How to calculate assets for Financial Independence, Retire Early (FIRE)

Audaxer

dont_look_now said:

twister_teddy said:

That's kind of the problem that I am having, most of the FIRE related content I find is focused for US.  Is there a good source, calculators focused around UK laws and market dynamics. 
Most of the shares I've invested are global funds, so I understand that average growth needs to be over 4% (which it is) and similar historical figures are for the real estate in UK.
I don't quite understand why you would say that its a 30 year retirement, mathematically as long as the growth is over 4% average, the capital should never decrease and only increase. Am I missing something technically ?

E.g. for each £100,000 of starting capital, suppose you try to draw £4,000 to spend in the first year; and if inflation is 1%, you'd increase that to £4,040 in the seond year; and so on.

However, if your porfolio crashes 50% (i.e. halves) just after you retire, then you're drawing £4,000 from a portoflio of only £50,000. Suppose markets stay down for 5 years, so you've now spent £20,000 in total (even without allowing for inflation), which reduces your remaining portfolio to £30,000! But in the sixth year. there is a recovery, and the portfolio rises 100% (i.e. doubles), which cancels out the halving. So you are back to a £60,000 portfolio. But not to £100,000, which is where somebody with the same portfolio who hadn't retired yet (and so wasn't drawing from the portfolio) would be. So your draw rate would be up to about 7%, which may well not be sustainable for too long.

These accidents can happen at any time. But the longer your retirement, the more chance there is for them to happen, so the less likely it is that 4% (or any other withdrawal rate) will be sustainable without running out of money. So the length of retirement is very relevant. The studies which suggested a 4% rate might be safe were based on a 30-year retirement. But that suggests that it wouldn't be safe for a longer retirement. And for other reasons, 4% may be over-optimistic even for 30 years.

I think that is why you need a good cash buffer, so that you do not need to drawdown anything in loss years.

Audaxer

dunstonh said:

I understand that inflation has to be factored in over time with the 4% withdrawal rule. I also think that 4% is more towards of minimal growth. Overall (10 year or so average) the stock returns are usually higher than 4% although I am willing to be proved wrong based on long term historical figures.  

People needing a regular income tend to invest more cautiously than those looking for growth.  So, here is the sequence of returns for a sector allocated portfolio for medium risk (around 60% equity) using benchmark figures as the returns.

20 years and annualised 5.78%.

So, if you take 2.5% of that away for inflation cover you are left with 3.28%.

Overall (10 year or so average) the stock returns are usually higher than 4% although

10 years is not long term.  That is medium term.  And the last 10 years have been far better than a typical 10 year period.  Take a look at the charge and compare 2000 to 2009 with 2010-2019

Your example of a 50% drop and then to stay at that level for 5 years is a bit of an extreme example

But possible and has happened.     However, take the early 2000s.  A 43% drop from peak to trough over a 3 year period with no value gained in 5 years.  With a level 4% withdrawal, you would be around 35% lower than 5 years earlier.

That's interesting to see a sequence of returns over the last 20 years for a medium risk portfolio. It will be interesting to compare how a fully invested portfolio with these returns compares to one with a 3 or 4 year cash buffer to use in the negative years. I think I'll have to do a bit of spreadsheet work.

twister_teddy

Eco_Miser said:

For UK focussed content see Monevator. In particular see https://monevator.com/why-the-4-rule-doesnt-work/ for a discussion on the 4% rule.  Read the comments, dig through the archives,  follow links to other blogs, there's lots of UK FIRE stuff about.

Thank you, will have a read through the forum. It seems the 4% safe withdrawal rate comes with a lot caveats, however the way I am seeing it as a rough guideline, and with some degree of smart redundancy and resiliency planning it's not impossible to keep a cash flow without biting into the capital.
I would also be interested to speak to the UK folks who have tried and tested the FIRE. 

twister_teddy

Audaxer said:

dunstonh said:

I understand that inflation has to be factored in over time with the 4% withdrawal rule. I also think that 4% is more towards of minimal growth. Overall (10 year or so average) the stock returns are usually higher than 4% although I am willing to be proved wrong based on long term historical figures.  

People needing a regular income tend to invest more cautiously than those looking for growth.  So, here is the sequence of returns for a sector allocated portfolio for medium risk (around 60% equity) using benchmark figures as the returns.

20 years and annualised 5.78%.

So, if you take 2.5% of that away for inflation cover you are left with 3.28%.

Overall (10 year or so average) the stock returns are usually higher than 4% although

10 years is not long term.  That is medium term.  And the last 10 years have been far better than a typical 10 year period.  Take a look at the charge and compare 2000 to 2009 with 2010-2019

Your example of a 50% drop and then to stay at that level for 5 years is a bit of an extreme example

But possible and has happened.     However, take the early 2000s.  A 43% drop from peak to trough over a 3 year period with no value gained in 5 years.  With a level 4% withdrawal, you would be around 35% lower than 5 years earlier.

That's interesting to see a sequence of returns over the last 20 years for a medium risk portfolio. It will be interesting to compare how a fully invested portfolio with these returns compares to one with a 3 or 4 year cash buffer to use in the negative years. I think I'll have to do a bit of spreadsheet work.

That's exactly I'm thinking, with some degree of backup and smart planning the negative returns can be evened out. Obviously it would silly to to expect a  persistent 4% return every year. All it needs is a good strategy to even out those bumps and spikes (negative and positive). 

dont_look_now

A good strategy involves holding some things other than equities, such as some bonds and a cash buffer. The downside is that all these other things tend to have lower returns than equities, and drag down the average for the whole portfolio.

The returns from US equities have been higher than the global average.This may or may not continue, but it would be reckless to go for US equities alone (for the part of the portfolio in equities). Global equities have averaged something like inflation + 5% over the last 100 years.

If you expect an average return of inflation + 5% from your equities (and some would say that is over-optimistic in current circumstances), but also hold some lower-return assets to guard against sequence-of-returns risk, then your portfolio will struggle to have an average expected return as high as inflation + 4%.

In practice, flexibility in spending helps. If you start a long retirement by spending 4% of your initial capital, and need to spend very penny of that, then you could be in trouble if you are a bit unlucky. However, if you could cut back your spending to 3% or 2% in adverse conditions, then you are more likely to be OK. And OTOH, if you have good luck, you would be able to increase spending at some stage.

twister_teddy

dont_look_now said:

A good strategy involves holding some things other than equities, such as some bonds and a cash buffer. The downside is that all these other things tend to have lower returns than equities, and drag down the average for the whole portfolio.

What I have learned so far a typical asset allocation of 80% stocks, 15% bonds and 5% cash with a respective return of 5%, 2% and -3%. Obviously its  just a generic guideline and exact asset allocation will vary from person to person depending on a number of personal and market factors. 

dont_look_now said:

In practice, flexibility in spending helps. If you start a long retirement by spending 4% of your initial capital, and need to spend very penny of that, then you could be in trouble if you are a bit unlucky. However, if you could cut back your spending to 3% or 2% in adverse conditions, then you are more likely to be OK. And OTOH, if you have good luck, you would be able to increase spending at some stage.

Absolutely, there has to be some cushioning for the earlier years if the market tumbles. And then overshooting the pot size to some extent can should provide some room to cut back if needed for some time.    

Audaxer

dont_look_now said:

If you expect an average return of inflation + 5% from your equities (and some would say that is over-optimistic in current circumstances), but also hold some lower-return assets to guard against sequence-of-returns risk, then your portfolio will struggle to have an average expected return as high as inflation + 4%.

If inflation averages say 2.5% per year, I'd be quite happy if my portfolio grows at 3% plus inflation per year on average.

noClue

https://monevator.com/why-the-4-rule-doesnt-work/

cfw1994

noClue said:

https://monevator.com/why-the-4-rule-doesnt-work/

I get all that....but it gets even harder when you have other pensions kicking in at different times.   

My spreadsheet suggests that by 75, our income needs will almost entirely be met by 5 pension sources.....& of course, notwithstanding potential major health challenges (very hard to factor in entirely), it is likely that discretionary spending will reduce in those laters years, probably quite significantly.

All this means any withdrawals for the early years might be well over a 3-4% “SWR” number.....it’s about managing that stream carefully, I believe.

As OP suggests, it all needs some degree of backup and smart planning throughout: this isn’t “set & forget” territory!

Audaxer

cfw1994 said:

noClue said:

https://monevator.com/why-the-4-rule-doesnt-work/

I get all that....but it gets even harder when you have other pensions kicking in at different times.   

My spreadsheet suggests that by 75, our income needs will almost entirely be met by 5 pension sources.....& of course, notwithstanding potential major health challenges (very hard to factor in entirely), it is likely that discretionary spending will reduce in those laters years, probably quite significantly.

All this means any withdrawals for the early years might be well over a 3-4% “SWR” number.....it’s about managing that stream carefully, I believe.

As OP suggests, it all needs some degree of backup and smart planning throughout: this isn’t “set & forget” territory!

As you will have 5 pensions kicking in at different times, it sounds more like things will get easier over time . I agree that should not limit you to a 3-4% "SWR" on your investments. Saying that, if all income needs are easily covered by age 75, it may be preferable to convert most investments to cash at that age, especially if you plan to spend it while you can and have no desire to leave a big inheritance?