Personal Finance on a Napkin

[ERD50]

... of the money I had when I retired (9/99) more than 90% was generated in the previous 5 years, between 50% - 75% was in cash or very short term cash eq., and I invested most of it in early ’00. ...

OK, your scenario would match pretty closely with that story then. But I really do believe that is not typical at all. I'd bet most of the ERs here accumulated over many years and maintained a fairly aggressive AA during that phase.

With all the stock option action in the late 90's, you sure are not all that unique I suppose, but I'd still say not typical.

I guess the real take away is, be careful applying any generalized advice!


-ERD50

 

[haha]

Agree - valuation matters. Maybe Shiller PE10 can help set a reasonable expectation for future returns.

Even if the market were “reasonably valued” when he retired, there’s nothing wrong with each having reasonable expectations of success.

Re your first statement, that was really what I was trying to illustrate. Of course valuation matters-what matters is the productive power represented by the number of shares that one is able to buy.

As to the second statement, I agree that both Joseph and Josefina may have reasonable chances of success, depending on how one defines reasonable. What I said is "Is it even remotely possible that these two people should have the same expectations of success?"

I feel that by definition they cannot have the same distribution of outcomes, though Joseph may get lucky and not flame out.

And to ERD 50- whatever Josefina was worth 18 months prior to her retirement is water over the dam. What matters is how many shares she was able to buy, when she did actually buy them. Maybe she won a lottery, or a sexual harrassment suit the month prior to retirement and had been broke up to then. Would that then mean that her chances were very poor?

Ha

 

[MichaelB]

Re your first statement, that was really what I was trying to illustrate. Of course valuation matters-what matters is the productive power represented by the number of shares that one is able to buy.

As to the second statement, I agree that both Joseph and Josefina may have reasonable chances of success, depending on how one defines reasonable. What I said is "Is it even remotely possible that these two people should have the same expectations of success?"

I feel that by definition they cannot have the same distribution of outcomes, though Joseph may get lucky and not flame out.
Ha

Agree.

 

[ERD50]

And to ERD 50- whatever Josefina was worth 18 months prior to her retirement is water over the dam. What matters is how many shares she was able to buy, when she did actually buy them. Maybe she won a lottery, or a sexual harrassment suit the month prior to retirement and had been broke up to then. Would that then mean that her chances were very poor?

Ha

I totally agree that valuation is important, and I agree with that part of the assessment, and it is important for people to consider this.

But there seems to be an (unintended it seems, from your reply) inference that this an 'all else being equal' kind of comparison (that is usually assumed, or at least what I assumed). And it isn't - whether a windfall, or more money to start with, or different investment strategies up to retirement - other things are not equal. That is what I was trying to highlight/clarify. And that I feel the FIRECALC intro also provides this same unequal comparison, w/o explaining that effect.

-ERD50

 

[smjsl]

@ERD50: All other things ARE equal in Ha's example. Only the starting time of ER is different. Rest is the same. It's irrelevant how they got 1MM on that date and it does not change the outcome. Point is when you start your ER is very important whether 4%-rule will work for you or not.

@Ha: As I think others said, my understanding is that their chances are not the same at all, but both are "good enough" (if you believe in historical returns). After a few years, a person can reevaluate where they are now, since they then have more info and can limit historical returns to similar "beginnings", or alternatively, apply 4% rule (or whatever rule they follow) to most current situation, which by that point could disappoint them.

 

[Gone4Good]

What I said is "Is it even remotely possible that these two people should have the same expectations of success?"

I feel that by definition they cannot have the same distribution of outcomes, though Joseph may get lucky and not flame out.

Yeah, but nobody here is defining "success" as having "equivalent distribution of outcomes." Most of us define "success" as not outliving your money. And it is entirely consistent for both people in your example to have a 100% chance of success by that definition even if one dies with more money than the other.

I don't think you're illustrating any kind of flaw in FIRECalc's logic at all. The marginal scenarios in the historic record that determine whether a plan was "successful' are all periods where subsequent real returns were poor. It's not like you're assuming "average valuations." By definition, a 100% FIRECalc success says you're planning for the worst valuations our history has experienced.

 

[ziggy29]

@ERD50: All other things ARE equal in Ha's example. Only the starting time of ER is different. Rest is the same. It's irrelevant how they got 1MM on that date and it does not change the outcome. Point is when you start your ER is very important whether 4%-rule will work for you or not.

Or at least how much it bulletproofs your chances.

All else being equal, obviously I'd rather start my 4% (or 3% or 3.5% or whatever I ultimately choose) when stocks have a PE10 of (say) 12 than when it's 20. That suggests current valuations are low enough to make a crash of 2008-09 magnitude less likely.

Another way to look at it is that I'd feel more comfortable with a higher withdrawal rate if equity valuations were currently low when I started retirement.

 

[smjsl]

I'd rather start [...] when stocks have a PE10 of (say) 12 than when it's 20.

I agree with everything you said. Statement above made me think of something else though. If you believe PE10 is a good predictor of how stocks will behave in the future, then you should be in the business of market timing, would not you agree? Then again, if history supports that in the past PE10 was a great predictor, then any 4%-3%-2%-or-any-other% rule you derive from the same history has same chance of supporting your retirement as market timing driven by the PE10.

 

[MichaelB]

I agree with everything you said. Statement above made me think of something else though. If you believe PE10 is a good predictor of how stocks will behave in the future, then you should be in the business of market timing, would not you agree? Then again, if history supports that in the past PE10 was a great predictor, then any 4%-3%-2%-or-any-other% rule you derive from the same history has same chance of supporting your retirement as market timing driven by the PE10.

[FONT=&quot]This is not timing or predicting. Also not about future stock behaviour. It is about current valuation and the belief that a lower current valuation leads to higher future annual returns. [/FONT]

 

[ziggy29]

I agree with everything you said. Statement above made me think of something else though. If you believe PE10 is a good predictor of how stocks will behave in the future, then you should be in the business of market timing, would not you agree?

Yes and no, though to some degree it's just relying on history like the 4% rule is relying on history. History tells us where the typical PE10 ranges are just as history tells us that 4% shouldn't fail for a 30-year retirement. (I don't think we should selectively embrace history in some areas and reject it in others.)

As I said earlier, the difference between the 4% rule and a valuation-based approach is that there is no emotionless, mechanical method to follow in the latter. And being as many of these investment strategies are specifically designed to eliminate guesswork, crystal ball gazing and emotional decision-making, one can't really cleanly incorporate valuation considerations into a purely mechanical strategy. But despite that, it's pretty intuitively clear that all else being equal, with the same size nest egg and same initial withdrawal rates and amounts, a market with a lower valuation is less likely to fail *given history* than one with a higher valuation.

 

[REWahoo]

Point is when you start your ER is very important whether 4%-rule will work for you or not.

Although they are certainly related, when you start isn't nearly as important as what happens the first few years after you retire.

A couple of relevant quotes from the guy who wrote FIRECalc:

Say you retired at $1 million after several great years in the market, and planned to take $60,000 a year. Well below your 15% returns for recent years. Seems safe.

If you were unlucky enough to retire at the end of a string of great years and just before several lousy years in a row, you might have had $500,000 by the end of year 3, take your $60,000, and then get zero return for the 4th year.

So for the next year, you are starting with 440,000, and taking $60,000. After just 5 years, you are down to nearly a third of your starting nest egg. Continuing to draw that 6% of the starting balance will obviously wipe you out.

This is where the 4% figure comes in. Historically, about 4% would have survived ~30 years even if a retirement began just as a downturn started. This is based on the longest and worst downturns we've had in our history.

If you retire into an UPturn, and your nest egg doubles in the first few years, then following the 4% rule for the next few decades will insure your descendants remember you fondly!

http://www.early-retirement.org/forums/f28/explain-the-4-withdrawal-rate-19234.html#post354796

First, a 3.98% withdrawal works, using the default settings in FIRECalc, 95% of the time for 30 year withdrawals, while the rate drops to 3.73% for 50 years, and 3.56% for 75 years.

What makes the safe rate as low as it is is almost always what happens in the first 5-7 years of a retirement. If you are lucky enough, or your crystal ball is good enough, to retire into a rising market, then by the time your portfolio has been growing for those 5-7 years, it can withstand almost anything, and your problem will be what to do with all the money, not worrying about the withdrawal rate.

Think of this like sea turtles. If a hatchling can get past the predatory birds and get into the ocean, it's OK for the long run.

So a prolonged downturn at the the beginning is the threat. How big a threat is it? Since 1871, we have only had two 5-year periods when each year-end stock market value was lower than the previous year-end, and that was back in the pre-depression days. (This is adjusted for inflation -- there was only one such period when I ignore inflation). There were only three periods with consecutive 4 year downturns, and only five 3 year downturns.

Because the impact is so critical at the beginning, it doesn't make a whole lot of difference how long you'll keep going -- that's why the rate drops only 0.4% when the duration chances from 30 to 50 years.

http://www.early-retirement.org/for...rate-for-young-retirees-23422.html#post434788

 

[ERD50]

@ERD50: All other things ARE equal in Ha's example. Only the starting time of ER is different. Rest is the same. It's irrelevant how they got 1MM on that date and it does not change the outcome. Point is when you start your ER is very important whether 4%-rule will work for you or not.

It is relevant depending on what point you are trying to get across. I think I see now, that the point Haha is making is that $1M in equities isn't simply $1M in equities (and keeping that separate from how/when that $1M was obtained). Valuation matters. And I agree.

It 'triggered' me on the other point though, since it is so similar to the FIRECALC intro, so I commented on that aspect of it also (taking into account how/when the $1M was obtained).

I don't think you're illustrating any kind of flaw in FIRECalc's logic at all. The marginal scenarios in the historic record that determine whether a plan was "successful' are all periods where subsequent real returns were poor. It's not like you're assuming "average valuations." By definition, a 100% FIRECalc success says you're planning for the worst valuations our history has experienced.

I agree. Whether we want to call it a 'flaw' or not is debatable, but it does seem that FIRECALC will be sensitive to 'bad' valuations (retiring when stocks are at high bubble-like prices). So maybe the 'flaw' is that it is overly conservative (telling you you need a large portfolio) if you run FIRECALC at a time when your portfolio is at more normal valuations.

I hope that made sense, it gets kinda circular in words.

-ERD50

 

[FIREd]

This is one of the most intersting paradoxes (or delusions) of the whole asset allocation/SWR paradigm.

Say Joseph retired October 2007 with $1mln. With this he bought 10,000 shares of World Market Index, a very diversified balanced index fund. Josefina retired roughly 18 months later, in March 2009. She also had $1mln, and invested it in the very same low expense fund that Joseph bought about 18 months earlier. But her million bought 15,000 shares, 50% more shares than Joseph was able to buy.

So each retired with $1mln, and each expected a "safe" 4% withdrawal rates, adjusted annually for CPI inflation, so they each take $40,000 the first year and CPI adjust the withdrawal in the following years

Is it even remotely possible that these two people should have the same expectations of success?

Not in the universe that I know.

Ha

FIREcalc shows that If you retired in 1929 with $1M or in 1932 with $1M, you would have been able to live on $40K per year (adjusted for inflation) for the next 30 years in both cases. It's just that if you retired in 1929, you would have left very little to your heirs and if you retired in 1932, you would have left a fortune. If you measure success by the size of the estate you leave behind, then the timing of your retirement will indeed have a crucial impact on your success.

I do think that valuation is important when assessing how to invest your money though, whether you are retired, retiring or not even close to retirement. When they retired in 2009 (PE10<15) and 2007 (PE10>25) respectively, Josephina should have been mostly in stocks while Joseph should have been mostly in bonds, which would have allowed him to rebalance into stocks as they got cheaper.

 

[Gone4Good]

I agree. Whether we want to call it a 'flaw' or not is debatable, but it does seem that FIRECALC will be sensitive to 'bad' valuations (retiring when stocks are at high bubble-like prices). So maybe the 'flaw' is that it is overly conservative (telling you you need a large portfolio) if you run FIRECALC at a time when your portfolio is at more normal valuations.

I'd say FIRECalc is sensitive to valuations that are consistent with it's data set. 2000 valuations were higher than anything we had witnessed previously so I'd argue someone retiring in that year would have been 'off the reservation' with respect to FIRECalc's output. I don't think the same can be said for 2010.

And I agree that FIRECalc is probably conservative with respect to "normal valuations." But I don't think we're there, either.

 

[smjsl]

History tells us where the typical PE10 ranges are just as history tells us that 4% shouldn't fail for a 30-year retirement. (I don't think we should selectively embrace history in some areas and reject it in others.)

That's what I also meant.

the difference between the 4% rule and a valuation-based approach is that there is no emotionless, mechanical method to follow in the latter.

Say you believe PE10 is a good market valuation and will usually range in 10-20 range. You could certainly devise a mechanical method around that. E.g. instead of having X% in stocks at certain time (perhaps based on age or some other factors), come up with some formula to adjust X% based on PE10 value as well. E.g. X% + (15-PE10)*2%, so at PE10 = 10, your target allocation would be X+10% and at PE10 = 20, X-10%, and for all values in between you get something in between accordingly. There... a mechanical method to follow...

a market with a lower valuation is less likely to fail *given history* than one with a higher valuation.

True. Question is what is the correct market valuation? Is it PE10? Maybe next time it is 10 and then going to 20, it's not because of rebounding market but because earning are collapsing... ? And vice versa, if it's 20, perhaps it will go to 10 not because market will go lower but because market prices will increase but not as fast as earnings?

 

[Katsmeow]

That could be - again, assuming that the windfall-er ( windfall-ee? is there such a word?), had it all in MM.

What I'm really getting at is it isn't the typical retiree scenario, and therefore not a very useful (and maybe harmful?) way to look at it for most all of us.


-ERD50

Perhaps my DH is atypical but I can see one particular retirement scenario where having a sudden lump sum happens quite often. That is the retiree that takes a lump sum in lieu of pension. DH retired in June and just received his lump sum which is by far the most significant portion of the portfolio.

 

[haha]

FIREcalc shows that If you retired in 1929 with $1M or in 1932 with $1M, you would have been able to live on $40K per year (adjusted for inflation) for the next 30 years in both cases. It's just that if you retired in 1929, you would have left very little to your heirs and if you retired in 1932, you would have left a fortune.

I completely understand what you are saying, really, I do. But FireCalc isn't god. It is roughly 4 unique 30 year trips through one of many many possible histories. (And only one trip through the two periods that you compared.) It happens to be the history that did occur, but that is in fact merely an accident of chance.

Among other differences is something that one poster mentioned, if only to discount it. The Margin of Error. I won't do this run because I am not in doubt about this issue, but if one were to go through the period that you mentioned, he might find that the max drawdowns from the 1929 start would scare many people right out of the market. These two trips are different in every possible way other than one, the one you have highlighted- the Firecalc success/failure go/nogo verdict.

Ha

 

[MasterBlaster]

This is one of the most intersting paradoxes (or delusions) of the whole asset allocation/SWR paradigm.

Say Joseph retired October 2007 with $1mln. With this he bought 10,000 shares of World Market Index, a very diversified balanced index fund. Josefina retired roughly 18 months later, in March 2009. She also had $1mln, and invested it in the very same low expense fund that Joseph bought about 18 months earlier. But her million bought 15,000 shares, 50% more shares than Joseph was able to buy.

So each retired with $1mln, and each expected a "safe" 4% withdrawal rates, adjusted annually for CPI inflation, so they each take $40,000 the first year and CPI adjust the withdrawal in the following years

Is it even remotely possible that these two people should have the same expectations of success?

Not in the universe that I know.

Ha

I had the same question, that Dory answered in 2006...


My question...

The twin paradox ?

Does the reverse of that work too ? You retire with $1 mil taking $40k/year out. Several years later it is worth $700k due to down markets. But your buddy retires now with $700k and will take out only $28k. Could your buddy then look at past peaks and take out the same $40k/year as you.

Dory's response...

Yes, other than the fact that the later retiree will have to assume a shorter withdrawal period, to match the earlier retiree's remaining years.

Again, step back and look at the reasoning.

If Bob has $300k in long term treasuries and $400k in the S&P 500 index, and Joe has exactly the same thing at the same time, and both do exactly the same things with these funds, then there is no way that their future results can differ. It doesn't matter that one of them used to have a lot more money, and the other is perhaps starting from a lump sum payout of a retirement plan -- the future results have to be the same for them.

This seems even more counter-intuitive than the original example, but I see, after looking at the historical numbers, the reason this seemingly anomalous situation works is that historically, we haven't had extended bear markets that exceeded 5 years, and very few that exceeded even 2 years. So the fact that the first guy was unlucky enough to retire into a serious long term bear market means that it is behind him -- and if so, then it is behind the other guy as well -- he just didn't have to deal with it.

Since 1871, we have only had two 5-year periods when each year-end stock market value was lower than the previous year-end, and that was back in the pre-depression days. (This is adjusted for inflation -- there was only one such period when I ignore inflation). There were only three periods with consecutive 4 year downturns, and only five 3 year downturns.

Had this not been the case, then we would be talking about the 2% rule, or maybe the 1% rule I suspect.

So... the best time to retire is after a bunch of crappy years. If history is any guide, it will only get better.


dory36

(Can you see people watching the market, waiting to retire, saying "Oh crap - another good year -- now I have to postpone my retirement again!")

PS - if you want to look at numbers, see the original source data for Irrational Exuberance and for a good part of what Firecalc and the REHP spreadsheets use, at http://www.econ.yale.edu/~shiller/data/ie_data.htm. I used the start-of-year figures for the above.

 

[ziggy29]

Among other differences is something that one poster mentioned, if only to discount it. The Margin of Error. I won't do this run because I am not in doubt about this issue, but if one were to go through the period that you mentioned, he might find that the max drawdowns from the 1929 start would scare many people right out of the market. These two trips are different in every possible way other than one, the one you have highlighted- the Firecalc success/failure go/nogo verdict.

True. Although the mechanical method is designed to eliminate the emotion from investment decisions, it's hard to imagine someone in 1931 or 1932 having the intestinal fortitude to not panic and stay put. It was hard enough in late 2008 and early 2009! And that would have been a shame since 1933 was the single best calendar year the modern U.S. stock market has ever had. Missing out on a lot of the gains of '33 would have been death for 4% starting in 1929.

For me, 4% came too close to failing in '29 to feel comfortable that (a) it won't be breached in the future and (b) I wouldn't do something stupid out of fear to sabotage myself.

 

[NW-Bound]

I am one who likes to look at his past personal high water mark and wants to exceed it.

I've been keeping track of our investments for several years on a monthly basis.

I am doing it on the daily basis. Counting money is fun... Heh heh heh...

It sure would be nice to never have to touch the principal...

I do it by keeping my part-time work, and also by not buying that RV with fancy cabinetry and countertop.

 

[LOL!]

I want more money, but I that is separate from trying to exceed a previous highwater mark. There are two issues with this.

(1) The highwater mark itself was because a quick run-up in 2007. A better value might be just before the run-up or an average value over several months in Fall/Winter 2007.

(2) It's now close to 3 years later. I don't need the $300K I spent in the last 3 years anymore because I've lived those years and they are behind me -- gone, done with. I need money for future years. If I was planning to live to 100, I am 3 years closer with 3 years less expenses to worry about.

 

[ERD50]

Perhaps my DH is atypical but I can see one particular retirement scenario where having a sudden lump sum happens quite often. That is the retiree that takes a lump sum in lieu of pension.

OK, that's another one. Maybe this is more common than I think. I never took a poll or anything, but I'd still guess most of the retirement portfolios were accumulated along the way. So again, we should always tailor things to our specific situations.

I had the same question, that Dory answered in 2006...

MB, thanks for that twin paradox summary. I'm sure I've read it before, not sure I was ready to absorb it at the time though.

Perhaps my DH is atypical but I can see one particular retirement scenario where having a sudden lump sum happens quite often. That is the retiree that takes a lump sum in lieu of pension. DH retired in June and just received his lump sum which is by far the most significant portion of the portfolio.

But FireCalc isn't god. It is roughly 4 unique 30 year trips through one of many many possible histories.

Ha

I think I reflected on this recently (comparing daily temperatures to seasons and decades of temperature swings) - we might look at FC as having 100-some data points, but maybe that's really only a handful of patterns. And maybe we can't derive much from that at all.

-ERD50

 

[oilspill]

Trying to make money without honest labor, without committing fraud or deception, is exceedingly difficult. That's why "investing" in the market is nothing more than rolling the dice.

 

[NW-Bound]

You retire with $1 mil taking $40k/year out. Several years later it is worth $700k due to down markets. But your buddy retires now with $700k and will take out only $28k. Could your buddy then look at past peaks and take out the same $40k/year as you?

Dory's response...
If Bob has $300k in long term treasuries and $400k in the S&P 500 index, and Joe has exactly the same thing at the same time, and both do exactly the same things with these funds, then there is no way that their future results can differ.

I think Dory mis-answered the question, and that he missed the proposition stated in the question. The two results HAVE to differ, if Bob withdraws $40K/yr and Joe withdraws $28K/yr from the same portfolio of $700K at the later time mark. Well, the term "same portfolio" is a misnomer, because they will not be the same for long, if the amounts withdrawn differ.

We have been through this before. A retiree starting with $1M in 2007 WILL not do as well as the one starting with $1M in 2009. The first MAY survive, but will have many sleepless nights and definitely end up with less money than the second, although the two both have $700K in 2009.

Of course, the first can downshift his spending to match his frugal buddy's $28K/yr, and their fate will be identical.

PS. What I intend to do is to withdraw 4% based on CURRENT portfolio. It lasts forever that way!

 

[bbbamI]

I am doing it on the daily basis. Counting money is fun... Heh heh heh...

I wouldn't mind doing it on a daily basis while everything is coming up roses, but in the 'oh crap' times, it was all I could do to look at my holdings at the end of each month.