Author Topic: A common error when calculating your target amount  (Read 15318 times)

Shane

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Re: A common error when calculating your target amount
« Reply #50 on: November 25, 2015, 06:35:33 PM »
The point that frugal Mustachians aren't immune to inflation just because we spend less is well taken. It makes sense. I accept that to the extent that we still have to buy some things, those things will be relatively more expensive than before inflation.

My argument is in favor of flexibility in early retirement. If an ~4% inflation adjusted withdrawal rate becomes unsustainable due to a period of high inflation, my family and I plan to relocate to a lower COL area where we may be able to live from dividends alone, without touching our stash at all. Problem solved.

The currently highly valued US$ makes international geographic arbitrage especially attractive. For an early retiree who can live in the U.S. on $25K/year, relocating to Chiang Mai, Thailand, would most likely mean he could live well on half that amount. See Go Curry Cracker's recent posts on their new home in Thailand for an example of how life might look in a lower COL part of the world.

Another option we're considering is staying in the U.S. during economic downturns or periods of high inflation, but living unconventionally, e.g., volunteering on an organic farm through the WWOOF Program or Workaway. Typically, for just a couple to a few hours a day of volunteer labor on a farm, it's possible to receive accommodations and good, healthy, organic food, which, arguably, are two of the biggest costs in ER.

Prairie Stash

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Re: A common error when calculating your target amount
« Reply #51 on: November 25, 2015, 06:37:30 PM »
Alright, let's try a different example. If the stuff I purchase increases 5%/year (personal inflation rate) and national inflation is 3% will the 4% rule work? This is micro economics, national inflation is macro economics.

It is possible for an individual to have spending rates increase faster than national inflation if they always buy the same items every year. In that case the person needs to adjust or they'll fail. The corollary is also true.

I'm pretty sure not everyone buys the same items in the same quantity to get the same inflation rate as the formula states. National inflation rates are a benchmark, same as the vanguard ETF is a benchmark for stock returns. Some people come in higher, some come in lower. In this case don't beat the benchmark!

nereo

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Re: A common error when calculating your target amount
« Reply #52 on: November 26, 2015, 11:56:04 AM »
Alright, let's try a different example. If the stuff I purchase increases 5%/year (personal inflation rate) and national inflation is 3% will the 4% rule work? This is micro economics, national inflation is macro economics.

It is possible for an individual to have spending rates increase faster than national inflation if they always buy the same items every year. In that case the person needs to adjust or they'll fail. The corollary is also true.

I'm pretty sure not everyone buys the same items in the same quantity to get the same inflation rate as the formula states. National inflation rates are a benchmark, same as the vanguard ETF is a benchmark for stock returns. Some people come in higher, some come in lower. In this case don't beat the benchmark!

Wait - if I understand your question correctly, it can be summarized as "if I increase my spending faster than (some metric) will my portfolio be ok?"

The obvious answer is that it will add more risk.  Any increase in spending increases the risk that your 'stach will run out.  The Trinity study (along with FireCALC and FireSIM) utilized national inflation rates. 
Spending more = higher probability of failure.  Spending less = lower probability of failure.

Don't miss the forest for all the trees. 

Prairie Stash

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Re: A common error when calculating your target amount
« Reply #53 on: November 26, 2015, 12:24:33 PM »
Alright, let's try a different example. If the stuff I purchase increases 5%/year (personal inflation rate) and national inflation is 3% will the 4% rule work? This is micro economics, national inflation is macro economics.

It is possible for an individual to have spending rates increase faster than national inflation if they always buy the same items every year. In that case the person needs to adjust or they'll fail. The corollary is also true.

I'm pretty sure not everyone buys the same items in the same quantity to get the same inflation rate as the formula states. National inflation rates are a benchmark, same as the vanguard ETF is a benchmark for stock returns. Some people come in higher, some come in lower. In this case don't beat the benchmark!

Wait - if I understand your question correctly, it can be summarized as "if I increase my spending faster than (some metric) will my portfolio be ok?"

The obvious answer is that it will add more risk.  Any increase in spending increases the risk that your 'stach will run out.  The Trinity study (along with FireCALC and FireSIM) utilized national inflation rates. 
Spending more = higher probability of failure.  Spending less = lower probability of failure.

Don't miss the forest for all the trees.
I agree, I haven't missed the forest.

My point still is that if your personal inflation rate differs from national inflation rate because the purchases you personally make are quite different than the average statistical citizen then there is potential for someone to be overly conservative in retirement dates (low personal inflation) or reckless (high personal inflation rate). In plain English you either worked too long or too little. Or you can consider the differential to be a safety factor if your own inflation rate lags the national rate.

Its one of the intrinsic assumptions of the SWR that gets little focus. Most of us focus on the returns side but not the inflation side, inflation can be the sinister monster under the bed.

EscapeVelocity2020

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Re: A common error when calculating your target amount
« Reply #54 on: November 27, 2015, 07:11:20 PM »
Your example of raises is in a boom time with lack of employees.

Not in an inflationary time.  Look at the stagflation from the 70s.  Wages weren't keeping up with inflation real time, and workers were scared to leave jobs in a bad economy.  A job is not a "good" solution to inflation. It's okay, but lags even worse than most good investments.

...
I've talked with several folks that were in the workforce in the 70's.  I only threw out my example because it was very similar to theirs.  If I thought my experience was an anecdote, I would've said as much.  Instead, I feel that it is an eye-opener for us younger people that weren't working in the 70's.

Or maybe I'll flip my line of questioning on its head, since no-one is addressing questions about what folks are doing to prepare for it, other than acknowledging that  'yeah, we should be weak at the knees in the face of inflation' but thinking that rents and passive investments will do 'plenty well enough'.

Run a thought experiment where inflation spikes, for a decade, to 7%.  I would imagine that the government would pull out 'all the stops' to 'whip inflation' (although I'm not sure what it would look like, since we're as pro-inflationary as I can imagine with interest rates at zero and quantitative easing.  Maybe the government will move from giving us some money (https://www.irs.gov/uac/Facts-about-the-2008-Stimulus-Payments / https://www.irs.gov/uac/First-Time-Homebuyer-Credit-Questions-and-Answers:-Basic-Information) to just giving everyone lots of money somehow.  Honestly, predicting the future is a weak point and I never put my own money on my ability.  But I do like to think about these things.

Where would you be after a decade of 7% inflation?  Can you raise rents 7% (or more) 10 years in a row with the same tenants?   Are your companies the stalwarts of the economy that can raise dividends and interest 7% for a decade because people can't survive without them?

Yeah, I think inflation could single-handedly put an end to ER (hence my 'active income' comment).  But I don't have any easy answer to what to do about it.

TomTX

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Re: A common error when calculating your target amount
« Reply #55 on: November 27, 2015, 08:43:19 PM »
Real estate isn't the answer for me.  I've got a rental now that I'm not renting because it is a hassle.   I want passive income only in fire from investments.  I'm not against part time work for a few months a year to enhance earnings.   I fell OMY syndrome for a while now.  I have a new position at work and no longer hate my job.

What. The. Fuck.

If you're not renting, it isn't a rental. It's a money pit. Either rent it out or sell it off and put the money to work instead of sucking in more money for repairs, utilities, property taxes, etc.

brooklynguy

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Re: A common error when calculating your target amount
« Reply #56 on: November 28, 2015, 06:54:08 AM »
Can you raise rents 7% (or more) 10 years in a row with the same tenants?

Roughly speaking, yes, you should be able to.  If inflation is 7% per year for ten years, that means prices (including rents) are quickly rising.  As noted upthread, there is lag time, and not all prices for all goods and services in all markets rise uniformly, but if rents in your area are keeping pace with the overall inflation rate, then, by definition, you will be able to raise rents at the same rate.

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Are your companies the stalwarts of the economy that can raise dividends and interest 7% for a decade because people can't survive without them?

Likewise, in times of high inflation, the goods and services your companies sell will, by definition, be increasing in price.  That's how (and why) stocks operate as inflation-protection.

Was your reference to "interest" meant to refer to bonds?  Bondholders will generally be harmed by inflation.  Inflation will hurt any lender-side holder of fixed-rate debt, who gets repaid in less-valuable dollars (it's the flipside of being the borrower-side holder of a fixed-rate mortgage, which is a superb inflation hedge).  Bonds are nothing more than a contractual loan, so, if the contract specifies a fixed rate of interest, then of course the issuer won't be gratuitously raising the interest it pays in order to compensate its bondholders for the loss in the dollar's purchasing power.

EscapeVelocity2020

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Re: A common error when calculating your target amount
« Reply #57 on: November 28, 2015, 12:52:26 PM »
Can you raise rents 7% (or more) 10 years in a row with the same tenants?

Roughly speaking, yes, you should be able to.  If inflation is 7% per year for ten years, that means prices (including rents) are quickly rising.  As noted upthread, there is lag time, and not all prices for all goods and services in all markets rise uniformly, but if rents in your area are keeping pace with the overall inflation rate, then, by definition, you will be able to raise rents at the same rate.

Quote
Are your companies the stalwarts of the economy that can raise dividends and interest 7% for a decade because people can't survive without them?

Likewise, in times of high inflation, the goods and services your companies sell will, by definition, be increasing in price.  That's how (and why) stocks operate as inflation-protection.

Was your reference to "interest" meant to refer to bonds?  Bondholders will generally be harmed by inflation.  Inflation will hurt any lender-side holder of fixed-rate debt, who gets repaid in less-valuable dollars (it's the flipside of being the borrower-side holder of a fixed-rate mortgage, which is a superb inflation hedge).  Bonds are nothing more than a contractual loan, so, if the contract specifies a fixed rate of interest, then of course the issuer won't be gratuitously raising the interest it pays in order to compensate its bondholders for the loss in the dollar's purchasing power.

BG, you somehow seem much younger than 35 all of a sudden.  People should really start talking to older folks at the office, they love to talk about stuff like this.  But no, there is no way you could consistently raise rents 7% for 10 years with one tenant, unless it is Gordon Gekko and you have his favorite NYC penthouse.  Every year your renter re-up's their lease, meanwhile being stretched by daily expenses (groceries, your rent, utilities), they will be shopping around on their big expenses.  And eventually they wise up to the idea that they can save money if they buy a house, because it's a fixed 30 year loan on an asset that is appreciating, and they too can rent it out if need be.  Being a renter gets stupid painful in a high inflation environment, so yeah, I'm not impressed by how forward thinking people are when they throw that out. 

Bonds aren't 'necessarily' bad in an inflationary environment, it's when the Fed starts raising their interest rates to compete with inflation that bonds suck, but that was the last war.  I'm not so certain the Fed would do that this time around, but until you get the whole picture about what is causing inflation, you really don't know how the Fed will act.  People in the past would've looked at you like you were nuts if you told them that the government shut down because of some imaginary debt ceiling, or that TARP had to pass (and it failed on the first try) otherwise banks might all ultimately collapse and destroy pretty much modern life as we know it.

arebelspy

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Re: A common error when calculating your target amount
« Reply #58 on: November 28, 2015, 02:27:12 PM »
If you own properties and the rents in the area AREN'T going up, and you own stocks in the business selling things, the electric company, gasoline producers, etc. and the prices of those things aren't going up (leading to more profits for you), where is the inflation?

BK's point is that inflation by definition is increasing rents, food prices, gas prices, etc.  So if you are the owner of those things, you're making more money.

If you aren't making more money, there's no inflation happening.
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EscapeVelocity2020

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Re: A common error when calculating your target amount
« Reply #59 on: November 28, 2015, 05:51:24 PM »
In this case, Rebs, I'd urge you to talk to people with experience.  I see your 'theoretical' point, but inflation is much more insidious than just saying 'the text book tells us we will be OK owning the things around the inflation'.  For instance, you didn't address my point that it gives renters incentives to buy.  It also 'nudges' people not to spend.  So yes, inflation is complicated and once again I'm asking what innovative ways ER folks plan to deal with it.  Historically, if you talk to anyone working in the 70's, having an active income was the only solution (or becoming a hippie, growing your own food and living in a collective, etc.).

arebelspy

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Re: A common error when calculating your target amount
« Reply #60 on: November 28, 2015, 06:12:51 PM »
As I said up thread, I've done a lot of research into inflation, including talking to people who lived through it, reading a lot about it, etc.

There's some really good E-R.org threads on inflation.

As I said there a few years ago:
Quote
Speaking as a younger person, while I understand the effects of inflation, my mind still boggles at a statement like this:
Quote
Originally Posted by clifp
3 years of double digit inflation.
Simply because I understand compounding, I think, that idea (3 years of double digit inflation) just floors me.

There's just a huge gap between understanding something and living it.

I've done a lot of research and reading, and talking to people, trying to prepare.  That's about the best I can do.

As far as your point that rising rents incentives people to buy, there's two sides to every coin.

There's also a double incentive not to buy:
1) House prices are rising (as housing is one thing that's generally tied to inflation), so people often see the rising home prices and don't want to buy because they feel they missed the best chance, and want to wait for them to fall a bit, and
2) It also (at least historically) comes with high interest rates, which disincentives people. When rates were 15-18% in the 70s, yeah, people still bought, but it's still a disincentive, to where those renters are thinking "rents may have gone up 7%, but at least I'm not paying 17% on a mortgage."

Inflation is a complicated issue, and your solution of "only having a job" is frankly a mass oversimplification.
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EscapeVelocity2020

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Re: A common error when calculating your target amount
« Reply #61 on: November 28, 2015, 06:47:35 PM »
Thanks for the reply, and I'm encouraged that YOU have done some secretive research that you are not sharing any real facts about :)  Are TIPS going to be better than Real Estate over the next decade or two?  Could you at least let me in on where you think I should be putting my 'at risk to inflation' extra - maybe mirror your optimized portfolio that you aren't telling us about?  Or will we even have to worry about inflation in our lifetimes, maybe the government can continue to find ways to make inflation look just about right, even if, in general, people can't find jobs that optimize their potential or continue to get too much access to credit to buy things they cannot really afford.

I'm a HUGE fan of the internet, because people now can create as they wont (and scrape virtually ephemeral income) vs. the bondage of an 'active income' (producing hard goods that sit on shelves and end up in landfills), but real inflation in the form of rents and groceries going up in price, in my humble opinion, is eventually going to catch up to these innovations.  We've enjoyed the wind at our back (globalization, internet, QE and low energy prices). 

But what do I know - maybe the salad days will come to an end (high market valuations and low inflation) in our generation or the next, or maybe we have hit Nirvana.  Many super-smart Hedge Funds are falling apart over the fact the stock market remains near all time highs and many super-smart Economists are baffled by the fact inflation didn't result from QE and ZIRP...

I have no qualms with the status quo and people enjoying it, but would like to do what is typical of generations before us - prepare for harder times.  And I thought that's what this thread was about... 

arebelspy

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Re: A common error when calculating your target amount
« Reply #62 on: November 28, 2015, 07:16:31 PM »
As I said earlier (or maybe in the other inflation thread), AA is crucial.

The thing I don't understand is why you don't just tilt your AA towards being overly prepared for inflation, if that's the bugaboo that's scaring you.

It comes with other risks, but that seems like the straightforward solution.
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Re: A common error when calculating your target amount
« Reply #63 on: November 28, 2015, 07:36:10 PM »
One of the problems of the internet is that there are holes in it, and one of the holes is precisely the period when there was double digit inflation and interest rates, because anything after the 50s/60s had not made it to the history books when the internet was developed.

As someone who bought a house when mortgages were at 17.5% interest, and lived through that period, it was a terrible time for those who were living on fixed incomes - but everyone was having problems because although everything adjusts, income tends to adjust months or a year after prices, so you are always feeling the pinch.

brooklynguy

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Re: A common error when calculating your target amount
« Reply #64 on: November 28, 2015, 08:48:08 PM »
For instance, you didn't address my point that it gives renters incentives to buy.

Are you saying that rising rents can somehow mean non-rising rents?  If rents are rising then rents are rising.  And if they're not rising, then they're not rising.  It's not just theoretical, it's unassailably true in the real world.

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Historically, if you talk to anyone working in the 70's, having an active income was the only solution

How many of these working folks with whom you spoke also owned a massive stash of stocks and/or rental real estate?

For the reasons already given, although there are no perfect solutions, owning productive assets provides good protection against inflation, so having a job is not the only solution, or even the best solution.

Bonds aren't 'necessarily' bad in an inflationary environment

If they pay a fixed rate of interest, they are.  If you hold fixed-rate debt and inflation occurs, you get repaid in dollars having the same nominal amount but a lower real value, regardless of whether or not:

Quote
the Fed starts raising their interest rates to compete with inflation

If you make a loan with a locked-in fixed rate of interest (which is what you are doing when you purchase a fixed-rate bond), you are absolutely, necessarily harmed by inflation.