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Dangers of Relying on the 4% Rule in Early Retirement Scenarios

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  • #16
    Excellent article, The Happy Philosopher.

    I doubt most people (outside of WCI) talking about the 4% rule even realize it's (a) a probability (b) based on historical data using (c) a particular ratio of equities that covers (d) a maximum of 30 years retirement. It's treated like the Word of God handed down to Moses in the FIRE community. I believe the financial analysis of the studies is sound, but it's easy enough to violate any of those four guidelines. Another blogger recently extended the analysis to 60 years and came up with a "safe withdrawal rate" of 3.5%.

    Of course, any planned withdrawal rate is subject to using the crystal ball. Most people in their 30's and early 40's are delusional about projecting living costs thirty years down the road. There's simply too much life that's going to happen along the way. It's the equivalent of punching numbers into a retirement calculator, verifying there's a big fat number in the end and calling it quits on any future retirement planning.

    Personally, I'm not planning on any safe withdrawal rate or having SS benefits making life easier. If my portfolio consistently generates more than we're spending every year (active or passive involvement), we'll never run out of money. I don't care much about being buried with a huge net worth, but the financial peace of mind that comes with seeing an ever-increasing portfolio is hard to beat. Drawing down on retirement funds never appealed to me. That means being able to generate $200K in relatively passive income through investments, real estate, private loans and ownership in small businesses rather than selling off chunks of our portfolio.

    Instead of a "safe withdrawal rate", I think in terms of generating annual income with the fewest amount of hours. Everyone puts in some amount of time managing their retirement portfolio. After already taking a lengthy semi-retirement for the last couple years, I've come to realize that putting in some active hours each week is far more enjoyable than only doing "retirement" stuff. For someone who wants a safe withdrawal rate, it's the same as saying you'll be able to consistently generate a higher ROI than 3.5% to 4%. That's a pretty low hurdle for anyone willing to do something aside from sitting around while your index funds do their thing.

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    • #17




      Excellent article, The Happy Philosopher.

      I doubt most people (outside of WCI) talking about the 4% rule even realize it’s (a) a probability (b) based on historical data using (c) a particular ratio of equities that covers (d) a maximum of 30 years retirement. It’s treated like the Word of God handed down to Moses in the FIRE community. I believe the financial analysis of the studies is sound, but it’s easy enough to violate any of those four guidelines. Another blogger recently extended the analysis to 60 years and came up with a “safe withdrawal rate” of 3.5%.

      Of course, any planned withdrawal rate is subject to using the crystal ball. Most people in their 30’s and early 40’s are delusional about projecting living costs thirty years down the road. There’s simply too much life that’s going to happen along the way. It’s the equivalent of punching numbers into a retirement calculator, verifying there’s a big fat number in the end and calling it quits on any future retirement planning.

      Personally, I’m not planning on any safe withdrawal rate or having SS benefits making life easier. If my portfolio consistently generates more than we’re spending every year (active or passive involvement), we’ll never run out of money. I don’t care much about being buried with a huge net worth, but the financial peace of mind that comes with seeing an ever-increasing portfolio is hard to beat. Drawing down on retirement funds never appealed to me. That means being able to generate $200K in relatively passive income through investments, real estate, private loans and ownership in small businesses rather than selling off chunks of our portfolio.

      Instead of a “safe withdrawal rate”, I think in terms of generating annual income with the fewest amount of hours. Everyone puts in some amount of time managing their retirement portfolio. After already taking a lengthy semi-retirement for the last couple years, I’ve come to realize that putting in some active hours each week is far more enjoyable than only doing “retirement” stuff. For someone who wants a safe withdrawal rate, it’s the same as saying you’ll be able to consistently generate a higher ROI than 3.5% to 4%. That’s a pretty low hurdle for anyone willing to do something aside from sitting around while your index funds do their thing.
      Click to expand...


      Good points. I always feel a little stupid putting numbers into certain calculators, they dont account for reality really. Maybe for those that are set in their ways and have no other spending goals (ie, if its their and safe, spend it!). However, with us lots of big things like student loans roll off and spending is slated to increase in later years according to my plan and thats harder to account for. Its easy to get the answer you want assuming nothing changes but that is the opposite from the usual.

      Comment


      • #18




        Excellent article, The Happy Philosopher.

        I doubt most people (outside of WCI) talking about the 4% rule even realize it’s (a) a probability (b) based on historical data using (c) a particular ratio of equities that covers (d) a maximum of 30 years retirement. It’s treated like the Word of God handed down to Moses in the FIRE community. I believe the financial analysis of the studies is sound, but it’s easy enough to violate any of those four guidelines. Another blogger recently extended the analysis to 60 years and came up with a “safe withdrawal rate” of 3.5%.

        Of course, any planned withdrawal rate is subject to using the crystal ball. Most people in their 30’s and early 40’s are delusional about projecting living costs thirty years down the road. There’s simply too much life that’s going to happen along the way. It’s the equivalent of punching numbers into a retirement calculator, verifying there’s a big fat number in the end and calling it quits on any future retirement planning.

        Personally, I’m not planning on any safe withdrawal rate or having SS benefits making life easier. If my portfolio consistently generates more than we’re spending every year (active or passive involvement), we’ll never run out of money. I don’t care much about being buried with a huge net worth, but the financial peace of mind that comes with seeing an ever-increasing portfolio is hard to beat. Drawing down on retirement funds never appealed to me. That means being able to generate $200K in relatively passive income through investments, real estate, private loans and ownership in small businesses rather than selling off chunks of our portfolio.

        Instead of a “safe withdrawal rate”, I think in terms of generating annual income with the fewest amount of hours. Everyone puts in some amount of time managing their retirement portfolio. After already taking a lengthy semi-retirement for the last couple years, I’ve come to realize that putting in some active hours each week is far more enjoyable than only doing “retirement” stuff. For someone who wants a safe withdrawal rate, it’s the same as saying you’ll be able to consistently generate a higher ROI than 3.5% to 4%. That’s a pretty low hurdle for anyone willing to do something aside from sitting around while your index funds do their thing.
        Click to expand...


        Good points. I think people in their 40's start having a pretty good idea of what spending will be like going forward (minus a total disaster), but basing spending patterns on what we are doing in our 20's or early 30's is flawed. Our spending inflates naturally and stabilizes from about 35-55 according to BLS data I referenced in the article. Of course when health care is not subsidized by employer based insurance spending can really blow up, especially at the more modest/frugal income ranges.

        I  would say if you are generating more passive income per year that you can spend the 4% rule should not be on your list of concerns

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        • #19


          I  would say if you are generating more passive income per year that you can spend the 4% rule should not be on your list of concerns ?
          Click to expand...


          No question about that. ;-)

          More interesting is thinking about the difference between generating cashflow vs. increasing net worth for drawdown in retirement. My "real" investments started with buying residential properties and the analysis relies almost entirely on cashflow. No one cares much about future equity. It's nice to talk about and the properties will appreciate over time, but it doesn't matter much since why would I sell them?

          WCI views net worth and cashflow as equivalent because you can convert between them. That's not really true. Aside from transaction costs, there's a significant upfront time for finding and evaluating deals that generate worthwhile returns (unlike bank CDs). A $1M portfolio for a retirement investor is worth $25K annually. The same $1M spent on acquiring cashflow could easily earn $300K annually from buying a small business or equivalent. Even if I put another $50K into automating the business (mostly me not being there), that's 10x what the retirement investor will earn. And my returns are largely inflation proof since prices will increase over time.

          It's unfortunate that very few investors will build a $1M retirement portfolio (especially without including their home). That makes it a pretty impressive accomplishment. It also left me completely underwhelmed that achieving it meant getting only $25,000 of pre-tax money every year in retirement.

          Comment


          • #20


            After already taking a lengthy semi-retirement for the last couple years, I’ve come to realize that putting in some active hours each week is far more enjoyable than only doing “retirement” stuff.
            Click to expand...


            My plan exactly! I'm fortunate in that my specialty is easily amenable to part-time work, so am considering either locums or regular part time for when FI comes in a few years.... If I can easily make 50-100K per year with extremely limited work hours, that will put very little stress on the retirement portfolio, especially in the early years when we want to travel and spend more, and would provide flexibility in the event of bad sequence of returns issue.

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            • #21


              If I can easily make 50-100K per year with extremely limited work hours, that will put very little stress on the retirement portfolio
              Click to expand...


              I've had the exact same thought, but whenever I do the math, I come to the conclusion I'd rather work one year full time than numerous years at very-part-time.

              A more complete explanation and math in this post: Should I Take 40 Weeks Off Every Year?

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              • #22





                If I can easily make 50-100K per year with extremely limited work hours, that will put very little stress on the retirement portfolio 
                Click to expand…


                I’ve had the exact same thought, but whenever I do the math, I come to the conclusion I’d rather work one year full time than numerous years at very-part-time.

                A more complete explanation and math in this post: Should I Take 40 Weeks Off Every Year?
                Click to expand...


                Ponder this though - what to do when you are technically FI (using whatever metric you like). I'm assuming that part-time would be more desirable because you are either a little burned out or you just have a lot of things you want to do with your free time. If you go severely reduced time like you detail in your post (40 weeks off) you are really only working either for fun or to reduce sequence of returns risk. If markets do well you can stop completely and the result will be you worked part time instead of full time, in effect massively improving your lifestyle. If markets don't do well then you keep working. It is essentially a hedged bet that you win unless the market tanks...and then you win anyways because you still are working

                Also only making 50-100 you can do magic with the federal tax code...

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                • #23





                  I do come from a background/culture that makes me want to contribute to their college/grad school (which differs from many others here who may not feel such an obligation). My parents helped me significantly, but also persuaded me to make choices that ultimately meant I was able to go to undergrad basically for free due to scholarships, and then was able to use their support to only need relatively small loans when I pursued my medical degree (from a state school). I strongly disliked some of their advice at the time, but I reaped the benefits when I didn’t have 6-figure debt at the end of medical school the way all my friends did. I work now at a place where someone who went straight through undergrad and medical school without some scholarships/family support would easily have $400k in loans (tuition alone adds up to $400k for those 8 years, so it’ll be more than that when other costs are added in). 
                  Click to expand…


                  I do come from a similar couture where parents bear the cost of children’s education, who in turn does the same to their children and also help support the parents in old age.

                  But I also hate being socked with high costs of tuition just because I am a saver who leads a careful life whereas others who squandered away their chances and are in low paying jobs and they get a free ride that my daughter can’t. So if the privates do not offer merit based scholarship I will send mine to a state school and reserve the money for a graduate / medical / business school.
                  Click to expand...


                  My son is a senior in high school, and we are engaged in the college tour and selection process. In one particular (private) university presentation, it was virtually transparent that if you are admitted and cannot afford to attend, those that could would be essentially paying your way. I guess that it is like this in many other areas of society: healthcare, public education, food, housing, etc., but in a discretionary spending setting, this left a bit of a bad taste in my mouth AND made me feel badly about feeling badly about it!

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                  • #24




                    2) FIRE via extreme monetary efficiency is great (MMM method) but much more susceptible to having the boat capsized by major life events like illness, divorce, etc. because there is less margin for error.
                    Click to expand...


                    This so much!

                    Not only are you so much more susceptible to having your boat capsized by something unexpected, but you become completely committed, entrenched, enslaved by this lifestyle the further into it you go, the longer you are retired, the more years that go by that you work less, etc.

                    You might be happy with the idea of a MMM lifestyle today, but in 10 years you might want to go out and do something exciting, or you might have some opportunity present itself, and all you have is regret.  You can't go back and make money that you passed up.  Those dollars are lost forever.  And the future earning potential diminishes with every passing year in which you become that much less employable, your skills diminish, and so on.

                    Of course MMM lifestyle could work out wonderfully, your needs and tastes and hopes and dreams may never change, and your spouse will stay completely content through all of this, all the way until you die.  But the MMM lifestyle starts out by digging yourself in a hole and digging it a little deeper every day, forever and ever.

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                    • #25
                      I object to the high cost of tuition because of this fun fact: "The 6-year graduation rate for first-time, full-time undergraduate students who began their pursuit of a bachelor's degree at a 4-year degree-granting institution in fall 2008 was 60 percent." All the financial pain with none of the theoretical career benefits.

                      It's under 40% for graduating within four years.

                      I don't know many parents saving for college who are planning on 6-8 years for the four year program.

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                      • #26
                        The biggest problem I have with the MMM lifestyle is simply that it is all eggs in one (small) basket. It may be great to retire at 35 and live on 20k/year, but all it takes is an SUV sideswiping your bike putting you in the hospital to ruin your family's finances forever. The hospital bills eat through the 1M that was supposed to last forever, and when you can finally work again, people find out that you haven't worked in 4 years and give you the "don't call me, i'll call you" routine. Then what? I'm a firm believer in having Plan B, C, etc for life because you just never know.

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                        • #27
                          The other issue with the MMM lifestyle is the MMM lifestyle.  We live a reasonable lifestyle, yet still enjoy many of the world's pleasures (great vacations, good wines and scotch, enjoyable activities around town) without breaking the bank.  Spending 8,000-10,000 a month is plenty for all the things we enjoy doing, and saving a lot on our physician salary.  I agree with having backup plans, but do not really desire the MMM lifestyle to begin with.

                          I believe we have reached financial independence, yet are still aiming for financial freedom (http://www.physicianonfire.com/financial-independence-versus-financial-freedom/).

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                          • #28




                            The other issue with the MMM lifestyle is the MMM lifestyle.  We live a reasonable lifestyle, yet still enjoy many of the world’s pleasures (great vacations, good wines and scotch, enjoyable activities around town) without breaking the bank.  Spending 8,000-10,000 a month is plenty for all the things we enjoy doing, and saving a lot on our physician salary.  I agree with having backup plans, but do not really desire the MMM lifestyle to begin with.

                            I believe we have reached financial independence, yet are still aiming for financial freedom (http://www.physicianonfire.com/financial-independence-versus-financial-freedom/).
                            Click to expand...


                            I completely agree, though it is an anathema (I love using that word) in early retirement discussions. I like good beer/wine, I need one or two great trips per year, and I like comfortable socks (not the cheap ones you get at Target). If I have to do a little part time work to afford those things in retirement (working at REI or Trader Joe's), so be it, dammit!

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                            • #29
                              That is a great word, and I also love it. Absolute agreement.

                               

                              You could have just said, "the problem with the MMM lifestyle is its the MMM lifestyle". Ha.

                               

                              I said this on some other site, its kind of odd that we find one persons lifestyle more moral or great just because its ascetic and we are a bit in awe of it. In reality there is no true "best" lifestyle and its what makes him happy, if doing menial tasks gives you a sense of being, great! Im happy for you, and there is nothing wrong with that...for you. It certainly doesnt do it for me, and there is no reason to feel bad about it or like its less of a life or youre an extravagant person. Different strokes for different folks, nbd. He gets enjoyment from those kind of things, and I'll just keep doing me. No need to ascribe value, other than the monetary value that represents the gap in our lifestyle choices of course.

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                              • #30
                                Ascetic is another great word

                                If you take the MMM lifestyle to its next logical step, the blog becomes a single post "Here's how I sold my house and rented this chilled tube so I can save so much money by living the rest of my life in frozen hibernation.  I only have to eat ONCE a YEAR and waste ZERO dollars on entertainment.  Who doesn't love a good sleep?"

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