So when we talk about 6% investment returns...

[El_Viajero]

When we forum participants and MMM talk about long-term returns on investments in something like, say, the Vanguard Total Stock Market Index fund, we often talk about how 5%-8% (compounded) is likely in the long run.

Just so I can be sure we're all speaking the same language here:

1. We're adjusting for inflation, right? So it's reasonable when planning to assume something like 6ish percent AFTER inflation?

2. We're including increases in value, NOT reinvested dividends, correct? In other words, the 6ish percent return I'll ostensibly receive is what I would get even if I took all my dividends from VTSAX, et al. as cash and blew them on cigarettes, booze, and lottery tickets?

This feels like such a newb question, but I can't seem to find this info anywhere.

[bacchi]

1) Yes, it's adjusted for inflation.
2) No. The 4% rule includes increases in value and dividends. Spending the dividends on hookers and blow is eating into your withdrawals for other living expenses.

[El_Viajero]

1) Yes, it's adjusted for inflation.
2) No. The 4% rule includes increases in value and dividends. Spending the dividends on hookers and blow is eating into your withdrawals for other living expenses.

Makes sense. Guess I better sell the Ferrari I bought with those stock dividends!

[Car Jack]

Don't sell the Ferrari if you have kids about to go to a public college.  FAFSA doesn't even look at cars, so that 512 BB is just your daily driver while $2000 in iBonds must be counted and sold off to pay for college.

[AdrianC]

1. We're adjusting for inflation, right? So it's reasonable when planning to assume something like 6ish percent AFTER inflation?

For planning purposes I'd knock a couple of points off that, so 4% real (after inflation) total return (with dividends reinvested) for stocks.

Bonds will be less, of course.

[maizefolk]

1. We're adjusting for inflation, right? So it's reasonable when planning to assume something like 6ish percent AFTER inflation?

Yup. The long run compound annual growth rate (CAGR) of the US Stock market is about 6.8% after inflation (but with dividends reinvested). If you don't adjust for inflation it's more like 9%.

Always look at the CAGR and not the average return because if a stock goes down -50% in year1 and up 100% in year 2, the average annual return is 25%, but the price is only back to where it started.

[talltexan]

Hookers used to do so much better back when everyone felt like they could hire them with their dividend income.

[Telecaster]

Hookers used to do so much better back when everyone felt like they could hire them with their dividend income.

Damn, I miss the dot.com bubble.   

[SeattleCPA]

I'm new here so apologies if i'm edging off into a forbidden topic... But that up front apology made...

Lots of pretty smart people use "semi-standard" investment return estimate formulas and come up with way, way lower expected returns over the next decade. Like 3%-ish... (That might be a 5% nominal rate of return and then with 2% inflation only a 3% real rate of return...)

BTW, these formulas matter a lot to guys like me (older, savings done, etc)... They don't matter to someone in an accumulation phase much at all because the small expected returns occur when your balances are small...and you'll presumably get the typical historical "real" returns when it really matters which is when you balances are big.

Related to that, if the market tanks in next year, that'll basically cause these same formulas to return results that look a lot more like long-term averages.

[Bicycle_B]

Original Poster,

I think the 4% rule means that you can reasonably plan on not running out of money in 30 years if you plan on drawing 4%, and each year's 4% will go up after inflation.  So, in practical terms, plan on 4%.

There are people who differ from this perspective on these boards.  But to me it looks like MMM himself recommends the 4% after inflation, not 6%:   

http://www.mrmoneymustache.com/2012/05/29/how-much-do-i-need-for-retirement/

Even where he proposes estimating 5% returns during the accumulation phase, MMM suggests using 4% for after retirement:

http://www.mrmoneymustache.com/2012/01/13/the-shockingly-simple-math-behind-early-retirement/

It's worth noting that MMM doesn't recommend a 100% stock allocation.  The study he quotes in the post above ran an allocation of 50% stocks and 50% bonds.  So returns may be lower than that of the stock market in the long run, but are more stable and safe (Google sequence of returns risk).

[maizefolk]

A safe withdrawal rate is different from our best guess of future returns. For guessing future returns you just want to get as close to truth as possible. For picking a safe withdrawal rate, planning to spend a little too much is much MUCH worse than planning to spend a little to little. That, combined with sequence of returns risk, is why safe withdrawal rates are lower than the expected future growth rate of the stock market.

When I'm projecting how long it'll take me to reach FIRE, I use 6.8%*. When I'm projecting how much I'll be able to spend during FIRE, I use 4%.

[SeattleCPA]

Just to add color, to do my compound interest calculations for next several years of estimates, I'm using a 3% return. That's probably a little bit conservative. But it's maybe not that conservative. (I'm using Swensen allocation and so have about 30% of my traditional assets' asset allocation going to treasuries.)

If I was going to do really long-run forecasts for a Swensen style allocation, I think the right number (for a real return) is about 5.25% once you let the mutual fund company skim a bit off the top.

For my withdrawal rate modeling, I use 4.56% because that gets me and DW get to a 90% success rate over a life expectancy there's only a small chance we'll exceed... and because it would be pretty easy for me to dial down spending if we hit a bad patch of returns at the start of retirement. (My safe withdrawal rate is actually a variable withdrawal rate, in other words.)