Author Topic: confused on plotting YMOYL style crossover point chart  (Read 3605 times)

BZB

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confused on plotting YMOYL style crossover point chart
« on: February 27, 2014, 07:43:03 PM »
I would like to make something like a YMOYL style "Crossover Point" chart that I can post on my wall as a visual reminder to encourage me to keep working toward FI. In the book you should plot the following on a monthly basis: 1) income from work 2) expenses 3) income from investments. Where I am confused is the formula they use in the book for income from investments:
(capital x current long-term interest rate)/12 months = monthly investment income
The "crossover point" (financial independence) would occur when income from investments equals or exceeds expenses.

My capital would be the money I have invested in my Roth IRA and my 403B accounts. What do I use as the long-term interest rate? For example, some of my money is in Vanguard VBIAX. Should I multiply by the SEC yield? (listed as 1.88% on 2/26/14) Also I am vested in a Teacher Retirement System pension I'm no longer paying into that will give me a set amount every month when I start drawing money from it. Do I just ignore that for the crossover point calculation?
Thanks!

pop pop!

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Re: confused on plotting YMOYL style crossover point chart
« Reply #1 on: February 27, 2014, 08:29:57 PM »
If you are assuming a 4% withdrawal rate in retirement (e.g., you are shooting to save at least 25 X annual spending before retiring that MMM recommends), then perhaps you would use 4% for the interest rate. 

ice813

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Re: confused on plotting YMOYL style crossover point chart
« Reply #2 on: February 27, 2014, 08:53:28 PM »
I use this system and I use 4% since that will be what i can safely withdraw from my stache during retirement. The math ends up being very easy just divide your stache by 300.

MDM

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Re: confused on plotting YMOYL style crossover point chart
« Reply #3 on: February 27, 2014, 09:12:30 PM »
Depends how detailed you want to get.  The previous suggestion to use 4% (and your thought to ignore the pension) gives you the simplest and probably-not-too-bad estimate.

Here's another alternative (just one of many possible):
- Do include the known pension amount.  That is indeed investment income.
- Look at the "big chunks" of invested capital and assign separate interest rates to each. 

E.g., if you look at VBIAX here http://quotes.morningstar.com/fund/VBIAX/f?t=VBIAX, it shows a $10K investment growing to $19K over 10 years.  The average annual return was (19/10)^0.1 - 1 = 6.6%

Also for example, if you had another big chunk in VTSAX (http://quotes.morningstar.com/fund/VTSAX/f?t=VTSAX), the $10K grew to $21K so that average annual return was (21/10)^0.1 - 1 = 7.7%

Note that your expenses will increase with inflation, so you should subtract expected inflation from any expected interest rate.  E.g., if you assume 3% inflation then you would use 3.6% and 4.7% respectively for VBIAX and VTSAX.  If the pension does not have a cost-of-living increase feature, then eventually (due to inflation) it won't be worth much.

Looking at the previous paragraph, one can see why "use 4% and ignore the pension" can be a decent approach.  You really should check your investment allocation, however, to understand what you can reasonably expect.

And last but not least, "past performance is no guarantee of future results".


secondcor521

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Re: confused on plotting YMOYL style crossover point chart
« Reply #4 on: February 27, 2014, 10:56:16 PM »
Note that your expenses will increase with inflation, so you should subtract expected inflation from any expected interest rate.  E.g., if you assume 3% inflation then you would use 3.6% and 4.7% respectively for VBIAX and VTSAX.

I agree with most of the rest of what you wrote, and in general you are correct that you need to account for inflation when projecting things forward over longer periods of time or in high inflation environments, but for a YMOYL wall chart in the US right now you would not need to subtract off inflation.  The answer varies depending on who you believe:

1.  If you believe the author of YMOYL, then inflation is either non-existent or can be combatted indefinitely with creative savings approaches, such as moving to a less expensive country or living with friends.  I have heard this didn't work out well for him, but that's what he thought.

2.  If you're using 4% as the rate (which is what I do, BTW), then that rate accounts for the effects of inflation already.  Subtracting inflation would be double-counting it.

Also, the wall chart is a graph of current income and current expenses over time compared to investment income over time.  One would expect these three lines to increase at wage growth, inflation, and investment growth over time, so they'll all be exponential curves (although for me, the income line is very jaggedy because I plot it on a monthly basis and my income varies from month to month).  If you just eyeball it, you'll be able to pretty much take a pencil and graph it forward to project the crossover point (or you could do a exponential best fit in Excel).

If I were OP I'd use 4% for the Roth and 403B accounts.  For the pension I'd probably just add the monthly pension amount to the investment income amount.  So for example, if OP had $100K in the Roth and 403B, and would get $300 a month from the pension, I would calculate monthly investment income as:

  ($100K * 4% / 12) + $300

which would be about $633 per month.

MDM

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Re: confused on plotting YMOYL style crossover point chart
« Reply #5 on: February 28, 2014, 09:35:36 AM »
Thanks secondcor521 for the YMOYL specifics - good to know.

I think we're saying the same thing about "using 4% as the rate".  That is, retirement investments will "typically" earn ~4% above the inflation rate so that's why people use 4% as a first approximation.


BZB

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Re: confused on plotting YMOYL style crossover point chart
« Reply #6 on: March 01, 2014, 08:11:32 AM »
Thank you for all the replies! I will use (capital x 4%)/12 = monthly income from investments.
I'm not sure if i will add in the pension to this formula because I won't be able to draw that money until I reach a certain age. My focus right now is just to make a wall chart that will encourage me to lower spending and invest all savings to reach FI.
I will play with cFIREsim and FIREcalc to get more advanced calculations.