Target FI amount and when one has reached it

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sky
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Target FI amount and when one has reached it

Post by sky »

Our protagonist has set a target financial independence investment amount based on actual living expenses and a safe withdrawal rate.

When he looks at his investment account, the value changes a bit each day as the value of equities and funds fluctuate.

On a good day, his spreadsheet of assets shows that he has reached his target.

But the next day, before he can hand in his letter of resignation to his employer, the market turns down a bit and his wealth is a bit short of target.

Should he continue working and saving to give himself a buffer? If so, how much?

Should he base his decision to "quit the job and retire" on an average value over the past quarter, or year? or perhaps the lowest value in the past quarter? or year?

How does one know when is enough?

vexed87
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Re: Target FI amount and when one has reached it

Post by vexed87 »

I thought the whole point in SWR calculation was that once you hit that figure, it doesn't how much the markets fluctuate from one day to the next, it is by its nature the "safe withdrawl rate". Obviously if your portfolio only hit the mark because of a freak swing in the market, it wouldn't be wise to assume you were set for life. I would hope that my portfolio naturally grew to the desired sum during a period of stability, and perhaps not at the peak of a bull market, therein lies to difficulty as we never know when we are at the peak!

black_son_of_gray
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Re: Target FI amount and when one has reached it

Post by black_son_of_gray »

Ultimately, I would say it is a personal decision (knowing when 'is enough', but I'd still go with the ERE plans and resign. The concept of a 'buffer' should already be included in the safe withdrawal rate, so a 'bit short of target' should still be safe. E.g. SWR 3.3% rather than 3.0%. It's a matter of degrees, not exactly a threshold. FI is a bit like pregnancy, no? 1) It's bound to happen once you set on the path and have all the appropriate prenatal (i.e. financial) care; 2) It is rare that a woman gives birth on EXACTLY the due date. 3) There is some wiggle room on what day it happens -most of the time it's fine 4) It's scary to be extremely premature, there can be complications and it isn't optimal, but things can still work out ok (depends on how premature).

Average values are fine to look at, but it seems that what you really want to know is the volatility of the portfolio - in terms of deviation and draw-downs.

Ydobon
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Re: Target FI amount and when one has reached it

Post by Ydobon »

Pull the trigger and avoid 'one more year' syndrome.

If you're that close, what's the worst that can happen? You have to get a part-time job? :lol:

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jennypenny
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Re: Target FI amount and when one has reached it

Post by jennypenny »

My personal goal is to be able to go 3 years (in a row) without any withdrawals if my ROI is flat or negative. For me, that translates to about a 10% buffer. My cash allocation is always at least enough to cover that.

Is our protagonist invested in the PP? That might change the recommendations you get.

BPA
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Re: Target FI amount and when one has reached it

Post by BPA »

Ydobon wrote:Pull the trigger and avoid 'one more year' syndrome.

If you're that close, what's the worst that can happen? You have to get a part-time job? :lol:
This is also my attitude. Worst case scenario for me? Sell my house and move to another cheaper one and/or get a part-time job.

Scrubby
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Re: Target FI amount and when one has reached it

Post by Scrubby »

At least in my case, having to take a part time job would be a bad deal. Finding one can be hard, and the pay would probably be less than half of what the full time job pays. I prefer a fuzzy limit because there are several variables to consider. How old are you? If you're young then working one more month won't take a large percentage out of the rest of your life. If you're old it will. If you have just barely enough then one extra month will make a noticeable contribution, but the law of diminishing returns apply because one more month won't make much of a difference if you already have a lot of money. How desperate are you to quit your job? If you really hate it then it's better to live off an absolute minimum, but if it's ok then it might be a good idea to continue a while longer to have an easier life when you do retire.

almostthere
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Re: Target FI amount and when one has reached it

Post by almostthere »

Another measure is income. What percent of your projected expenses is being covered by income from investments?

I can easily live off the income from investments, and it sure is pleasant feeling. It also is a great confidence builder b/c there will be many doubts in the first year or so of retirement.

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GandK
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Re: Target FI amount and when one has reached it

Post by GandK »

jennypenny is right. The portfolio type is the main difference in this equation.

If our protagonist lost 10% of his net worth/income, what would that look like? What would he change/cut in his lifestyle, and is that an acceptable situation to him? If not, I'd say a buffer is in order. A 10% drop is highly likely at some point.

Moving on, how about 20%? Or 50%? Progressively less likely, but still possible. At what point is it unacceptable or unsustainable? What is the plan then?

Just thinking out loud with you here.

Edit: Corrected for reading comprehension fail.

sky
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Re: Target FI amount and when one has reached it

Post by sky »

For the purpose of discussion, our protagonist has put his entire egg in an S&P 500 index fund, and his SWR target is 3.6% per year.

Upon retirement, he wishes to diversify a bit, but is unsure what to do with current market conditions (bonds unfavorable). For the moment, he will continue to ride the S&P 500 train.

His goal is to disappear incommunicado into the mountains for a number of months to write his manifesto and to decompress from too many years of wage slavery. No TV, no wifi, no cell phone. Each June he will don his hiking boots and come down from the mountain to withdraw his 3.6%. While one might think that a life as a mountain hermit is a frugal one, the protagonist needs pretty much all of the investment income to live. And soon, he will be moving to the big bad city. As a new man, having completed his spirit journey and having rediscovered himself through introspection, he now wishes to frugally live the good life as part of society.

IlliniDave
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Re: Target FI amount and when one has reached it

Post by IlliniDave »

Strictly speaking, I think "SWR" is more properly thought of as a systematic withdrawal rate. The "safeness" of such strategies are generally established by backtesting against historical data (ala the Trinity Study). There's no guarantee that the future will look like the past.

You didn't say how old our protagonist is, which provides some idea how long the nest egg is expected to hold up. "Success" for such strategies is tied to avoiding depletion (shortfall) over some number of years. I don't recall seeing a lot of study applied to a young retiree who's looking at maybe 50-60 years.

In a more practical sense, do you really think those last few dollars being in the account mean anything? Would our protagonist fail if the nest egg were 1% short and he had only 99% of his planned-for income? If the answer is "yes" he might consider adding 20-40% to his nest egg. If the answer is "no" things may be tenable the way they are, as he can consider lowering his consumption if he gets uncomfortable with a period of poor stock returns. Most of the withdrawal studies don't adjust when assets fall, which is fine in an academic setting. But it can be a stressful thing to watch for a real person who really counts on that money to live.

Scott 2
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Re: Target FI amount and when one has reached it

Post by Scott 2 »

I like the idea of living on the withdrawal strategy for a year, while continuing to work.

bibacula
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Re: Target FI amount and when one has reached it

Post by bibacula »

Is Zarathustra willing to work for money, even a low-status job, if necessary? Would he view it as an adventure?

If so, a 3.6% withdrawal rate seems extremely conservative, and market fluctuations won't matter.

If not, he should ask himself whether there is such a thing as a "safe" withdrawal rate for a young person.

The Old Man
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Re: Target FI amount and when one has reached it

Post by The Old Man »

The 4% SWR is a Rule of Thumb, not a rule of law. This assessment also applies to other percentages that you may come up with. The historical SWR analysis is generally based on a 95% success rate, but that still leave a 5% chance of failure which is still very high. If your number comes up, what are you going to do? You should have a back-up plan - this conclusion arises regardless of SWR that you may ultimately decide on.

sky
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Re: Target FI amount and when one has reached it

Post by sky »

Some very good advice here on what can go wrong in the process of establishing a financial independence target amount.

I think that it is correct to say that it is all about how you calculate the safe withdrawal rate. If you don't trust 4%, then use a lower number and work longer.

The original question was related more to the index one uses to determine when the financial independence target has been reached.

It could be a simple "if investment account value exceeds the financial independence target amount then quit job".

However, in a period where market values are approaching all time highs, one might want to protect one self from high volatility at the peak by using an average over time. For example, "if the S&P 500 value is below the 90 day simple moving average and investment account value is above financial independence target amount, then quit job".

This may be splitting hairs, because in extreme conditions (a market rebound high after a severe low), the difference between market high and 90 day sma is only about 5% using this simple moving average formula.

IlliniDave
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Re: Target FI amount and when one has reached it

Post by IlliniDave »

There are many "all time high" periods baked into something like the Trinity Study or any other backtesting method. In 1930 the SP500 was around 30 and steadily climbed for the next 85 years to around 2100 today (and it's total return has outpaced that). Nearly it's whole history has been spent at or near all-time highs. My instinct is that something like a 90-day moving average is meaningless. Equities are somewhat expensive right now from a PE perspective. If that's a big concern you might consider oversizing your assets by 20-40% relative to your target (and lower your WR accordingly) so you can withstand a significant near-term downturn and still keep your $/mo target without going above your 3.6% WR. The bigger the downturn you want to offset the higher the oversizing. But, keep in mind all the SWR and similar studies have been subjected to The Original Great Depression, the 1970s, 2000-2002, and newer ones maybe even 2007-2009. So arguably you're okay where you're at from the SWR research perspective irrespective of the current value of the SP500.

bibacula
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Re: Target FI amount and when one has reached it

Post by bibacula »

I think you're focused on the wrong risk (short-term volatility). Instead, a multi-decade period of low returns would be far more damaging.

Here's a short piece by Brett Arends at Marketwatch: https://secure.marketwatch.com/story/he ... 2015-04-28

tl;dr: There have been 50-year long periods in US history when stock prices rose at the same pace as inflation (0% real price gain). The only real return was from dividends.

Long-term valuation metrics (Shiller's CAPE, Tobin's Q, Buffet's market cap/GDP ratio) are the best known predictors of future returns. Ignore short-term noise.

A Life of FI
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Re: Target FI amount and when one has reached it

Post by A Life of FI »

biracial wrote: tl;dr: There have been 50-year long periods in US history when stock prices rose at the same pace as inflation (0% real price gain). The only real return was from dividends.
Though keep in mind that the average dividend during the period in the article (1915 to 1982) in the above post was 5% (as per the article in the above post, I also checked against Shiller's site referred in the article) and the real return above inflation was close to 0% but still positive at .6% (as per the article in the above post).

Thus someone with a 4% withdrawal rate would be reinvesting on average 1.6% (5% + .6% - 4% = 1.6%) every year over the period in the article and this reinvesting would lead to a beginning investment balance in 1915 of $500,000 turning into an inflation adjusted balance of $1,450,000 at the end period (1982).

Also keep in mind that the author of the article picked a period with started with a bull market (1915) and ended with a bear market (1982) (i.e. a period that would lead to a very poor performance) - And the value of the portfolio still tripled in real terms over the period a 4% withdrawal rate.

If he would have compared bull market in the 1915 to the bull market in the 1980's (1989 to be exact) the portfolio would have increased to about $3,700,000 inflation adjusted - an increase in real terms of more than 7 times the original portfolio.

bibacula
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Re: Target FI amount and when one has reached it

Post by bibacula »

A Life of FI wrote: Also keep in mind that the author of the article picked a period with started with a bull market (1915) and ended with a bear market (1982) (i.e. a period that would lead to a very poor performance)...
This is the point. If you start withdrawals at a period of very high valuation (like TODAY), future returns will be very low (perhaps 2-3% real).

Short-term volatility isn't a risk for long-term investors.

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jennypenny
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Re: Target FI amount and when one has reached it

Post by jennypenny »

bibacula wrote: Short-term volatility isn't a risk for long-term investors.
I thought someone (was it Todd Tresidder?) wrote an article about how volatility and low returns at the beginning of the drawdown period can have a devastating effect on the portfolio.

Edit: It was Tresidder who wrote the article I was thinking of ... http://financialmentor.com/retirement-p ... rate/13192

ImageSequence of Returns by jp_homestead

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