Author Topic: 4% Rules question assuming one does not invest in non-guaranteed investments  (Read 2671 times)

sallylee

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Since the 4% rate relies on stocks and bonds, what formula would we use to see if we can retire assuming the principal remains with a growth of only 3% per year? For example, lets say I have 1 million in cash and my annual spending is $40k and I only expect a guaranteed return of 3% per year. But the trinity study is based on 65 years of retirement with 30 years to spend your money.

Is there any formula to use to determine what age you can retire based on your current liquid assets and how much spending per year with  a guaranteed rate of return per year?

Half-Borg

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When you have a fixed return of 3%, you can obviously spend 3% instead of 4%

For a more elaborate playing with numbers, you should try out FIREcalc or cFIREsim
« Last Edit: February 26, 2016, 01:37:15 AM by Half-Borg »

FXF

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When you have a fixed return of 3%, you can obviously spend 3% instead of 4%

For a more elaborate playing with numbers, you should try out FIREcalc or cFIREsim
Well yes, but inflation would eat away at what your living standard.

SwordGuy

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Yes it would, if the underlying value the 3% is based on does not increase with inflation.

Your other option is to decide in what year you will die and set a percentage to run out at the end of that year.   Since you can't know that unless you plan to commit suicide (not an option I recommend :)), it's not really a safe plan.

jack06

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Since the 4% rate relies on stocks and bonds, what formula would we use to see if we can retire assuming the principal remains with a growth of only 3% per year? For example, lets say I have 1 million in cash and my annual spending is $40k and I only expect a guaranteed return of 3% per year. But the trinity study is based on 65 years of retirement with 30 years to spend your money.

Is there any formula to use to determine what age you can retire based on your current liquid assets and how much spending per year with  a guaranteed rate of return per year?

The average inflation rate in the US between 1913 and now is close to 3%. Thus with a 3% guaranteed return (assuming this 3% is not inflation adjusted), you can spend 0$ if you want to preserve 100% of the inflation-adjusted capital.

If you don't want to preserve capital, then you can estimate how many planned years of retirement using your life expectancy plus some more (for example: you want to retire at 40 and your life expectancy is 85, you may want to target 50 years of retirement) and you can withdraw roughly 1/50 of your stash each year. But then you will certainly get some social security. So you can withdraw more in the first years. But it is quite easy to calculate: the total you will be able to withdraw is exactly $1M in today's $. The problem with such as plan is that you can still outlive your money if you live to 100.

arebelspy

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You asked this question in another thread, so allow me to quote my response here into this one as well.

(The numbers put forth in the other thread were slightly different than here, for anyone reading this, so don't let that confuse you).

--------------------------------------------------------------

I have a question about the 4% rule. If you have 1.5 million saved up and you have no debt and spend $50000 per year with no other expenses and you are 30 years old can you retire? Because 40000 times 25 is 1.25 million. And is this what this means

Yes, but only if you have a plan to limit withdrawls in poor performing years, especially in the first 10 or 20 years...  Why?  The scenario for 4% shows that 95 times out of 100 scenarios (of historical returns), you DONT run out of money within 30 years.

Sally cited a WR of 3.3% (50k/1.5MM), which has never failed historically.

In other words, Sally, to answer your question: yes, that's what the 4% rule means.

If you are in America, and you retired in any year between 1890 or 1985 (that 90 year span), and had 1.5MM (in real dollars, so whatever that was equivalent to at the time) and spent 50k (in real dollars), you would never have run out of money.  You would have survived the great depression.  The inflation of the 70s.  Multiple world wars.  The tech boom, and bust.

It's not guaranteed; if the future is worse than ever in the past, it might not work out.  But you'd have to be pretty pessimistic, IMO, to think that will be the case.  Indications seem to be that things are only getting better, and even if the economy stagnates, will it be worse than the great depression?  I'd think probably not, personally.

How much of this 1.5 million is it expected to return, does the calculation assumes this money goes to a index 500 fund or can this all go to a cd? If it goes to the CD rather than a market do you know how much a CD needs to return ?

The original 4% rule had a mix of 60/40 stocks/bonds, but there have been studies ranging from 0% stocks up to 100%.

Having your money all in a CD is very, very risky, almost guaranteed to fail.  Having it in stocks is risky in the short term, if you had to take it all out at once, because, as you know, the market can "crash"--that means, temporarily, people are undervaluing things.  It's bad to sell at that point.  But stocks are ownership in businesses--real businesses selling goods and services to people.  Electric companies.  Grocery stores and restaurants.  Clothing companies and construction firms.  Tech companies.  And on, and on, and on. Those companies may have a little dip in their profits as the economy deals with the crash, but overall they'll keep doing what they're doing.  And people will notice, and go "hey, these companies are making money, I want to own some of that," and prices will come back.

You can recover from a stock market crash.

On the other hand, you cannot recover from inflation eating away at your principal.  We're very unlikely to have massive deflation to bring back the buying power of your dollar. So if you invest in a CD paying 2%, and inflation is 3%, suddenly your money is "worth" 1% less in buying power.  That 1.5MM gains 2% (30k) in nominal dollars, but loses 3% (45k) to inflation.  Suddenly your money lost 15k without you spending any.  The 4% rule works because the stock market, on average, gains 7% above inflation.  So if you only spend 4% + inflation, you'll never run out of money--in fact, your money will grow and grow.  It won't every year (and you need to only take 4%, rather than that 7%, because of this--if it's down early in your retirement, taking too much out then could handicap your portfolio's ability to come back). The market rarely returns its average.  But over time, your money will grow, and grow.  It just won't in a CD.

So what about TIPs?  These are paying approximately 0% right now, but the benefit of them is they're tied to inflation.  So you get inflation + X% (where X is the going rate--like I said, about 0 right now).  That's much better, overall, than the 2% of a CD.  So let's say you did that.  How much would you need invested?  Well, you'd need your overall expenses x the number of years you have left.  You're literally going to pre-fund each year of your life, earn 0% real on it, but have it keep up with inflation.  So if you think you're going to live 50 more years, you take your annual expenses and multiply by 50.  So in your case, 50k x 50 = 2.5MM.  This, again, has the risk that you guess too low, and outlive your money (whereas a sub-4% rule very likely has your money grow and grow).

I'd suggest, for someone thinking of retiring and worried about the stock market, to begin to learn about it.  What it actually is.  It can be gambling, if you're buying and selling, or "investing" on a short time frame (days, or weeks).  If you're long term purchasing shares of companies and viewing it as ownership of those companies, with no plans to sell (buy and hold), and ignoring the short term fluctuations, you'll do just fine.

Hope that helps.  :)
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boarder42

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There is very simple math in play here as others have stated.

avg inflation 3.3%

if you earn 3% you're losing .3% of your money even if you spend none. 

You need to get over the irrational fear of stocks and read JLcollins stock series.  then go put your money in vangaurd VTSAX and retire.
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JZinCO

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Slightly off-topic, but on topic with regards to the interaction of volatility and return influencing a SWR,
I've not yet read a rigorous evaluation, or even second opinion, on the suggestion that TIPS would be a better income producing asset than the classic stock/bond split evaluated by pfau, trinity, bengen, etc...
http://www.prospercuity.com/swr.htm

Does anyone have thoughts? I suppose I could run it through Tyler's portfolio charts as a sniff test.

edit: Read a discussion on BH https://www.bogleheads.org/forum/viewtopic.php?t=62767 and I am satisfied with the answer there.
« Last Edit: February 26, 2016, 09:31:55 AM by JZinCO »
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arebelspy

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Slightly off-topic, but on topic with regards to the interaction of volatility and return influencing a SWR,
I've not yet read a rigorous evaluation, or even second opinion, on the suggestion that TIPS would be a better income producing asset than the classic stock/bond split evaluated by pfau, trinity, bengen, etc...
http://www.prospercuity.com/swr.htm

Does anyone have thoughts? I suppose I could run it through Tyler's portfolio charts as a sniff test.

edit: Read a discussion on BH https://www.bogleheads.org/forum/viewtopic.php?t=62767 and I am satisfied with the answer there.

That Bogleheads thread is superb, thanks for the link.

Unfortunately there is no magic solution.  TIPs has its advantages, but also its drawbacks.  And it has the same flaw as almost everything else: to ensure it'll continue to work during the bad times, you have to way over save (i.e. work too long).

I think there's a place in a portfolio for TIPS.  A 100% TIPS would make me have trouble sleeping at night.  :)
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Eric

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You could use your money to purchase an inflation adjusted annuity.  Then you're letting someone else take the risk (both downside and upside).
"Compound interest is the most powerful force in the universe."  -- Einstein

arebelspy

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You could use your money to purchase an inflation adjusted annuity.  Then you're letting someone else take the risk (both downside and upside).

true, but again, no such thing as a free lunch. then you're taking on other risks (plus, at today's rate, again working way longer than necessary in order to remove certain risks).
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Eric

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You could use your money to purchase an inflation adjusted annuity.  Then you're letting someone else take the risk (both downside and upside).

true, but again, no such thing as a free lunch. then you're taking on other risks (plus, at today's rate, again working way longer than necessary in order to remove certain risks).

Agreed.  It definitely wouldn't be the first thing I'd recommend, but if someone is completely stock averse, then it's at least a viable, albeit expensive, option. 
"Compound interest is the most powerful force in the universe."  -- Einstein

arebelspy

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You could use your money to purchase an inflation adjusted annuity.  Then you're letting someone else take the risk (both downside and upside).

true, but again, no such thing as a free lunch. then you're taking on other risks (plus, at today's rate, again working way longer than necessary in order to remove certain risks).

Agreed.  It definitely wouldn't be the first thing I'd recommend, but if someone is completely stock averse, then it's at least a viable, albeit expensive, option.

Ah yes, it is a pretty good solution for that, if they are unable to move past the investing in the stock market idea.
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sallylee

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for the stock market i just invest in vanguard total market and vanguard index 500 only is this enough? i heard clinton only invest in index 500. I used to do individual stocks for the dividends and reits but i keep losing principal that is why i am afraid of stocks. i also heard there is a guranteed stock annuity fund not sure if those are good or not. Where you invest a fixed sum of money and when market goes up you make money and when it goes down you earn 0%.

arebelspy

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Check out JLCollins' Stock Series:
http://jlcollinsnh.com/stock-series
We are two former teachers who accumulated a bunch of real estate, retired at 29, and now travel the world full time with a kid.
If you want to know more about me, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (occasionally) blog at AdventuringAlong.com.
You can also read my forum "Journal."