Improve Your Numbers

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Nomad
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Improve Your Numbers

Post by Nomad » Thu May 16, 2019 4:05 pm

Looking at a journal by a new person known as Kipling, I noticed that they included the net present value (NPV) of the state pension.
I'd hadn't seen this in anyone else's journal so I had a ponder if it made sense.
On reflection, I think it does and it simplifies the question of when the magic number has been reached...

jacob
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Re: Improve Your Numbers

Post by jacob » Thu May 16, 2019 4:15 pm

Yes and no. In the US FIRE-sphere it's practically tradition not to include NPV of social security, but it is also tradition to use the 4%-rule even though that only has a 30 year horizon. Thus with those assumptions, it cancels out. Retire at 35->A chance (albeit small) of running out of money by 60ish -> SS from 62+ until death.

More detailed calculations can (and should) be made.

What you should not do is to add the NPV of your social security to a 4% goal.

IlliniDave
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Re: Improve Your Numbers

Post by IlliniDave » Thu May 16, 2019 4:47 pm

It's a way of doing it, but one can equivalently just subtract the expected annuity/pension/SS from future spending estimates and use that residual needed expense figure to arrive at a number. Intuitively, that's seems like a much more straightforward approach to me. PV calculations are a little out of my lane anyway, although I have messed with including them in assessments of my overall financial picture. I didn't find them useful except they puffed up my "net worth" by quite a lot.

Seppia
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Re: Improve Your Numbers

Post by Seppia » Thu May 16, 2019 5:19 pm

With the current state of funding of many pension funds (USA and Europe), I would advise extreme caution.
Many countries/states are fighting a war against math, and we know how these tend to end.
While I do not expect pensions to completely disappear unless some catastrophic event happens (in which case, we would have much bigger fish to fry), I am pretty sure they’ll be lower (or we’ll get them much later) than current “promises”

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unemployable
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Re: Improve Your Numbers

Post by unemployable » Thu May 16, 2019 5:29 pm

One thing I like to do is figure the "equivalent net worth at a 4% WR"* from a hypothetical salary. You simply take your monthly take-home and multiply by 300, or your yearly take-home and multiply by 25. So a job that pays you $3,333/month is equivalent to a stash of $1 million. This assumes you spend all the take-home amount.

It's just a mental exercise and should go without saying that $40k/yr isn't literally the same as being a millionaire, but it is a way to convert a future income stream to present dollars. It still has planning value -- for example if you take home 2k/month but want to "live like a millionaire" while you're working you need another $400k to draw from somewhere, assuming 4% WR throughout.

*I need a catchier name for this, something that doesn't sound like an accountant came up with.
jacob wrote:
Thu May 16, 2019 4:15 pm
it is also tradition to use the 4%-rule even though that only has a 30 year horizon.
My understanding and analysis has lead me to assume a portfolio that doesn't fail within 30 years is highly unlikely to fail during the period of one's life after that, or put another way, if a portfolio fails it will do so within the first 30 years no matter how long you live. Granted, I don't have any hard research for this other than basic backtesting.

BookLoverL
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Re: Improve Your Numbers

Post by BookLoverL » Fri May 17, 2019 3:14 am

I can't say I have any confidence that the state pension will still be around by the time I get to pension age - I think they're going to keep putting the age you can start to draw it up, and eventually probably decide that with climate change, etc. that there are better things to spend that money on. So I'm making my plans based on there being zero state pension, and if there is one by the time I get there, it'll be a pleasant bonus.

tonyedgecombe
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Re: Improve Your Numbers

Post by tonyedgecombe » Fri May 17, 2019 5:15 am

I think it's linked to life expectancy in the UK now, at least that was the plan. I'm assuming it will always be there because pensioners are reliable voters.

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Bankai
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Re: Improve Your Numbers

Post by Bankai » Fri May 17, 2019 6:46 am

Yeah I don't see UK state pension being abandoned or drastically reduced anytime soon. It's already the lowest (by far) among big western European countries and there are tons of people with no other income or assets who rely solely on it. It's much more likely that some other pensioners' perks will be chopped (winter fuel, free tv licence etc.) and MAYBE the age will rise to 71-72, if that. You can't really put it any higher than that - how many ppl in their 70's are even capable of working nowadays?

Fish
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Re: Improve Your Numbers

Post by Fish » Fri May 17, 2019 7:50 am

I’ve previously considered including pension PV in NW but disregarded it as not useful from a FIRE perspective unless it can be cashed out for more immediate use. Some DB pensions have a feature where you can trade the annuity for its PV, and the option can be exercised any time after leaving the company. In this case the PV becomes relevant to retirement planning. But otherwise I offer a +1 to jacob’s response for US-based retirees, and +1 to iDave’s method. Basically, more detailed calculations are needed to make an informed decision on retirement; one does not pull the trigger upon observing that NW has reached the target SWR.
unemployable wrote:
Thu May 16, 2019 5:29 pm
One thing I like to do is figure the "equivalent net worth at a 4% WR"* from a hypothetical salary. You simply take your monthly take-home and multiply by 300, or your yearly take-home and multiply by 25. So a job that pays you $3,333/month is equivalent to a stash of $1 million.

*I need a catchier name for this, something that doesn't sound like an accountant came up with.
This concept is called “human capital” in retirement literature. From the Boscaljon paper linked below:
Total wealth for an individual is comprised of human capital and financial wealth. At the start of an individual’s life cycle total wealth is comprised almost entirely of human capital (HC) which is defined as the present value of future earnings power. Human capital decreases at an increasing rate over time. Eventually human capital is totally depleted for all individuals and total wealth is comprised entirely of financial wealth.
Some papers you might find interesting:
  1. The Theory of Life-Cycle Saving and Investing (2007) by Zvi Bodie, Jonathan Treussard and Paul Willen
    • Provides an interesting framework for answering common financial questions (e.g. buy vs. rent).
    • Table 1 shows human capital as a multiple of current income. It varies with current age, years to retirement, education and gender. For example a 35yo male has human capital = 25.9x (presuming work until 65), but it varies dramatically as parameters are changed. The effect of varying the discount rate is not shown in the table.
    • https://papers.ssrn.com/sol3/papers.cfm ... id=1002388
  2. Time, Wealth and Human Capital as Determinants of Asset Allocation (2004) by Brian Boscaljon
  3. Lifetime Financial Advice: Human Capital, Asset Allocation and Insurance (2007) by Roger Ibbotson, Moshe Milevsky, Peng Chen and Kevin Zhu
    • Is a textbook that discusses how to account for human capital in asset allocation and insurance decisions. Chapters 2-3 are the most interesting.
    • Argues that human capital is bondlike which suggests a 100% allocation to equities is appropriate early in the career when human capital is abundant.
    • Advocates for more life insurance at a younger age since human capital is at its highest at this stage.
    • http://citeseerx.ist.psu.edu/viewdoc/do ... 1&type=pdf
unemployable wrote:
Thu May 16, 2019 5:29 pm
My understanding and analysis has lead me to assume a portfolio that doesn't fail within 30 years is highly unlikely to fail during the period of one's life after that, or put another way, if a portfolio fails it will do so within the first 30 years no matter how long you live. Granted, I don't have any hard research for this other than basic backtesting.
You can observe this by comparing the SWR for a 30 vs. 60 year retirement horizon. If they are the same then your premise is validated. For the research, look at the first table in ERN’s SWR paper. This presents portfolio success rates as a function of SWR, retirement duration and asset allocation. You will find for rock-solid SWR approaching 100% in the 30-year case, the success rate is similarly high for 60 years. For more borderline SWRs, this no longer holds and longer durations start to have more failures.

https://papers.ssrn.com/sol3/papers.cfm ... id=2920322

Add: You’ll notice this only works for high equity allocations. A 3.25% WR in a 25% stock portfolio has a 100% success rate at 30 years and only 65% for 60 years. This is to say although you can invest in anything with a 3% SWR and be ok for 30 years, the allocation matters for longer horizons which is pertinent to FIRE. You can either rely on safety nets or continue withdrawing from human capital (“semi-ERE”) to increase the success rate. This is also why one should not include SS as part of a plan to FIRE on a 4% SWR, if taking the safety net approach.
Last edited by Fish on Fri May 17, 2019 8:09 am, edited 1 time in total.

Cheepnis
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Re: Improve Your Numbers

Post by Cheepnis » Fri May 17, 2019 8:05 am

I don't include my pension contributions in my monthly numbers because I don't understand how my contributions extrapolate to future payments. It's a private pension that's currently 93% funded (down from 97% and 95% the past two years), and payments are based on a credit system. You earn vesting credits and work credits by the # of hours worked and those somehow are used to calculate your monthly benefits. Nobody I've talked to can give me a straight answer about how that works though!

In any case I won't be eligible to withdraw for some time and I'm not really planning on the pension surviving that long anyway. If it does that's all the better!. My SR would sure look extra nice if I got to included those payments in my #'s though!

Fish
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Re: Improve Your Numbers

Post by Fish » Fri May 17, 2019 8:12 am

Cheepnis wrote:
Fri May 17, 2019 8:05 am
I'm not really planning on the pension surviving that long anyway. If it does that's all the better!. My SR would sure look extra nice if I got to included those payments in my #'s though!
In this case, you could consider the pension contributions as a tax (like SS/FICA) and exclude it from your after-tax savings rate calculation.

BookLoverL
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Re: Improve Your Numbers

Post by BookLoverL » Fri May 17, 2019 8:17 am

Well, it depends what is meant by soon - I've got 40 years to go before I get to 65, and 45 to go before I'm 70, so politically, anything could happen by then. It's entirely possible that I'll still be able to claim a pension at 70, but I don't want to rely on it. Somebody who's in their 40s or 50s in the UK right now can probably depend on getting their pension at some point, I'd imagine.

Cheepnis
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Re: Improve Your Numbers

Post by Cheepnis » Fri May 17, 2019 8:26 am

@fish, I think I already do that...? All my numbers are post tax and even though it would be nice to have the pension contributions on my paycheck I don't have any say where that money goes, it's just part of my total package. All my income numbers are derived from my actually hourly pay after accounting for taxes, other payroll deductions, and other hourly contributions to various union funds.

Or are you saying I should subtract that "lost capitol" from my income each month?

IlliniDave
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Re: Improve Your Numbers

Post by IlliniDave » Fri May 17, 2019 8:42 am

The topic of human capital is one I think about sometimes (though I don't try to include it as such in the math). In a way it argues against ER for many of us in the sense ER, from a monetary perspective, is the discarding of human capital. At least I know I can't "earn" enough through cost avoidance/added financial value during ER to offset the imputed cost from giving up my paycheck. But in my mind the financial dimension is only a tiny slice of human capital and putting a dollar value on myself feels sort of icky. I don't want to adopt the mindset that in effect I'm paying quite a lot for the early portion of my retirement. Even though it's true enough if you look at it from that perspective, it strikes a dissonant harmony in a guy that fancies himself somewhat frugal.

Fish
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Re: Improve Your Numbers

Post by Fish » Fri May 17, 2019 9:36 am

@Cheepnis - As long as you’re not including the pension contributions in either net income or expenses, then your SR calculation treats it as a tax. You’re correct about already doing this (I made a mistake in assuming that you were doing otherwise). I would recommend reading the pension plan documentation and learning to calculate your monthly benefits using the formulas. The exercise has value. However, you might want to feign ignorance on this topic to avoid being bombarded with pension questions from your colleagues.

@iDave - When human capital is mentioned, there is usually a presumption that the purpose of life is work, that the purpose of work is to earn money, and that the purpose of money is consumption. Financial planning is to used to optimize (read: maximize) consumption, usually subject to the constraint of working to normal retirement age. Few papers in the literature go the other direction and seek to minimize working years while maintaining a set standard of living.

But yes, early retirement has a huge opportunity cost in lost income as human capital expires unused. It’s also dissonant to me that the more one earns, one somehow has an increasing obligation to work and convert that human capital to money. In my experience, it seems to be common advice that one should learn to like or at least tolerate a high-salary career because not everyone has that opportunity.

You shouldn’t feel too bad about retiring iDave. You’re well above-average on this forum when it comes to having realized the potential of your human capital. :)

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unemployable
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Re: Improve Your Numbers

Post by unemployable » Fri May 17, 2019 10:36 am

@Fish

What I take from those citations is that my quick calculation is a legitimate exercise that the putative scholars have researched on a more formal level. However I still feel the phrase "human capital" itself is too vague on the surface and in any event covers a concept broader and deeper than the hard-number equivalent I'm working with. I'm working towards a sort of pronounceable acronym/number combination, with the number bring the withdrawal rate. Something like VEOW-4, Virtual Equivalent Of Working at a 4% WR for example. I'd really like the "V" to be something beginning with "M". "Money" isn't specific enough.

I did nail "fiscal death" as far as I'm concerned.

Probably the reason my scenarios fail either within the first 30 year or never at all is because I'm so tilted to equities in the first place. The concept of <50% in stocks (really, <70%) over the long term is alien to me, although I do make various tactical allocations. Most of my failures occur in the 20-25 year range, which happens to be right where Social Security would kick in for me. I do run some models that very conservatively include Social Security, mostly to see whether it will bail me out of a left-tail scenario.

bigato
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Re: Improve Your Numbers

Post by bigato » Fri May 17, 2019 3:24 pm

ahahaha I'm all for MEOW-4

IlliniDave
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Re: Improve Your Numbers

Post by IlliniDave » Fri May 17, 2019 4:34 pm

Fish wrote:
Fri May 17, 2019 9:36 am

@iDave - When human capital is mentioned, there is usually a presumption that the purpose of life is work, that the purpose of work is to earn money, and that the purpose of money is consumption. Financial planning is to used to optimize (read: maximize) consumption, usually subject to the constraint of working to normal retirement age. Few papers in the literature go the other direction and seek to minimize working years while maintaining a set standard of living.

But yes, early retirement has a huge opportunity cost in lost income as human capital expires unused. It’s also dissonant to me that the more one earns, one somehow has an increasing obligation to work and convert that human capital to money. In my experience, it seems to be common advice that one should learn to like or at least tolerate a high-salary career because not everyone has that opportunity.

You shouldn’t feel too bad about retiring iDave. You’re well above-average on this forum when it comes to having realized the potential of your human capital. :)
Fish, that first paragraph is well-stated. I don't feel bad about retiring, or about theoretically squandering my remaining human capital. For those of us that don't believe the primary purpose of life is to work for money, time and energy are often better spent away from that endeavor. Rather than having second thoughts about retiring, I reject the personal finance concept of human capital as one that is useful for me in my value hierarchy.

I am from the school who bought into (and doesn't regret) pursuing a relatively high wage career. If one can enjoy or at least tolerate it, it provides an efficient solution to the inflow problem. The hard thing is keeping the outflow capped far below the inflow because, as you point out, we have cultural expectations working against us.

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unemployable
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Re: Improve Your Numbers

Post by unemployable » Fri May 17, 2019 9:57 pm

I'm going with Monetized Equivalent Of Work (MEOW), with a numerical suffix indicating the hypothetical withdrawal rate.

From your take-home pay...
For MEOW-3, multiply monthly pay by 400 and annual pay by 33.3
For MEOW-4, multiply monthly pay by 300 and annual pay by 25
For MEOW-5, multiply monthly pay by 240 and annual pay by 20, and so on.

MEOW-X represents the amount of money you'd need to quit working and keep spending at an X% withdrawal rate.

Income diverted into retirement accounts should not be included in calculation of MEOW. Spending less than you earn otherwise should be reflected naturally in increasing net worth, which is a separate pool of assets from MEOW.

It's not terribly groundbreaking but it's a name and a framework for something I routinely think about.

Laura Ingalls
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Re: Improve Your Numbers

Post by Laura Ingalls » Sat May 18, 2019 5:08 pm

jacob wrote:
Thu May 16, 2019 4:15 pm
Yes and no. In the US FIRE-sphere it's practically tradition not to include NPV of social security, but it is also tradition to use the 4%-rule even though that only has a 30 year horizon. Thus with those assumptions, it cancels out. Retire at 35->A chance (albeit small) of running out of money by 60ish -> SS from 62+ until death.

More detailed calculations can (and should) be made.

What you should not do is to add the NPV of your social security to a 4% goal.
Not always
https://www.gocurrycracker.com/spending-future-social

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