Like you said, that is a very conservative estimate, but entirely accurate. If we experience a horrible depression which gives me no investment returns for 20 years, I still will be able to retire at age 43.
The rule of thumb is that you need (Current_Expenses x 25). This is a 4% withdrawal rate, and should last you forever. If you want to go even safer (the Trinity Study suggests that 4% is plenty safe) go with 3% and multiple your expenses by 33.
Implication: You must save 25 dollars or so for each dollar you spend. So you go out and earn an extra 25 dollars, or figure out how to spend one dollar less.
This is a 4% withdrawal rate, and should last you forever. If you want to go even safer (the Trinity Study suggests that 4% is plenty safe) go with 3% and multiple your expenses by 33.
According to The 4 Percent Rule is Not Safe in a Low-Yield World, the 4% withdraw rate was calculated to have a 6% failure probability over 30 years using historical data. Using today’s lower interest rates to recompute, the failure probability over 30 years is now 57%.
It is true that with a 50% stock, 50% bond diversification, there has been a small historical failure rate for the 4% withdrawal rate. If the first 30 years after my retirement are the worst seen since WWII, then I may be in trouble.
With this in mind, we may hedge against this. You may work for a bit longer and save enough to go with a 3.5% or even a 3% withdrawal rate, take on jobs or projects intermittently during your retirement to boost your savings, or receiving social security or some other another government social program once you are old enough to qualify. Other more random factors which may hedge in your favor will be your children growing up and moving out of the house (permanently lowering your expenses), downsizing your home or moving to a rental once your kids are grown, or receiving an inheritance.
Of course, the paper you cite anticipates a higher failure rate due to lower bond rates. These lower rates may be a historical aberration, as mentioned in the abstract. I have not invested in bonds because of the very low rates, and am holding a stock-only, albeit dividend paying, index fund. I view bonds as a hedge against deflation. Besides junk bonds, the ROI is much too low for my taste.
I am anticipating an eventual portfolio of 50% Stock, 30% REITs and 20% Bonds, unlike the study’s 50% stock, 50% bond. I also hope to have some rental property, but this is a long term idea. In the meantime, I should anticipate more volatility, but until I retire I will be comfortable with that. If you, on the other hand, prefer otherwise, you should go with bonds, save more and aim for a lower withdrawal rate.
However, the crux of this sequence is not investing, but extreme saving. Investing strategies differ due to anticipated needs and tolerance of risk. However, making a habit of saving most of your income should give you the greatest possible utility no matter what your investment or retirement plans are.
Bond rates are correlated with stock returns, and the paper assumes a lower-than-historical stock return as well. I don’t know whether today’s low bond rates are an anomaly or whether the historically high rates/returns in the US were an anomaly, but it seems to me there’s a fairly high chance the latter is the case. As the paper points out, the 4% wouldn’t have worked in most other countries. If you assume the current rates will continue, then even a 2.5% withdraw rate will have a 10% failure probability over 30 years, and you’d have to go to 1.3% withdraw rate to get a 1% failure probability over 40 years. (And this is assuming optimal mix between stock and bonds so you wouldn’t be able to achieve greater withdraw rate at same failure probability by switching to more stocks for example.)
I myself am doing “”extreme saving”, but it’s a big decision and I think people should make the choice with an accurate picture of the likely benefits and risks. Saying “4% withdrawal rate should last you forever” seems to be overselling the benefits and underplaying the risks. “Making a habit of saving most of your income should give you the greatest possible utility no matter what your investment or retirement plans are” seems like an even stronger statement, which I don’t see how you can defend.
How much are these estimates influenced by a hindsight bias; by a knowledge that during the last century the American economy was able to provide this growth, but many other countries’ economies were ruined at some moment. -- What would happen if someone tried this early retirement idea 100 ago by investing half of their income into Russian market and taking away only 4% per year? How about Germany?
Even if I believe that within the next 50 years some markets will safely provide 4% annual growth, what is the probability that USA will be in that set, and how would you derive this probability from an outside view?
It is not a hindsight bias; it is based using an analysis of historical returns to anticipate future returns, which is a distinction. But you make a good point on comparing the American economy to foreign economy. If someone invested in the Russian economy 100 years ago, they would have lost everything in the Communist Revolution, likewise if they invested in Germany, they would have lost it in WWI, WWII and the partition of East and West Germany. However if you invested in either country 30 years ago, you would have made bank on the fall of Communism.
Generally, if is difficult to hedge against political risks in your own country. If WWIII happens, then pretty much nothing is guaranteed. Investments, property, careers and lives are in uncertain flux, and all may be lost. Barring such catastrophic events, I may hedge the risk of American underperforming the rest of the work by investing in foreign companies, or trans-national companies. This is not something I will be doing right now (I have more faith in America’s economy then the rest of the world) but it is something to consider for the future.
Historically would you in fact have lost everything in a longterm position in the German stock market in World War I and II? Not necessarily. It certainly wasn’t a good place to invest, but there are companies such as Daimler that predate World War I and still exist today. Personal risk, of course, might depend on citizenship and ethnicity. I’m not sure if foreign investors (neutral, allied, or axis) were treated differently. E.g. I don’t know whether a young German/Swiss/British citizen who bought and held shares in Daimler in 1910 would still have owned them in 1960 absent an explicit sale or not. But I suspect at least some subset of hypothetical 1910 shareholders would not have lost everything over the ensuing 50 years.
Like you said, that is a very conservative estimate, but entirely accurate. If we experience a horrible depression which gives me no investment returns for 20 years, I still will be able to retire at age 43.
The rule of thumb is that you need (Current_Expenses x 25). This is a 4% withdrawal rate, and should last you forever. If you want to go even safer (the Trinity Study suggests that 4% is plenty safe) go with 3% and multiple your expenses by 33.
Implication: You must save 25 dollars or so for each dollar you spend. So you go out and earn an extra 25 dollars, or figure out how to spend one dollar less.
According to The 4 Percent Rule is Not Safe in a Low-Yield World, the 4% withdraw rate was calculated to have a 6% failure probability over 30 years using historical data. Using today’s lower interest rates to recompute, the failure probability over 30 years is now 57%.
It is true that with a 50% stock, 50% bond diversification, there has been a small historical failure rate for the 4% withdrawal rate. If the first 30 years after my retirement are the worst seen since WWII, then I may be in trouble.
With this in mind, we may hedge against this. You may work for a bit longer and save enough to go with a 3.5% or even a 3% withdrawal rate, take on jobs or projects intermittently during your retirement to boost your savings, or receiving social security or some other another government social program once you are old enough to qualify. Other more random factors which may hedge in your favor will be your children growing up and moving out of the house (permanently lowering your expenses), downsizing your home or moving to a rental once your kids are grown, or receiving an inheritance.
Of course, the paper you cite anticipates a higher failure rate due to lower bond rates. These lower rates may be a historical aberration, as mentioned in the abstract. I have not invested in bonds because of the very low rates, and am holding a stock-only, albeit dividend paying, index fund. I view bonds as a hedge against deflation. Besides junk bonds, the ROI is much too low for my taste.
I am anticipating an eventual portfolio of 50% Stock, 30% REITs and 20% Bonds, unlike the study’s 50% stock, 50% bond. I also hope to have some rental property, but this is a long term idea. In the meantime, I should anticipate more volatility, but until I retire I will be comfortable with that. If you, on the other hand, prefer otherwise, you should go with bonds, save more and aim for a lower withdrawal rate.
However, the crux of this sequence is not investing, but extreme saving. Investing strategies differ due to anticipated needs and tolerance of risk. However, making a habit of saving most of your income should give you the greatest possible utility no matter what your investment or retirement plans are.
Bond rates are correlated with stock returns, and the paper assumes a lower-than-historical stock return as well. I don’t know whether today’s low bond rates are an anomaly or whether the historically high rates/returns in the US were an anomaly, but it seems to me there’s a fairly high chance the latter is the case. As the paper points out, the 4% wouldn’t have worked in most other countries. If you assume the current rates will continue, then even a 2.5% withdraw rate will have a 10% failure probability over 30 years, and you’d have to go to 1.3% withdraw rate to get a 1% failure probability over 40 years. (And this is assuming optimal mix between stock and bonds so you wouldn’t be able to achieve greater withdraw rate at same failure probability by switching to more stocks for example.)
I myself am doing “”extreme saving”, but it’s a big decision and I think people should make the choice with an accurate picture of the likely benefits and risks. Saying “4% withdrawal rate should last you forever” seems to be overselling the benefits and underplaying the risks. “Making a habit of saving most of your income should give you the greatest possible utility no matter what your investment or retirement plans are” seems like an even stronger statement, which I don’t see how you can defend.
How much are these estimates influenced by a hindsight bias; by a knowledge that during the last century the American economy was able to provide this growth, but many other countries’ economies were ruined at some moment. -- What would happen if someone tried this early retirement idea 100 ago by investing half of their income into Russian market and taking away only 4% per year? How about Germany?
Even if I believe that within the next 50 years some markets will safely provide 4% annual growth, what is the probability that USA will be in that set, and how would you derive this probability from an outside view?
It is not a hindsight bias; it is based using an analysis of historical returns to anticipate future returns, which is a distinction. But you make a good point on comparing the American economy to foreign economy. If someone invested in the Russian economy 100 years ago, they would have lost everything in the Communist Revolution, likewise if they invested in Germany, they would have lost it in WWI, WWII and the partition of East and West Germany. However if you invested in either country 30 years ago, you would have made bank on the fall of Communism.
Generally, if is difficult to hedge against political risks in your own country. If WWIII happens, then pretty much nothing is guaranteed. Investments, property, careers and lives are in uncertain flux, and all may be lost. Barring such catastrophic events, I may hedge the risk of American underperforming the rest of the work by investing in foreign companies, or trans-national companies. This is not something I will be doing right now (I have more faith in America’s economy then the rest of the world) but it is something to consider for the future.
Amusingly, they wouldn’t’ve lost everything: http://lesswrong.com/lw/h5p/what_rate_of_return_should_you_expect/8pvq
Try historical returns in Argentina.
Historically would you in fact have lost everything in a longterm position in the German stock market in World War I and II? Not necessarily. It certainly wasn’t a good place to invest, but there are companies such as Daimler that predate World War I and still exist today. Personal risk, of course, might depend on citizenship and ethnicity. I’m not sure if foreign investors (neutral, allied, or axis) were treated differently. E.g. I don’t know whether a young German/Swiss/British citizen who bought and held shares in Daimler in 1910 would still have owned them in 1960 absent an explicit sale or not. But I suspect at least some subset of hypothetical 1910 shareholders would not have lost everything over the ensuing 50 years.
Such a rule of thumb will probably have a bigger impact on my actual behavior than the rest of the linked info combined.