Question for Dory36 on FIRECalc

[moguls]

Dory36,

I have a situation where I have accumulated several years of deferred income with my employer that will be greater than my living expenses for the first 10 years of retirement. The payout of the deferred income will be fixed payments ending over a the 10 year period. In using FIRECalc I entered my data as follows:
1. I did NOT include my deferred income account value in the initial portfolio value.
2. I entered my normal expected expenses (including taxes) in the annual withdrawal field.
3. Under Withdrawal Change 1, I entered a reduction (negative no.) to my withdrawal starting in year 1 to reflect the deferred income payments. NOT inflation adjusted.
4. Under Withdrawal Change 2, I entered a further reduction in withdrawal to reflect Social Security benefits starting in yr 8.
5. Under Withdrawal Change 3, I entered an increase in expenses in year 11 to reflect the requirement to increase withdrawals to cover the end of the deferred income payout. NOT inflation adjusted.

The reduction in withdrawals entered in year 1, are greater than the initial withdrawal (I'll actually have more income than I need - benefit from living below means). My question is does FIRECalc recognize this resulting negative withdrawal and increase my portfolio by the excess for these first 10 years?

Thanks.

Moguls

 

[dory36]

My question is does FIRECalc recognize this resulting negative withdrawal and increase my portfolio by the excess for these first 10 years?

It sounds like you did exactly what I'd have done in the same situation.

Yes, FIRECalc adjusts the portfolio upwards in that situation. To test this, enter a zero portfolio and a zero withdrawal, and put in a negative withdrawal amount to start in a future year. Run the "detail results" to see the zero portfolio amount continue until the year you specified.

I'm hard at work on nah, I'm retired -- at my convenience, I'm working on revising the text regarding the withdrawal changes. I hope the new version will be easier to follow. But it sounds like you did fine -- I hope the numbers were what you wanted to see!

Dory36

 

[moguls]

Thanks for the feedback. I'm running my numbers through several calculators to increase my comfort level with my planning.

By the way have you heard of any feedback on T. Rowe Price's Retirement calculator. I've seen it written up as a good calculator in several publications. But, I found it to be very conservative. In fact the best withdrawal rate I've received from it is about 3.2%. Way too conservative even for my taste.

Anyone have any comments?

Moguls,
(Looking forward to the ski season.)

 

[area52]

I've used the T Rowe Price and I think it's whacked.

Way too conservative, and if I recall my calculators correctly, in its methodology it say it uses forward looking assumptions. ie: Fake data made up for a future world the way we THINK it will be. I think that's why it's so conservative

 

[dory36]

I'm not familiar with the T Rowe Price calculator, but if I made my living in part off of how much people had invested with me, I'd probably lean on the "put more aside" direction as well. Ditto if I was advising people who I thought might take whatever I said without questioning and testing my comments.

Sure beats the 10% I've heard in years past, though!

Dory36

 

[moguls]

Thanks Area52 and Dory36.

I guess there's a lot of folks who'll rely on the type of estimations provided by the likes of T.Rowe. Unfortunately the uneducated will just have to continue working .

Thank goodness for sites like this one and Intercst's Retire Early site providing realistic information for all of us on the FIRE quest.

Moguls
(one who's glad he found the light!)

 

[Ted]

The main thing that makes the results of the TRP model "conservative" is that the "withdrawal amount" that the user enters is implicitly increased by 3% per year to cover inflation. Unlike FIRECalc, there is no provision for accounting for a possible future reduction in (inflation adjusted) living costs.

Most people's expenditures (at least inflation-adjusted) tend to decline as they age. The major exception is health care costs, but it seems reasonable to believe that most (in fact, more) of these will continue to be covered in the future by Medicare.

The problem inherent in any model that is based on past market performance is that it is cannot account for fundamental economic shifts that will affect future performance.

Aside from possible catastrophes such as another world war that would obviously have a drastic affect on investment returns, what will be the effect of the increasing ratio of retirees to workers, as retirees liquidate their financial assets?

What will happen to economic growth if there is no radically new technological development on the scale of the automobile, the airplane, television, and the internet? In particular, will there be a reasonably "cheap" replacement for oil as it becomes increasingly scarce? Given these pessimistic possibilities, I think that a good degree of conservatism is warranted in interpreting the "probabilities" generated by retirement models.

 

[intercst]

Ted writes,

The main thing that makes the results of the TRP model "conservative" is that the "withdrawal amount" that the user enters is implicitly increased by 3% per year to cover inflation. Unlike FIRECalc, there is no provision for accounting for a possible future reduction in (inflation adjusted) living costs.

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

The FireCalc program increases withdrawals for the actual inflation encountered during the pay out period examined. The worst 30-Year period 1966-1996 had average inflation of 5.41% per annum. If the T.Rowe Price model is limiting inflation to 3%, you'd come up short during a period like 1966-1996.

I though the reason T. Rowe Price was "more conservative" was because it used Monte Carlo analysis rather than the calculations based on historical data that FireCalc employs. Monte Carlo techniques can yield much lower withdrawal rates depending on what assumptions are made.

intercst

 

[moguls]

Intercst writes:

I though the reason T. Rowe Price was "more conservative" was because it used Monte Carlo analysis rather than the calculations based on historical data that FireCalc employs. Monte Carlo techniques can yield much lower withdrawal rates depending on what assumptions are made.


TRP may be using monte carlo simulations, but they must also me making some other assumptions to give them such conservative results.

I've use the monte carlo models developed by Gummy at http://home.golden.net/~pjponzo/gummy_stuff.htm and consistently get less conservative numbers than FIRECalc.

Moguls
(543 days to FIRE)

 

[Ted]

The fact that FIRECalc incorporates inflation in its analysis is certainly a good feature that makes its results more useful. I don't want to sound too critical of such models, but simply to point out the impossibility of predicting the future, or even of confidently predicting future probabilities.

The T. Rowe Price model uses Monte Carlo simulation, but that requires statistical data (average rates of return and standard deviations thereof) that comes from historical data on market returns. I think that TRP's data is mostly the data compiled by Ibbotson Associates, going back to about 1928. So, conceptually, the TRP model is doing pretty much the same thing with "recreated" historical data as FIRECalc is doing with actual historical data. Unfortunately, past performance is no guarantee of future results for markets any more than for mutual funds!

About the only investment that I regard as almost completely predictable as to its real rate of return is inflation-protected Treasury Bonds (TIPS). Given the possibility of increased inflation and reduced real rates of return on stocks, I think that TIPS are an extremely attractive investment for retired people. In fact, a person could practically set up their own "annuity" using them.

 

[Michael]

The TRP calculator uses expense ratios over 1% for equity, and long term rates of return below 10%. They lowered the return on equities in their portfolio to below the historic returns to provide an additional element of safety, but these lowered numbers are just guesses. The 500 Monte Carlo scenarios would likely include imaginary depressions far longer than any in US history. These factors combine to put the 99% success safe withdrawal rate of their calculator to about 2.6% If living on 2.6% or less makes you feel more secure, and allows you enough to live on, go for it. You can always withdraw more later on if the size of your portfolio increases significantly.

You are correct that mere mortals such as ourselves cannot predict the future with absolute certainty. In the past, 4% would have survived all retirements starting from 1871. Living on less than 4%, if you can do so comfortably, will provide an additional element of safety in case something much worse than the Great Depression occurs in our future.

 

[Ted]

I'd like to expand on what I mentioned in a previous post in which I mentioned that inflation-protected treasury securities (TIPS) are the safest long-term investment in that they guarantee a return that increases with inflation. I mentioned that a person could set up their "own annuity" using TIPS.

Then I got to thinking about the withdrawal rate that could be sustained, and used FIRECalc with 100% invested in TIPS to verify it. It turns out that for long-term expected retirement on the order of 25 years or more, a person would essentially need to withdraw only the interest from the bonds. This sounds modest in that the bonds are presently nominally paying about 2.8%, but that is before the inflation rate is added. So, it inflation occurs at, say 3% (as assumed by the T. Rowe Price model) TIPS will return 5.8%.

In contrast, a long-term immediate annuity right now will pay a return of about 6.7% per year on the principal amount, but that is not inflation-adjusted and leaves nothing for the annuitant's beneficiaries. But if you own TIPS and only withdraw interest, the principal will not only be preserved, but will grow to match inflation.

I just hope that Congress doesn't decide that TIPS are too good a deal for investors at the expense of taxpayers, and discontinue them. (Presumably the payment provisions of the outstanding TIPS would be honored.)

 

[Michael]

It seems to me that if you withdraw all of the inflation adjust portion of TIPS, your portfolio will not keep up with inflation. It will steadily shrink. The way I understand it, older retirees can increase their safe annual withdrawal by using a lot of TIPS, but younger retirees must plan for 40 plus years. Adding a few equities to the TIPS can help the maximum safe withdrawal rate over 40 plus year periods, and significantly increase the average terminal value of the portfolio. If the portfolio increases in size, this offers the possibility of increasing withdrawals in the future.

 

[Ted]

The way that TIPS work is that the par value of the bonds is "bumped up" each year in proportion to the inflation in the CPI that has occurred.  Then, the interest payment is determined by applying the stated interest rate for the particular issue (typically around 3%) to the adjusted par value.  Thus, both the par value and the interest payments increase in proportion to inflation.  

If a person spends the interest payments, the principal will increase in dollar terms to match inflation, thus maintaining its value in real terms (although the increase in value is taxable as it occurs like the "original issue discount" on a zero coupon bond).

In my previous post, I stated that TIPS "are presently nominally paying about 2.8%, but that is before the inflation rate is added. So, it inflation occurs at, say 3% (as assumed by the T. Rowe Price model) TIPS will return 5.8%." Actually, the 5.8% represents the total return -- interest plus increase in par value. To insure that the purchasing power of the interest payments remained constant, a person could only spend the interest payments themselves. Thus, they could only spend 2.8% of the par value each year -- not 5.8%.

Based on past history, one would expect stocks to deliver a higher total return in the future than TIPS.  Thus, the higher the percentage of stocks in a portfolio, the higher the "probable" return, as best as most of us can assess future probabilities.  But that higher return on stocks is not guaranteed -- especially within the time horizon of retirees.  I'm not predicting that U.S. stocks in the future will experience the protracted malaise of Japanese stocks, but nobody can guarantee that they won't.  So retirees should consider an ultra-safe "core" for their portfolio that will protect against both inflation and possible protracted non-performance of stocks.  This can be accomplished with short-term bonds, but at least at present they are paying less interest than the total return on TIPS, and the tax treatment is essentially the same.

 

[Michael]

Placing a portion of one's portfolio into TIPS as a safe core makes sense. Putting 67% of a portfolio into TIPS can increase the safe withdrawal percentage for those who need more than 4%. Those who need less than 3% can afford to risk a larger percentage of equities if they so choose.

http://rehphome.tripod.com/safetips.html

Mike

 

[Dogcliff]

Cross-post from Safe withdrawal Rates\Firecalc (corrected):

Yo, Cptn' Bill;

After repeating the below calc several times, I am baffeled by the results. Are 30 yr treasury returns that far superior to the stock market ? (I wouldn't guess so) ...or did I fatfinger the calc?

TIA,

dc

Solutions: 20% in 30 Year Treasuries and 80% in equities ...expense ratio of 0.18% The average (mean) portfolio balance following the withdrawal in year 35 was $7,462,371.

80% in 30 Year Treasuries and 20% in equities ...expense ratio of 0.18%. The average (mean) portfolio balance following the withdrawal in year 35 was $2,889,998,211.

Assumptions:
starting with a portfolio of $330,000 and taking out $48,000 the first year, and the same amount after adjustments for inflation (PPI) each year except as follows:

Starting in year 7, the withdrawal was decreased by $7,200 (your Social Security; adjusted for inflation).

Starting in year 9, the withdrawal was decreased by $7,200 (spouse's Social Security; adjusted for inflation).

Starting in year 0, the withdrawal was decreased by $21,000 (adjusted for inflation).

Starting in year 5, the withdrawal was decreased by $20,000 (adjusted for inflation).

In year 1, the portfolio was increased by a single (inflation-adjusted) $50,000 addition (as from the sale of a house).

In year 1, the portfolio was increased by a single (inflation-adjusted) $225,000 addition (as from the sale of a house).

In year 1, the portfolio was decreased by a single (inflation-adjusted) $150,000 reduction (as for a major purchase).

 

[Dogcliff]

'There they go again'...posting to their own post. Think I've got it. I failed to include the required decimal in the 'rest invested' field. 8.0 input returns a a much more belivable result than 80 in that field.

Thanks for head scratchin' with me...

dc

 

[wzd]

Hey Dory -

Why does the TIPS rate matter when the 30yr treasury option is selected? That's a kind of strange interaction!

Dogcliff - 8% is a pretty high rate for TIPS, which are usually 2 to 2.5% real return, plus inflation.

Wayne

 

[Dogcliff]

OK...so your best guess return number goes here?!? I was inputting the percentage of 'rest invested', not the return...AHHHH... try again...

Dory, what's the real deal? Just what should go in the 'rest invested' field?

dc

 

[dory36]

Sorry for the confusing wording -- the program assumes some amount in something that mimics the stock market, and the balance in some fixed income investment. Just check one of the fixed income choices - the one that most closely mimics your fixed income investments.

TIPS rates are ignored for everything except TIPS investments.

Dory36

 

[wzd]

Dory, I agree with the intent behind your statement that the tips rate is ignored for all except tips investments, but if I run the above scenerio with 30 year treasuries, and with 0 in the tips box, I get:

You have proposed a withdrawal of 14.55% of your starting portfolio.

We looked at the 96 possible 35 year periods from 1871 until 2002, and the 35 partial periods from 1967 until 2002, starting with a portfolio of $330,000 and taking out $48,000 the first year, and the same amount after adjustments for inflation (PPI) each year except as follows:

...

Your Success Rate is 100.0%
In 100.0% of the years, the portfolio would have maintained a positive balance through the withdrawal in year 35.

The average (mean) portfolio balance following the withdrawal in year 35 was $2,844,170.

(This assumes your portfolio consists of 80% in 30 Year Treasuries and 20% in equities that behave like the market as a whole, with an overall expense ratio of 0.18%.)

----------------------------------------------------------------------
and with 10 in the tips box I get:
You have proposed a withdrawal of 14.55% of your starting portfolio.

We looked at the 96 possible 35 year periods from 1871 until 2002, and the 35 partial periods from 1967 until 2002, starting with a portfolio of $330,000 and taking out $48,000 the first year, and the same amount after adjustments for inflation (PPI) each year except as follows:

...

Your Success Rate is 100.0%
In 100.0% of the years, the portfolio would have maintained a positive balance through the withdrawal in year 35.

The average (mean) portfolio balance following the withdrawal in year 35 was $3,908,531.

(This assumes your portfolio consists of 80% in 30 Year Treasuries and 20% in equities that behave like the market as a whole, with an overall expense ratio of 0.18%.)

--------------------------------------------------------------------------
and with 80 in the tips box I get:
You have proposed a withdrawal of 14.55% of your starting portfolio.

We looked at the 96 possible 35 year periods from 1871 until 2002, and the 35 partial periods from 1967 until 2002, starting with a portfolio of $330,000 and taking out $48,000 the first year, and the same amount after adjustments for inflation (PPI) each year except as follows:

...

Your Success Rate is 100.0%
In 100.0% of the years, the portfolio would have maintained a positive balance through the withdrawal in year 35.

The average (mean) portfolio balance following the withdrawal in year 35 was $2,889,998,211.

(This assumes your portfolio consists of 80% in 30 Year Treasuries and 20% in equities that behave like the market as a whole, with an overall expense ratio of 0.18%.)
-----------------------------------------------------------------

I think Dogcliff has uncovered something! You can see that firecalc agrees 30 year treasuries were selected in the output!

Wayne

 

[Bob_Smith]

Wayne, you're right! I ran my numbers again. Changing the yield in the TIPS field changes the output - even if you tell FIRECalc there are no TIPS in the portfolio! Dogcliff is on to something.

 

[dory36]

Yikes! You are right! You have discovered a bug that has been lurking a long time. OK, everybody who has retired, you go back to work, right away!  

Here is what I found:

First, most prior calculations should have still been pretty close to the mark, as you'd only see the problem creep in to a significant degree if you select Treasuries as your investment choice, and you typed in an unrealistic TIPS coupon, as was done accidently by Dogcliff and then illustrated by wzd.

The effect of the bug is that during the years when there were no such thing as 5 or 30 year Treasuries, Firecalc used theoretical TIPS returns as a substitute (for those years only). Since all these interest rates track each other fairly closely, the impact would only be dramatic with unrealistic entries in the TIPS coupon box. But obviously no one would bother insuring that vaue is realistic when they are using Treasuries as a choice of fixed income investment.

(TIPS are a recent option, but their return is theoretically predictable from other known values plus a user-entered coupon, thanks to Intercst's work. So the older TIPS returns are what TIPS would have returned if there were such things as TIPS back then.)

I have changed it now, to use Commercial Paper as a substitute for Treasuries for those years before Treasuries existed.

Dory36

 

[unclemick]

Dory36

Not to worry. Back in 93, no computer at home, plenty of dryer sheets, and no work. Actually used TABLES IN A BOOK! 6-8% was considered a doable range back then(?Vanguard if memory serves?).

Debug on Dory but remember its only second to ER - your primary mission or did you give up mission statements when you left work. I threw mine the same place my Daytimer went.

 

[Dogcliff]

Joy...finally a Doglliffproof calculator. Thanksall...

dc