Author Topic: FIRE number in terms of shares  (Read 968 times)

ChpBstrd

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FIRE number in terms of shares
« on: April 05, 2018, 10:43:31 AM »
I've been thinking about an alternative method for calculating one's ability to FIRE besides net worth, which bounces all over the place and might not be a reliable indicator of portfolio durability when prices are relatively high.

E.g. for an all-stock S&P 500 portfolio, the portfolio's net worth divided by the PE ratio of the S&P roughly equals the expected corporate earnings of the portfolio. Corporate earnings can be expected to return to shareholders (in the long run) through buybacks, dividends, debt reduction, reinvestment in the business, and/or capital gains due to all the above.

The S&P 500 has earned about $100/year for the past few years. http://www.multpl.com/s-p-500-earnings/table

The ETF SPY is roughly equal to one tenth of a unit of the index, so for each share you obtain about $100/10 = $10/year in expected earnings (that can be expected to grow with inflation). If your spending needs are $50k/year, a portfolio with 5,000 shares of SPY would make you FI because $10 earnings x 5,000 shares = $50k. (FWIW, today's cost of that portfolio is $1.325M, so we're at a 3.7% WR applying the net worth based terminology. But this calculation fluctuates with market swings.)

Thus, it's not the market value of the portfolio that makes you FI, it's the expected future earnings of the shares you own. The goal is not to attain a portfolio with market value X on any given day, it's to obtain a portfolio with Y number of shares which have earnings sufficient to cover your spending.

Shares owned times average EPS over the past few years would be a reliable indicator of one's ability to retire in December 1999 or March 2009. The market price of one's portfolio on those dates would not be. In the first case, the person who quit when they reached their FIRE number in terms of net worth would have retired too soon and in the second case too late.

If you have bonds, real estate, or other income, you would do the above exercise for only the portion of income you still need. E.g. if income from these sources was 10k, you'd do the exercise for the remaining 40k to obtain your FIRE number in terms of shares.

Thus we accumulators should be encouraged by falling stock prices, and those who are already FI don't need to care about their net worth / market prices any more - provided that they own enough shares. For accumulators, each day you can buy a share brings you closer to your FIRE number in terms of shares - regardless of market price.

What do you think about this way of thinking, as opposed to net-worth based approaches?

alanB

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Re: FIRE number in terms of shares
« Reply #1 on: April 06, 2018, 07:04:55 AM »
Thus, it's not the market value of the portfolio that makes you FI, it's the expected future earnings of the shares you own. The goal is not to attain a portfolio with market value X on any given day, it's to obtain a portfolio with Y number of shares which have earnings sufficient to cover your spending.
I agree, there is way too much focus on market prices.  Stock directly represents ownership in a business.  Ask a small business owner, "what is the value of your business?"  Their response will be based on revenue and earnings, not what they could sell it for tomorrow.  Somehow people seem to understand this for productive real estate, where you are encouraged to focus on monthly income and think of appreciation as an added bonus. 

This is an important and underappreciated point:
Corporate earnings can be expected to return to shareholders (in the long run) through buybacks, dividends, debt reduction, reinvestment in the business, and/or capital gains due to all the above.
A lot of people seem to think of the stock market as zero-sum speculation, with no awareness that increase in share price is tied to an increase in underlying value.  On the other hand, stating net worth based on a sum of stock valuations naively assumes that the market is 100% efficient, but I don't really see a better option.  I expect that if you adjusted your net worth based on CAPE to what you think the price "should be" you would get to the same place as you are suggesting.

What do you think about this way of thinking, as opposed to net-worth based approaches?
Safe withdrawal rate should combine future earnings as well as your ability to spend down principal as needed.  If you adjusted your withdrawal rate in response to earnings that would of course improve your odds.  Whether average EPS or CAPE matters more, I don't know, I will think about it for a while...