Author Topic: Learning about FIRE  (Read 1669 times)

frugalor

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Learning about FIRE
« on: October 14, 2020, 12:53:42 PM »
Hi, I have just found out FIRE a couple days ago.  Since then, I have been listening to/watching youtube videos and reading online material.  The latest thread I was reading is https://forum.mrmoneymustache.com/welcome-to-the-forum/the-4-rule-is-for-the-stash-not-the-withdrawal-right/

I want to know if my understanding is correct:

Let's say I have a 1m investment portfolio today.  And let's say my current year expenses is projected to be 40k.  So I first withdraw 40K from the 1m, put the 40K to a money market account/checking account.

Now my portfolio is at 960k.

And next year comes along, assuming a 7% return, my portfolio is at 1.027m.  I take 4.1k out. (assuming 3% inflation).  And then repeat the process.

Let's say I am 45 and will live to 95.  According to this calculation, I will actually have more than 2m left over for my kids when I die.  Is this too good to be true?  (see my fire-portfolio.ods attachment)

That was the big picture question.  The other question is about income and health care cost.  So in order to get an affordable health plan from healthcare.gov, the portfolio needs to be set up to generate the right amount of dividends as income, is that right?

And the 40K yearly withdrawal needs to cover all the expenses including taxes for the dividend income, right?  I would appreciate for some real numbers from people who are doing this.

mschaus

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Re: Learning about FIRE
« Reply #1 on: October 14, 2020, 03:43:41 PM »
I'll just quickly say that, yes, you've pretty much got it! On all your points. There are nuances that you will learn but you've got the gist.

Indeed, it seems miraculous in the sense that you can make what amounts to a university endowment that lasts forever, except it's just for your own family.

RedmondStash

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Re: Learning about FIRE
« Reply #2 on: October 14, 2020, 03:59:36 PM »
Welcome. If you're just getting started, I also recommend JL Collins' blog posts; they do a good job of laying out the principles of FIRE. Here's one to get started:

https://jlcollinsnh.com/2011/06/08/how-i-failed-my-daughter-and-a-simple-path-to-wealth/

swashbucklinstache

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Re: Learning about FIRE
« Reply #3 on: October 14, 2020, 04:09:19 PM »
Let's say I have a 1m investment portfolio today.  And let's say my current year expenses is projected to be 40k.  So I first withdraw 40K from the 1m, put the 40K to a money market account/checking account.

Now my portfolio is at 960k.

And next year comes along, assuming a 7% return, my portfolio is at 1.027m.  I take 4.1k out. (assuming 3% inflation).  And then repeat the process.

Let's say I am 45 and will live to 95.  According to this calculation, I will actually have more than 2m left over for my kids when I die.  Is this too good to be true?  (see my fire-portfolio.ods attachment)
More or less, this is the idea.
However, it is important to note that, while the long term after-inflation returns of the stock market have been approximately 7%, you won't get exactly 7% every single year, and that matters. Specifically your equation is:
year 1: (x-y)*z
year 2: x2-y2)*u
^repeated long enough, you'd expect the averages (not simple arithmetic mean) of the z's and u's to approach 7%.
e.g.
year 1: (1 million - 40k) * z
year 2: (y1 result - 41k) * y

Sequence of returns risk, or SORR, is the risk that you get a few bad years right up front. Mathematically this matters because you have both addition and multiplication in there. For a simple extreme example, imagine you start with $10 and spend 1$ a year. The first year the market drops 80%. (10 - 1) * .2 = 1.8. The next year it goes up 400%, and that leaves you with (1.8 - 1) * 4 = 3.2. If you'd had the opposite order of years, you'd have (10 - 1) * 4 = 36, then (36 - 1) * .2 = 7. Even though the average return is the same over the time period in question.

The 4% guideline is attempting to take this into account to spit out a reasonable failure rate of a portfolio - if it didn't, it would just be the 7% rule =).

As you continue reading material, you'll find that most FIRE failures fail because of this (or because spending goes way up). Google Early Retirement Safe Withdrawal series to dive into the weeds. Keep in mind as you read though that people pay a lot more attention to the failure cases because the impact of running out is a lot more important than getting super rich. For instance, while your calculations showed ending up with 2m, nothing's to say you won't end up with 3m even without extremely good (historical) returns.

Different calculators use different approaches to attempt to deal this, but none are foolproof. And they all come with the important disclaimer that past performances are not indicative of future results -> 7% is not a mathematical law, just what we've seen in the past (in the US, in a period of global US domination, in a period of massive productivity gains for the planet, etc.).

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That was the big picture question.  The other question is about income and health care cost.  So in order to get an affordable health plan from healthcare.gov, the portfolio needs to be set up to generate the right amount of dividends as income, is that right?

And the 40K yearly withdrawal needs to cover all the expenses including taxes for the dividend income, right?  I would appreciate for some real numbers from people who are doing this.
Yes you need to include income taxes as an expense with the 4% calculation. The good news is that taxes will likely be very low on 40k withdrawals, especially since not all of that withdrawal may be subject to tax, e.g. only the gains in a taxable account, none of it in a Roth IRA. E.g. you might sell 40k from your taxable account, made up of 32k of contributions (not taxed further) and 8k in market gains (subject to tax). Or, 40k from your 401k which will all be subject to tax.

Dividends should be thought of as forced withdrawals for the most part when it comes to tax accounting, which is why many don't actually prefer them.

Metalcat

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Re: Learning about FIRE
« Reply #4 on: October 14, 2020, 04:13:36 PM »
Yes, that's the basic theory.

However, spend a whole bunch of time here and read a ton on the subject matter, and then you will feel far more confident in exactly how the numbers work for your particular situation.

The basics are simple, the details are where it gets complicated.

frugalor

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Re: Learning about FIRE
« Reply #5 on: October 14, 2020, 04:27:37 PM »
Thanks folks for replying so far.  I know I used a very simple and naive formula.  If the investment portfolio drops 80% in the first year, I guess I'll need to look for a job again :)

But let's say everything is normal and calm.  So my investment portfolio can actually be split into, say, 500K in non-retirement account, and 500K in 401k/ira account, right?  I actually don't need a 1m investment portfolio in a non-retirement account, right?

I am 45. In about 15 years, I can tap into the 401K, and about 10 years after that, I can tap into social security.

If there are no disasters in the first few years, this should work out, right?

swashbucklinstache

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Re: Learning about FIRE
« Reply #6 on: October 14, 2020, 05:49:25 PM »
Thanks folks for replying so far.  I know I used a very simple and naive formula.  If the investment portfolio drops 80% in the first year, I guess I'll need to look for a job again :)
Or maybe buy bullets because this probably means the world is collapsing and you'll need them for protection =)

Quote
But let's say everything is normal and calm.  So my investment portfolio can actually be split into, say, 500K in non-retirement account, and 500K in 401k/ira account, right?  I actually don't need a 1m investment portfolio in a non-retirement account, right?
That's correct. A somewhat unwise person once said, "it's your money, use it when YOU need it." =).
As a note, if you plan on spending any of the 401k/IRA money before 59.5, you'd be best served to read up on this forum and others on the best ways to do so (Roth IRA conversions / pipeline, 72t). For ballparking it, and especially low withdrawals like 40k, you are absolutely correct that which account your dollars are in doesn't matter much. Namely, someone with 1 million in Roth can support 40k of spending. Someone with 1 million in traditional might only be able to support 38.5k of spending and 1.5k of taxes on withdrawals (wild guess). Someone with taxable and/or a mix of taxable/Roth/traditional would be somewhere in between.

Quote
I am 45. In about 15 years, I can tap into the 401K, and about 10 years after that, I can tap into social security.

If there are no disasters in the first few years, this should work out, right?
If your 40k estimates are at all accurate and sustainable over time and you have 500/500 + social security, you're almost certainly golden if the first years go well. I'd still recommend taking 6 months to settle in, read, and track your expenditures before doing anything. There are some real questions to ask yourself about future expenditures before diving in the deep end. It doesn't do any good having a rock solid plan supporting 40k if you need 60k to be happy. Or, like, you haven't included $ for healthcare / kid's college / a new roof every 20 years / new socks / end of life care / etc.

That said, if you're in poor health or something because of your work with a 1 million dollar net worth I would probably quit immediately in your shoes, unless you also have a million dollar salary or something =).
« Last Edit: October 14, 2020, 06:00:13 PM by swashbucklinstache »

frugalor

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Re: Learning about FIRE
« Reply #7 on: October 14, 2020, 07:15:02 PM »
Hi @Bristles, Yes for the bullets :) In fact, if I do FIRE, I'll have time to learn how to use a gun.

And yes I will look into FIRE more before I actually go for it.  But knowing about it gives me an option should I lose my job for whatever reason.

I am in high tech with good paycheck.  But the hours are long and the work and the environment is burning me out.  I still have good health.  But I start to experience some health issues here and there.  A couple days ago Mr. Money Mustache's talk showed up on my youtube's recommendation list.  Some of what he said make a lot of sense to me.  I do want to enjoy my life and live "free" while I still have good health.  But for high earners like us, it'll be difficult to let go of the fat paychecks.

But let's say I do decide to go FIRE now.  That would mean my income will be drastically lower between now and when I am 69 1/2 years old for social security.  That would mean my social security check will be very low, right?

swashbucklinstache

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Re: Learning about FIRE
« Reply #8 on: October 14, 2020, 07:31:27 PM »
But let's say I do decide to go FIRE now.  That would mean my income will be drastically lower between now and when I am 69 1/2 years old for social security.  That would mean my social security check will be very low, right?
It will be lower, and you should make sure you have the 40(?) quarters of earnings to qualify at all, if readily possible, even if you don't plan to include the SS payments at retirement age in your plans.

You can use online calculators to calculate how much your payments will be impacted. Notably there are two "bend points" where each additional year of high earnings gives you meaningfully less marginal payment than the last. It is based on your highest 35 years. Take care as you look around, because the official SS calculator may be assuming you continue working until retirement age.

seattlecyclone

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Re: Learning about FIRE
« Reply #9 on: October 14, 2020, 07:44:52 PM »
But let's say I do decide to go FIRE now.  That would mean my income will be drastically lower between now and when I am 69 1/2 years old for social security.  That would mean my social security check will be very low, right?

Not necessarily!

In a nutshell, the way the social security formula works is they scale all your previous years' earnings (that you paid social security tax on) up for inflation, pick the top 35 (including some zeroes if you worked less than 35 years), and add it up. If you started a part-time job in high school when you were 15 and worked some every year since, once you hit 50 you're basically only getting credit for the difference between what you earn that year and what you earned in your 36th-highest-paid year.

So yes, if you do leave your job in your 30s or 40s you won't be getting credit for quite as much work as if you worked into your 50s or 60s. This is mitigated by the "bend points" in the formula. They convert the top-35-year total into a monthly figure. For people hitting age 62 in 2021, the benefit at full retirement age will be 90% of the first $996 of averaged earnings, 32% of the next $5,004, and 15% of the rest. The exact bend points depend on the average earnings across America, which looks to be a bad deal for those hitting age 62 in the year they use 2020 numbers, but I digress...

The upshot is that once you hit ~$418k of lifetime earnings you're already at that first bend point and further earnings make less of a difference toward your eventual benefit. Earn ~$2.5 million and you're at the second bend point, where further earnings really don't matter as much.

Some examples:
Earn $418k and get $896/month from social security.
Earn $1 million (over twice as much!) and get $1,339/month (not even 50% more!).
Earn $2 million and get $2,101/month (roughly 50% more than if you earned half as much).

EscapeVelocity2020

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Re: Learning about FIRE
« Reply #10 on: October 14, 2020, 11:06:08 PM »
But let's say I do decide to go FIRE now.  That would mean my income will be drastically lower between now and when I am 69 1/2 years old for social security.  That would mean my social security check will be very low, right?

It's a philosophical choice, really.  Quit the stressful job and put zeros in for the remaining earning years (after the 40 minimum quarters) that count toward SS (basically assuming that SS was never an important part of your FIRE), or find a fun W-2 job that allows you to maximize the SS earnings...  There are lots of games to play to optimize taxes, SS, health insurance - but it all comes from a position of weakness compared to having a job. 

In other words, retire to a self-directed job (many ER's are self-employed), or retire to a benefit-centric job (getting your SS history and health insurance), or take a few years off while figuring out what sunset job will fill in those final earning years...

Lot's of ways to skin the cat, and it all depends on if you have dependents, if you get a lot of personal return out of consumption, and if you enjoy the returns on the challenge of being 'different'.

 

Wow, a phone plan for fifteen bucks!