The Money Mustache Community
Learning, Sharing, and Teaching => Ask a Mustachian => Topic started by: martyconlonontherun on August 20, 2017, 05:59:09 PM

So I understand the 25x rule builds in inflation for FI, but how do you guys project what your annual expenses will be at the time? My conservative FI date is 20 years away and my annual expenses are 25k now but if you use 3% for inflation over the next 2 decades my expenses jump to 50k a year. I would hate to see my target keep moving away.

All the calculations are done in present day dollars. This is both on the income side and the expense side. You could do the sums in nominal dollars, but then the income would be (nominally) higher too. In fact, due to technological improvements, there is deflation in real cost of "living" which makes the 25x rule a bit conservative if all you want to do is "not starve".

So I understand the 25x rule builds in inflation for FI, but how do you guys project what your annual expenses will be at the time? My conservative FI date is 20 years away and my annual expenses are 25k now but if you use 3% for inflation over the next 2 decades my expenses jump to 50k a year. I would hate to see my target keep moving away.
Just use real numbers, since it's so much easier. Sure your spending will increase with inflation, but so will your salary and investments.

I was thinking about this just yesterday. Right now total household expenses are about $50k a year and FIRE is probably 1520 years out as we have five kids to raise and get through college (though I don't plan on paying for all of their education by any means). About $15k of our current annual expenses is rent. In 1520 years I hope to have a paid off house which would drop our expenses to about $35k. In addition, most of the kids will be out of the house by then which will reduce expenses even more. So if today I need $1.25 million, by the time I've saved up say $750,000 I might find that our household expenses have been reduced enough to make that feasible.
Bottom line is that it's a moving target. Also, 25x assumes no other income, no SS, etc. If you're sitting on a $1 million at age 45 it's pretty unrealistic to think you're just going to spend the next 50 years sitting around the house/beach/golf course/fishing hole, etc. You'll probably do some sort of work. It just may be something that brings in a lot less than a full time career.

All the calculations are done in present day dollars. This is both on the income side and the expense side. You could do the sums in nominal dollars, but then the income would be (nominally) higher too. In fact, due to technological improvements, there is deflation in real cost of "living" which makes the 25x rule a bit conservative if all you want to do is "not starve".
The disconnect I have is that the 25x rules takes into account inflation at the time of retiring. Since it is based on stache versus savings rate, income and investment increases really doesn't matter. So right now, I could retire at 625k, but when I retire it will most likely be 1,250k. At that point, the inflation is covered by the7% return and 4%WR. But until than, any increases in salary will be going towards the stache. I think my FI number is best done if I guess what my inflated expense number will be at the time of retirement. The only reason I care is I want to make a chart to be able to fill in every month on getting closer to FI as a visual reminder.
I understand it is conservative with the 4% rule, but I will also be having kids so I expect my expenses to stay the same as I pay off the house in the shortterm but use that money on kid expenses in the future.

I think my FI number is best done if I guess what my inflated expense number will be at the time of retirement. The only reason I care is I want to make a chart to be able to fill in every month on getting closer to FI as a visual reminder.
You can make the chart in present dollars. Just adjust the dollar amount by updating the numbers as time progresses. The chart target should be 25 x spending; update the chart if your spending changes. Your target, spending, and investment values will all adjust with inflation as you go assuming you input the new numbers when they come.

I think my FI number is best done if I guess what my inflated expense number will be at the time of retirement. The only reason I care is I want to make a chart to be able to fill in every month on getting closer to FI as a visual reminder.
You can make the chart in present dollars. Just adjust the dollar amount by updating the numbers as time progresses. The chart target should be 25 x spending; update the chart if your spending changes. Your target, spending, and investment values will all adjust with inflation as you go assuming you input the new numbers when they come.
Plot nominal asset returns and nominal expenses on one axis, with 25x nominal spending and nominal stash size on a second axis. The returns are the exciting thing... the 25x is only a way of predicting returns in nominal terms.

I make inflation part of expected returns. I expect 10% per year returns and 3% inflation. So my Stache increases 7% per year. Then I use my current spending as a goal at retirement.

I make inflation part of expected returns. I expect 10% per year returns and 3% inflation. So my Stache increases 7% per year. Then I use my current spending as a goal at retirement.
yes pretty much this. i use 6% returns and my current spending b/c i want to be more conservative. and people would still say thats too high with the current market valuations.

If you're far enough away from FI that inflation of your living expenses is a significant concern, any estimates you make are broad guesses anyway. Changes in healthcare, internet costs, electric cars, renewable power, your job's salary prospects, etc etc could all have impacts just as large or larger than inflation on your necessary stash and the speed to get there.
Once you're down to <5 years out it makes sense to do some more detailed planning (and you can estimate inflation then), but farther out than that it's just for fun. Save as much as possible and hope for the best. Trying to nail down what your expenses will be 20 years from now is an exercise in futility.

All the calculations are done in present day dollars. This is both on the income side and the expense side. You could do the sums in nominal dollars, but then the income would be (nominally) higher too. In fact, due to technological improvements, there is deflation in real cost of "living" which makes the 25x rule a bit conservative if all you want to do is "not starve".
The disconnect I have is that the 25x rules takes into account inflation at the time of retiring. Since it is based on stache versus savings rate, income and investment increases really doesn't matter. So right now, I could retire at 625k, but when I retire it will most likely be 1,250k. At that point, the inflation is covered by the7% return and 4%WR. But until than, any increases in salary will be going towards the stache. I think my FI number is best done if I guess what my inflated expense number will be at the time of retirement. The only reason I care is I want to make a chart to be able to fill in every month on getting closer to FI as a visual reminder.
I understand it is conservative with the 4% rule, but I will also be having kids so I expect my expenses to stay the same as I pay off the house in the shortterm but use that money on kid expenses in the future.
It not only takes inflation into account at time of retirement but also during the accumulation phase.

All the calculations are done in present day dollars. This is both on the income side and the expense side. You could do the sums in nominal dollars, but then the income would be (nominally) higher too. In fact, due to technological improvements, there is deflation in real cost of "living" which makes the 25x rule a bit conservative if all you want to do is "not starve".
The disconnect I have is that the 25x rules takes into account inflation at the time of retiring. Since it is based on stache versus savings rate, income and investment increases really doesn't matter. So right now, I could retire at 625k, but when I retire it will most likely be 1,250k. At that point, the inflation is covered by the7% return and 4%WR. But until than, any increases in salary will be going towards the stache. I think my FI number is best done if I guess what my inflated expense number will be at the time of retirement. The only reason I care is I want to make a chart to be able to fill in every month on getting closer to FI as a visual reminder.
I understand it is conservative with the 4% rule, but I will also be having kids so I expect my expenses to stay the same as I pay off the house in the shortterm but use that money on kid expenses in the future.
It not only takes inflation into account at time of retirement but also during the accumulation phase.
Can you explain how it takes account of inflation during the accumulation phase? My expenses right now are $25k ($625k needed stache to retire today). If using 3% (overly conservative, I know) to inflate my expenses over the next 20 years, I'm looking at yearly expenses of $40k. If I used the 25x then, I would need a stache of $1m, right?
I think for younger, liteMustachians the 25x rule really isn't accurate. I know there are 100 assumptions being made that any number will vary wildly and its an exercise of futility but just want to make sure I am aiming at the right number.

Because you are thinking about things in absolute terms vs. relative.
The 4% or 25x rule basically guarantees that A) a 4% withdrawal rate is X% successful over a 30 year period, and B) that 25X expenses sustains that 4%
If you target 25X current expenses in today's dollars, and your expenses are consistent with inflation, the 4% rule works.
If you target 25X current expenses, then suddenly expenses double outside of inflation, 25X of your expenses in the past is useless.
This is why the math in his "The Shockingly Simple Math behind Early Retirement" blog post works.
If $25k is $50k in the future, the accumulation formulas take that into account, if lifestyle creep is the reason behind that doubling of expenses, you are SOL.

The 25x rule is not wrong. The rule is about draw down rates from retirement date, not 20years before retirement.
Whatever you assume 20 years out will probably be wrong, So don't overthink it. Just work hard to increase your income, cut wasted spending, live well within your means and increase your savings rate.
To get a rough idea of retirement date you can use today's spending, but just choose a real rate of return and not a nominal rate of return. Maybe assume a 4% or 5% real return.
Still, the exercise is really just for education/ entertainment purposes. There will be many curveballs thrown your way before 20 years are done.

Because you are thinking about things in absolute terms vs. relative.
The 4% or 25x rule basically guarantees that A) a 4% withdrawal rate is X% successful over a 30 year period, and B) that 25X expenses sustains that 4%
If you target 25X current expenses in today's dollars, and your expenses are consistent with inflation, the 4% rule works.
If you target 25X current expenses, then suddenly expenses double outside of inflation, 25X of your expenses in the past is useless.
This is why the math in his "The Shockingly Simple Math behind Early Retirement" blog post works.
If $25k is $50k in the future, the accumulation formulas take that into account, if lifestyle creep is the reason behind that doubling of expenses, you are SOL.
After the point of retirement, the 4% is sustained by 3% going to inflation and 4% going to WR based on 7% returns. However, before i get to retirement, all 7% is going towards towards my stache in my investment accounts, it isn't hedging my expense inflation at that point.
I agree with Itchyfeet that the rule isn't wrong, but I think it should be clarified to 25x (expenses at time of retirement)

Because you are thinking about things in absolute terms vs. relative.
The 4% or 25x rule basically guarantees that A) a 4% withdrawal rate is X% successful over a 30 year period, and B) that 25X expenses sustains that 4%
If you target 25X current expenses in today's dollars, and your expenses are consistent with inflation, the 4% rule works.
If you target 25X current expenses, then suddenly expenses double outside of inflation, 25X of your expenses in the past is useless.
This is why the math in his "The Shockingly Simple Math behind Early Retirement" blog post works.
If $25k is $50k in the future, the accumulation formulas take that into account, if lifestyle creep is the reason behind that doubling of expenses, you are SOL.
After the point of retirement, the 4% is sustained by 3% going to inflation and 4% going to WR based on 7% returns. However, before i get to retirement, all 7% is going towards towards my stache in my investment accounts, it isn't hedging my expense inflation at that point.
I agree with Itchyfeet that the rule isn't wrong, but I think it should be clarified to 25x (expenses at time of retirement)
That's not correct. That's not how the 4% rule was developed for one, and for two, that 7% return is already the real return, so if you subtract inflation you're double counting it. The 4% rule has no reliance on 3% inflation. 4% was chosen because that was the lowest WR that worked in all scenarios, including high inflation, low returns, or some combination. The 70's had double digit inflation and were fine.