Joined: 04 Jan 2003
Location: Henderson, Nevada, USA
**** Heavy Hitter
Joined: 26 Nov 2002
|Posted: Tue Sep 23, 2003 11:24 am Post subject: Re: I recommend <I>The Millionaire Next Door</i>
|Hi Chips, my post is below. A further post I had just made on why intercst's study is not appropriate for most people is below that.
Partly I posted because I couldn't tolerate without saying something the threads I noticed going back to last month where everyone had a goal of 25x with no understand necessarily of the implications of intercsts's study. Word games typically revolve around intercsts data, but my points I think draw the discussion in a more useful direction. Hopefully it will attract some here as a result. I think my second post is a bit of a corker! It was the first time I was properly able to illustrate why I think intercst's report is bad in a way I think perhaps hocus has been trying unsuccessfully to do for so long.
P.S. Have read Millionaire book. I found the wealth equations somewhat arbritary in the sense that if your career started later or any number of other scenerios, it can give bad results. This could potentially depress rather than encourage savers. I know the author needed perhaps to do this to seperate out the PAWs from UAWs etc..
I've been reading some of the earlier posts from this newish board and I wanted to add some ideas of my own.
I think that whilst the ideas put forth by Larry Waschka in The Complete Idiot's Guide to Getting Rich are interesting, I don't think they are all that useful.
Example from the quoted book:
Stage 1: You spend less than you earn and save the difference. You are accumulating wealth.
Stage 2: Your savings appreciates in value (not including new contributions) an equal or greater amount than what you contribute. i.e. You have a $100,000 port earning 10% and your annual savings are $9000. Your port is appreciating by more than what you are saving, and if you wanted you could stop saving so much.
Stage 3: Your savings appreciate in value an equal or greater amount than your annual income. At this point you are essentially FI without the safety net of 25x spending.
As one's gross salary increases, the goalposts keep moving on you when you attempt to build up a net worth of one year's gross income. This can be very discouraging as some posters noted. Such a measurement has little relevance to FIRE. A better measurement would be to prepare a FIRE budget and compare last year's savings to the budget to see what multiple you managed to save. You could also compare total gains in your portfolio from market returns and new investments against the same measurement. Lastly, if you want to compare total net worth to something, then compare it to your future FIRE budget and not a variable gross salary which has little connection to your actual spending. Your saving is to support future spending and the measurements of progress used should reflect that.
FIRE Budget $25,000
Net Worth: $37,500
FIRE multiple: 1.5x
As most people ultimately are working towards a multiple of your FIRE budget, intercsts's often quoted and mostly incorrect 25x, it is a far better measurement of your progress. Many will save their pay rises above inflation and so the movement of salary over the years won't change the calculation other than inflationary adjustments. Additionally, you could track what multiple of a year's FIRE budget last years new investments and return (above inflation) delivered.
This approach is modelled after your FIRE goals rather than an arbitary basis which has little relevance to your specific situation.
Hope it helps.
Post about the study and different approches uses here:
| Ok, I'm not locked onto the 4% rate as a fact, but am more than willing to listen to opposing points of view. My own personal withdrawal rate was/is going to be 3.5%. What do you think a safe number is, and why? Telling me intercst is wrong without an opposing viewpoint is not entirely helpful to debate.
Just thinking over your reply a bit more to see how I could put up a post that might be useful to a number of readers on the board.
Intercsts's study over at the REHP board puts forth that you can live off 4% withdrawal rate with 25x annual spending and that you spend down your assets to $0 at the end of 30 years. It calculated this based on historical returns and starting at any retirement date for any bunch of years, would your money have survived the 30 years at a 4% withdrawal rate fully invested in a mix of US stocks and US bonds, the allocation is usually around 75/25 stocks/bonds.
I would suggest that you ask yourself whether you are comfortable with spending down your investments to zero. This is done on the basis that you live partially on their income and partially on principle by selling some shares etc. If the returns are low or negative in the early years, you'll be selling more shares and lowering your principle faster than planned. The market will likely rise back up in a few years time but sadly you've already sold extra units of your mutual fund or extra shares that had dropped in value in order to live, so your portfolio won't rise back up to previously planned. As you have less assets now, your income from them is reduced forcing you to sell even more shares than expected in your original spend it down to zero plan. Soon you'll run out of money even if the market comes back to a stellar valuation because you had to sell more in the early years.
On a spend down to zero scenario, there is a line curve as your nest egg drops over the 30 years. In the early years you have most of your principle in tact and so mostly you're living off investment return, a little of the principle. Later you have less and live more off asset sales and less of returns because you have less assets remaining. If you get a batch of bad results in the early years however, that curve gets ever steeper and money runs out sooner. You sell too many assets early on and later have too little remaining to deliver much income and so are forced to sell at an accelerated rate. That's what can happen when you spend down your nest egg and there's nothing you can do to stop it if you take that approach.
Does that sound good to you? Does that sound like a safe plan for you and those you care about?
If you decide that it sounds too risky, then an alternative would be to plan to keep your principle, your total portfolio, and live off the real returns it provides. Real meaning after inflation returns. Some years are better than others and some markets can be down for many years, so here is where the idea to diversify to markets other than just the US comes in. Investing internationally and in other non-correlated asset classes, things that may go up when your US investments go down. This can smooth out your returns each year, lower your risk overall and provide a reasonably predictable income over time. US stocks and US bonds are on a similar investment cycle, if the US has problems then all your assets start to slide downwards making them harder to live off. This way you keep hold of your mutual fund unit allocation & individual shares and are able to ride the prices down and then back up again comfortably. The volatility of any one market doesn't much affect you because you're invested 20% here, 20% there etc. Rarely are all stock markets down all year and all real estate and bonds and cash. This way you don't get crippled because you don't have all your eggs in one basket (the USA) and you don't have to sell investments at half their value because they've dropped in price and you need to live.
Looking back at the spend your money down to zero, take out 4%, have 25x your spending in investments before quitting intercst plan, the 4% withdrawal plan is because part of your annual budget is coming from principle sales and part from returns. If you think sliding your assets down to zero in an uncontrollable manner is unsafe, then the basis of intercsts study and findings don't suit you at all. He's spending his capital down, you're not. This means the much relied upon 4% is wrong for you, it is based on extra returns coming over the short-term from selling lots of shares to reduce your principle down. This boosts the withdrawal rate in the short-term whilst adding the kind of risks discussed above. Furthermore, his study uses US historical investment returns. To be able to live off your investments spread into a mix of asset classes, the returns aren't exactly the same and so the data he used isn't completely applicable to you. You would want to use data that reflects your asset allocation mix and not assume it is all US stock and US bond returns. The market is also overvalued, so future expected returns in some markets like the US are expected to be lower for some few years. This may affect your planning too.
This is the kind of broader real-life thinking that is frequently discussed over at the www.nofeeboards.com, full of previous Fools who saw the flaws in the implications of intercsts study where his numbers were right, but FIRE methods wholly inappropriate for most investors. I'm happy to discuss your thoughts here but anyone is most welcome there who has a keen interest in the subject matter. I just could say nothing when I saw 4% w.d rate being manded around at a goal and the likely lack of understanding why that is so risky.
| There was also an earlier discussion where a dummy's book recommended comparing net worth to gross salary.
Petey, I'm one who won't return to TMF with its present management.
I wonder about this quotation and which book you are quoting. Similar material is found in The Millionaire Next Door for defining Prodigious Accumulators of Wealth (PAW) and related concepts. Are you are referring to this book, a favorite of mine and one I happily recommend? If so, let me register a mild mannered, ever-so-polite dissent from the pejorative "dummy's". I agree with you about looking at current and projected spending, rather than gross salary, in planning retirement spending and hence the required size of the FIRE stash. I also agree with The Millionaire Next Door that it valuable to look at PAW's and to consider how they got there. The authors say that the path you have chosen -- entrepreneurship -- produces the largest number of PAWs. (OK, I admit indulging here in an ad hominem argument. I enjoyed it. )
Last edited by peteyperson on Tue Sep 23, 2003 3:35 pm; edited 2 times in total