Author Topic: Newbie question: Still unclear on this  (Read 3054 times)

87tweetybirds

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Newbie question: Still unclear on this
« on: July 16, 2013, 11:09:02 AM »
So I am new to thinking about retirement. I'm 25 and while I've been saving toward retirement, ER is a wonderfully new concept for me. My question is this; When you do go to retire, are you somehow cashing in on that 4% increase of your investments for your living expenses, or are you selling off the amount of investments you need that year for expenses with the understanding the the other investments continue to grow. I guess the logistics of how you go about retiring after you have the $ is foggy for me. If you could help clear that up that'd be great!

87tweetybirds

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Re: Newbie question: Still unclear on this
« Reply #1 on: July 16, 2013, 11:28:35 AM »
withdraw 4% of your "Stash"
Ok, so you cash in/withdraw 4% of your investments/"stash" that clears it up. Thanks!

worms

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Re: Newbie question: Still unclear on this
« Reply #2 on: July 16, 2013, 11:38:17 AM »
Or more simply, only touch the dividend income to maximum of 4% of the capital value.

fiveoclockshadow

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Re: Newbie question: Still unclear on this
« Reply #3 on: July 16, 2013, 12:23:00 PM »
It's really a little from column A and a little from column B.

In retirement you typically need a pretty steady income.  The 4% safe withdrawal rate (or any other number you chose) is an estimate of what you would draw from your portfolio when you first retire.  Now, overtime your withdrawal will like increase because of inflation, but your portfolio on average will as well.

Year-to-year, however, the value of your portfolio might vary wildly if you have a high allocation of stocks - and a 4% rate assumes that you do.  So, after a market crash you might actually be drawing quite a bit more than 4% for a few years.  The assumption is the portfolio value will start to recover over time.  After a long run up in stock prices your portfolio might seem giant, and you'd really be drawing much less than 4%.  But you are assuming the portfolio value is likely to crash back to earth at some point in the future.

So the 4% number is really just an estimation tool for you to decide how big a stash you need before beginning your retirement.  You might say "I need 30K a year in which case I need a stash of 750K to start retirement".  Over time you will draw 30K in inflation adjusted dollars - so 10 years hence you might be drawing 36K instead.  During that time your portfolio value will go all over the place but you won't change how much you take out in inflation adjusted dollars.  The key is that by doing back testing (looking at historical returns) and random testing (creating random futures based on the statistics of historical returns) we know that 4% withdrawal means that regardless of all the wild gyrations over time your portfolio will "survive" (i.e. not go to zero) in "most all" (e.g. over 95%) of the scenarios tested.

As to the mechanism by which you withdraw your 30K per year it doesn't matter too much, but the general idea behind portfolio theory is you would take any earnings beyond dividends and interest by selling the assets that are at the highest value in your portfolio.  Some years you might not sell anything and instead need to decide what to buy with the dividends and interest you didn't need, other years you might need to sell quite a few things.

Clear as mud?

worms

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Re: Newbie question: Still unclear on this
« Reply #4 on: July 16, 2013, 01:36:45 PM »
Ok, but I was deliberately trying to simplify :)! 

I agree that the 4% is better as a planning tool than as a rule to live by after retirement.  I would be looking to adjust my portfolio to a dividend-based strategy in the years up to retirement, so would be unlikely to still be holding an Apple.  I would probably also be more conservative and plan on a 3% withdrawal, but having a planning rule based around multiplying my expenditure by 33 would make my head hurt!

matchewed

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Re: Newbie question: Still unclear on this
« Reply #5 on: July 16, 2013, 01:46:04 PM »
Ok, but I was deliberately trying to simplify :)! 

I agree that the 4% is better as a planning tool than as a rule to live by after retirement.  I would be looking to adjust my portfolio to a dividend-based strategy in the years up to retirement, so would be unlikely to still be holding an Apple.  I would probably also be more conservative and plan on a 3% withdrawal, but having a planning rule based around multiplying my expenditure by 33 would make my head hurt!

Deliberately simplifying works when standing back and looking at the big picture. Expenses x25, 4%SWR rules, Saving Rate correlated to Time to FIRE.

When you get to the points of those things - I have 25 x Expenses, I'm a few years from FIRE... that's when these simplifications are too simple. Reality is granular and specific to circumstances. By the time you're ready to FIRE you should have a good enough grasp of finance to handle those granular and specific parts of managing your life in FIRE.