Don't tell anyone, but I found the secret to success!

[FUEGO]

Portfolio survivability success, that is. I hope I got your attention!

I've been thinking about the firecalc results and how it would be nice to know at some point early in the game whether you are destined for success or failure. That is, at some point when you can still do something about it. I did a little study of a hypothetical 40 year retirement period with a 4% SWR of 60,000 on a 1.5 million portfolio w/ a little social security about 30 years into it. This is loosely based on my own circumstances in what I hope will be ~10 years or so. I'll be late 30's, maybe 40 by the time I can FIRE.

I was searching for a magic rule that would tell me at some point in the first 5 to 15 years whether my portfolio was destined for failure or success.

Apologies to PhD level finance professors, but I'm not a PhD researcher. I just wanted a quick peek at firecalc results to test my hypothesis that there may be a good indicator of future success/failure at some point in time significantly preceding the end date of the portfolio (in this case, 40 years). I followed a basic methodology as follows: Get spreadsheet of year by year inflation adjusted portfolio balances. There were 97 results. For simplicity's sake, let's call it 100 results. There happened to be 10 "failures" in firecalc, giving me a ~90% success rate. Failure is defined as zero or lower portfolio value at any point in the simulation according to firecalc.

I wanted to look at what I call a "soft failure". I would define that as the point at which I would have trouble sleeping at night (because my wife would be kicking me for losing most of our retirement savings). For this analysis, I assumed any time my end of year portfolio balance was 50% or less of the original balance (adjusted for inflation), I experienced a soft failure. For each analysis year, I took a minimum value of all year-end balances and summarized the results at the far right hand side of my spreadsheet (it's attached here). I sorted the analysis periods by these minimum portfolio values.

Then I examined the worst three deciles of analysis periods. The worst decile were the traditional failures where a zero portfolio balance was obtained at some point in the 40 year analysis period. The next to worst decile had a minimum value at some point in the analysis period of between 5% and 39% of the initial portfolio value. The third worst decile had a minimum value at some point in the analysis period of between 40% and 52% of the initial portfolio value. The best 7 deciles are what I would call "successful" - that is, the end of year portfolio value was never less than ~50% of the initial portfolio value.

I pose the following question: is it possible to determine whether the portfolio will fail by looking at the portfolio balance as a percentage of the initial balance at 5, 10, and 15 years from the start?

By looking at the results, I would answer "Yes".

The portfolio balance as a percentage of the initial balance at 5 years wasn't very useful. The 10 and 15 year percentages were increasingly more useful (see table below). The worst decile had an average of 59% and 39% of the initial portfolio remaining after 10 and 15 years, respectively. The 2nd worst decile fared better with an average of 75% and 60% of the initial portfolio remaining after 10 and 15 years, respectively. The third worst decile, consisting of marginal soft failures, fared even better with an average of 91% and 85% of the initial portfolio remaining after 10 and 15 years, respectively. The percentages of the initial balance remaining were fairly variable. The 15 year percentages are the most reliable predictors of portfolio success.

Table of average portfolio balance as a percentage of the initial balance:

......................5 yr 10 yr 15 yr
1st worst decile 89% 59% 39%
2nd worst decile 79 75 60
3rd worst decile 97 91 85
4th worst decile 98 108 112

Setting a rule of thumb for when to go back to work and stop portfolio draws is difficult. Serisouly, who wants to go back to work after 10 or 15 years of chillin' in the sun?!? One would have to balance their own desires and correctly weight the desirability/disutility of false positives and false negatives from a "percent of initial balance" test at 10 and 15 years.

A false positive would be an analysis period that has a 10 or 15 year "percent of initial balance" below the 10 or 15 year threshold that indicates one needs to find other sources of income to supplement portfolio withdrawals (go back to work!). However the analysis period ends up as a successful run.

A false negative would be an analysis period where the 10 or 15 year "percent of initial balance" exceeds the 10 or 15 year threshold (ie - you're headed to success) but ends up falling in the lowest two deciles (either a hard failure or a soft failure).

I'll throw out 60% and 50% as proposed thresholds I might personally use for the 10 and 15 year "percent of initial balance" thresholds, respectively. The 60% threshold at 10 years would catch 6 out of 10 hard failures and 3 out of 10 2nd worst decile soft failures. Only one potential false positive was observed out of the remaining ~80 trials (and that false positive was in the 3rd worst decile, or marginally a soft failure).

The 50% threshold at 15 years would catch 9 out of 10 hard failures (zero balances) and 4 out of 10 soft failures. No false positives were observed.

Application of the 10 or 15 year "percent of initial portfolio" tests would significantly reduce the chances of a catastrophic failure of the portfolio (ie reaching a zero balance) and would moderately reduce the chance of a soft failure (reaching less than 50% of the initial balance).

Here's the link to my firecalc run that generated this data.

(sorry folks, I accidentally deleted the spreadsheet of my analysis!)

 

[FUEGO]

Comments/Critiques? Anyone else ever ponder things like this?

This type of 10 or 15 year checkup might not be appealing to a traditional RE type quitting work at 50-55 years of age. That would put them at age 60-70 when they are figuring out that they have to get back in the rat race.

For a very early ER (say age ~40), this approach wouldn't be as hard to stomach. I'd rather suck it up at 50 or 55 and go back to work, even if it means swallowing my pride. At least I won't be eating the proverbial cat food at age 65-70 when I may not be able to work. And it would give me a little peace of mind that it is ok to quit working at an early age, knowing that I can always work later for some extra money.

I work with a couple of guys that left my profession for 5-10 years and then came back later to resume working in it. They have fared ok and are making a good living now. It might be hard at first to get reacquainted w/ working and learning the new software/rules that apply to your profession, but not that bad. At least not as bad as being broke at age 65 or 70 and being out of the work force for 25-30 years where your skills might be completely worthless.

 

[Gumby]

Sounds like a reasonable approach to the problem. Even without running the numbers, if my portfolio dropped below 60% in the first ten years, I would seriously consider going back to work. One question -- did you rerun Firecalc at the 10 and 15 year points with, respectively, 60% and 50% of your starting balance (inflation adjusted)? What did that do for your success rate?

 

[FUEGO]

One question -- did you rerun Firecalc at the 10 and 15 year points with, respectively, 60% and 50% of your starting balance (inflation adjusted)? What did that do for your success rate?

I ran it now. With 60% of initial portfolio, 38% success after 10 years (ie 30 yrs remaining in withdrawal period). With 50% of initial portfolio, 35% success after 15 years (ie 25 years remaining in withdrawal).

However, one issue with re-running firecalc at a later point is that it loses some of that time-series correlation from year to year.

I think my approach to this is a common sense, easily implementable solution to portfolio survivability. Somewhere around 10-15 years seems to be the "point of no return" from a work/don't work view point. At least if you are trying to return to your original occupation.

 

[Animorph]

How about finding the 100% successful SWR (~3%?) and then seeing if your portfolio grows enough in the first few years that your initial 4% SWR is now at the 100% success level? The reduction in length of retirement should also help raise the 100% successful SWR as you age, though your retirement may be too long for that to be a big effect.

Dan

 

[FUEGO]

How about finding the 100% successful SWR (~3%?) and then seeing if your portfolio grows enough in the first few years that your initial 4% SWR is now at the 100% success level? The reduction in length of retirement should also help raise the 100% successful SWR as you age, though your retirement may be too long for that to be a big effect.

Dan

I believe I modeled what you are talking about. I'm getting a lot more false positives that under the method I presented above. That is, the analysis tells me I can expect failure (or a risk of failure) in a number of cases where the minimum portfolio value experienced at each end of year period is never less than 50% of the initial portfolio value. At 15 years, I would have a "failure" (a portfolio value less than 100% successful) about 1/3 of the time. How could I use this information in my decision to return to work or not?

 

[ERD50]

-- did you rerun Firecalc at the 10 and 15 year points with, respectively, 60% and 50% of your starting balance (inflation adjusted)? What did that do for your success rate?

I think there is a problem with that approach - as FUEGO says ' it loses some of that time-series correlation from year to year.'

Another way to put that is, there are some really bad stretches for starting your retirement. By rerunning FireCalc with the ending portfolio from a previous run, you expose yourself to those bad stretches a second time. That distorts what really happened historically. The Great Depression was not followed by another Great Depression 10 years later, for example.

But, interesting analysis. I'm leaning towards the idea that trying to dissect the numbers further, in order to find an earlier 'red flag' may be pushing towards 'data mining'. But.... it's got me thinking.

Good work FUEGO.

-ERD50

 

[FUEGO]

I'm leaning towards the idea that trying to dissect the numbers further, in order to find an earlier 'red flag' may be pushing towards 'data mining'. But.... it's got me thinking.

I agree re: data mining. To a certain extent that is what I am doing. My 60% and 50% rules of thumb wouldn't necessarily apply to a retiree with a different investment mix, higher or lower initial withdrawal rate, etc. But I think the data reinforced what I was thinking would be true (and what Gumby touched on): if your portfolio drops precipitously in the first 10-15 years you do need to be concerned. And 10-15 years into ER isn't too late to return to work. Or cut expenses. Or both.

One would have to be willing to return to work in the slim chance that the portfolio takes a nose dive after 10-15 years. For me, it wouldn't be the end of the world.

From taking a quick look at the data, it appears that returning to work at 10-15 years would remedy portfolio shortfalls after a period of 5-10 years of working (ie - earning sufficient income so that no portfolio withdrawals are necessary).

I guess for some folks it might be a trade-off. Work a bit more now vs. a slim (~10%) chance of returning to work for 5-10 years more later. One could work for maybe 4-5 more years, pad the portfolio by an extra 30-40% over that time, and then retire on a 3% withdrawal rate that is "100%" safe (historically). However you still have the cases where you might see your portfolio value decline to 50-60% of it's initial value even with a 3% withdrawal rate. And out of sample results could also be worse than historical results.

From a quick analysis, I would almost say it sounds better to have a 10% chance of having to work for 10 more years after not working for 10-15 years instead of working an extra 4 years initially to pad the portfolio and take a lower WR, and then still having some nonzero chance of being forced back to work. Intuitively, it seems the early portfolio failures (zero balances) or soft failures are caused by extremely poor investment performance and not the difference in 3% vs 4% annual withdrawals. And if you make it past the first 15 years with your portfolio substantially intact, you are likely to weather the rest of the withdrawal period.

 

[lucija]

Thanks FUEGO, I enjoyed reading through your analysis. We hope to "check you" around 45, so I often wondered how to re-evaluate where we stand.

My gut (no analysis whatsoever) was telling me we could be in real trouble if the value of out portfolio drops to (inflation adjusted) 75% after 5 yrs, 60% after 10 and 50% after 15. Nice to see I was not far off...

My fall back plan (in the event of any one of the above cases) is to cut out travel and get a part time gig with health insurance. Paid insurance + lack of travel alone can easily cut our spending down to 2/3.

 

[FUEGO]

Lucija,

Your guidelines sound pretty good. Just looking at the numbers, the 5 year values don't look too promising as predictors of future success. But if by 8-10 years into it you are not seeing a good recovery of value, it might be time to consider work/expense reductions like you mentioned.

I'm thinking the same thing as you - employer provided health insurance plus minimal travel would reduce spending by a third, so the remaining expenses should be easy to cover on either me or DW working 1/2-3/4 time.

Maybe the main takeaway here is "stay flexible". And the younger you call it quits, the more flexible you need to remain.

 

[Bestwifeever]

For a very early ER (say age ~40), this approach wouldn't be as hard to stomach. I'd rather suck it up at 50 or 55 and go back to work, even if it means swallowing my pride. ... And it would give me a little peace of mind that it is ok to quit working at an early age, knowing that I can always work later for some extra money.

and

My fall back plan (in the event of any one of the above cases) is to cut out travel and get a part time gig with health insurance. Paid insurance + lack of travel alone can easily cut our spending down to 2/3.

Very interesting analysis and good idea to keep running it. My only problem as a world-class worrier is the assumption that should my portfolio drop that much, I can just get a j*b. I can think of many reasons that might not be so simple, but I'll just say this one: what if there is high unemployment to go along with that bear market?

So I'm thinking the finances should be reviewed as to how they stand on their own, without plan B scenarios in the back of your mind?

 

[HFWR]

Secret to success: 2, 11, 13, 25, 37, 52

In "high" tech, at least, the technology would have changed so much in 10-15 years, I'm not sure you could count on going back to w*** in your same field...

For instance, circa 1993, chemical-mechanical polishing (CMP) was just getting started in semiconductor processing, and was used to planarize the dielectric. Fast-forward to 1998, CMP is now used to planarize metal, that metal being copper, which has replaced aluminum...

Besides, you'd have to move to China...

 

[rs0460a]

I truly found...

the secret to "sucess".

My DW was to retire last year (May) along with me.

I retired; she continues to w*rk .... (not "emotionally ready")...

Life is great ...

- Ron

 

[FUEGO]

My only problem as a world-class worrier is the assumption that should my portfolio drop that much, I can just get a j*b. I can think of many reasons that might not be so simple, but I'll just say this one: what if there is high unemployment to go along with that bear market?

Definitely a valid concern. I would guess there is a correlation of some sort between difficulty finding a job due to a bad economy and low stock market values due to a bad economy. But most economic slumps end, and then at that point it might make sense to consider working for an income if portfolio values remain depressed.

Or in the alternative, reduce spending somehow.

 

[ERD50]

The next step that I see is to model cutting expenses at year 10. Would that improve that lower decile, so that instead of dropping from 59% in year 10 to 39% in year 15 - would a spending cut soften that drop in year 15 significantly? And how much of a cut would it take?

You could model this so you are prepared, but if you are OK at year ten, just keep spending what you were.

Looks like one could do this with the 'supporter' features of FireCALC.

-ERD50





......................5 yr 10 yr 15 yr
1st worst decile 89% 59% 39%
2nd worst decile 79 75 60
3rd worst decile 97 91 85
4th worst decile 98 108 112

 

[FUEGO]

In "high" tech, at least, the technology would have changed so much in 10-15 years, I'm not sure you could count on going back to w*** in your same field...

I tend to agree that it could be a difficult transition to re-enter your prior industry. The degree of difficulty would be very specific to what field you worked in and what exactly you did in that field (ie management vs. hands on technologist). There would have to be a significant amount of retraining, learning new software/regulations, etc. And you might have to be willing to take a step or two back in pay grade and/or responsibility while you are relearning the ropes.

But I have seen folks in my field at least get out of the work force for 5-10 years and reenter successfully. Also think of working mothers that take off 5-10 years to raise kids and then re-enter the work force. A difficult challenge, no doubt but not insurmountable. Or one could change careers altogether.

 

[FUEGO]

The next step that I see is to model cutting expenses at year 10. Would that improve that lower decile, so that instead of dropping from 59% in year 10 to 39% in year 15 - would a spending cut soften that drop in year 15 significantly? And how much of a cut would it take?

Sounds like a good approach. I'm leaning towards adopting some sort of more flexible withdrawal scheme for my own portfolio versus the standard "4% fixed plus CPI" approach. Something that makes me cut back if the portfolio gets lean and on the flip side allows me to spend more (if I want) if the portfolio gets significantly larger.

Most analysis periods show significant growth in portfolio value. It would be nice to increase standard of living in fat times. Am I really still going to take $60,000/yr if I have a $4 million portfolio?

Another approach that I have considered is the "old fashioned" approach of living off of dividends and interest payments. It goes against the modern approach of managing a portfolio for total return and cannibalizing the portfolio to fund withdrawals. However dividends/bond coupons don't tend to fluctuate as much year to year as equity values.

 

[megacorp-firee]

Portfolio survivability success, that is. I hope I got your attention!

Fuego, can you give me the readers digest version of this? I'm FIREd and no longer have the attention span to read anything longer than a menu.
... what's the bottom line? Thanks.

 

[rogersteciak]

Setting a rule of thumb for when to go back to work and stop portfolio draws is difficult. Serisouly, who wants to go back to work after 10 or 15 years of chillin' in the sun?!?

During those 10 to 15 years, why not figure out how to earn additional investment income from sources other than the stock market? There is no shortage of books and seminars (and scams) on wealth building. The best approach is to take something you love doing (such as a hobby) and figure out how to make decent money at it. The 4-Hour Workweek by Timothy Ferris describes an approach that might work for some people.

The idea of "passive income" and "portfolio income" is to generate income while you spend much of your time sleeping or laying on the beach (or however you like spending much of your time). Time and common sense (and perhaps a very small amount of risk capital up front) are the major ingredients needed for success. You are your own boss because you are in control of your time and efforts (i.e., if you don't like a particular deal for any reason, just say NO and don't pursue it).

If you prefer to work for The Man, there are ways to come back to the job market as an independent contractor or change to a different career field. Having 10 to 15 years to think about your alternatives (in terms of having a "Plan B" just in case) means you can think about a lot of different ideas until you find one that works for you. You'll also have time to get any training or retraining you need.

There is the psychological aspect of "working" to consider. Some people enjoy what they do and consider the paycheck as a nice bonus above and beyond the fun of it all. That is why a hobby-turned-profitable sideline business works for many people. Many years ago, the National Association for the Self-Employed had a bumper sticker that read: I love my boss. I love my job. I'm self-employed.

 

[rogersteciak]

Another approach that I have considered is the "old fashioned" approach of living off of dividends and interest payments. It goes against the modern approach of managing a portfolio for total return and cannibalizing the portfolio to fund withdrawals. However dividends/bond coupons don't tend to fluctuate as much year to year as equity values.

The disadvantage of "total return" is that you are depending on Mr. Market to be in a good mood when you want to sell your assets. If Mr. Market is in a bad mood, you will not get a good price.

The main advantage of dividend-based investing is that Mr. Market largely becomes irrelevant (so long as you bought your dividend-paying stocks when Mr. Market was in a bad mood and offered them to you at a low price relative to their fair value). You dividend income is based on how well the underlying company does (meaning the company's Board of Directors has to approve the payment of a dividend) rather than how the "idiots next door" (meaning Mr. Market) feel about what the company's stock is worth.

A second main advantage of dividend-based investing involves dividend growth. Many companies increase their dividend payments over time at a rate that is often higher than inflation. There are over 300 companies in the United States that have increased their dividends for 10 years or more (Google on dividend achievers [Mergents]) and over 50 companies that have increased their dividends for 25 years or more (Google on dividend aristocrats [Standard and Poors]). Not all of these dividend-paying stocks might be right for you, but they certainly are a good place to start your analysis to create a shopping list.

The Ultimate Dividend Playbook by Josh Peters describes a good approach for analyzing dividend-paying stocks.

Edited to add: Divident-Paying ETFs: A Source of Retirement Income - Seeking Alpha

 

[FUEGO]

During those 10 to 15 years, why not figure out how to earn additional investment income from sources other than the stock market? There is no shortage of books and seminars (and scams) on wealth building. The best approach is to take something you love doing (such as a hobby) and figure out how to make decent money at it. The 4-Hour Workweek by Timothy Ferris describes an approach that might work for some people.

My goal of ER'ing would be to not work. I'm sure I could stumble onto the secret to passive income and wealth along the way, but it would involve work. I'd rather just keeping working at my current fairly high salary for a while longer if I'm going to work anyway.

Unfortunately, I don't think anyone will pay me to do what I love doing. If I had found my avocation, my calling in life, I would probably be pursuing it right now instead of posting on a forum centered around retiring early (and not working). I may stumble upon something someday that could potentially earn me money, but it takes effort to earn money (client relations, advertising/publicity, paperwork, collections, AP/AR, legal issues, employment/compliance issues, etc). It takes effort, that is, if I'm serious about making money.

 

[FUEGO]

... what's the bottom line? Thanks.

I meant to put a little abstract in here somewhere. Thanks for the reminder!

Basically it is this: About 10-15 years into your retirement, look at your portfolio balance in inflation adjusted dollars versus what it was when you retired. If you have less than 50-60% of your portfolio remaining at that point (adjusted for inflation), you are very likely to run out of money or have a very low portfolio balance at some point in the future. In other words, I'm proposing a FIRE check-up about 10-15 years into retirement. If your portfolio value at 10 to 15 years is less than 50-60% of the initial value, start thinking about earning income from some other source, or reducing expenses, or both.

It more or less boils down to common sense. Don't continue blindly following a plan if signs start showing that you are headed to failure. I haven't really seen other research showing what signs might indicate failure well before the failure event actually occurs. With this rule of thumb, you can be a bit more certain of whether your retirement falls in the 90% of cases where you will do just fine (historically), or the 10% of cases where failure was reached or closely approached. If you find yourself in the 10% of cases where failure is imminent, you can do something to remedy the problem before it is too late. (ie - go back to work for 5 years in your 50's instead of working for the rest of your life once you are in your 60's+).

 

[lucija]

FUEGO - In many ways your thinking and reasoning is echoing my own thoughts...

...<snip>...Unfortunately, I don't think anyone will pay me to do what I love doing. If I had found my avocation, my calling in life, I would probably be pursuing it right now instead of posting on a forum centered around retiring early (and not working). I may stumble upon something someday that could potentially earn me money, but it takes effort to earn money (client relations, advertising/publicity, paperwork, collections, AP/AR, legal issues, employment/compliance issues, etc). It takes effort, that is, if I'm serious about making money.

The following is a valid concern.

...<snip>...In "high" tech, at least, the technology would have changed so much in 10-15 years, I'm not sure you could count on going back to w*** in your same field... <snip>

Luckily for me, I have no intentions of getting another high tech job once I am done with this one (or whichever one allows me to ER). If I have to go back to a full time job it will be doing something completely different.

....Maybe the main takeaway here is "stay flexible". And the younger you call it quits, the more flexible you need to remain.

So true...

 

[walkinwood]

Thanks for a very thoughtful post. I need to set a portfolio value that will send me back to work. I plan to use the 4/95% method advocated by ESRBob in his book.

A decline in portfolio in the first few years is a good reason to rethink ER especially for those like me, who are in their late 40s or younger. There is a better chance of getting back to your old salary levels than if you wait 10-15 years.

However, I think if you did the analysis, the false-indicators would overwhelm any meaningful guidelines.

I think I'll set it to 20% below initial value in the first 5 years. There is no science behind that number - just a feeling of comfort.

 

[donheff]

I need to set a portfolio value that will send me back to work...

I think I'll set it to 20% below initial value in the first 5 years. There is no science behind that number - just a feeling of comfort.

Wow. 20% drops are pretty common. I think I would work a few more years before retiring rather than pull the plug with a fair to good chance of having to undo.