Author Topic: 4% rule saved amount based on cost value or current value?  (Read 1098 times)

Ukwhat?

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4% rule saved amount based on cost value or current value?
« on: December 10, 2016, 12:27:52 AM »
In 3 years our mortgage will be paid off and 6 after that we should have around 25times annual spending saved. My question is, is the value of 25x the amount that shares have cost you or the current value?


For example, if for those 6 years the index funds rose by 20% a year and I'm only looking at the current value then it will take significantly less investment to get he 25x, but then if the shares drop to -5 for the next few years such that the average is 7% the  amount invested is no longer 25x.

Conversely if it was the other way round -5 followed by 20 you would have significantly more in the fund.

Maybe I am missing something?

Is it as simple as theoretically saving the 25x in 0% account then investing in one go or do you consider the performance during the saving window?

Thanks

shuffler

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Re: 4% rule saved amount based on cost value or current value?
« Reply #1 on: December 10, 2016, 01:49:55 AM »
My question is, is the value of 25x the amount that shares have cost you or the current value?
Current value.

For example, if for those 6 years the index funds rose by 20% a year and I'm only looking at the current value then it will take significantly less investment to get he 25x, but then if the shares drop to -5 for the next few years such that the average is 7% the  amount invested is no longer 25x.
Yes, that is called 'sequence of returns' risk.

Is it as simple as theoretically saving the 25x in 0% account then investing in one go or do you consider the performance during the saving window?
You could save 25x in a 0% account, but it'd (very probably) take you longer to do that than if you had invested it.

Yes, most people do account for some returns (~7%, historically, after inflation) on their investments during "the accumulation phase".  It doesn't change that fact that you eventually want/need to get to 25x, but most people are trying to figure out when they'll get to 25x, and accounting for that 7% return helps them figure out their "FIRE date" with (hopefully) more accuracy.

Ukwhat?

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Re: 4% rule saved amount based on cost value or current value?
« Reply #2 on: December 10, 2016, 02:33:31 AM »
So you effectively could assume a target average return of 7% during this period and use a calculated value as the actual FIRE fund balance. If you actually achieved 10% return then it could be worth saving and investing a little more until the 25x balance is achieved with a calcualted 7% return?

So it is almost like if you used a compound interest calculator to calculate how much you need to add to your fund assuming a 7% return to get the 25x amount, that once you have invested this much you should be generally ok even if the actual perfjoamcne is different.

We just don't want to think 'oh we have now got 25x saved in the fund' but actually the fund value has increased dramatically by 50% in the 6 years ( so we have actually only added somewhere around 17x) and the value then drop for the next few years (to an average of 7%), meaning we would have to work more to add more money to it to get back to the 25x from the approx 20x we actually be at.

TomTX

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Re: 4% rule saved amount based on cost value or current value?
« Reply #3 on: December 10, 2016, 05:53:29 AM »
No. That's just an extra safety blanket. Prior returns are meaningless.

Look at your total today.

Is it at least 25x projected annual expenses?

Great! You can retire using the 4% rule.

Retire-Canada

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Re: 4% rule saved amount based on cost value or current value?
« Reply #4 on: December 10, 2016, 08:20:25 AM »
We just don't want to think 'oh we have now got 25x saved in the fund' but actually the fund value has increased dramatically by 50% in the 6 years ( so we have actually only added somewhere around 17x) and the value then drop for the next few years (to an average of 7%), meaning we would have to work more to add more money to it to get back to the 25x from the approx 20x we actually be at.

In theory there is enough safety margin that initial negative returns are okay with the 4%, but a poor start is also the easiest way to fail so I would understand the concern. If I get you 25x my COL in my investments I'll pull the plug for sure. If I am concerned about a big run up I'll just add a few easy layers of safety to get started on the right foot:

- minimize my non-essential spending for the first couple years [ie local camping holidays instead of a trip to Europe]
- setup an easy PT job that's fun for a small bit of extra $$
- use a more conservative asset allocation that can resist sequence of return risks [ie more bonds or a ladder of GICs for the first few years, etc..]

If the markets drop I'd be fine and still have my free time to enjoy. If markets chug along without a massive correction than after a few years I'll have a huge safety margin built in and I can relax get back to my luxury spending.

What I wouldn't do is work a few extra years FT just in case I needed to save the extra 25 - 17 = 8yrs worth of expenses.  That just seems like a poor balance of risk vs. return given that we don't know what the market will do and it may not crash. It just might be flat for a decade to revert to mean returns.