The Money Mustache Community
Learning, Sharing, and Teaching => Investor Alley => Topic started by: alwaysonit on October 03, 2016, 05:57:10 AM
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I made an investment policy 2 years ago;
http://forum.mrmoneymustache.com/investor-alley/rate-or-slate-my-investement-policy!/msg420728/#msg420728
In summary, I am a 29 year old professional gambler worth 1.075 million. I take 100,000 emergency fund from what I'm worth and use the remainder as my net worth for calculations. My AA is 60% equities (VWRL) and 40% safe deposits. Now I am updating this with the following assumptions, all which are conservative. Constructive criticism is encouraged.
A long term inflation rate of 2%, as this is a government target and also what is generally predicted.
Long term real returns of 4% on my equities (Vanguard all world). I think this is on the conservative side of realism.
Long term real returns of -1% on my safe investments. Again this is conservative, currently its about -0.5%.
I will live until 101 years old.
Using an annuity formula, if I retire now (which I will assume as my income is uncertain, again conservative), I can withdraw 0.94% of my safe investments and 4.25% of my equities per year and it will expire in 72 years.
This brings the following formula, where x is my equity split and W is my net worth;
W[0.0425x + 0.0094(1-x)] = 40,000, which breaks down to
W[0.0331x +0.0094] = 40,000
My original investment policy said I will never go over 60% stocks while I dont have a fixed income and, sticking with this policy, the above formula shows that based on my assumptions I should stay at 60% stocks until I hit at least a net worth of 1,367,000.
My net worth amount where I can safely drop my stock allocation will then be:
1.45 mil 0.55%
1.55 mil 0.5%
1.65 mil 0.45%
1.75 mil 0.4%
1.9 mil 0.35%
2.07 mil 0.3%
2.25 mil 0.25 %
2.5 mil 0.2%, which I will never go lower than.
Of course all of these assumptions are open to revision, but I will never revise them during a bear market or correction in case my emotions get involved.
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This thread raises some interesting questions that may apply to you: http://forum.mrmoneymustache.com/post-fire/using-the-rising-equity-glidepath-to-reduce-sequence-of-returns-risk/
I don't think it makes sense to exclude your emergency fund from your NW. At a certain point, it's all just money.
What's your target spending?
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Following.
Congrats on your system continuing to work the last two years, for ~200k/yr.
I don't necessarily agree with dropping the stock percentages that much--I'd rather lower your WR, to ride out drops, than risk long term growth by not having enough equities.
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Using an annuity formula, if I retire now (which I will assume as my income is uncertain, again conservative), I can withdraw 0.94% of my safe investments and 4.25% of my equities per year and it will expire in 72 years.
I'm not sure which numbers you are using.
Stash of 1.075 million - 100,000?
Withdrawing 28.5K for a WR of 2.9%?
Using Excel, and assuming your withdrawals are indexed for your 2% inflation, I get you running out of money in year 61 using 60/40.
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Target spending is 40,000.
AdrianC, this would leave 585k in equities and 390k in fixed income.
An annuity with present value of 585k, earning a rate of 4% per period with 72 periods gives an annuity (yearly withdrawal) of 24,877
An annuity with present value of 390k, earning a rate of -1% per period with 72 periods gives an annuity of 3,672
So total yearly withdrawal of just over 28.5k.
http://www.financeformulas.net/Annuity_Payment_Formula.html will do the calculations for you.
How did you do your calculations?
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Target spending is 40,000.
AdrianC, this would leave 585k in equities and 390k in fixed income.
An annuity with present value of 585k, earning a rate of 4% per period with 72 periods gives an annuity (yearly withdrawal) of 24,877
An annuity with present value of 390k, earning a rate of -1% per period with 72 periods gives an annuity of 3,672
So total yearly withdrawal of just over 28.5k.
http://www.financeformulas.net/Annuity_Payment_Formula.html will do the calculations for you.
How did you do your calculations?
Simple iteration in Excel, one row per year.
2% inflation, 6% return from stocks, 1% return from bonds, rebalanced to 60/40 each year.
If I put your initial withdrawal at 40k (4.1% WR) I get you running out in year 36 with 60/40.
Your annuity calculation isn't rebalancing. Maybe that's our major difference?
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Net worth is now 1,550,000 - going by my OP 4 years ago I should reduce equities to 50% (still 60% now).
I need to reassess my financial goals as I am now in a relationship and a family requires more funds.
I am unsure where I will settle but one country is more expensive than the other - should I plan my AA for this option (requires more equity) and only reduce equity if this option is ruled out?
Also, I may buy a house to settle in a few years - is the best method to take funds for the purchase from both equity and safe part of my portfolio to keep them at the AA I want to have going forward after the purchase?
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Congrats on the NW update!
Bond yields are now extremely low and so the expected real return on safe investments should now be considered about -2% instead of -1%. I agree with all your other assumptions from 2016.
The even lower real return on safe investments, plus the need to generate more income, suggest you need a higher equity allocation. Of course, the entire herd is doing this. The problem with more equities is your increased vulnerability to a long-term correction that forces you to sell shares low for multiple years (think 1929 or 2000, not 2018 or 2020). Additionally, have you done the math on the downside to long-duration bonds if inflation popped up to, say, 4%? It would be a global financial crisis bigger than 2008, where "safe" assets are hit harder than many people think is possible.
There are ways other than AA to reduce your vulnerability. If I was you, I'd consider going 100% equities and hedging about half of the portfolio using options. For example, a collar strategy involves buying a safety net for oneself (long put) and selling the probability of one's upside beyond a certain point (short call). This lowers the volatility of your portfolio to levels similar to a bond-heavy AA. It also allows for certain algorithmic strategies such as planning to drop the hedge for a profit if stocks have fallen by X%. I would use the longest-duration options you can, so that you can bridge across the duration of a year-long market event, for example, and because the slower time decay allows you to tilt the collar at lower cost (e.g. paying a small net debit upfront to allow yourself more upside than downside). You will need to use a fund more liquid than the Vanguard all-world for your hedged allocation - not sure about the choices in Europe. As a gambler, you might be temped by other strategies in the casino known as options-world, but in your position I'd stick to playing defense. You've won your retirement, now see if you can hold it.
If you buy a house, I suggest taking funds proportionally out of each bucket of your AA, thereby maintaining the same AA as you had before, whether that is your current 60% stocks, 40% bonds or if you go with my suggested 50% naked stocks, 50% hedged stocks. The house has very little to do with stock/bond market risk.
The decision about which country to retire in involves a lot of factors. I suggest you work a bit longer to afford the more expensive country if that is what you want. Making your AA more risky so that you can live in a more expensive place is adding risk from two directions! It's akin to going all-in on speculative investments so you can afford a big mansion.