Author Topic: Adjusting the 4% rule for paid off home?  (Read 2153 times)

Half Stached

  • 5 O'Clock Shadow
  • *
  • Posts: 90
  • Age: 47
  • Location: Seattle
Adjusting the 4% rule for paid off home?
« on: July 31, 2018, 10:22:18 PM »
I was realizing earlier this week that all of my calculations using the 4% rule don't take into account the fact that we own a paid off home. Has anyone tried to incorporate this asset to increase the safe withdrawal rate? I don't want to immediately sell this place (which would essentially just turn this asset into a sum paying for rent) but it does seem like there should be a way to leverage this. For example, say we go for a 4.5% withdrawal rate, but if our 'stache lost 20%+ of its value after 10 years of retirement then we'd sell the home and rent. This essentially would give us two separate swings at 4.5%+ withdrawal rate (separated by 10 years), instead of 1 swing at 4%. Thoughts?

Finances_With_Purpose

  • Pencil Stache
  • ****
  • Posts: 650
    • Finances With Purpose: deploying resources wisely to live vigorously
Re: Adjusting the 4% rule for paid off home?
« Reply #1 on: July 31, 2018, 10:30:18 PM »
Unless you're planning to sell soon, it's irrelevant.  Your home lowers your cost of living, presumably (unless it's a fancy home), and that's where its value is. 

You have an imputed cost to pay for shelter, but unless you buy a pretty cheap home you may not save on that. 

Many people buy homes that don't necessarily lower their cost of living a lot, even once paid, which is OK, but it doesn't enable you to withdraw more unless/until you have made plans to sell and move into a rental or something significantly cheaper.  Even then, I would not count it until it is sold. 

If you're 65-70 and planning to shrink your living space/decrease your cost soon, then great, consider it, but otherwise I would leave it be.  YMMV. 

jlcnuke

  • Pencil Stache
  • ****
  • Posts: 871
Re: Adjusting the 4% rule for paid off home?
« Reply #2 on: August 01, 2018, 04:45:51 AM »
I was realizing earlier this week that all of my calculations using the 4% rule don't take into account the fact that we own a paid off home. Has anyone tried to incorporate this asset to increase the safe withdrawal rate? I don't want to immediately sell this place (which would essentially just turn this asset into a sum paying for rent) but it does seem like there should be a way to leverage this. For example, say we go for a 4.5% withdrawal rate, but if our 'stache lost 20%+ of its value after 10 years of retirement then we'd sell the home and rent. This essentially would give us two separate swings at 4.5%+ withdrawal rate (separated by 10 years), instead of 1 swing at 4%. Thoughts?

Selling the home and renting increases your monthly bills. So you can have a 4% SWR on your portfolio and lower monthly bills, or have a 4% SWR on a higher portfolio value and higher monthly bills... it's generally pretty much a wash if you keep an equivalent living situation.  Your bills are your bills and you'll always need a place to live, so you can increase or decrease your living costs but that doesn't change the SWR %, only how big or small your portfolio is.

thd7t

  • Handlebar Stache
  • *****
  • Posts: 1308
Re: Adjusting the 4% rule for paid off home?
« Reply #3 on: August 01, 2018, 07:36:40 AM »
I guess you could cash-out refinance and invest the cash, if you do it while we're still in this low interest rate environment.  There's a lot of discussion of that available.

boarder42

  • Walrus Stache
  • *******
  • Posts: 7849
Re: Adjusting the 4% rule for paid off home?
« Reply #4 on: August 01, 2018, 07:41:18 AM »
remortgaging your house would allow you to have a higher SWR in most historic cases - having a paid off house actually is a negative to the life expectancy of wealth.

the 4% rule is just based on your expenses so house or not you have a set of expenses.

1MM stache no mortgage 40k per year - 91.67% chance of success historically
1MM stache no mortgage 45k per year - 75% chance of success historically

1.2MM stache 200k mortgage 40k per year plus mortgage payment - 92.59% chance of success historically
1.2MM stache 200k mortgage 45k per year plus mortgage payment - 77.78% chance of success historically

this is based on 90/10 AA and a 40 year retirement horizon 2018 - 2057  200k mortgage with 4.625% rate.

use2betrix

  • Handlebar Stache
  • *****
  • Posts: 1699
Re: Adjusting the 4% rule for paid off home?
« Reply #5 on: August 01, 2018, 10:11:31 AM »
In a very basic view - if your expenses are $4000/mo with a $1000/mo mortgage, and you pay off your house, all of a sudden you only need $3000/mo instead of $4000/mo.

That being said, depending where you live, property taxes/insurance may be a large part of that “mortgage” as most people lump that into one payment category.

boarder42

  • Walrus Stache
  • *******
  • Posts: 7849
Re: Adjusting the 4% rule for paid off home?
« Reply #6 on: August 01, 2018, 10:12:31 AM »
In a very basic view - if your expenses are $4000/mo with a $1000/mo mortgage, and you pay off your house, all of a sudden you only need $3000/mo instead of $4000/mo.

That being said, depending where you live, property taxes/insurance may be a large part of that “mortgage” as most people lump that into one payment category.

yes but you had to pay down the mortgage to get to that point its not like it magically is nothing now.

formerlydivorcedmom

  • Pencil Stache
  • ****
  • Posts: 625
  • Location: Texas
Re: Adjusting the 4% rule for paid off home?
« Reply #7 on: August 01, 2018, 02:40:48 PM »
I'm considering my home as the emergency fund for long-term care.  If both of us need long-term care, sale of the house will cover the costs above our normal withdrawal rate for some time.

That said, I live in an area with a reasonable cost of living, so I won't have a home worth $1M+

use2betrix

  • Handlebar Stache
  • *****
  • Posts: 1699
Re: Adjusting the 4% rule for paid off home?
« Reply #8 on: August 01, 2018, 04:43:22 PM »
In a very basic view - if your expenses are $4000/mo with a $1000/mo mortgage, and you pay off your house, all of a sudden you only need $3000/mo instead of $4000/mo.

That being said, depending where you live, property taxes/insurance may be a large part of that “mortgage” as most people lump that into one payment category.

yes but you had to pay down the mortgage to get to that point its not like it magically is nothing now.

Yes, which would be reflected in your monthly expenses going from $4000/mo to $3000/mo. So - based on the 4% rule, you would need $250k less than someone who would be renting a place for $1000/mo for the rest of their life.

Again, this is a very surface level example.

boarder42

  • Walrus Stache
  • *******
  • Posts: 7849
Re: Adjusting the 4% rule for paid off home?
« Reply #9 on: August 01, 2018, 05:00:11 PM »
In a very basic view - if your expenses are $4000/mo with a $1000/mo mortgage, and you pay off your house, all of a sudden you only need $3000/mo instead of $4000/mo.

That being said, depending where you live, property taxes/insurance may be a large part of that “mortgage” as most people lump that into one payment category.

yes but you had to pay down the mortgage to get to that point its not like it magically is nothing now.

Yes, which would be reflected in your monthly expenses going from $4000/mo to $3000/mo. So - based on the 4% rule, you would need $250k less than someone who would be renting a place for $1000/mo for the rest of their life.

Again, this is a very surface level example.

Yes but you had to pay down the mortgage. This arguement only looks at one side of the equation. You actually reach FIRE sooner in almost all cases by not paying down amortgage. Also your math is wrong you don't need 25x your mortgage payment you simply need the balance remaining on your mortgage. So if you owe 100k and pay 1k a month you don't need 25x 12k you need 100k and youre money historically will survive more frequently.

Half Stached

  • 5 O'Clock Shadow
  • *
  • Posts: 90
  • Age: 47
  • Location: Seattle
Re: Adjusting the 4% rule for paid off home?
« Reply #10 on: August 01, 2018, 07:31:01 PM »
Hmmm... when I run a simulation through cFiresim, I do get something out of this, though. For example, if you run a 40 year retirement with a $1,000,000 starting 'stache, you have a 95% success chance by spending $36,983 annually. However, if assume that you have a $250K home that you sell after 10 years and then pay rent of $10K/year (essentially 4% of the sale price) then you end up with a 95% success rate by spending $40,168 - an 8.6% increase. Of course, if after 10 years everything looked clear, you wouldn't have to sell the home.

If I run my own numbers through a similar simulation, I end up with over a 10% improvement - going from about $62K to $69K.

Is there something wrong with this analysis?

jlcnuke

  • Pencil Stache
  • ****
  • Posts: 871
Re: Adjusting the 4% rule for paid off home?
« Reply #11 on: August 02, 2018, 10:18:53 AM »
$1M portfolio, 40 year retirement, paid off home:
Quote
FIRECalc Results
Looking for a spending level that will result in 95% success rate . . . . . . . . . . . . . . . [done]

A spending level of $36,582 provided a success rate of 95.4% (108 total cycles, of which 5 failed). This spending level is 3.66% of your starting portfolio. (Your spending is assumed to come from any Social Security and pensions you entered, as well as from the portfolio.)

Here is a plot of the success rate of this spending rate (in the center) and a few that are smaller and larger. The vertical axis shows the success rate.

$1.25M portfolio, 40 year retirement, sold home, invested that $250k, and now renting:
Quote
FIRECalc Results
Looking for a spending level that will result in 95% success rate . . . . . . . . . . . . . . . [done]

A spending level of $45,728 provided a success rate of 95.4% (108 total cycles, of which 5 failed). This spending level is 3.66% of your starting portfolio. (Your spending is assumed to come from any Social Security and pensions you entered, as well as from the portfolio.)

Here is a plot of the success rate of this spending rate (in the center) and a few that are smaller and larger. The vertical axis shows the success rate.

Rent for a home that costs ~$250k around here goes for ~$1,000-1,400/month. Property taxes and insurance costs average about ~$200/month around here.

So, paying TI of PITI (your 'housing costs) on the paid off home leaves you with $34,182 out of the $36,582 with the paid off home.

Paying rent (your housing costs), would cost you about $12k/year, leaving you with $33,728 out of that $45,728. Obviously different markets will behave differently with rental prices as well as taxes and insurance rates. Here, it's about a wash.

Half Stached

  • 5 O'Clock Shadow
  • *
  • Posts: 90
  • Age: 47
  • Location: Seattle
Re: Adjusting the 4% rule for paid off home?
« Reply #12 on: August 02, 2018, 10:04:39 PM »
Thanks for running the numbers, jlnuke! Reading your post made me realize I wasn't being very clear in my question. Compare the following two scenarios:

Scenario 1:
$1million stache. $250K home, completely paid off. Live on what provides a 95% success rate in cFiresim for a 40 year retirement.

Scenario 2:
$1 million stache. $250K home, completely paid off. Live for 10 years in home, then sell it. Due to having to rent, after those 10 years, you have an additional annual payment of 10K/year for that rent. Live on what provides a 95% success rate in cFiresim for a 40 year retirement (thus having 10K of extra spending for the last 30 years of the 40 year retirement).

These were the two scenarios that I was finding the significant change in safe withdrawals.

Half Stached

  • 5 O'Clock Shadow
  • *
  • Posts: 90
  • Age: 47
  • Location: Seattle
Re: Adjusting the 4% rule for paid off home?
« Reply #13 on: August 03, 2018, 12:08:20 PM »
Ah - thanks, spartana! That is something I hadn't considered. I'll have to think/research more about how rents and housing prices can diverge before I do anything too radical.

Prairie Stash

  • Handlebar Stache
  • *****
  • Posts: 1784
Re: Adjusting the 4% rule for paid off home?
« Reply #14 on: August 03, 2018, 12:52:23 PM »
I have a paid off home. It functions as a bond would, I have a HELOC that I can tap into for 3-7 years worth of living (currently set for three, i have an investment loan secured  against the house which is tax deductible, my portfolio is otherwise too heavy into my fake bonds). In a downturn, I can toss capital into the stock market, just like you would with bonds. I'm 100% flexible by design, thats my situation.

FIRE assumes that in the bad year you still need money. If you sell your stocks during downturns, it hurts, which is why 4% is employed, it allows the stocks to grow (7%) during good years to compensate for bad years. f I don't sell during bad years, waiting for the upturn to repay my HELOC, it decreases my risk.

A paid off house can function like bonds. I'm not saying its ideal, but thats the effect it may have. Spend some time comparing how you can use your house like a bond fund, its very enlightening and educational. For myself, i save 3% interest on the mortgage loan that I otherwise would have. Bonds would have to yield 4%, given my tax structure, to increase my NW the same amount.

I have several other factors, like being Canadian, mortgages with 5 year terms and no interest deductions on mortages.  I can also advance a mortage quite easily, but I can't lock it in for 30 years. 

To stir the pot, a paid off house should be compared to your BOND portfolio. Its functionally similar. However, you should also limit your bond portfolio (@boarder42), or be prepared for reading far too much about mortgages and returns ;) If you can't compare your mortgage to bonds, you've only done 80% of the work (assuming an 80/20 stock/bond ratio).

Bonds don't compare as well as stocks. It's much more fun to gloss over them, however if you can do it you'll have a much better understanding.

Half Stached

  • 5 O'Clock Shadow
  • *
  • Posts: 90
  • Age: 47
  • Location: Seattle
Re: Adjusting the 4% rule for paid off home?
« Reply #15 on: August 03, 2018, 02:05:46 PM »
We'd like to stay in Seattle for at least a few years, but moving to a LCOL is certainly a viable option down the road.

I'm interested in understanding more about considering a HELOC as a bond fund. Currently, we have nothing in bonds - 60% in stocks and 40% in home. What resources would you recommend?


Prairie Stash

  • Handlebar Stache
  • *****
  • Posts: 1784
Re: Adjusting the 4% rule for paid off home?
« Reply #16 on: August 03, 2018, 02:31:42 PM »
I'm interested in understanding more about considering a HELOC as a bond fund. Currently, we have nothing in bonds - 60% in stocks and 40% in home. What resources would you recommend?
This forum ;) it has threads on it already with a lot of comments debating the fine points. Start by searching out bond threads and skimming them to understand how bonds work.

The biggest issue I had was bonds in general and why bother with them? Why not do 100% stocks? The first thing to figure out is why a 100% stock fund performs worse then an 80/20 mix, it seemed counterintuitive to me at first. The next part that you (and I) glossed over is having an investment strategy document. You should be able to write down exactly why you're investing the way you do and you need to stick to the plan (experience says the moment you don't stick with the plan, you're screwed). The investment strategy is your insurance policy for the next recession, most of us who went through 2008 did fine, loads of people rode through that without problems because they stuck with their plans.

If you think bonds are a waste of time, many do, you should be able to articulate why. Right or wrong, you should be able to tell your partner why you don't have bonds. I don't have traditional bonds, I can tell my wife why, whether she agrees or finds it boring is debatable.

After you decide the ratio of bonds thats suitable for you, then listen to @boarder42 advice on stocks vs mortgages, not before. Until you sort out your profile (and 100% stocks is an acceptable answer) you're attempting to go to step 2 without completing step 1. Did you intend to have a 60/40 split or was that by accident of aggresive savings? The HELOC strategy only works if you have a bond target to start with.

Good news, you are doing great financially. I'm not trying to discourage you, I''m only trying to look from a different angle.

boarder42

  • Walrus Stache
  • *******
  • Posts: 7849
Re: Adjusting the 4% rule for paid off home?
« Reply #17 on: August 03, 2018, 02:40:45 PM »
I disagree immensely with the HELOC strategy. You paid down a fixed rate mortgage and then took out a HELOC which is variable and callable. Not even close to the same as before plus HELOCs aren't free they have originating fees.

Personally I'm leaning towards REITs for my bond allocation. The purpose of a bond is that it doesn't track with stocks. REITs do the same but with equity like returns.

Half Stached

  • 5 O'Clock Shadow
  • *
  • Posts: 90
  • Age: 47
  • Location: Seattle
Re: Adjusting the 4% rule for paid off home?
« Reply #18 on: August 03, 2018, 02:46:52 PM »
I'm not trying to discourage you, I''m only trying to look from a different angle.

On the contrary! This is exactly the kind of information I am looking for - thank you! I'll dig through the forums - I wasn't finding much just straight googling.

Overall, I feel like we're doing great at the FI game, I am just interested in learning to do better. :)

Half Stached

  • 5 O'Clock Shadow
  • *
  • Posts: 90
  • Age: 47
  • Location: Seattle
Re: Adjusting the 4% rule for paid off home?
« Reply #19 on: August 03, 2018, 02:49:53 PM »
I disagree immensely with the HELOC strategy. You paid down a fixed rate mortgage and then took out a HELOC which is variable and callable. Not even close to the same as before plus HELOCs aren't free they have originating fees.

Personally I'm leaning towards REITs for my bond allocation. The purpose of a bond is that it doesn't track with stocks. REITs do the same but with equity like returns.

Well, that ship has already sailed as we paid cash when buying our place last year - no mortgage. Given that, how would you best leverage the equity in our home?

boarder42

  • Walrus Stache
  • *******
  • Posts: 7849
Re: Adjusting the 4% rule for paid off home?
« Reply #20 on: August 03, 2018, 03:27:41 PM »
I disagree immensely with the HELOC strategy. You paid down a fixed rate mortgage and then took out a HELOC which is variable and callable. Not even close to the same as before plus HELOCs aren't free they have originating fees.

Personally I'm leaning towards REITs for my bond allocation. The purpose of a bond is that it doesn't track with stocks. REITs do the same but with equity like returns.
My HELOC was free and no annual fee via my Credit Union as long as I had $15k in an account there (I did). So it didn't cost anything. But I agree I think its a bad investment strategy. Not only are the rates much higher than a regular fixed rate mortgage or refi, they are adjustable.  I never used mine so was just an EF.

There was an annual fee 1500 dollars the return on investing 15k on avg over 30 years

boarder42

  • Walrus Stache
  • *******
  • Posts: 7849
Re: Adjusting the 4% rule for paid off home?
« Reply #21 on: August 03, 2018, 03:51:47 PM »
I disagree immensely with the HELOC strategy. You paid down a fixed rate mortgage and then took out a HELOC which is variable and callable. Not even close to the same as before plus HELOCs aren't free they have originating fees.

Personally I'm leaning towards REITs for my bond allocation. The purpose of a bond is that it doesn't track with stocks. REITs do the same but with equity like returns.
My HELOC was free and no annual fee via my Credit Union as long as I had $15k in an account there (I did). So it didn't cost anything. But I agree I think its a bad investment strategy. Not only are the rates much higher than a regular fixed rate mortgage or refi, they are adjustable.  I never used mine so was just an EF.

There was an annual fee 1500 dollars the return on investing 15k on avg over 30 years
meh...I keep a $30k liquid EF in a money market account at the CU. I'm in the "not maxing out every penny" camp so no biggie to me. I have even been known to give things away for free (the horror!) instead of trying to sell them ;-). Plus $1500 in 30 years will probably buy one frappacino at Starbucks. Not that K go to Starbucks that is. Plus you have to deduct what I would have paid to get that HELOC if that money wasn't in the bank (and earning approx 5% interest at that time). Everything was free including appraisal.

It's 1500 a year.  So compounded that 15k would be 261k and your 30k would be 520k.