noob needs help understanding assumptions

[ReluctantMillennial]

Hello -

I discovered MMM this year and have started making some serious adjustments to my life.  Lifehacker had a post of the most helpful personal finance advice, and in it I found the link to this article:  http://www.forbes.com/sites/robertberger/2015/03/03/how-much-of-your-income-should-you-save/

The worksheet there seems to mesh pretty well with what MMM has posted, and I'm convinced of the math.  I'm stuck on one part, however, and if anybody could explain it, I'd be most appreciative.  In the spreadsheet, the withdrawal rate is defaulted at 4%.  I'm thinking, "Okay, that's the amount of the total 'stache I'll withdraw when I'm not working.  So that means if I only withdraw 3%, the total amount required to retire should go down."  Wrong.  When I adjust it to 3%, the numbers go up.  The equation is annual income times savings rate (which I'm totally on board with) divided by the withdrawal rate.

What am I missing here?

[NoStacheOhio]

Try reading through this thread and see if it makes any more sense: http://forum.mrmoneymustache.com/investor-alley/stop-worrying-about-the-4-rule/

Edit: actually, start here: http://www.mrmoneymustache.com/2012/05/29/how-much-do-i-need-for-retirement/

[use2betrix]

Hi! Welcome to the forum.

We will use some basic numbers, your results may vary.

A 4% withdrawal rate is based of the income you can "safely" withdraw from your total nest egg without ever having the nest egg go down because its gains are higher than your withdrawal rate.

So if you can live comfortably off of a $40,000 salary, you would need $1,000,000 for a 4% withdrawal rate.

Now, if you felt 4% was too risky, and wanted only a 3% withdrawal rate, you would need closer to $1,350,000 to achieve the 3% for $40,000

[BarkyardBQ]

Or, say you've figured out how much your annual spending is.

X/WR = target amount

30000/.04 = 750,000
30000/.03 = 1,000,000

[Cheddar Stacker]

Yeah, it's really just basic algebra, but it's counterintuitive so it's a mistake people often make.

Now that you know that, work on changing your mindset to accomplishing a 5% SWR.

And welcome to the party!

[ReluctantMillennial]

Try reading through this thread and see if it makes any more sense: http://forum.mrmoneymustache.com/investor-alley/stop-worrying-about-the-4-rule/

Edit: actually, start here: http://www.mrmoneymustache.com/2012/05/29/how-much-do-i-need-for-retirement/

Thanks, I reread the entry you listed and read through the comments.  I was having a hard time understanding how the withdrawal rate was related to risk.

Appreciate all the help!

[Guesl982374]

Try reading through this thread and see if it makes any more sense: http://forum.mrmoneymustache.com/investor-alley/stop-worrying-about-the-4-rule/

Edit: actually, start here: http://www.mrmoneymustache.com/2012/05/29/how-much-do-i-need-for-retirement/

Thanks, I reread the entry you listed and read through the comments.  I was having a hard time understanding how the withdrawal rate was related to risk.

Appreciate all the help!

I like to think of concepts at the extremes. I am oversimplifying to make the point (no inflation, ridiculous returns, etc.):

1) Risky: Nestegg of $100K, living expenses $40K. - What do you think the probability is of running out of money on a 30+ year time line? 99.9%. You'd need to get 50% returns every year to even have a chance ($100K increases by 50% to $150K, you withdraw $40K, etc)

2) Not Risky: Nestegg of $100,000,000, living expenses $40K - What do you think the probability is of running out of money on a 30+ year time line? 0%
100,000,000 / 40,000 = 2,500 years without any kind of investment gain.

In #1, your withdrawl rate (WR) is 40/100 or 40% and it is highly risky. In #2, your WR is 40/100,000 or 0.04% and your money will out live you.

[fattest_foot]

The part that's confusing you is safe withdrawal rate (SWR) and actual withdrawal rate.

In the OP, you were saying if you decreased withdrawals to 3%, the total portfolio requirement should go down. This is actually true. If you had a $1 million stash and you were withdrawing 3% instead of 4%, that $1 million would be overkill and your total amount should decrease ($30,000 instead of $40,000)

What the calculator is doing, however, is the safe withdrawal rate. It's saying if you were to withdraw 4% of your portfolio indefinitely, it would never run out with spending being a constant number ($40,000 on a $1 million portfolio). If your required spending doesn't change (i.e. it's still $40,000), it's assuming that it is now 3% of your portfolio balance which gives you a higher total portfolio balance ($1.3M).

I think the answer what you thought it'd be doing, you'd decrease total withdrawals to $30,000 and end up needing a 4% SWR on a portfolio of $750,000 (insert your own numbers obviously).

[Jack]

The worksheet there seems to mesh pretty well with what MMM has posted, and I'm convinced of the math.  I'm stuck on one part, however, and if anybody could explain it, I'd be most appreciative.  In the spreadsheet, the withdrawal rate is defaulted at 4%.  I'm thinking, "Okay, that's the amount of the total 'stache I'll withdraw when I'm not working.  So that means if I only withdraw 3%, the total amount required to retire should go down."  Wrong.  When I adjust it to 3%, the numbers go up.  The equation is annual income times savings rate (which I'm totally on board with) divided by the withdrawal rate.

What am I missing here?

Let's say you want to live on $40,000/year in retirement. With a 4% withdrawal rate, that means you want $40K to be 4% of your total assets: 40,000/0.04 = 1,000,000. With a 3% withdrawal rate, that means you want the same $40K to only be 3% of your total assets, which means you need more assets: 40,000 / 0.03  = 1,333,333.

[ReluctantMillennial]

The part that's confusing you is safe withdrawal rate (SWR) and actual withdrawal rate.

In the OP, you were saying if you decreased withdrawals to 3%, the total portfolio requirement should go down. This is actually true. If you had a $1 million stash and you were withdrawing 3% instead of 4%, that $1 million would be overkill and your total amount should decrease ($30,000 instead of $40,000)

What the calculator is doing, however, is the safe withdrawal rate. It's saying if you were to withdraw 4% of your portfolio indefinitely, it would never run out with spending being a constant number ($40,000 on a $1 million portfolio). If your required spending doesn't change (i.e. it's still $40,000), it's assuming that it is now 3% of your portfolio balance which gives you a higher total portfolio balance ($1.3M).

I think the answer what you thought it'd be doing, you'd decrease total withdrawals to $30,000 and end up needing a 4% SWR on a portfolio of $750,000 (insert your own numbers obviously).

Thanks, this is it.  I saw the equations and knew they were right, but couldn't really get the math to match up with words in a way that made sense as I thought about it.

You all are wonderful.