might wish to lock in part of your gains (enough to guarantee a satisfactory retirement) and leave the rest in stocks, etc, with the hope of additional growth. But why risk running out of money altogether if you can lock in success today?

Otherwise, what I have found is that there is a lot of flexibility as the details of when you get the money needed to start retirement. If your analysis shows that you need $1 000 000 but you don't have that much, you might switch to part time employment to add more money and/or reduce withdrawals in the earlier years. In addition, you might have an inheritance coming within a decade or so and/or you might be moving to a smaller house in a few years. Both would add to your investment accounts, but not right now. It turns out that you don't have to wait.

Play around with FIRECalc. It is exceedingly flexible. By playing what-if games, you will see that there are opportunities that you have not thought about yet.

Have fun.

John R.
 
Educate me on your analysis. I didn't quite follow everything.

JWR1945 is the co-creator of the Data-Based SWR Tool (I am the other co-creator). The data-based approach to SWR analysis is an alternative to the conventional methodology approach used in the study published by intercst at RetireEarlyHomePage.com and used by Dory36 in FireCalc.

Research that has been done in development of the data-based approach has discredited the REHP study. All of the findings of the REHP study are rooted in its core premise that changes in valuation have zero effect on long-term returns. This premise has been rejected by the following experts: (1) William Bernstein; (2) Rob Arnott; (3) Andrew Smithers; (4) Robert Shiller; (5) Peter Bernstein; and (6) Ed Easterling. William Bernstein declared REHP-type studies "highly misleading" in his book "The Four Pillars of Investing." He calculated the SWR at the top of the bubble using an analytically valid methodology and found that the 4 percent number you often here cited at this board was off the mark from what the historical data says by two full percentage points.

It's not possible today to hold a reasoned discussion of the realities of SWRs at this forum. If you are looking for background, check out the "SWR of 6.21 Percent for 27 Years?" thread and the "Yahoo Finance Quiz" thread. If you want to ask questions, it would be better for the time-being if you took them to the SWR Research Group board (at NoFeeBoards.com).

The SWR question is too important for aspiring early retirees to forever be denied access to information as to what the historical data really says. In the event that you have your questions answered to your satisfaction at the SWR board, I hope that you will pay the community back for the help it has given you by taking your new understanding of the issue back to this board and helping to steer it to where it too will permit an exchange of honest and informed posts on this important topic.
 
I am relieved to learn the REHP study has not been "discredited" by Bob Brinker. Then I would really be worried :)

John Galt
 
Tommy_Dolittle
This analysis has an error in it relating to thresholds and special thresholds.  It turns out that the balances in FIRECalc are all in nominal dollars.  That is, they do not include an adjustment for inflation.

The idea behind thresholds is that, if your portfolio does exceedingly well, go ahead and convert (at least, some of) it to TIPS and/or ibonds because they provide true safety.  For example, if you need $40000 per year for 30 years (but not more) and you already have a portfolio balance of $1 200 000, why not lock in success?  Or if you need it for another 40 years and you have a balance of $1 600 000, why not lock in success?

If you were just starting out, you might wish to lock in part of your gains (enough to guarantee a satisfactory retirement) and leave the rest in stocks, etc, with the hope of additional growth.  But why risk running out of money altogether if you can lock in success today
JWR1945:
Excellent point. (Of course it is easy to say excellent point, if your point was on the mark with mine ;)
One of the most important things about being an investor, is to know yourself, and how you personally handle the fickleness of markets.
I was about 80% in equities when 2000 came around.
After the smoke cleared, I was down about 35%. I did not sell anything, and about 5 mos. ago, I got back to my starting point at year 2000.
That was my light bulb moment.
I switched to 80 percent other, and 20% stock. (Other, being CD's, short-term corporates, I Bonds, Tips, and a very conservative hedge fund.
I have always been a mostly equities guy in the accumulation period. (Retired 17 years ago).
It is difficult to get off that horse, but when we figured out we did not need equities to live the rest of our lives
out, the decision was really a no-brainer.
The only reason I continue with a 20% equity position, is would like to (long range, I hope), leave something to my children.
In any case, your point is well taken. If you know how much you require to live, and you don't use net-worth as a score-keeping tool, why not use the time you have left for concentrating on things that are more important to you.

Regards, Jarhead



5

















5
Click to expand...
 
That was my light bulb moment. I switched to 80 percent other, and 20% stock.

Was there anything that you read at this forum that influenced your decision, Jarhead?
 
Hello *****! While we are waiting for Jarhead, it
occurred to me that would be an interesting question
for all, i.e. how many visitors here have changed their allocation due to what they learned here. I have learned a lot and had a lot of fun, but I don't believe
my allocation would be any different if I hadn't
found this site. That's typical for me (ignoring sometimes
good advice). Still, an intriguing question..................

John Galt
 
Ben Graham, Bogle, and a tad Bernstein - with allocation based on age.

The forum influenced my fondness for Firecalc., broke down and read Four Pillars, reinforced my plodding along with hobby stocks, and of course - most importantly - the use of generic brand dryer sheets and monitoring carefully the number of cycles per sheet.

In short - reinforced my prejudices. Also picked up some possible candidates for mad money/dividend stocks. And potential retirement backup spots - should a hurricane blow us out after 25 yrs.

All in all a great place to hang out - even if I'm a blockhead and my mind is made up.
 
P.S. - I've always used the term - four legged table:

defined pension
SS
IRA
income stream - dividends/real estate.

Please note some simiarity to 'three level' and 'certain multiple streams of income concepts'.

Heh, heh, heh - the legs are not of equal length and arrive at different times. But that was my idea twenty years ago - probably influenced by Vanguard.
 
Hello Jarhead. I have thought that I may take up golf again some day (last played in 1975). Anyway, loved the game, but I was just too busy to play much. If I do
start again, my goal also will be to shoot my age............................for 9 holes :)

John Galt
 
Hello Jarhead.  I have thought that I may take up golf again some day (last played in 1975).  Anyway, loved the game, but I was just too busy to play much.  If I do
start again, my goal also will be to shoot my age............................for 9 holes  :)

John Galt
Click to expand...

If you haven't played golf since l975, you've missed some of the changes in equipment.
I'm actually hitting longer off the tee now than I was at age 40. The drivers now are almost all titanium. (Giving a spring load effect at impact, and because they are lighter, it is easier to increase head speed.
Know what you mean about time restrictions on playing golf. One of the main reasons I retired early was because of that. I also like to fly-fish, but it actually is a far distant 2nd. to golf.
Well, John, you can't use the excuse of no time to play golf now, so maybe you ought to dust off your clubs and get out there and suffer with the rest of us. ;)
Regards, Jarhead
 
Thanks, Jarhead (and UncleMick and John Galt as well).
 
Things I've changed as a result of this board.

John,

This board led me to Bernstein, which led me to shift our retirement portfolio to value rather than a mix of value/growth. (Of course a case can be made for Berkshire Hathaway being a growth stock.) We'd been buying small-cap growth indexes and now that portion is all small-cap value.

I've been able to focus my ER thoughts & questions on this board rather than exclusively on those around me. My spouse really appreciates you guys.

I made a military career out of observing my mentors. Some examples I emulated, many I didn't. I'm doing the same thing in ER... and I'm depending on all of you to show me what's next.
 
Hey Nords, I hope we all are not a bunch of lemmings. :)

Cheers,

Charlie
 
Hey lemmings are probably pretty happy up until the last 14 seconds of their lives, and even that might seem to be a pretty fun time if there are so many lemmings in the air ahead of you that you cant see the ground coming up...

Then again, unless you're the lead lemming, all you have to look at is non-stop lemming butt. :-/
 
Re: Another urban legend

right up until one of you turns traitor with a Wal-Mart greeter's job.
Click to expand...

Hey, are we going to start a pool as to who'll be first to become a Wal-Mart greeter?
 
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