If you are an adherent follower of FIRE movement, chances are very slim that you did not hear about the 4% withdrawal rule. Have you heard about firecalc?
In 4% withdrawal rule, research study supports once you accumulate 25X of your annual expense you don’t need to worry about money to maintain your current lifestyle. In other words, you no longer need to work again.
Trinity study is the source of 4% withdrawal rule. Chances are you’re one among the many people who fiddled with retirement calculator tool to find out how much you need to retire.
For example, If you plan to spend is $30,000 annually , then your portfolio needs to be worth 25 * $30,000 = $ 600,000 in value. Assuming you will spend $30,000 every year, then you can withdraw 4% of it ($30,000) each year.
But if you plan to spend is $40,000 annually , then your portfolio needs to be worth 25 * $40,000 = $ 1 million in value. Assuming you will spend $40,000 every year, then you can withdraw 4% of it ($40,000) each year.
This rule gives you an idea how much you should have saved before you retire to maintain the current lifestyle. It’s plain and simple right!
But life and market cannot be fit in calculator. Its totally unpredictable, throws constant surprise at us. (Don’t you agree?)
Market consists years of booms, crash. Also it reacts to War, recession, political turmoil etc.
Kind of these situations are out of control for an individual investor. Then how do we know, how well your retirement portfolio fare in these market cycles?
I am not saying 4 percent rule is not effective. As an investor, Its our duty to know how our portfolio performs in keeping up with various market cycles.
What if there is a recession a year after you retired? So what happens to your portfolio.
What if there is a bull run year after you retired? So what happens to your portfolio.
What if there is a bear run year after you retire? So what happens.
As an investor we look at the an average returns of the index before we invest. But market has its own ways to perform, it never moves in straight line, nobody can predict where it moves next.
As an investor you would be concerned about your portfolio as market generates negative returns rate when you continue to withdraw.
To see where your portfolio stands on various market cycles, we use firecalc retirement calculator.
Firecalc is a retirement calculator tool to check where your portfolio stands using the data from the past.
Firecalc: Things to watchout
a) By default, it considers 75% invested in stocks and 25% invested in bonds.
b) It considers the expense ratio to be 0.18 %
C) It includes various market cycle since 1871.
It is more of a simulator than viewing it as retirement calculator tool. Here the portfolio value is $ 750,000 and yearly spending is $30K for 30 years. (Ignore 40 years in image)
Portfolio construction: 75 percent stocks and 25 % bonds.
Retirement years: 30 , Expense: 0.18
Withdrawal rate: 4%
The lowest portfolio value at the end of your retirement years: -$ 300,740
The average portfolio value at the end is $ 1,419,766 the highest value is $ 4,259,606.
Success rate of the portfolio is 95.1%, Meaning there is a 5% chance your portfolio might go below “zero” before the end of 30 years.
( Even $1 portfolio inclusive in success rate) I don’t see how a 90 year old man having $ 1 as success!
If you are person who is inclined to equity , not a conservative investor. Let us make the portfolio to be 100% stocks. Don’t like to throw money on expense. (Let’s include Vanguard S&P 500 ETF expense :0.03 percent)
Portfolio construction: 100 % stocks.
Retirement years: 30 , Expense: 0.03
Withdrawal rate: 4 %
The lowest portfolio value at the end of your retirement years: -$ 240,407
The average portfolio value at the end is $ 1,522,487, the highest value is $ 4,488,698.
Success rate of the portfolio is 96.7%. Changing expense from 0.18% to 0.03% increase the success rate 1.5 percent.
That is a meaningful difference.
Now a days people want to retire early instead of getting stuck in a cubicle. So 30 year retirement is RIP long ago. Thanks to Tim Ferriss.
People are retiring before the actual retirement. So they spend more than 30 years in retirement. We are going to see how our portfolio performs in 40 years of retirement.
since the year is more in retirement, I am deducting my withdrawal rate by 1%
Portfolio construction: 100% stocks.
Retirement years: 40, Expense: 0.03
Withdrawal rate: 3%
The lowest portfolio value at the end of your retirement years: $ 505,061
The average portfolio value at the end is $ 3,294,745 the highest value is $ 11,713,041.
Success rate of the portfolio is 100%. Hurray!
By reducing the withdrawal rate just by1 percent , our success rate is 100 % even when the retirement tenure is longer.
4 % percent withdrawal is safe, but 3 % withdrawal is even more safer. It forces you to make your portfolio larger to maintain your current lifestyle.