Hello MMM community. I'd like to hear your thoughts on comparing and backtesting the following two scenarios:
1. Fire and use part of your nest egg to buy a property outright. Spend less money because you're saving on rent.
2. Fire with a bigger nest egg and rent for the rest of your life.I tried to use this tool
https://ficalc.app/ to backtest both scenarios. Someone on youtube mentioned Ficalc and i really liked it for its simplicity, but the same kind of backtest can be done with other tools as well. I am not affiliated with this web site.
The numbers I used as inputs are just to simplify calculations, not anyone's actual numbers. If you feel they are too low, multiply all of them by 10 if you want.
I used the following assumptions: $1MM nest egg, 4% fixed withdrawal rate adjusted for inflation, 30 years retirement length.
Scenario 1. Keep $700K in the stock market (Ficalc defaults to 80% US stocks, 15% US bonds, 5% cash). Use $300K to buy a property (yes, i know it's low for most places in the US but again, these numbers are used for simplicity). Then run a backtest with a 4% withdrawal rate, so that's $28K per year which is $40K per year minus the estimated rent you would be saving on a $300K property, which is $1K per month or $12K per year in this example.
Scenario 2. Keep renting and invest the entire $1MM nest egg in the same portfolio of 80% US stocks, 15% US bonds, 5% cash. Use the same 4% withdrawal rate for spending, so $40K per year adjusted for inflation. That includes the estimated $1K per month rent you would be paying in this case, also adjusted for inflation.
With these inputs, both back tests show a 95.9% success rate. Scenario 2 is what
https://ficalc.app/ shows by default if you open it. To run Scenario 1, just reduce the nest egg to 700K and yearly spend to 28K and you will get the exact same success rate.
Questions and comments:
One assumption I made for this comparison is that the rental yield on the property is the same as planned withdrawal rate which is why the success rate is equal for both scenarios. So, 12K/300K = 4% gross rental yield on the property (the rent you wouldn't be paying, adjusted for inflation). Alternatively, investing that amount and withdrawing the same $12K per year infl. adj. at a 4% withdrawal rate gives you the same results. Question: what's the best way to stress test this assumption perhaps by using a range of different rental yields and different withdrawal rates as well?
I tried to model the same scenarios with estimated social security as additional income (ficalc has that option), so in that case, buying a property would reduce the failure rate because you're adding the same amount of SS in both scenarios while keeping expenses lower in Scenario 1.
This comparison doesn't account for the value of the property after you pass away so if someone wants to leave it to children or significant others, it's also an important consideration. For someone who doesn't have heirs or just doesn't care, a reverse mortgage is also an option increase income even though it's generally a bad deal.
Another assumption is that both rent and spend growth are tied to inflation but depending on where you are, these may be different. For example, if you want to stay in a gentrifying area or let's say a developing country on an upward trajectory, it may be better to buy a place before rents for similar places get out of control or the local currency appreciates vs the USD.
Then there are non-financial considerations such as being able to renovate and furnish your place as you please, not having to move when the landlord needs the place, etc.
This kind of comparison can be used before you FIRE but you can also use it at any point of your retirement if you're renting and want to buy or conversely, considering selling the property your own, investing the money and spending the extra income on rent. The only caveat is that if you use it later in retirement, you will have to account for the same kind of sequence of returns risk that recent retires face without the same ability to get back into the job market if things go wrong. So it's probably better to use a lower safe withdrawal rate in this case.
Anything I'm missing? Any additional thoughts or other examples?