Author Topic: Where does the 7% come from?  (Read 1660 times)

dominikm

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Where does the 7% come from?
« on: January 04, 2020, 10:57:56 PM »
Hey all!

Excited to be here. I learnt about MMM years ago but now it's 2020 and I've blow all my money since my early 20s just having fun. I have almost zero super (Australian version of 401k). There is like 20k in there from when I quit work 7 years ago or so. I've not added any contributions since being self employed. So, I'm starting from zero essentially.

It's time to take this serious and retire when I'm 40. I'll be 33 at the end of Feb. I run my own online businesses at a half assed effort. So I know serious focus will allow me to scale and get the money that I need in 7 years.

So I've started to save a lot and cut costs. That side of things doesn't seem that hard. After understanding the concepts of MMM it's makes logical sense.

But my big question is where does the 7% come from that ends up getting you 4% after inflation.

Looking at things like this I don't see 7%.
https://www.dividend.com/dividend-stocks/uncategorized/other/vti-vanguard-total-stock-market-etf/

So if you don't have investment property that's paid off 100% earning you an extra $2k/m where do you get the 7% from?

Are there forum posts that have been done about this so I can understand it better. Or is a blog post about this?

I know there is a big thread that's a stick that says don't worry about the 4% but after reading the first few pages it's didn't really address what I'm asking.


Thanks!
Dom

bacchi

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Re: Where does the 7% come from?
« Reply #1 on: January 04, 2020, 11:40:03 PM »
It's about total growth with dividends reinvested.

https://dqydj.com/sp-500-return-calculator/

The 4% is also not (annualized return - inflation). The 4% is just the "safe" withdrawal rate given the historical record of returns.

dominikm

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Re: Where does the 7% come from?
« Reply #2 on: January 05, 2020, 01:49:23 AM »
It's about total growth with dividends reinvested.

https://dqydj.com/sp-500-return-calculator/

The 4% is also not (annualized return - inflation). The 4% is just the "safe" withdrawal rate given the historical record of returns.

Got it!

So it's not an annual return. It's just the safe withdrawal rate and if you add in the dividends you get plus the other money you have coming in as you are retired with the methods you choose then you get your 4% roughly and your balance stays the same.

Is that basically it?

efree

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Re: Where does the 7% come from?
« Reply #3 on: January 05, 2020, 04:51:06 AM »
No, it is not about the balance basically staying the same. The thing is, if the stock market (including dividends) got you 7% every year then you could withdraw 7% every year and your money would never end. But the stock market doesn't work like that. It could go -30% one year and +40% the next year. Or it could go 2% up five years in a row. If you happen to retire at the start of those five years and withdraw 7% each year then your money will go down a lot (20-25%). If in the sixth year the market goes up 20% then it's all fine, but if it goes down 20% then you're in deep trouble because now you only have 60% of your starting amount left.

This is why withdrawing 7% is not safe, even though on average, long term, the returns should be higher than 7%. 4% is the safe withdrawal rate as researchers have determined it based on past data. It means that even if the stock market goes down 40% or whatever happens, you should still be able to withdraw 4% of your original amount and expect that your portfolio will not run out in the next 30 years.

ysette9

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Re: Where does the 7% come from?
« Reply #4 on: January 05, 2020, 04:54:51 AM »
Here is some more reading on the 4% withdrawal rate: https://www.madfientist.com/safe-withdrawal-rate/. You should understand how it works and the risks and safety behind it so you can feel confident in your number at retirement.

Bernard

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Re: Where does the 7% come from?
« Reply #5 on: January 05, 2020, 11:58:05 AM »
No, it is not about the balance basically staying the same. The thing is, if the stock market (including dividends) got you 7% every year then you could withdraw 7% every year and your money would never end. But the stock market doesn't work like that. It could go -30% one year and +40% the next year. Or it could go 2% up five years in a row. If you happen to retire at the start of those five years and withdraw 7% each year then your money will go down a lot (20-25%). If in the sixth year the market goes up 20% then it's all fine, but if it goes down 20% then you're in deep trouble because now you only have 60% of your starting amount left.

This is why withdrawing 7% is not safe, even though on average, long term, the returns should be higher than 7%. 4% is the safe withdrawal rate as researchers have determined it based on past data. It means that even if the stock market goes down 40% or whatever happens, you should still be able to withdraw 4% of your original amount and expect that your portfolio will not run out in the next 30 years.


For that reason, we can make adjustments. If you start retiring at the bottom of a long bull market, and you see returns of +10, +12 + 15 and +29% (just had that in 2019), your war chest will grow tremendously. Even if after 6 or 8 or 10 years the market produces small losses, you will have more money than anticipated and can make up for that.
But if you retire at the top of a bull market, and the returns are marginal if not negative, your starting balance will shrink, and thus the 4% should be safe. There's some school of thought that if you retire at "normal" retirement age, you may be able to take out up to 7% per year, as long as the market provides such returns. When the market no longer provides such returns, you'd have to adjust accordingly.

dominikm

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Re: Where does the 7% come from?
« Reply #6 on: January 06, 2020, 05:34:16 AM »
Thanks everyone! I understand now.