FIREcalc

Financial Independence/Retire Early -- Learn How!
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arrete
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FIREcalc

Post by arrete » Mon Mar 21, 2005 1:26 pm

My baby brother is up here in Maine with me. He really wants out of his job. He brought all his retirement data, etc. and I've been trying to convince him that he probably has enough to retire right now if he wants to. Dory36's calculator has been extremely helpful in this regard. Dory has made a lot of improvements I didn't know about. Anyway, being able to run various scenarios is really giving my brother an idea of what is going on with his investments in terms of ability to FIRE. You always use your own judgement and every case is different, but dory's calculator is a good way to ease a person into thinking about FIRE.

http://www.fireseeker.com/

arrete

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ben
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Post by ben » Mon Mar 21, 2005 1:38 pm

Fully agree. And let's not forget that the calculator is basing reply on the historical WORST case scenario :shock:. of a poorly diversified portfolio :shock:, US based only :shock:while blindly pulling a set % plus inflation increases nomatter WHAT the market does :shock:.

Each :shock:points out where one can do things differently and hopefully better.

Cheers!
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Post by peteyperson » Mon Mar 21, 2005 9:04 pm

ben wrote: Fully agree. And let's not forget that the calculator is basing reply on the historical WORST case scenario :shock:. of a poorly diversified portfolio :shock:, US based only :shock:while blindly pulling a set % plus inflation increases nomatter WHAT the market does :shock:.

Each :shock:points out where one can do things differently and hopefully better.

Cheers!



Does this take the worst return series but ignore current valuations and what that indicates about current future expected returns?

i.e. Int'l ScV long-run 13%, but next decade or two somewhat less than that? Surely this would affect what one can draw-down long-term and if the valuation is bad may put results below worst previous case because the start point was so bad? Siegel has just found the opposite case for railroad stocks where they started so damn cheap that they beat out the S&P 5oo index over time.

Petey

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Post by hocus2004 » Tue Mar 22, 2005 1:40 am

Does this take the worst return series but ignore current valuations and what that indicates about current future expected returns?

My understanding is that FIRECalc uses the results generated by the REHP study. That would mean that the analytical flaws of the REHP study are carried over to FIRECalc.

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Post by ben » Tue Mar 22, 2005 5:23 am

It does not make guesses about the future. Firecalc is based on history. The future might be different but some of the :shock:should help negate a future enviroment worse than the worst time in the past. Cheers!
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Post by hocus2004 » Tue Mar 22, 2005 6:48 am

It does not make guesses about the future. Firecalc is based on history.

You have it backwards, Ben.

FIRECalc is not only based on a guess, it is based on the most far-fetched guess imaginable. It is all rooted in the assumption that on the day of your retirement, the laws of investing will all be turned on their heads and for the first time in history, valuations levels will have zero effect on long-term returns. In the days when he was shooting straight, raddr posted a standard deviation analysis to determine how likely it was that this guess would come true in the real world. His analysis puts the odds of this at 1 chance in 740.

The Data-Based SWR Tool just looks at history and reports accurately how stocks will perform in the future in the event that they perform in the future somewhat in the way they have always performed in the past. No spin. Just a straight data-based analysis. That's the ticket, Ben. That's the way to go when you are seeking to make a determination as to whether your retirement plan is a safe one or not.

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Post by ben » Tue Mar 22, 2005 6:57 am

In current high valuation territory we do not have that many data points so anything can happen. Meanwhile even if FIREd at current valuations historically the 4% would hae survived and thereby have been safe. Right?
Cheers!
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Post by hocus2004 » Tue Mar 22, 2005 7:12 am

Meanwhile even if FIREd at current valuations historically the 4% would hae survived and thereby have been safe. Right?

I can't tell if you are kidding around on this one or not. The answer is "no, that's not right."

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Post by TRyan » Tue Mar 22, 2005 10:37 am

Wish the Dory calculator had a way to account for RE in your portfolio. Been using a 50/50 mix of stocks to bonds ... not knowing how to account for 50% rental RE.

Oh well ...
"Buy Low Sell High"

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Post by ben » Tue Mar 22, 2005 11:13 am

Yes one of my issues with current calculators is that they do not give us the chance to see how things would have worked out with a more modern portfolio structure - be it reits, commodities, PM, foreign equity, foreign bonds Etc.

There is of course a good reason for that; we do not have nearly as much data - even though raddr does some good footwork studies on adding commodities and foreign on raddr-pages.com:
As you can see, adding EAFE made a huge improvement in the historical SWR numbers. In fact, substituting EAFE for the S&P500 added a whopping 1.2%/yr. to the SWR, a > 30% improvement. A 50:25:25 mix of EAFE: S&P500 :Comm. Paper was not far behind at 4.9%.

Will international diversification help us going forward? We won't know the answer for a long time but I suspect that the value of international diversification may even be greater going forward. This is because for most of the past few decades neither the S&P500 or the EAFE were valued particularly high or low relative to each other. Now, however, the relative valuations have diverged and the S&P500 is trading at significantly richer valuations relative to the EAFE. I think that for this reason the EAFE has the better prospects in the next few decades. I'd be very leery of letting the equity portion of my retirement portfolio ride 100% on the S&P500 or TSM (Total Stock Market) index.



And the commodities conclusion:

http://raddr-pages.com/Retire%20Early%2 ... utures.htm you can scroll to the bottom for the conclusion. This would has a portfolio including both commo/sp500/scv/foreign/tips opf 20% each with a HSWR of 5.7%.

Again; as raddr points out in the text there is limited data for some of these asset classes and it does not predict the future - but to ME it does give me some usefull knowledge.

Cheers!
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Post by karma » Tue Mar 22, 2005 4:54 pm

I may give this dory calculator a try. Something simple is good to try and entice people to FIRE. I don't suppose the "tool" is explicit enough for anyone to use. If it is, I'd try that, too.

karma

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Post by peteyperson » Tue Mar 22, 2005 5:23 pm

ben wrote: Yes one of my issues with current calculators is that they do not give us the chance to see how things would have worked out with a more modern portfolio structure - be it reits, commodities, PM, foreign equity, foreign bonds Etc.

There is of course a good reason for that; we do not have nearly as much data - even though raddr does some good footwork studies on adding commodities and foreign on raddr-pages.com:
As you can see, adding EAFE made a huge improvement in the historical SWR numbers. In fact, substituting EAFE for the S&P500 added a whopping 1.2%/yr. to the SWR, a > 30% improvement. A 50:25:25 mix of EAFE: S&P500 :Comm. Paper was not far behind at 4.9%.

Will international diversification help us going forward? We won't know the answer for a long time but I suspect that the value of international diversification may even be greater going forward. This is because for most of the past few decades neither the S&P500 or the EAFE were valued particularly high or low relative to each other. Now, however, the relative valuations have diverged and the S&P500 is trading at significantly richer valuations relative to the EAFE. I think that for this reason the EAFE has the better prospects in the next few decades. I'd be very leery of letting the equity portion of my retirement portfolio ride 100% on the S&P500 or TSM (Total Stock Market) index.



And the commodities conclusion:

http://raddr-pages.com/Retire%20Early%2 ... utures.htm you can scroll to the bottom for the conclusion. This would has a portfolio including both commo/sp500/scv/foreign/tips opf 20% each with a HSWR of 5.7%.

Again; as raddr points out in the text there is limited data for some of these asset classes and it does not predict the future - but to ME it does give me some usefull knowledge.

Cheers!



Hi Ben,

This is only partly true.

To use quick'n'dirty example:

S&P 500 at P/E over 20 today.

Dividend 1.8%

Real historical S&P 500 growth 1.8%
(inflation 3.2% historically, total return 5% historically)

BTW, here we're not saying we know the future growth, we're saying companies over time have produced 1.8% real growth. This has been lower in the high inflation eras like the 70s but even then companies produced 1.1% real growth. The 70s did poorly because investors bid stocks down from P/E 15.5 to 7.5, not because earnings didn't keep up with inflation as is I think the common perception.

Lastly, P/E mean revision to between 14-16 (depending on whose mean valuation you accept - Bogle said 14.1x in his Common Sense book but more recently has said 16 like Grantham). Depending over what period you compress the priced - average has taken one decade to mean revert - this affects your long-run return by varying amounts.

The studies and calculators work on the basis that the S&P 500 produced 6.3% real from 1900-2004, but that a good chunk of that was lost due to selling underwater shares some of those years. This reduces the return to say 4.75% real and holding a proportion of bonds delivered maybe 2% real & mix those together and you get 4.06%. This is rough and dirty.

How useful is this today? Answer, not much. Why?

S&P 500 Dividend 1.8% + 1.8% Real growth +/- P/E expansion/contraction. If compacted over a 30 year payout, you lose 0.74% with P/E contraction (original studies use 30-year payouts).

S&P total real return (pre-tax): 2.86% real.

What one has to bear in mind is two things. Firstly one lost around 1.5% of real return due to selling underwater stock during past studies, even with bond diversification. The above 2.86% gordon equation result takes today's valuations, mean reverts them over three decades, but assumes no loss due to selling underwater from your starting FIRE position. This of course is not realistic as the studies do show. You lose something to having sell something every year for expenses. We can be smarter about allocations and avoid selling more often as I have indicated and more diviersified portfolios work to that end, but you'll still lose something. Being very generous we could say we only lose 0.50% instead of 1.5% for selling underwater. This reduces the S&P 500 real return over next 30 years to 2.36% real. This also assumes me don't have any high inflation periods where companies struggle to obtain the 1.8% real growth - we skirt over that possibility too. Also ignores fees. So overly optimistic assumptions and real returns a sad 2.36% real (pre-tax).

Substituting other asset classes for more balance will work, but their starting valuations in each case make a big difference as the S&P 500 clearly shows. The lack of P/E expansion which has padded returns over the years and the 2.7% lower dividend vs 4.5% historical dividend yield for the S&P 500 is the other component to why returns are so poor. However, one needs to run a gordon equation analysis as above in order to determine how something like the EAFE index might deliver.

EAFE Index growth approx. 1.5% real + 1.83% dividend - 0.55% P/E contraction (P/E 18.85 to 16 over 30 years) = 3.88 real. This excludes loss due to selling underwater. So call it 3.38% real. Mix EAFE and S&P 500 together and you get 2.87% real.

The problem though is that you've made a lot of optimistic assumptions there. Both ignores fees. One will need the value premium or the small premium - or both - to come out ahead and post real returns anywhere near 4% via indexing. Mixed with bonds, etc., this still won't get your 4% real. The numbers just don't add up.

Just as an aside, TIPS over 30 years using 10-year TIPS and reinvesting get an estimated 4% real with little taxes and cuts out volatility due to holding to redemption. This is why I think this is attractive as one asset in a collection of assets. I would drawdown over 40 years to ensure they lasted the remainder of the my lifetime, but given market levels TIPS/I-Bonds certainly have attractions on a returns-basis. Down the line we may again see value investments posting near or double-digit real returns but as things stand today we should pick assets in the distribution phase that give the best return for a given level of risk. On a risk-adjusted basis (whether you consider risk to be volatility or risk to capital), TIPS are very attractive held individually (not in a fund) and spent down.

Petey

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Post by BenSolar » Wed Mar 23, 2005 5:48 am

Hi Petey, nice post.
peteyperson wrote: Just as an aside, TIPS over 30 years using 10-year TIPS and reinvesting get an estimated 4% real with little taxes and cuts out volatility due to holding to redemption.


This line puzzles me though. 10 year TIPS don't offer any where near 4% real return. I guess you are talking about drawing down principle too?
"Do not spoil what you have by desiring what you have not; remember that what you now have was once among the things only hoped for." - Epicurus

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Post by peteyperson » Thu Mar 24, 2005 3:39 am

BenSolar wrote: Hi Petey, nice post.
peteyperson wrote: Just as an aside, TIPS over 30 years using 10-year TIPS and reinvesting get an estimated 4% real with little taxes and cuts out volatility due to holding to redemption.


This line puzzles me though. 10 year TIPS don't offer any where near 4% real return. I guess you are talking about drawing down principle too?



Yes that's right.

If one draws down principal over 30 years, that is 3.33% each year of principal. The remainder is the partial interest as you get the full sum in the first year and declining amounts of interest as the capital declines. This compares very favorably to a 75/25 S&P 500/Bond Index mix which has only given 4% itself over 30 years with considerably more risk to capital, risk of lower returns and volatility accepted. TIPS are held to 10-year maturity and so volatility is moot. :wink:

One can also get a little over 3% on 40 year payout which I think suits my perspective of retirement at 60, poss. 40 year payout (one hopes).

The only way the system works where you intentionally spend the capital is if it can cover your likely lifespan (this exceeds actuary estimates at age 65) and if the capital value can be determined ahead of time. If you hold 10-year TIPS to maturity in a ladder form with say a 20% allocation, 2% would come due each year, plus interest. One would spend the capital and reinvest some of the net interest as one does not use all of it in the early years to provide enough in the latter years as capital declines. This is a very tax-efficient asset allocation (79% of return is return of capital) so is unaffected by poss. hiked tax rates as boomers retire causing a strain on public finances, and any fall in coupon rates on TIPS doesn't have much affect on return as the majority of return when drawing down over 30- or 40-years is not from interest.

You will likely have more than enough left in stocks, real estate, etc., to give to charitable causes, family & friends and so on. Has to be individual TIPS though, a fund won't do. The trick is the automatic redemption each year providing guaranteed cash flow in wide market declines, as well as increased returns from bonds that has been typical in the past.

Petey

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