The 4% Rule – A Castle in the Air

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zbigi
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Re: The 4% Rule – A Castle in the Air

Post by zbigi »

IlliniDave wrote:
Wed Sep 21, 2022 8:12 am
I'd given it a glance and saw some parallels with stuff I'd picked up reading John Bogle's writing. Worth the read, if for no other reason than to get exposed to the idea that until sometime in the early 20th century investment portfolios were measured by their yield not their market value, and that there's an alternative approach to the "modern" one.
Oh yeah, it's quite common in XIX century novels. The characters are described as "having 30,000 roubles per year" and not say "1 million roubles net worth".

steveo73
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Re: The 4% Rule – A Castle in the Air

Post by steveo73 »

Awesome post. I read every word.
IlliniDave wrote:
Wed Sep 21, 2022 6:05 am
So aside from spending within my planned living expense allowance, any additional spending comes with that internal debate you mention: I can, but should I?
Exactly.
IlliniDave wrote:
Wed Sep 21, 2022 6:05 am
No crisp answers there--it's something I'll just have to evaluate on an ongoing basis.
It's grey. These hard and fast rules may exist but they are silly examples. My wife the other day mentioned a house where my in-laws live. Houses there cost millions and my response is we won't be doing that.

Just to clarify this situation my wife is more frugal than myself and has no urge to live in a fancy house.
IlliniDave wrote:
Wed Sep 21, 2022 6:05 am
The connection I see is something you've pointed out--for anyone practicing more than token financial stewardship spending rates aren't very systematic. So it speaks to the practical limits of the theory and arguably it's chief weakness, maybe even more so than investment returns.
It's your expenses that are the issue. Your WR is a really good metric calculated on your spending that year but it's just an indicator. For example if we spend $30k on our roof our WR will be approximately 7%. I don't want to do this but if I do it's cool. It's just like spending pre-retirement in that spending money should be about getting value out of your spending. The difference is can/do you want to go back to work so if anything your spending is more constrained.
IlliniDave wrote:
Wed Sep 21, 2022 6:05 am
Even with the luxury I had of only having to grapple with a shorter retirement period I baked in conservative assumptions one atop the other until my risk tolerance was overcome. I even got some snarky reactions over on bogleheads.org while discussing readiness for either being too much of an oversaver or spending too little. As you'd expect those came from the YOLO/FOMO mindset.
I don't want to do this. I do think people should think more deeply about their spending and their plan and the metrics they use especially WR's..

People roll differently though. My wife doesn't seem to care. She just feels that we can sell the house if we run out of money and live elsewhere. WE live in Sydney in a 4 bedroom house. House are really expensive. We wouldn't have a huge amount of money left over but we could do it. I don't want to sell the house.
IlliniDave wrote:
Wed Sep 21, 2022 6:05 am
But the more important ingredient is understanding yourself--what it takes as a threshold for you to have a lifestyle of contentment, how hard you're willing to work to avoid spending a dollar, how well you deal with financial risk, an understanding of the viability of returning to the workforce, how flexible you can be with regard to spending year-to-year, things like that. If all that adds up to somewhat rigid requirements, then the lower you'd probably want to drive SWR because that will increase your ability to achieve systematic spending without derailing the train. There are other factors to heap on top: length of intended retirement and the importance of legacy and such.
Your plan is personal. It's an individual thing. It's very hard to compare plans and metrics (like WR's). There are limits to this approach dependent on how honest we are with ourselves and others. Are those really your expenses and more importantly will you be happy spending that amount over the course of your life. Are you prepared/can you go back to work ? Do you have back-ups ? How reliable are those back-ups ?
IlliniDave wrote:
Wed Sep 21, 2022 6:05 am
There isn't a precise formula I know of to convert those human factors into numbers. My approach was to build in a lot of flexibility to pare back outflow (e.g., I plan for annual spending well above what I determined my contentment threshold to be) which led to a fairly small anticipated SWR. But that number wasn't the plan, just fallout from the plan. Atypical aspects of my accumulation situation allowed me to achieve that without spending too many additional years in the workforce. That the current economic direction of the US makes me more concerned for the fate of others than for myself is an indication the few years sacrifice might have been worth it.
Good stuff.

steveo73
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Re: The 4% Rule – A Castle in the Air

Post by steveo73 »

xmj wrote:
Wed Sep 21, 2022 6:50 am
I do recommend you take a look at the paper I linked. It bases the entire discussion about withdrawal rates for *perpetuities* on empiric grounds.
https://www.jeffreyco.com/docs/james-p- ... 20copy.pdf

Are you talking about this ?

Personally I don't like that paper. It's pushing a certain philosophical approach to managing money. I don't personally agree with that philosophical approach.

It is though a really good example of clarifying your objective. If you are looking to provide money on-going for your kids or whatever then take a certain approach. So if you want your money never to run out you need a specific approach. Your WR is sort of specific to your personal situation.

steveo73
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Re: The 4% Rule – A Castle in the Air

Post by steveo73 »

IlliniDave wrote:
Wed Sep 21, 2022 8:12 am
so the initial stake required for someone to fund themselves in perpetuity based on yields alone was quite high--pretty much in the ball park of a 1%-2% withdrawal rate anyway
Spot on. That article is pushing something that to me is really inefficient for basically everyone. I think it's pushing two things:-

1. Have your money last forever.
2. Some simplistic investment advice.

You can do that just by getting your WR really low and using the same investment approach you would use anyway.

There is an opportunity cost question stating is the extra work worth it to achieve that goal. ERE solves that problem (in my opinion too simplistically) via stating working longer but because saving rates are so high it doesn't matter as it's such a short time period. It's a play on expenses but life to me isn't that simple or I can't/won't just spend that amount of money. Just based on my age and other circumstances I don't need a 50 year retirement via my savings within financial assets alone but my expenses can change which impacts me today but also into the future.

xmj
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Re: The 4% Rule – A Castle in the Air

Post by xmj »

See that's where difference in personal philosophies comes in.

To me the notion of spending down principal through whatever fashion of the day currently shilled isn't a way to a viable future. I was provided some great possibilities in life. This allowed me to take chances I wouldn't otherwise have taken. Obviously that should be true for the next generation and then some.

Meanwhile the name of my game is high savings rates, creating a professional environment I like and can sustain for the long run, enjoying the present and using a multi-decade perspective to all that.

ertyu
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Re: The 4% Rule – A Castle in the Air

Post by ertyu »

Whereas I am fairly confident that in my case, if I save up "for the next generation" the next generation would just spend down the principal once they get their hands on it, I am quite attracted to the idea of only living on dividends -- mostly to appease my own risk aversion. I am comfortably FI at 4% on total return basis in local terms in my country of origin -- comfortably by ERE standards rather than western middle class standards, but still FI. I am, however, very reluctant to trust the 4% rule for reasons I've already discussed. I don't know if I buy the 85% equities, 15% munis allocation discussed in the paper xmj posted, though -- the idea of the author was to use the 15% munis to avoid having to draw down the equity principal, but that still assumes an inverse correlation between stocks and bonds (namely, bonds will effectively cushion a drop in dividends during a severe recession as happened for their portfolio in 2008/9). That inverse correlation, however, is currently breaking down due to the resurgence of stagflation. I don't know if that would be the portfolio allocation i'd be comfortable with going forward even if we assume that i'll live off the 1.7%* dividend yield of my equities.

* - the most recent number given by the author of the paper.

1.7% of my liquid net worth happens to be exactly a minimum wage where I'm from (though as in the US, most people earn above that even in minimum wage jobs as the number has not been updated for the last couple of years)

IlliniDave
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Re: The 4% Rule – A Castle in the Air

Post by IlliniDave »

I too find the idea of living solely off dividends/interest an attractive one. Being US-Based and having about 60-65% of my invested assets in a traditional 401k plan means that if I live long enough, I'll be required by law to sell assets (and pay tax). Granted I could use the net proceeds of the distributions to re-buy similar assets in a taxable account, in which case I'd be essentially selling off a smaller amount of assets to pay taxes. That will force me to at least get used to overcoming the aversion I have to selling assets. And if necessary skim some amount of the distributions for living expenses if required/desired. Since when push comes to shove taking those distributions is an at-the-point-of-a-gun situation and should ensure excess annual tax flow once I hit the required age, it's sort of made the whole issue moot for me. Unless stagflation persists for an substantial length of time I probably can get by on the annuity earned from my employment and distributions from my taxable account until I start receiving Soc Sec and hitting that point undergirded my OMY decisions. After that I'll just do what the law requires and make incremental money managing decisions.

Again, I see a strong parallel to what the paper discusses and simply accumulating until you have a WR of a little under the dividend rate when you retire (roughly 1.7% now, iirc), maybe somewhat lower if you want to have an additional bucket with some bonds or whatever because you want to be rigid about your spending allowance year-to-year (or you can just tighten your belt and ride out dividend dips), and match your stock allocation to the withdrawal rate. Your heirs/future descendants won't get equitable payouts in perpetuity, but you'll be in good shape and your heirs will likely get something. But that's an expensive route with the cost being the sacrificing a number of years of potential retirement if you're like me and aren't comfortable at a 1.0 JAFI spend rate even for one year, much less the rest of your life. Rough calculation for accumulation is $1.4M USD per $20K USD portfolio-sourced spending per year.

If you want to go across generations with the setup you probably need to drive the withdrawal rate down to 0.7% or below because you'll have to pay a trustee. Lower still if a significant amount of the money is held in a tax deferred retirement account. Even outside a retirement account you're looking at maybe something over $3M per person to generate $20,000 annually for each. More if you want to hedge for the possibility that dividend growth over time will fall short of what it did in their 30-year window. Great if you have a significant business to sell or hit some sort of ginormous windfall maybe, but very difficult and lengthy knocking back even a large chunk of every paycheck. Obviously the author not talking to everyday salarymen.

xmj
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Re: The 4% Rule – A Castle in the Air

Post by xmj »

Fair points.

Two things to note:
-Right now 2yr treasuries yield more than the S&P500 as far as interest / dividends are concerned, so that yield will probably expand further in the near future (what can't last won't last, etc).
-And then, the paper seems to recommend something like spending 4/3rds of dividends (so indeed selling some assets), as the authors reason that most firms don't payout 100% of their earnings (using some for stock repurchases, reinvestments, issuing options to sr. mgmt etc).

steveo73
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Re: The 4% Rule – A Castle in the Air

Post by steveo73 »

IlliniDave wrote:
Thu Sep 22, 2022 6:13 am
. But that's an expensive route with the cost being the sacrificing a number of years of potential retirement if you're like me and aren't comfortable at a 1.0 JAFI spend rate even for one year, much less the rest of your life. Rough calculation for accumulation is $1.4M USD per $20K USD portfolio-sourced spending per year.

If you want to go across generations with the setup you probably need to drive the withdrawal rate down to 0.7% or below because you'll have to pay a trustee. Lower still if a significant amount of the money is held in a tax deferred retirement account. Even outside a retirement account you're looking at maybe something over $3M per person to generate $20,000 annually for each. More if you want to hedge for the possibility that dividend growth over time will fall short of what it did in their 30-year window. Great if you have a significant business to sell or hit some sort of ginormous windfall maybe, but very difficult and lengthy knocking back even a large chunk of every paycheck. Obviously the author not talking to everyday salarymen.
The cost of doing this to me is huge. I'd be working for decades longer if I was to achieve this. It's a massive cost.

I'm also skeptical this is good for anyone.

steveo73
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Re: The 4% Rule – A Castle in the Air

Post by steveo73 »

xmj wrote:
Thu Sep 22, 2022 6:39 am
Fair points.

Two things to note:
-Right now 2yr treasuries yield more than the S&P500 as far as interest / dividends are concerned, so that yield will probably expand further in the near future (what can't last won't last, etc).
-And then, the paper seems to recommend something like spending 4/3rds of dividends (so indeed selling some assets), as the authors reason that most firms don't payout 100% of their earnings (using some for stock repurchases, reinvestments, issuing options to sr. mgmt etc).
The big question is why ?

I thought that paper was poor because the goal of having money last forever is easy. You just go 100% broad stock index and have a 2% or even higher WR.

The why though is pretty important. I should inherit a lot of money and this approach is easily achievable for me. I've thought through spending large amounts of money. My take is you provide gifts to your kids without conditions and you don't leave too much. The rest goes to charity.

My SIL is 40. She is basically a socialite who doesn't work and has never had a proper job. Her life to me seems wasted. She lives in New York without a job and is traveling overseas and having a party in a beach house for her 40th. My MIL didn't really bring up her 4 kids. She just socialized. To me her life seems weird and boring.

xmj
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Re: The 4% Rule – A Castle in the Air

Post by xmj »

Your assumptions are different than a family trust making payouts to several dozens if not hundreds of people.

You can adapt your personal spend rather easily (just don't buy as much, skip foreign holidays, etc) but if you *must* withdraw, and it's March 2003, March 2009 or March 2020 (funny, eh?), you'll be lots better off just selling down your short term bonds to match distributions and refilling them over time.

As for why... again I counter, why not? Run a business in an area you're great in, with sales going through the roof over time, and you'll probably create generational wealth earlier than actually being aware of that.

IlliniDave
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Re: The 4% Rule – A Castle in the Air

Post by IlliniDave »

steveo73 wrote:
Thu Sep 22, 2022 6:59 am
The big question is why ?

I thought that paper was poor because the goal of having money last forever is easy. You just go 100% broad stock index and have a 2% or even higher WR.
The goal was even more rigid. It was to have all descendants receive identical, unvarying, inflation-adjusted payouts in perpetuity. If that is not a person's goal then it's a lot of overkill and probably easily fails the is-it-worth-it test. It's probably not hard to set up a trust that will last "forever" and give varying payouts, just cap the annual total payout to something appropriately less than the actual dividends received the prior year (less to cover any taxes and admin costs) then divide that by the number of recipients and that's the payout, recalculated every year. Depending on how growth in the family stacks up to dividend appreciation, payouts could go up or down both year-to-year and over time. But the client family made variance in sustainable payout to each descendant across generations their definition of risk, and the talk outlined a low risk approach based on that definition.

Even seemingly small annual payouts on the order of say $2k-$4K current dollars a year could ensure a good start on funding an education for great^nth grandchildren with some luck. No idea what the trust in question is handing out to each person, but there's no need to provide upper middle class income to everyone, so it's something a person could think about for their estate plan with even a relatively modest residual, even if they themselves withdraw more aggressively, do TR, or whatever. Just a consideration for those so inclined.

Myself, I wouldn't urge anyone here to replicate the paper's route, but it does give a ROM idea of how a person could pursue a perpetual vehicle if they wanted, and alludes to how expensive going from 90% or 95% type of success probability to 99.9% (or whatever) is for any sort of time frame. There are other routes to reasonable success probabilities that aren't as burdensome, including TR.

steveo73
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Re: The 4% Rule – A Castle in the Air

Post by steveo73 »

xmj wrote:
Thu Sep 22, 2022 7:19 am
As for why... again I counter, why not?
Four reasons (I bet there are a lot more):-

1. You will be working for a very very long time. I'm talking decades.
2. That sort of wealth isn't good for people.
3. You'll fail at obtaining that wealth anyway.
4. You aren't a martyr to future generations.
xmj wrote:
Thu Sep 22, 2022 7:19 am
Run a business in an area you're great in, with sales going through the roof over time, and you'll probably create generational wealth earlier than actually being aware of that.
Sounds simple. I reckon about .0001% people who set out to achieve this can actually do it.

I suggest if a 3% WR is absurd for the vast majority of people the idea in that paper is more absurd.

If you want to do it go for it but I have experience with family with huge wealth and I honestly believe that much money isn't good for you. If I receive that sort of money (let's say 20 million) and I have input into how that money is spent I'll give most of it away and still leave a lot of money to my kids.
Last edited by steveo73 on Thu Sep 22, 2022 5:52 pm, edited 1 time in total.

steveo73
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Re: The 4% Rule – A Castle in the Air

Post by steveo73 »

IlliniDave wrote:
Thu Sep 22, 2022 7:57 am
The goal was even more rigid. It was to have all descendants receive identical, unvarying, inflation-adjusted payouts in perpetuity. If that is not a person's goal then it's a lot of overkill and probably easily fails the is-it-worth-it test.
It's ridiculous. Plain and simple. I'll add that @xmj can't even justify why anyone would want to do this.
IlliniDave wrote:
Thu Sep 22, 2022 7:57 am
It's probably not hard to set up a trust that will last "forever" and give varying payouts, just cap the annual total payout to something appropriately less than the actual dividends received the prior year (less to cover any taxes and admin costs) then divide that by the number of recipients and that's the payout, recalculated every year. Depending on how growth in the family stacks up to dividend appreciation, payouts could go up or down both year-to-year and over time. But the client family made variance in sustainable payout to each descendant across generations their definition of risk, and the talk outlined a low risk approach based on that definition.
I have never seen a more extreme use case plus it's easy to set something up slightly less ridiculous that would work if you wanted it too.
IlliniDave wrote:
Thu Sep 22, 2022 7:57 am
Myself, I wouldn't urge anyone here to replicate the paper's route, but it does give a ROM idea of how a person could pursue a perpetual vehicle if they wanted, and alludes to how expensive going from 90% or 95% type of success probability to 99.9% (or whatever) is for any sort of time frame. There are other routes to reasonable success probabilities that aren't as burdensome, including TR.
Honestly it was silly. You'd have to be really rich and have basically no investment knowledge to consider this approach.

This comes back to my point regarding the lack of investment knowledge on this forum compared to the MMM forum. It's a little frustrating. It's clear you and others actually understand WR's and investing but all too often on this forum I see people setting themselves up for failure.

It doesn't have to be that hard.

Lastly that paper lacked rigor. There is so much better information out there. It actually shouldn't be referred to as a paper but as an ad for a poor investing approach. That wasn't anything at all like an academic paper.

Salathor
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Re: The 4% Rule – A Castle in the Air

Post by Salathor »

I would say that the idea of creating the Noble House (see James Clavell--one of my favorite authors, and probably my favorite book) is not inherently ridiculous. There's something powerful about building something great, a Rothschild like legacy.

But that said, I don't think I would create something to care for unknown numbers of unknown descendants in perpetuity. I'd rather raise up my daughters right and trust them with it. If they squander it--oh well, I guess I messed up! But I don't think they will. And if they're good with it, hopefully I'll have instilled in them the ability to pass it down appropriately as well.

steveo73
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Re: The 4% Rule – A Castle in the Air

Post by steveo73 »

Salathor wrote:
Thu Sep 22, 2022 7:02 pm
I would say that the idea of creating the Noble House (see James Clavell--one of my favorite authors, and probably my favorite book) is not inherently ridiculous. There's something powerful about building something great, a Rothschild like legacy
Let's be honest it is inherently ridiculous if we are talking real life and not fiction.

I love those books but it's like loving Batman or James Bond or something like that.

What is powerful about it - you'll be dead.

steveo73
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Re: The 4% Rule – A Castle in the Air

Post by steveo73 »

When it comes to WR's I think everyone should read this post:- https://livingafi.com/2021/03/17/the-20 ... more-15998

Just to sum his situation up in my words:-

1. A very close to 3% WR.
2. Lowish expenses (higher than is often suggested here) - 30k.
3. Life changed and that plan wasn't going to work anymore and he had to return to work.

There are in my opinion two learning's from that scenario:-

1. It's really really hard to accurately judge your expenses for a long period of time and this can lead to retirement failure.
2. Retirement failures are binary events. You either go back to work because you need the money or you don't. Leading a good life or doing your best in life is very different to having to go to work. A retirement failure is not necessarily a catastrophe.

xmj
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Re: The 4% Rule – A Castle in the Air

Post by xmj »

steveo73 wrote:
Thu Sep 22, 2022 5:46 pm
It's ridiculous. Plain and simple. I'll add that @xmj can't even justify why anyone would want to do this.

I have never seen a more extreme use case plus it's easy to set something up slightly less ridiculous that would work if you wanted it too.

Honestly it was silly. You'd have to be really rich and have basically no investment knowledge to consider this approach.

This comes back to my point regarding the lack of investment knowledge on this forum compared to the MMM forum. It's a little frustrating. It's clear you and others actually understand WR's and investing but all too often on this forum I see people setting themselves up for failure.

It doesn't have to be that hard.

Lastly that paper lacked rigor. There is so much better information out there. It actually shouldn't be referred to as a paper but as an ad for a poor investing approach. That wasn't anything at all like an academic paper.
I do agree with you on the rigor and investment knowledge parts - fortunately the same author has others papers targeted to a trustee audience that go into more explicit detail how to accomplish the approach. This paper's audience were the trust's beneficiaries, so adapting the message to be relevant to that audience is par for the course.

As to justifying... I typically don't. Philosophically, in a few years (with >66% SR, heh) I've gone from
"How can I exit this as quickly as possible and what shortcuts do I have to take?" (finite game)
to
"How can I refactor this to do it forever?" (infinite game)
So overall I try to find an answer to the following:

- What would have to be true about a world in which I continue working for pay way past the point of needing to?
- What would I work on?
- Who would I do that with?
- How would the setup look like?
- What the hell is it all for?

And I've personally come up with a suite of great answers that suit me. And once they don't, the setup would allow me to change my mind again ;-)

steveo73
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Re: The 4% Rule – A Castle in the Air

Post by steveo73 »

xmj wrote:
Fri Sep 23, 2022 12:03 am
I do agree with you on the rigor and investment knowledge parts - fortunately the same author has others papers targeted to a trustee audience that go into more explicit detail how to accomplish the approach. This paper's audience were the trust's beneficiaries, so adapting the message to be relevant to that audience is par for the course.
If you like it that's cool. I like a lot more rigor. That came across as a sell and selling something of low quality.
xmj wrote:
Fri Sep 23, 2022 12:03 am
As to justifying... I typically don't.
Why not ? If you can't justify your position maybe it's because your position is wrong. I find articulating your position can be beneficial to you. There might be more to the situation or even just clarifying why you feel a certain way can be helpful to you.
xmj wrote:
Fri Sep 23, 2022 12:03 am
So overall I try to find an answer to the following:

- What would have to be true about a world in which I continue working for pay way past the point of needing to?
- What would I work on?
- Who would I do that with?
- How would the setup look like?
- What the hell is it all for?

And I've personally come up with a suite of great answers that suit me. And once they don't, the setup would allow me to change my mind again ;-)
I see two points:-

1. This is to me the key point. Be prepared to change your mind. If you retain that freedom within your approach to life you can change course and get out of holes. You don't have to be defined via a low WR that doesn't make sense or having really low expenses that again doesn't really make sense or even being prepared to just state I'm going to do something different because I want too or even because I have too. Doom did a bit of both.
2. If you continue having that approach and reading in my opinion nonsense like that information you linked too you will be working forever. I figure you will change your outlook at some point. You'll come around or you'll die working because your approach is inherently flawed. I don't say that very often but I very rarely see such an extremist outlook. My FIL has told me he will die working and he has generational wealth. He just loves working and he has in my opinion a crappy job.

In stating all of that good luck to you. It'd be great if you came back on here and told me (and actually did it) that you now had a wealth of 100 million and you were going to change the world for good.

That would be awesome.

I support the worst footy team in the world. There is nothing I like better when I think player X is a dud and he proves me wrong. I love that. The reverse sucks just as much.

xmj
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Re: The 4% Rule – A Castle in the Air

Post by xmj »

steveo73 wrote:
Fri Sep 23, 2022 12:55 am
Why not ? If you can't justify your position maybe it's because your position is wrong. I find articulating your position can be beneficial to you. There might be more to the situation or even just clarifying why you feel a certain way can be helpful to you.
To be able to justify a position, and to justify it to others, are two rather different things.

steveo73 wrote:
Fri Sep 23, 2022 12:55 am
I see two points:-
[...]
2. If you continue having that approach and reading in my opinion nonsense like that information you linked too you will be working forever. I figure you will change your outlook at some point. You'll come around or you'll die working because your approach is inherently flawed. I don't say that very often but I very rarely see such an extremist outlook. My FIL has told me he will die working and he has generational wealth. He just loves working and he has in my opinion a crappy job.
Let's not forget we're on a forum styling itself "Early Retirement Extreme" where the benchmark is living on 7k/yr (requiring assets of 175k ish).
steveo73 wrote:
Fri Sep 23, 2022 12:55 am
I support the worst footy team in the world. There is nothing I like better when I think player X is a dud and he proves me wrong. I love that. The reverse sucks just as much.
We each pick our ways of being masochist at times.

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