FIRECalc, 4% rule, etc. - are they not producing a false sense of security?
I know this was discussed some time ago but I was just analyzing how come I don't feel secure with them when many people seem to rely on these for their planning, at least to some degree. So I think I understand why now. Hope the following line of reasoning is wrong somewhere (although I am sure I will be arguing otherwise).
Say you are planning for 30-year retirement, even though based on the recent thread, most people here try to plan for at least 40 years ahead it seems. Now, FIRECalc, 4% rule, and most if not all of the other research for retirement planning look at the "long" history of the last century. Most start with 1920's. FIRECalc starts with 1879 (i.e. about 130 years of history). This may seem long at first, but you have to keep in mind that compared to the 30 (or more likely 40) years, it's not long at all.
In other words, they look at just 3-4 time spans relative to what you are trying to predict.
How is it any different than trying to guess distribution of market returns over the next year if all you had was historical returns of the past 3-4 years? That's all we seem to be doing with above approaches.
Note how for the 30-year period FIRECalc says that it shows results of 110 runs! Those are not independent results however - they are based on many overlapping time periods. Similarly, if I gave you 3-4 years worth of data, you could produce in the same way hundreds of 1-year runs based on starting your 1-year periods each day in those 3-4 years: Jan 1 of year 1, Jan 2 of year 1, Jan 3 of year 1, etc.
So, do you think there is any point in trying to predict next year returns with any degree of certainty if you have results from just 3-4 prior years? Sure people add some fudge factors and buffers, but they seem pretty small compared to possible variations. Someone who says 'I use 3% instead of 4% in my rule' is (approximately?) saying, if past 4 years averaged 10% return, I will plan for at least 7.5% return during next "retirement" year (i.e. whole 25% lower than past average).
As another example - sometimes you hear : 'we never had 30 years of negative market returns'... well yes, but again, we only had a sample of 4 independent 30-year periods... If during 4 years worth of data you did not have a single year of negative returns (starting at any day), does it mean there is a good chance of not having a negative return over the next year? (I am sure some paper somewhere answers this question )
Some might say, 'Well at least I am looking at 3-4 years worth of data to plan my "retirement" year - that's better than nothing'... Is it? Or is it no more help than looking at your horoscope? (because there is so little data for your 30-40 year horizon that it's meaningless)
I know this was discussed some time ago but I was just analyzing how come I don't feel secure with them when many people seem to rely on these for their planning, at least to some degree. So I think I understand why now. Hope the following line of reasoning is wrong somewhere (although I am sure I will be arguing otherwise).
Say you are planning for 30-year retirement, even though based on the recent thread, most people here try to plan for at least 40 years ahead it seems. Now, FIRECalc, 4% rule, and most if not all of the other research for retirement planning look at the "long" history of the last century. Most start with 1920's. FIRECalc starts with 1879 (i.e. about 130 years of history). This may seem long at first, but you have to keep in mind that compared to the 30 (or more likely 40) years, it's not long at all.
In other words, they look at just 3-4 time spans relative to what you are trying to predict.
How is it any different than trying to guess distribution of market returns over the next year if all you had was historical returns of the past 3-4 years? That's all we seem to be doing with above approaches.
Note how for the 30-year period FIRECalc says that it shows results of 110 runs! Those are not independent results however - they are based on many overlapping time periods. Similarly, if I gave you 3-4 years worth of data, you could produce in the same way hundreds of 1-year runs based on starting your 1-year periods each day in those 3-4 years: Jan 1 of year 1, Jan 2 of year 1, Jan 3 of year 1, etc.
So, do you think there is any point in trying to predict next year returns with any degree of certainty if you have results from just 3-4 prior years? Sure people add some fudge factors and buffers, but they seem pretty small compared to possible variations. Someone who says 'I use 3% instead of 4% in my rule' is (approximately?) saying, if past 4 years averaged 10% return, I will plan for at least 7.5% return during next "retirement" year (i.e. whole 25% lower than past average).
As another example - sometimes you hear : 'we never had 30 years of negative market returns'... well yes, but again, we only had a sample of 4 independent 30-year periods... If during 4 years worth of data you did not have a single year of negative returns (starting at any day), does it mean there is a good chance of not having a negative return over the next year? (I am sure some paper somewhere answers this question )
Some might say, 'Well at least I am looking at 3-4 years worth of data to plan my "retirement" year - that's better than nothing'... Is it? Or is it no more help than looking at your horoscope? (because there is so little data for your 30-40 year horizon that it's meaningless)