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Author: Eldrehad Big gold star, 5000 posts CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 27660  
Subject: Eldrehad's School of Inflation Date: 4/24/2003 7:59 PM
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I posted this to answer someone's question about how much one needs to have in a retirement fund when the retire... to answer the question "How much do I need to save?"

I thought some of the folks might benefit from it... and hey, I thought it was not a badly written post, if I do say so myself... okay, maybe I wannt toot my own horn a bit too, but why not? It's my horn, isn't it?

By the way, for those unfamiliar with it, the term 'SWR rate' used below stands for 'Savings While Retired' - in other words it's the rate of return your portfolio will earn while you are in retirement (as opposed to saving for retirement).

Okay... with out further ado...

[Que applause... okay, it's only me clapping, but at least it's not as obnixious as that horn!]

~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~

One thing to keep in mind when deciding on a SWR rate, or even a long-term return rate for your investments going forward (what rate you're using to decide how much you need to put away each month to get that $1.25 million at retirement) is inflation.

Now we could say "I need $50,000 in today's dollars, so that's 30 years off and I'll assume inflation is 3.5%, so I crank everying into my calculator or fire-up Excel and... viola! Okay... now I'll have the right sized nest egg in today's dollars, but using a 4% SWR rate - hmmm... 4% in the first year will give me my $50K, but what if I live to the age of 90? Inflation's going to take a bit out so... (firing up Excel once more)... inflation on the savings side prior to retirement, inflation while in retirement... Calgon take me away!!

Well... you're in luck. Welcome to Eldrehad's shool of inflation. How do deal with those nasty inflation scenarios which make my rate of return calculations messy, in one single step.

[Fade to Eldrehad's school of inflation.]

Ready for the first and only lesson?

Professor Eldrehad: "Okay class, ready for the first and only lesson regarding how to deal with those nasty discounting calculations of the effects of inflation?"

Student #1 & #2 in unison: "Fire away Professor"

Professor Eldrehad: "Okay... lesson number one is: Ignore it."

Student #1: "Say what? Where's my refund, Eldrehad's a nutcase! What planet did this crackpot come from?"

Student #2: "Hey teacher... if we're supposed to ignore inflation, how about you lend me, say, $100,000, and I'll pay you back in say, 30 years... ignore inflation right, sounds like a fair deal then doesn't it?" (Rubbing hands eagerly together as she contemplates putting the $100K in a money market fund, reaping the interest payments, and returning the $100K some 30 years later to that poor unsuspecting fool of a teacher.)

Professor Eldrehad: "Okay... maybe 'ignore it' wasn't the right word, but you don't have to calculate it, at least not separately."

Student #1 begins heading for the exit, but decides student #2 is pretty cute and thinks he might stick around and ask her out to coffee after class.

Student #2 sticks around, still holding out hope for that interest free loan.

Professor Eldrehad: Clears throat and continues, "What I mean is, you don't have to calculate the effects on inflation if you use inflation adjusted rates of return in the first place."

Student #1 looks dreamy-eyed at student #2.... (I wonder if she prefers decaf or regular?)

Student #2 looks a bit crestfallen, sighing to herself (I'm not sure where he's going yet, but that interest free loan is looking less and less likely).

Professor Eldrehad: "For example, you wanted $1.25 million in your portfolio, in today's dollars, when it's time to retire, right? How do we get there? Well, if we start with $1.25 million as the goal and use the historical 10-11% long-term stock market average rate of return, we can certainly calculate how much you need to put away each month... but that only tells us how to get to $1.25 million in those future dollars, not today's. So what some do is say, "Okay, so... what's $1.25 million in today's dollars 30 years from now?" They run the calculation based on the historical average inflation rate (3-4% usually), come to a figure, and then make their other calculation based on the 10-11% stock market rate. Sound about right?"

Student #1 thinks to himself "I wonder if that Starbucks discount card is in my wallet"

Student #2: "Yeah... that's how I usually do it, there's another way? I mean you said I could ignore inflation, or at least not have to direcly calculate it... but how?"

Professor Eldrehad: "Yes, like I said, use the inflation-adjusted rate of return in the first place. We know that the long-term market averages a 10-11% return, agreed? So the inflation-adjusted rate of return is 10-11% minus 3-4% or somewhere in the neighborhood of 7%. 10 minus 3 and 11 minus 4 are both 7. So to get $1.25 million in today's dollars in 30 years, just use 7% as the inflation-adjusted rate of return and calculate how much your corresponding monthly savings must be to get there. Now you only have to do one complex calculation instead of two."

Student #1: Thinks to himself, "How much longer is the professer going to go on? Oh drat! Did I forget to brush my teeth after lunch?"

Student #2: Well that's certainly easier, but you said it'd work in retirement too... with the SWR rate, right?"

Professor Eldrehad: "Yup... all you have to do is use an inflation adjusted SWR rate as well. Now take your $1.25 million, what kind of perpetual income will that $1.25 million provide you if you invest in bonds that, say, return 7%?"

Student #1: (Maybe I have some gum in my pocket... must have gum before I ask her to coffee)

Student #2: "Well, the rate is 7%, so to calculate the inflation adjusted rate like you did, I subtract the inflation rate, and I'll use the low-end of the 3-4% range, or 3%... 7% minus 3% is 4%. So I've got an inflation adjusted SWR rate of 4%. $1.25 million multiplied by 4% is... $50K! Aha! so maybe I should make sure I invest my $1.25 million at 7% instead!"

Professor Eldrehad: "Exactly, but if 7% seems too risky for you in retirement that's fine... choose whatever rate you want, convert it to an inflation adjusted rate, and then see what new figure pops up as the lump sum you need when you are ready to retire. Of course, then you'll want to recalculate the new monthly dollar amount you'll need to squirrel away, again using the inflation-adjusted rate of return."

Student #1: ($1.25 million, is that what she said? Not only is she cute, she's rich! Dang! I need to find my gum!)

Student #2: I get it now... 'ignore inflation' by using inflation adjusted rates in all of my calculations. Calculating the inflation adjusted rate is a heck of a lot simpler than doing the whole separate discounting calculation I was doing before. Thanks Professor!

Professor Eldrehad: No problem.



Regards,

Eldrehad
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Author: Turtlicious Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5316 of 27660
Subject: Re: Eldrehad's School of Inflation Date: 4/24/2003 8:43 PM
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Hi Eldrehad, nice post!

If you don't mind, I have a couple of questions.

1) I thought SWR meant "Safe Withdrawal Rate." I don't understand how "Savings While Retired" fits.

2) If while saving for retirement you anticipate your rate of return to be 10-11% as per the historical averages, then why/how will the rate of expected return suddenly change to 7% when you actually retire?

Thanks in advance,
Turtle
~where is that dratted honking coming from?? ;-)



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Author: Eldrehad Big gold star, 5000 posts CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5317 of 27660
Subject: Re: Eldrehad's School of Inflation Date: 4/25/2003 10:33 AM
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1) I thought SWR meant "Safe Withdrawal Rate." I don't understand how "Savings While Retired" fits.

You know what... maybe it does mean "Safe Withdrawl Rate"... at least maybe it means that for most people. Okay... here's how my Savings While Retired rate fits.

Assume that as a retirement income I decide I want/need $50K per year. To make this simple, we'll ignore Social Security... or at least say that I decide I need a $50K income from my retirement portfolio, above and beyond anything that Social Security or other non-portfolio sources might provide. How big of a retirement nest egg do I then need to provide this income?

I'm a conservative fellow... and in my example the conservative approach is also the easiest to calculate. My approach is, "How much money do I need to have in the bank (or in bonds, or whatever) in order to guarantee that $50K income for life? For simplicity's sake, in the previous example I was using a perpetuity... finding out how much money I need to have in the bank in order for it to provide me $50K per year forever, without ever having to touch a dollar of the principal.

So if I decide to invest in bonds at, say, 7% - I take the annual interest payments divided by the annual interest rate and....

$50K / 7% = $714,286

So if I have $714,286 invested at 7%, the interest payment will be $50K per year, forever, so long as I never touch the principal and the interest rate does not change.

That's the underlying philosophy behind the SWR idea I wrote about earlier. But again, if the bond pays a nominal (on its face) interest rate of 7%, am I really getting 7% considering the effects on inflation? That $50K might be worth $50K during my first year of retirement, but what happens when I live to be 90? What about in my fifth year of retirement, or my 30th? That's where the inflation-adjusted rate kicks in. If I use the inflation-adjusted rate the calculation becomes:

Income desired / (Nominal interest rate - inflation rate) = Lump sum reqired

Or: $50K / (7%-3%) = $1.25 million

So in order to guarantee me that $50K income forever without having to touch the principal, invested at 7% and accounting for an inflation rate of 3%, I'll need $1.25 million.

Again... this is a very conservative approach. Many folks will tell me, "But you're not going to live forever, so you're overestimating your need. If you assumed you 'ate up' just a little bit of your principal every year, you'd find you didn't really need $1.25 million, you'd need less than that."

They'd be absolutely right... but that calculation requires me to determine how long I'll live... after all, my first method will work if I live forever, but to calculate that smaller amount do I assume I live in retirement for 20 years, 30 years, 40 years? That assumption can make a big difference. Secondly, such a calculation is a bit more complicated than what I've outlined above. While this second approach is the one I generally use when planning my own retirement, the purpose of my original post was to point out the advantage of using inflation adjusted rates of return, rather than calculating the effects of inflation separately - a point that was easier to make using the more simple calculation method.

If while saving for retirement you anticipate your rate of return to be 10-11% as per the historical averages, then why/how will the rate of expected return suddenly change to 7% when you actually retire?

The assumption here is that while retired my portfolio will no longer be invested in 100% stocks. This is because while the stock market is one of the best (if not the best) investment vehicles in the long run, it's often far too risky in the short run. Saving for retirement that's a decade, or two, or three away is much more long run than when one is actually in retirement. If you're somewhere, say, in your 30's and the stock market tanks and you lose 50% of your portfolio overnight, but your retirement's still 30 years away, you've got 30 years to make it up. If you're already in retirement - ouch!!

That's why the expected return suddenly changed, in my example, to 7% - it's because that I assumed that one would perhaps have part of his or her portfolio invested in stocks, but certainly not all of it (some invested more conservatively... perhaps bonds, or money market funds, or a host of other possibilities).

Hope that helps...

Regards,

Eldrehad




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Author: Turtlicious Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5318 of 27660
Subject: Re: Eldrehad's School of Inflation Date: 4/25/2003 11:31 AM
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Thank you Eldrehad, that does indeed help!

I really like the simpler calculation.

I am also very conservative and I certainly do not want to run out of money if I happen to live longer than expected. :) I like to plan for contingencies and keep my options open. And anyway, I don't mind leaving an inheritance to my kids. :)

The assumption here is that while retired my portfolio will no longer be invested in 100% stocks.

Ahhhh, okay. <click, and then there was light>

Thank you very much for explaining. I am bookmarking your post so I won't ever lose that formula. I will now sound very intelligent when I explain to DH why we need X dollars before he can retire. :)

Turtle
~grateful

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Author: Eldrehad Big gold star, 5000 posts CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5319 of 27660
Subject: Re: Eldrehad's School of Inflation Date: 4/25/2003 11:48 AM
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Thank you very much for explaining. I am bookmarking your post so I won't ever lose that formula. I will now sound very intelligent when I explain to DH why we need X dollars before he can retire. :)

I'm sure you would have sounded very intelligent anyway. :-)

Just one final thought... using the simpler formula will obviously lead to a 'need' result that is higher than the more complex calculation. Now... for some that's just what the Dr. ordered - better save too much than not enough these folks might say.

For others, they'll look at that higher number, then calculate how much they need to get there, and toss their hands up in the air and say, "My goodness... I can't save that much!" Frustration, for some, will lead to inaction - where if they made the more complex calculation and used the lower figure for their 'need' they might say, "Hey, I can do that!"

If this situation applies to you, or anyone else who happens to stumble upon this post, I can offer one suggestion. There are a lot of retirement calculators out there - some pretty good ones can be found via links here at the Fool. Some of these will ask you how much you want to have at death, how long you expect to be in retirement, etc., and do the more complicated calculation for you.

If these calculators don't ask you for your assumed inflation rate, chances are you're not getting inflation adjusted results (again, chances are... without 'testing' the calculations, I couldn't say for sure). If that's the case... whenever the calculator asks you for a rate of return on your investments, plug-in the inflation adjusted rate instead of the nominal (on its face) rate. This way you can get the calculator to take inflation into account, whether it asks you for your assumptions about inflation or not.

Regards,

Eldrehad





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Author: dsemmler Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5320 of 27660
Subject: Re: Eldrehad's School of Inflation Date: 4/25/2003 11:50 AM
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I just want to chime in with some comments here. I have been reading the Retire Early board here at the Fool and many of the people there discuss using a 4% safe withdrawal rate while in retirement. By this they mean, you can take 4% of your portfolio as your income each and every year.

In order to determine how much you will need, take the amount you want as your yearly income and simply divide by .04 to get the total you will need to sustain that income.

By doing this, you really eliminate the expected rate of return minus the inflation adjusted price. In the reading I have been doing there, it seems 4% is the key number for your SWR regardless of the other factors. To me, that calculation is even easier than adjusting for the price of inflation and your current/expected rates of return.

For example, you want $50,000 per year. Divide that by your future 4% SWR and you get the $1.25 million you discussed. If you want $80,000 per year, divide by 4% and you get $2 million. Basically, for every $10,000 you want in retirement income, you need to save $250,000 assuming a SWR of 4%.

I am a long way from retirement and this is my interpretation of what I have been reading on the RE board so I may have over-simplified it, but it appears to work the same as your calculations without the need for adjusting the rate by inflation.

dt

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Author: Eldrehad Big gold star, 5000 posts CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5321 of 27660
Subject: Re: Eldrehad's School of Inflation Date: 4/25/2003 12:25 PM
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For example, you want $50,000 per year. Divide that by your future 4% SWR and you get the $1.25 million you discussed. If you want $80,000 per year, divide by 4% and you get $2 million. Basically, for every $10,000 you want in retirement income, you need to save $250,000 assuming a SWR of 4%.

I am a long way from retirement and this is my interpretation of what I have been reading on the RE board so I may have over-simplified it, but it appears to work the same as your calculations without the need for adjusting the rate by inflation.


Ahhh... okay... looks like I corrupted the commonly-held definition of SWR a little, thanks for the clarification!

You are right, simply picking an SWR rate as you described is indeed much simpler than what I'm talking about, but that said there are still just a couple of points I'd like to make.

First, if we desire an income of $50K and assume an SWR rate of 4%, we'll get the 'need' of $1.25 million. First, however, I'd point out that if you're using $50K in today's dollars as your desired income, the $1.25 million 'need' will also be in today's dollars. So when you figure out what it'll take to get there, you still have to take inflation into account.

Secondly, just because the SWR rate of 4% doesn't necessitate that we calculate inflation-adjusted return rates doesn't mean that we're not making assumptions as to what those are. In fact, whatever rate we choose for our SWR, we are making these assumptions, it's just that they're implicit, or hidden. It's these assumptions (among others) that led us to choosing the figure of 4% as opposed to 3% or 5% for example. That said, I personally prefer to use calculations where these assumptions are explicit. The reason is, by simply taking 4% as an 'acceptalbe' SWR rate, I'm allowing someone else to make these assumptions for me. I'd much rather make them myself - but that's me, do what you are comfortable with.

Just as saving that 'magic' 10% of our income for retirement is a widely accepted figure, that figure won't be appropriate for everyone. I'd make the same argument with regard to SWR. 10% is widely accepted as a % of income saved, but how do I know whether it'll work for me? I have to do the calculations in more detail to find out for sure... same with the 4% SWR... I don't know if that'll work for me unless I do the more detailed calculations here as well.

Also... I'd like to extend an offer... if anyone would like me to walk through a set of specific figures... walk them through how I'd use inflation adjusted return rates to calculate what they think they need for retirement, I'd be happy to do so. I think it might help others who stumble upon this thread to see exactly what it is I'm suggesting, figure out how to tailor it to their own situation, and decide for themselves if this method (or some other method) better suits their needs.

Again... this is my approach, there are others that work perfectly well and have been effectively used to accomplish the same goals.

Regards,

Eldrehad



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Author: dsemmler Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5322 of 27660
Subject: Re: Eldrehad's School of Inflation Date: 4/25/2003 1:38 PM
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10% is widely accepted as a % of income saved, but how do I know whether it'll work for me? I have to do the calculations in more detail to find out for sure... same with the 4% SWR... I don't know if that'll work for me unless I do the more detailed calculations here as well.

Very good point. It never hurts to be as specific as possible pertaining to your individual situation.

Also... I'd like to extend an offer... if anyone would like me to walk through a set of specific figures... walk them through how I'd use inflation adjusted return rates to calculate what they think they need for retirement, I'd be happy to do so. I think it might help others who stumble upon this thread to see exactly what it is I'm suggesting, figure out how to tailor it to their own situation, and decide for themselves if this method (or some other method) better suits their needs.

As I mentioned, I am very green in this area and would absolutely love it if you were to walk through an example with specific figures. I agree that it will help others, myself included, see how to calculate the numbers as specifically as possible. Thanks for the offer to do this for those of us that are still learning!

dt

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Author: Eldrehad Big gold star, 5000 posts CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5323 of 27660
Subject: Re: Eldrehad's School of Inflation Date: 4/25/2003 3:08 PM
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As I mentioned, I am very green in this area and would absolutely love it if you were to walk through an example with specific figures. I agree that it will help others, myself included, see how to calculate the numbers as specifically as possible. Thanks for the offer to do this for those of us that are still learning!

Okay… I'll go ahead and walk through a set of calculations from start to finish in order to demonstrate how I use inflation adjusted rates of return in order to determine how much I need to have in my portfolio on the day I retire, and how much I need to squirrel away now to get me there. Please note, I'm trying to demonstrate how using inflation adjusted rates work, so will keep the calculations and assumptions simple. Your own situation will vary for a number of reasons, and I'll try to point out along the way some of the other things you might want to consider, but I'm certainly not going to be able to address all of them in just one post.

The place I usually like to start with is, “How much do I need when the day to retire comes?” Again… we can make a lot of assumptions about Social Security, whether one will work during retirement, whether one's retirement funds will be tax free or not (are they in a traditional IRA? A Roth IRA? Fully taxable account?) etc. For the sake of simplicity let's assume that we desire to retire at age 65, expect to live until age 95, and want to leave $100,000 to our heirs – and that we want an income of $50k per year while in retirement… and that's $50k in today's dollars – we'll simply ignore all of these other issues for now. Other assumptions we need to make are – how much interest will my retirement portfolio earn? What will the rate of inflation be? We'll change our old assumptions a little and assume that the retirement portfolio will earn 8% and inflation will be at 3%.

Okay… the first calculation method we went over was to treat retirement income as a perpetuity, in other words, how much money do I need if I want to get $50k in income, forever, without ever having to touch the principal – while accounting for inflation? Please note: all of the 'Need' calculations that follow are in today's dollars, just as the $50k income we want is in today's dollars. That, after all, is the beauty of using inflation adjusted rates in every single calculation we make - it automatically converts everything into today's dollars.

That one was as follows:

'Need' = Desired income / (nominal interest rate – inflation rate)

'Need' = $50k / (8% - 3%)

'Need' = $1 million.

Alternately, we can use the 'accepted' SWR rate at 4%, and that calculation would look like this:

'Need' = $50k / 4%

'Need' = $1.25 million

The first calculation doesn't exactly suit our needs because it would leave $1 million to our heirs, and not the $100,000 we wanted to leave – while our heirs might not complain, we'd have to save more money to get there – and we really want to take that trip to Bermuda next fall, so we'd rather not save more than we half to so long as our main goals are accomplished. The second calculation just uses an 'accepted' figure – we really don't know whether this is appropriate for our situation or not.

Unfortunately, the calculation we really need to make is an awful lot more complex. I'll try to provide an example as best I can, and if I lose you, feel free to reply with questions.

Okay… some basic ground rules. I know I'll be in retirement for 30 years (retire at 65 and live to 95) and want to leave $100k behind. I know I want to withdraw $50k per year for each of those 30 years in today's dollars, so how do I get there? I personally like using Excel, so I'll use it here. If you don't have Excel or aren't familiar with it, there are online calculators available that will make the calculation for you – but I'd suggest using the inflation adjusted rate as outlined before.

So… we'll make my 7th grade algebra teacher proud and call that unknown, lump sum retirement 'need' X. I know that my nominal interest rate is 8%, and inflation is 3%. I also know that I'm going to withdraw $50K. So what does year one look like?

Balance at beginning of year 1 = X

Balance at end of year 1 (beginning of year 2) = (X - $50k) x (1 + (8% - 3%))

Note: the above calculation assumes that the $50k is withdrawn at the beginning of the year and that interest is compounded annually at the end of the year. Changing these assumptions will change the answer, but not significantly, so I think we're reasonably safe in making them.

And we keep making this calculation over and over again…. Year 2 looks like:

Balance at end of year 2 = (Balance at end of year 1 (from above) - $50k) x (1 + (8% - 3%))

And so on and so on and so on… finally we get to year 30… now calculating this by hand is near impossible, because we'd have 30 of these calculations all strung together on one side of the = sign, and $100k on the other (the amount we want left at the end of year 30, beginning of year 31) – even my 7th grade algebra teacher would have trouble solving for X! So I use Excel.

For those using Excel, and who want to follow along at home, I put the 'Need' in cell A1. I started with $1 million just as a placeholder. Using the above formula, I put the following Excel formula in cell A2:

=+(A1-50000)*(1+(0.08-0.03))

To the right of cell A1 (in cell B1) I just wrote the word 'Need', and to the right of cell A2 (in cell B2) I wrote the words 'End of Year 1'. My little spreadsheet, so far, looks like this:

$ 1,000,000 'Need'
$ 997,500 End of year 1

Now all I have to do is copy and paste the formula in B2 all the way down, and copy and paste End of year 1 all the way down (making it end of year 2 and 3, etc) until I get to end of year 30. My spreadsheet now looks like this:

$ 1,000,000 'Need'
$ 997,500 End of year 1
$ 994,875 End of year 2
$ 992,119 End of year 3
$ 989,225 End of year 4
$ 986,186 End of year 5
$ 982,995 End of year 6
$ 979,645 End of year 7
$ 976,127 End of year 8
$ 972,434 End of year 9
$ 968,555 End of year 10
$ 964,483 End of year 11
$ 960,207 End of year 12
$ 955,718 End of year 13
$ 951,003 End of year 14
$ 946,054 End of year 15
$ 940,856 End of year 16
$ 935,399 End of year 17
$ 929,669 End of year 18
$ 923,652 End of year 19
$ 917,335 End of year 20
$ 910,702 End of year 21
$ 903,737 End of year 22
$ 896,424 End of year 23
$ 888,745 End of year 24
$ 880,682 End of year 25
$ 872,216 End of year 26
$ 863,327 End of year 27
$ 853,994 End of year 28
$ 844,193 End of year 29
$ 833,903 End of year 30

Wow! I'm leaving $834k to my heirs… too much.

Side note: Some Fools are probably saying "Hey! the first calculation you made with these assumptions said we'd leave $1 million to our heirs, and now we're only leaving $834k what gives?" The difference here is simply one of timing. The first, simple calculation assumed that the $50k, under this scenario, was withdrawn at the end of each year and not the beginning. If we change the longer calculation's formula to reflect that assumption, we'd have $1 million at the end, just like the first example. See what I meant about certain calculation methods making assumptions for you that you didn't even realize you were making? Okay... side note over... onward!

Now it depends on what version of Excel you're using, but under the 'Tools' menu you'll probably find a function called 'goal seek' or 'solver'. This function will do the algebra for you. It may ask you for a target cell, a value, and what cell you want to change. In this case our 'target' cell is cell A31 – this is the cell we want to equal $100k, not $834k. The value is our $100k, and the cell we want to change is A1, or our 'Need'. So basically we're telling Excel “Tell me what 'Need' needs to be so that 'End of year 30' = $100k. When I do that, my spreadsheet looks like this:

$ 830,191 'Need'
$ 819,201 End of year 1
$ 807,661 End of year 2
$ 795,544 End of year 3
$ 782,821 End of year 4
$ 769,462 End of year 5
$ 755,435 End of year 6
$ 740,707 End of year 7
$ 725,243 End of year 8
$ 709,005 End of year 9
$ 691,955 End of year 10
$ 674,053 End of year 11
$ 655,255 End of year 12
$ 635,518 End of year 13
$ 614,794 End of year 14
$ 593,034 End of year 15
$ 570,185 End of year 16
$ 546,195 End of year 17
$ 521,004 End of year 18
$ 494,555 End of year 19
$ 466,782 End of year 20
$ 437,622 End of year 21
$ 407,003 End of year 22
$ 374,853 End of year 23
$ 341,095 End of year 24
$ 305,650 End of year 25
$ 268,433 End of year 26
$ 229,354 End of year 27
$ 188,322 End of year 28
$ 145,238 End of year 29
$ 100,000 End of year 30

Voila! Our need isn't the $1 million that the first calculation gave us, nor the $1.25 million our second calculation, but only $830,000. We might be able to afford that trip to Bermuda after all! And again, if you're using one of those online retirement calculators, just use the same assumptions - you'll live for 30 years in retirement, withdraw $50k per year, leave $100k to your heirs, and the interest rate your funds will earn in retirement is 5% (remember: we're using the inflation adjusted rate which is the nominal interest rate of 8% minus the inflation rate of 3%) and you should get a very similar result. Again, it might not be exactly the same depending on how the calculator works (assumes annual compounding of interest or monthly, for example), but it should be pretty darn close.

Another side note: Here's where the point of using the inflation adjusted rate instead of the nominal rate makes a big difference. If I make the exact same calculation as above, but use the nominal rate of 8% instead of the inflation adjusted rate of 5%, my 'Need' changes to $618k... a bit short of where we really wanted to be. Yes, you'll still get to withdraw $50k per year for 30 years and leave $100k, but that'll be $50k per year in those dollars, not inflation adjusted dollars, so while you'll still get the same $50k in year 30 as in year one, that $50k won't buy nearly as much as it used to.

Okay… rather than immediately answering the question, “How much do I need to save to get $830,000 in today's dollars in my account come retirement day” I'm going to take a little break. Two reasons… this post is pretty long as it is… and it'll give you a chance to digest and ask questions before we move on.

Feel free to reply with any questions/comments – or just to say, “Got it! Go ahead when ready!” or maybe even say, “You're a crackpot, don't bother going on 'cause I'm not gonna listen anyway.” ;-)

Okay… temporarily signing off…

Regards,

Eldrhead





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Author: TurkeyBreath Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5324 of 27660
Subject: Re: Eldrehad's School of Inflation Date: 4/25/2003 3:24 PM
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...“How much do I need to save to get $830,000 in today's dollars in my account come retirement day”...

More than my gross pay!

TB

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Author: dsemmler Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5325 of 27660
Subject: Re: Eldrehad's School of Inflation Date: 4/25/2003 3:48 PM
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Whew! I am saving that in my Reply Later so I can easily reference back for later digestion!

One concern here is what happens if your life lasts longer than you have planned? If you get to year 30 and you are still kicking, do you put yourself down or do you go out and get a job? :) I think this is a tricky thing to estimate but wouldn't you rather err on the side of having too much money?

You made mention of the money being taken either at the beginning of the year or the end of the year. If I follow correctly, is the amount needed less when taken at the end of the year because you have more money earning interest for a longer period of time? I just want to be sure I follow that.

Other than that, I don't have any additional questions from my first reading of the post. It is certainly a lot to digest and I thank you for the effort.

BTW, not sure if you know this or not but in Excel, if you click and hold the bottom corner of your cell and drag down, it will automagically copy/paste your formula and adjust for the new cell names. I wasn't sure if you were doing a physical copy/paste and then updating each cell. If so, this will save you a lot of time.

And thank you for putting it in terms of Excel. I love Excel and playing around with various spreadsheets and calculations.

dt

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Author: Eldrehad Big gold star, 5000 posts CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5326 of 27660
Subject: Re: Eldrehad's School of Inflation Date: 4/25/2003 3:53 PM
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More than my gross pay!

Maybe... but with luck we'll get to that calculation later... the whole point however is for me to try to teach at least one fellow Fool how to make these calculations for themselves.

That way if $830k is too much... they can try to figure out, by changing the assumptions, what will work for them.

Regards,

Eldrehad



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Author: Eldrehad Big gold star, 5000 posts CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5327 of 27660
Subject: Re: Eldrehad's School of Inflation Date: 4/25/2003 3:59 PM
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One concern here is what happens if your life lasts longer than you have planned? If you get to year 30 and you are still kicking, do you put yourself down or do you go out and get a job? :) I think this is a tricky thing to estimate but wouldn't you rather err on the side of having too much money?

You bet... outliving one's money is a frightening prospect. Assume you'll make it to 100, or 120 if that makes you more comfortable.

You made mention of the money being taken either at the beginning of the year or the end of the year. If I follow correctly, is the amount needed less when taken at the end of the year because you have more money earning interest for a longer period of time? I just want to be sure I follow that.

You are exactly correct. You follow it perfectly.

BTW, not sure if you know this or not but in Excel, if you click and hold the bottom corner of your cell and drag down, it will automagically copy/paste your formula and adjust for the new cell names. I wasn't sure if you were doing a physical copy/paste and then updating each cell. If so, this will save you a lot of time.

Ahh yes... my friend the fill handle, I know it well... I wasn't sure everyone would though, so I tried to make it as easy as possible. :-)

Regards,

Eldrehad




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Author: dsemmler Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5328 of 27660
Subject: Re: Eldrehad's School of Inflation Date: 4/25/2003 4:12 PM
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You bet... outliving one's money is a frightening prospect. Assume you'll make it to 100, or 120 if that makes you more comfortable.

I assume the same holds true if I want to retire at age 50 instead of age 65, correct? Just adjust the total time period accordingly.

Ahh yes... my friend the fill handle, I know it well... I wasn't sure everyone would though, so I tried to make it as easy as possible. :-)

Good point!

dt

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Author: Eldrehad Big gold star, 5000 posts CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5329 of 27660
Subject: Re: Eldrehad's School of Inflation Date: 4/25/2003 4:17 PM
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I assume the same holds true if I want to retire at age 50 instead of age 65, correct? Just adjust the total time period accordingly.

You got it! And you'll want to adjust the time period accordingly also when deciding 'How much to I need to put away to get there?'

Regards,

Eldrehad



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Author: admiraltroll Big gold star, 5000 posts Feste Award Winner! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5330 of 27660
Subject: Re: Eldrehad's School of Inflation Date: 4/25/2003 4:29 PM
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Excellent post Eldrehad. I have done many of these calcs but not using Excel - now why didn't I think of that :-)

Eldrehad Added to Fav Fools as much for the willingness to help others as for the content.

I would like to invite you to repost on the Foolish Collective board
http://boards.fool.com/Messages.asp?mid=18960165&bid=115096

Best Regards
Philip

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Author: Eldrehad Big gold star, 5000 posts CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5331 of 27660
Subject: Re: Eldrehad's School of Inflation Date: 4/25/2003 5:15 PM
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Other than that, I don't have any additional questions from my first reading of the post. It is certainly a lot to digest and I thank you for the effort.

You're welcome. :-)

Okay... now, this is how I'd approach the question, "How much do I need to save to get there?" Again, there's a lot of stuff I'm going to leave out for sake of simplicity in the calculations (taxes, how fast one's salary is going to grow, and a host of others), but hopefully this might serve to give you at least a decent starting point. Better to implement a plan that's not perfect and adjust and refine it along the way, than to get a late start because one was too busy trying to account for all of the possible details (not that those details aren't important, they can be very important, but I think you get my drift).

Okay... let's start with our 'Need'. We know that from the previous calculations (and for those turning in late look back a few posts in this thread and you'll find them) we need $830K on retirement day in today's dollars to achieve our goals.

So... how much do I need to put away in order to get there?

First, we need to make some assumptions. First, let's assume our portfolio earns a nominal rate of retrun of 10%, inflation is 3%, and we have 30 years until retirement day. Because many people like to talk about that 'magic' 10% (many suggest that saving and investing 10% of one's income is a good starting goal for retirement planning), let's start off with that figure, and adjust it if necessary. Let's also assume that we make $60k per year.

Side note: The calculation that follows is that we're making $60k per year each year for the next 30 years. "Aha!" you say "My salary is going to go up over time, what about that?" Again, we are making the calculation as simple as possible, but remember the earlier point... use inflation adjusted rates for everything in all our calculations. What does that mean in terms of our $60k salary? Well, if we assume our salary is going to grow by 3% per year, but inflation is also 3% per year, what's the inflation adjusted rate of our growth in salary? Well... 3% minus 3% is 0%. So... on an inflation adjusted basis, our salary always will be $60k in today's dollars. Bet you think I planned that out in advance, huh?

So what happens in year one? For the sake of simplicity let's assume we put that 10% in our retirement account at the beginning of each year, and interest is earned and paid at the end of each year. Yes, reality is it won't happen quite this way, but it shouldn't make a huge difference, so we'll stick with it for now.

Okay, let's fire up Excel and put in our assumptions. Starting in cell A1 I write 'Salary', next to that in cell B1 I enter $60,000. In A2 and B2 I load our next assumptions: '% Savings' and 10% respectively, then I do the same for 'Portfolio return'. Rember, we're looking at an inflation adjusted return rate which is the nominal rate (10%) minus the inflation rate (3%) so here we'll enter 7%. Finally below those I'm going to label my columns 'Beginning Balance' and 'Ending Balance' to keep track of how much is in my account in each year that follows. So far my spreadsheet looks like this:

Salary $ 60,000
% Savings 10%
Portfilio Return 7%
Beginning Balance Ending Balance

(Sorry... but I can't figure out how to copy the spacing over from Excel into this post and get everything to line up correctly... I hope you can still follow along)

Now to put in the formulas for the first year. The beginning balance for year one is going to be 10% of $60k (remember, we're funding our plan at the beginning of the year), or $6,000. The ending balance will have the $6,000 plus the interest on the $6,000 so the formula looks like this:

Ending balance = $6,000 x (1 + 7%)

In Excel, the beginning balance is in cell A5 and that formula is: =+B1*B2

The ending balance is in cell B5 and that formula is: =+A5*(1+$B$3)

Note: For those unfamiliar with Excel, those $ signs denote an absolute cell reference… that just means when we copy and paste this formula later, for example down one row, the A5 will change to A6 to reflect the next year's beginning balance, but B3 will not change – we don't want it to change as we want to use that 7% interest rate throughout.

Next, alongside these I write 'Year 1' in cell C5.

Now, we can't copy and paste down yet as we could in the last example, because we're still contributing every year. We'll put year two's starting balance below year one's in cell A6. That formula is going to be:

Year 1 ending balance + our contribution (which is 10% of our salary).

In Excel: =+B5+$B$1*$B$2

Again, we're using absolute references for B1 and B2 because we don't want our salary or % to change as we copy them down.

Now we can fill in the end of year balance, but since that's the same calculation we made for year one, we can copy the formula from cell B5 and put it in B6. Write 'Year 2' off to the right in cell C6 and our spreadsheet looks like this:

Salary $ 60,000
% Savings 10%
Portfilio Return 7%
Beginning Balance Ending Balance
$ 6,000 $ 6,420 Year 1
$ 12,420 $ 13,289 Year 2

Now we're ready to 'rock n roll'. Just copy row 6 all the way down until we get to 'Year 30'. After doing that my spreadsheet looks like this:

Salary $ 60,000
% Savings 10%
Portfilio Return 7%
Beginning Balance Ending Balance
$ 6,000 $ 6,420 Year 1
$ 12,420 $ 13,289 Year 2
$ 19,289 $ 20,640 Year 3
$ 26,640 $ 28,504 Year 4
$ 34,504 $ 36,920 Year 5
$ 42,920 $ 45,924 Year 6
$ 51,924 $ 55,559 Year 7
$ 61,559 $ 65,868 Year 8
$ 71,868 $ 76,899 Year 9
$ 82,899 $ 88,702 Year 10
$ 94,702 $ 101,331 Year 11
$ 107,331 $ 114,844 Year 12
$ 120,844 $ 129,303 Year 13
$ 135,303 $ 144,774 Year 14
$ 150,774 $ 161,328 Year 15
$ 167,328 $ 179,041 Year 16
$ 185,041 $ 197,994 Year 17
$ 203,994 $ 218,274 Year 18
$ 224,274 $ 239,973 Year 19
$ 245,973 $ 263,191 Year 20
$ 269,191 $ 288,034 Year 21
$ 294,034 $ 314,617 Year 22
$ 320,617 $ 343,060 Year 23
$ 349,060 $ 373,494 Year 24
$ 379,494 $ 406,059 Year 25
$ 412,059 $ 440,903 Year 26
$ 446,903 $ 478,186 Year 27
$ 484,186 $ 518,079 Year 28
$ 524,079 $ 560,765 Year 29
$ 566,765 $ 606,438 Year 30

As you can see, that 'magic' 10% leaves us just a little short of the $830k that was our goal. Again, good old 'solver' or 'goal seek' comes to our rescue. We set the 'target' cell, which in this case is our year 30 ending balance, as cell B34. We set this target cell to a value of $830,000 by adjusting our savings rate of 10%, which is in cell B2. So basically we're asking Excel to answer the question “What percentage of my salary do I need to put away in order to meet my savings goal of $830k (in today's dollars) 30 years from now? We let Excel do its thing and…. Voila! We get this:

Salary $ 60,000
% Savings 14%
Portfilio Return 7%
Beginning Balance Ending Balance
$ 8,212 $ 8,787 Year 1
$ 16,999 $ 18,188 Year 2
$ 26,400 $ 28,248 Year 3
$ 36,460 $ 39,013 Year 4
$ 47,224 $ 50,530 Year 5
$ 58,742 $ 62,854 Year 6
$ 71,066 $ 76,040 Year 7
$ 84,252 $ 90,150 Year 8
$ 98,362 $ 105,247 Year 9
$ 113,459 $ 121,401 Year 10
$ 129,613 $ 138,686 Year 11
$ 146,898 $ 157,181 Year 12
$ 165,393 $ 176,970 Year 13
$ 185,182 $ 198,145 Year 14
$ 206,357 $ 220,802 Year 15
$ 229,013 $ 245,044 Year 16
$ 253,256 $ 270,984 Year 17
$ 279,196 $ 298,740 Year 18
$ 306,952 $ 328,438 Year 19
$ 336,650 $ 360,216 Year 20
$ 368,428 $ 394,218 Year 21
$ 402,429 $ 430,599 Year 22
$ 438,811 $ 469,528 Year 23
$ 477,740 $ 511,182 Year 24
$ 519,394 $ 555,751 Year 25
$ 563,963 $ 603,441 Year 26
$ 611,652 $ 654,468 Year 27
$ 662,680 $ 709,068 Year 28
$ 717,279 $ 767,489 Year 29
$ 775,701 $ 830,000 Year 30

So as it turns out, based on our assumptions, we need to squirrel away about 14% of our salary every year (or month or week, however we want to do it) in order to fund our retirement goals… those goals being an inflation adjusted income of $50k per year for 30 years, leaving $100k in the account at the end of year 30, presumably to leave to our heirs, cover our final expenses, whatever.

When doing these calculations I always like using % of income instead of figuring out the actual dollar amount. The reason is our salary is growing. Remember, we assumed our salary would grow 3% per year, and we're actually assuming that our contributions are also growing at 3% per year (another one of those pesky inherent rather than explicit assumptions). It's just that we didn't have to calculate this impact because we converted it to an inflation adjusted rate of 0%.

Again, if you don't have Excel, or just plain don't like it (I understand, I don't much like spinach!), feel free to use one of the many online calculators out there. Just keep in mind that if the calculator's not asking you what inflation rate you want to use, chances are it's not calculating the impact of inflation for you. Of course, you can trick it into calculating the effects of inflation (go ahead, it won't mind being tricked, I promise) by simply putting in inflation adjusted rates of return for everything (what % your portfolio will earn in interest, what % your salary will grow, etc.).

Again… by using inflation adjusted rates, as opposed to nominal rates, we can accomplish the dual goals of making sure pesky inflation won't derail our well laid retirement plans, and make the calculations a whole lot easier than trying to figure out the effects of inflation separately.

Hope this helps, and if you've got any questions, shoot me a reply and I'll try to answer them.

Regards,

Eldrehad




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Author: Eldrehad Big gold star, 5000 posts CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5332 of 27660
Subject: Re: Eldrehad's School of Inflation Date: 4/25/2003 6:22 PM
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I have done many of these calcs but not using Excel - now why didn't I think of that :-)

Yes, Excel can be a very powerful and wonderful tool. If you set up the spreadsheets the right way, you can answer all kinds of questions with just a few keystrokes - all sort's of 'what if' scenarios.

For example, that last spreadsheet I created (the one that calculates that we need to save 14% of our salary to accomplish our retirement goal) - what if I scratch my head and say, 14%? I can't quite get there, I can get to 12%, how short of my goal will I be?

Voila! Excel has the answer.

Hmmm.... I'm still a little short, but is it possible to still get there? What does my rate of return need to be if I can't save any more than 12% of my income?

Viola! One 'goal seek' function later and we have the answer.

Or maybe we say, 14% huh? I can easily save 20% - but that historical return of 10%, I'm a conservative guy... I like bonds not stocks... can I get there saving 20% of my salary but only getting a 6% nominal return rate?

You get the picture - once the spreadsheet is set up, any of these questions can be answered with almost no additional effort.

I'd hate to have to do a whole other set of calculations in my HP financial calculator for each of these scenarios... frankly, I use Excel for just about everything. My financial calculator sits in my top desk drawer and is almost never used.

Regards,

Eldrehad



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Author: TurkeyBreath Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5333 of 27660
Subject: Re: Eldrehad's School of Inflation Date: 4/25/2003 8:45 PM
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More than my gross pay!

Maybe... but with luck we'll get to that calculation later... the whole point however is for me to try to teach at least one fellow Fool how to make these calculations for themselves...


And you're teaching us, well me anyway, new Excel tricks. Thanks.

I think you could add "and teacher,." to your Job description of Financial Analyst.

TB


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Author: dsemmler Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5334 of 27660
Subject: Re: Eldrehad's School of Inflation Date: 4/25/2003 11:31 PM
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Eldrehad,

I wish I could give your posts more than one rec and add you as a favorite fool multiple times! Your posts have been very helpful and I am working on my own spreadsheets right now.

I think this gets more into the individual specifics but do these calculations make any assumptions on whether this is a tax advantage account such as a 401(k) or Roth IRA, or a taxable account? Also, is that $60,000 salary the gross pay before any deductions?

I am really glad you have started this thread and taken the time to go through this example. It has helped me tremendously get a better understanding of what I need and how to get there. And as you said, Excel is great as you can do so many "what-if" scenarios just by changing a few numbers.

dt

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Author: Eldrehad Big gold star, 5000 posts CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5335 of 27660
Subject: Re: Eldrehad's School of Inflation Date: 4/28/2003 10:45 AM
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I think this gets more into the individual specifics but do these calculations make any assumptions on whether this is a tax advantage account such as a 401(k) or Roth IRA, or a taxable account? Also, is that $60,000 salary the gross pay before any deductions?

No... the calculations I presented do not take taxes into account at all. As I mentioned, I could only get into so much complexity in a few posts, and taxes was one aspect that my calculations ignored. Please note, this does not mean that I think taxes are unimportant... taxes are vitally important when planning for one's retirement.

The calculations I presented also didn't assume whether $60K was gross pay or net after deductions - it was simply the figure from which the percentage assumptions were made (in other words, depending on how you look at it, it could be either). If the $60K were gross pay, then we'd need to be saving 14% of our gross (in the preceeding example), and if the $60K were net pay, we'd need to be saving 14% of our net.

Taxes can be incredibly complex (as anyone just having submitted a tax return can attest to), and trying to account for them in retirement planning can also be very complex. I will repeat the words I read by a Fool author here recently, "Ignore taxes at your peril."

I know that might not be as helpful as you'd like it to be (and it's not as helpful as I'd like it to be either), but each individual tax situation is so different I couldn't find a way to encompass them in a meaningful fashion in just a few posts.

Regards,

Eldrehad




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Author: dsemmler Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5336 of 27660
Subject: Re: Eldrehad's School of Inflation Date: 4/28/2003 12:06 PM
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I know that might not be as helpful as you'd like it to be (and it's not as helpful as I'd like it to be either), but each individual tax situation is so different I couldn't find a way to encompass them in a meaningful fashion in just a few posts.

Your posts have been extremely helpful and I just wanted to verify that the taxes were not accounted for in the sample you provided. It just lets me know that is an additional item to consider when using the calculations that you provided. I have my spreadsheets put together and I have been doing quite a few "what-if" scenarios to see what a realistic retirement will look like.

dt

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Author: Eldrehad Big gold star, 5000 posts CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5337 of 27660
Subject: Re: Eldrehad's School of Inflation Date: 4/28/2003 12:29 PM
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I have my spreadsheets put together and I have been doing quite a few "what-if" scenarios to see what a realistic retirement will look like.

Then my effort in writing those posts was worth it. :-)

Thanks.

Regards,

Eldrehad



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Author: telegraph Big funky green star, 20000 posts Top Recommended Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5339 of 27660
Subject: Re: Eldrehad's School of Inflation Date: 4/28/2003 9:24 PM
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This is an interesting thread but highly dangerous....

Using this logic of 8% return, and taking 5% out each year...or any specific number...

Let us say you retired in 2000....

The first year, the market went down 20 percent, not up 8%......

The second year, the market wnet down 20 percent, not up 8%...

Over 30 years, the annual rate of return 'might' be 8 percent a year...however, if you retired in 2000, and thought you could take out 5% or more a year, you stood a good chance of being 'bust'.

Just to get back to 8% average growth will take two years of 40% growth, no? I don't believe it will happen....do you?

It is not 'long term' average, but the distributions that are critical.

There is lots of discussion on Safe Withdrawal rates and lots of links to other references that address the studies that have looked at this on www.retireearlyhomepage.com . Also some handy dandy calculators you can load and use for just this purpose, using historical data.



Just thinking that every year will be 'average' is like looking at rainfaill figures....some year there is drought...other years floods....to stake your life on 22 inches a year exactly of rain in Dallas isn't going to be right 99% of the time...but over 100 years, it has averaged that...and that drastically affects your calculations.


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Author: Eldrehad Big gold star, 5000 posts CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5340 of 27660
Subject: Re: Eldrehad's School of Inflation Date: 4/29/2003 10:34 AM
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This is an interesting thread but highly dangerous....

Forgive me, but I am going to have to take a very strong, yet respectful, exception with this characterization. This isn't a dangerous thread, or a dangerous set of calculations - if you choose to challenge the 8% return assumption, that's fine.

Yes, return on portfolio assets will vary from year to year. With the historical stock market average return rate in the neighborhood of 10-11%, choosing a nominal return rate of 8% while in retirement might be aggressive for some... but that's the whole point. This method allows each individual to choose for himself or herself what a reasonable rate of return for their retirement assets is.

If you think 8% is too aggressive, or represents a rate of return that must be more heavily invested in stocks than you'd like, thereby exposing the investor to more risk than you'd like (and the ups and downs that often accompany that risk), all one has to do is change the rate of return assumptions.

Think an 8% nominal rate is too high? Think that a portfolio not invested in stocks, but invested much more heavily in cash and more conservative investments will mitigate the 'up and down' danger of which you speak? Fine... assume a more conservative portfolio and change the return assumption to 6%, or 4%, or whatever makes you comfortable. What I have presented is a methodology by which each investor can decide for himself or herself what needs to be saved, and what it will take to get there. I would strongly encourage each investor to change any and all of the assumptions I used when creating their own retirement plans.

To me, the real danger is telling investors that some 'magic' 4% or 4.25% withdrawl rate is 'safe'. Just as the 'magic' figure of saving 10% of one's income for retirement can be dangerous... 10% will not necessarily work for every investor, and a SWR rate of 4% or 4.25% will not necessarily work for every investor. Investing and retirement planning is very complex. Respectfully, I believe that the 'one size fits all' approach of using an 'accepted' SWR is the dangerous one.


Regards,

Eldrehad







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Author: 1000 Big funky green star, 20000 posts Top Recommended Fools Feste Award Nominee! Coverage Fool Supernova Phoenix 1
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Subject: Re: Eldrehad's School of Inflation Date: 4/29/2003 11:07 AM
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Hi Telegraph and Eldrehad,

I respectfully agree with Eldrehad. He is putting forth a method or a guideline which each person must consider.

Again respectfully, saying it is dangerous is similar to one saying that retiring is dangerous even if one has a fully funded pension plan - companies do go bankrupt and pensions become worthless. So, yes there is a danger here too.

We each have to decide what next egg we are comfortable with when we retire. And I for one never considered the equations Eldrehad gave us. I am very math challenged. I have now copied them in a notebook to share with others. It is so neat what one can do with math if one gave it some consideration. I am just now seeing how many practical applications it can have if someone knows how to use it.

There is always a danger when one retires. Pensions fail, stock market crashes, bond yields go to zero, nuclear war send world back to the stone age, ETs attack settle humans on barren planet. The last few scenarios would make retirement dangerous regardless of how much money we set aside.

So there is always danger but one has to be able to understand the risks and have guidelines that allow one to make educated guesses. I doubt if many would like the idea of working the rest of their lives, living to 90 and realizing they could have retired comfortably at 55 with the money they had accumulated using the 8% rule. To me this would be a sickening thought. Much worse than running out of money a few years early.

So that too would represent a risk.

But I do concede that we do have to recognize what can go wrong. But I hate to see people afraid to retire due to unfounded fears or unlikely "what if" scenarios. I think what Eldrehad is doing is making us all aware of how to set up our guideline. It is each of our responsibility to decide how to use it.

tom

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Author: sykesix Big gold star, 5000 posts Top Recommended Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5344 of 27660
Subject: Re: Eldrehad's School of Inflation Date: 4/29/2003 11:50 AM
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To me, the real danger is telling investors that some 'magic' 4% or 4.25% withdrawl rate is 'safe'. Just as the 'magic' figure of saving 10% of one's income for retirement can be dangerous... 10% will not necessarily work for every investor, and a SWR rate of 4% or 4.25% will not necessarily work for every investor. Investing and retirement planning is very complex. Respectfully, I believe that the 'one size fits all' approach of using an 'accepted' SWR is the dangerous one.

I certainly agree that one size does not fit all, and agree with your post. By way of clarification though, when talking about 'safe withdrawl rates,' the "safe is usually written in qoutes. One source of confusion is that some people things that "safe" means safe in the future. Obviously, that's not true because we don't know what the future holds. "Safe" in this case means "did not fail in the past." I wish a different word had been chosen because of all the confusion it causes, but here we are. It is also inflation-adjusted by the way. A safe withdrawl rate of 4% (or whatever) might not work for every investor, but it is certainly an excellent starting point.




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Author: intercst Big funky green star, 20000 posts Top Favorite Fools Top Recommended Fools Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5345 of 27660
Subject: Re: Eldrehad's School of Inflation Date: 4/29/2003 12:15 PM
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Eldrehad writes,

<<telegraph: This is an interesting thread but highly dangerous....>>

Forgive me, but I am going to have to take a very strong, yet respectful, exception with this characterization. This isn't a dangerous thread, or a dangerous set of calculations - if you choose to challenge the 8% return assumption, that's fine.

Yes, return on portfolio assets will vary from year to year. With the historical stock market average return rate in the neighborhood of 10-11%, choosing a nominal return rate of 8% while in retirement might be aggressive for some... but that's the whole point. This method allows each individual to choose for himself or herself what a reasonable rate of return for their retirement assets is.

If you think 8% is too aggressive, or represents a rate of return that must be more heavily invested in stocks than you'd like, thereby exposing the investor to more risk than you'd like (and the ups and downs that often accompany that risk), all one has to do is change the rate of return assumptions.

Think an 8% nominal rate is too high? Think that a portfolio not invested in stocks, but invested much more heavily in cash and more conservative investments will mitigate the 'up and down' danger of which you speak? Fine... assume a more conservative portfolio and change the return assumption to 6%, or 4%, or whatever makes you comfortable. What I have presented is a methodology by which each investor can decide for himself or herself what needs to be saved, and what it will take to get there. I would strongly encourage each investor to change any and all of the assumptions I used when creating their own retirement plans.

To me, the real danger is telling investors that some 'magic' 4% or 4.25% withdrawl rate is 'safe'. Just as the 'magic' figure of saving 10% of one's income for retirement can be dangerous... 10% will not necessarily work for every investor, and a SWR rate of 4% or 4.25% will not necessarily work for every investor. Investing and retirement planning is very complex. Respectfully, I believe that the 'one size fits all' approach of using an 'accepted' SWR is the dangerous one.


This is probably why many people think telegraph has one of the best developed "B.S. detectors" on these boards.

If you look at the distribution of S&P500 returns over the past 130 years. The best 30-year period had a CAGR of 13.02% per annum, the worst 30 year period had a CARG of 5.13% per annum. Out of the 100 rolling 30-year periods from 1871-2001 the CAGR was below 8% in 40 of them.

I imagine that few retirees would consider an assumption that failed 40% of the time "safe".

Historical SWR analysis on the other hand seeks to find the worst case result. For a portfolio of 75% S&P500/25% fixed income, the inflation-adjusted withdrawal rate that would survive 30 years in every pay out period examined is about 4% of the initial balance for January start dates. Even if you decided to retire on the worst possible date in the past 130 years (Sept 16, 1929 -- the market high just before the Crash of 1929 and the Great Depression) the withdrawal rate only drops to 3.71%.

SWR analysis provides a very effective technique to measure to quantity of hot air being blown around by professional finance planners and those unschooled in arithmetic.

intercst


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Author: Eldrehad Big gold star, 5000 posts CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5347 of 27660
Subject: Re: Eldrehad's School of Inflation Date: 4/29/2003 12:28 PM
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If you look at the distribution of S&P500 returns over the past 130 years. The best 30-year period had a CAGR of 13.02% per annum, the worst 30 year period had a CARG of 5.13% per annum. Out of the 100 rolling 30-year periods from 1871-2001 the CAGR was below 8% in 40 of them.

Historical SWR analysis on the other hand seeks to find the worst case result. For a portfolio of 75% S&P500/25% fixed income, the inflation-adjusted withdrawal rate that would survive 30 years in every pay out period examined is about 4% of the initial balance for January start dates. Even if you decided to retire on the worst possible date in the past 130 years (Sept 16, 1929 -- the market high just before the Crash of 1929 and the Great Depression) the withdrawal rate only drops to 3.71%.

SWR analysis provides a very effective technique to measure to quantity of hot air being blown around by professional finance planners and those unschooled in arithmetic.


First, thanks for expanding my understanding of SWR rates - I've read a little about them, but not much.

I think I understand the point now... it's 'dangerous' to assume 8% based on historical evidence - but also based on historical evidence, a rate of 4% is 'safe', or at least has been in the past.

Agreed... I personally don't use 8% in my personal retirement calculations either. Would seem we've kind of been arguing past each other, not against each other.

Help me out a second though... you're saying that a 4% SWR would suggest that we withdraw 4% of our initial portfolio balance on an inflation adjusted basis and that historically doing so will have cause our portfolio to last 30 years?

So if we start with $1 million for example:

$1 million x .04 = $40,000.

So we withdraw $40k per year on an inflation adjusted basis?

Is that how it would work?

Regards,

Eldrehad




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Author: dsemmler Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5348 of 27660
Subject: Re: Eldrehad's School of Inflation Date: 4/29/2003 12:28 PM
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If you look at the distribution of S&P500 returns over the past 130 years. The best 30-year period had a CAGR of 13.02% per annum, the worst 30 year period had a CARG of 5.13% per annum. Out of the 100 rolling 30-year periods from 1871-2001 the CAGR was below 8% in 40 of them.

intercst,

You are hitting me with terms I am used to seeing on the RE board but not yet fully understanding. Be gentle here :)

I am looking for the definition of CAGR but if someone has the chance to respond before I find the answer, I would greatly appreciate it.

Thanks!

dt

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Author: dsemmler Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5350 of 27660
Subject: Re: Eldrehad's School of Inflation Date: 4/29/2003 12:30 PM
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CAGR

Ok, it stands for Compound Annual Growth Rate. Correct? Now I need to do more reading to make sure I understand what it really means.

Thanks.

dt

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Author: Eldrehad Big gold star, 5000 posts CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5351 of 27660
Subject: Re: Eldrehad's School of Inflation Date: 4/29/2003 12:31 PM
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I am looking for the definition of CAGR but if someone has the chance to respond before I find the answer, I would greatly appreciate it.

CAGR = Compound Annual Growth Rate

Regards,

Eldrehad



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Author: dsemmler Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5354 of 27660
Subject: Re: Eldrehad's School of Inflation Date: 4/29/2003 12:43 PM
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For anyone else that may not be familiar with what CAGR is or means, here are two links I found in my initial search which I am digesting right now.

http://www.investopedia.com/articles/analyst/041502.asp
http://www.fool.com/workshop/2000/workshop000302.htm

Hey, I noticed when I was copying the link to the second article that it had redirected me to a Fool article!

dt

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Author: intercst Big funky green star, 20000 posts Top Favorite Fools Top Recommended Fools Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5356 of 27660
Subject: Re: Eldrehad's School of Inflation Date: 4/29/2003 12:58 PM
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Eldrehad asks,

Help me out a second though... you're saying that a 4% SWR would suggest that we withdraw 4% of our initial portfolio balance on an inflation adjusted basis and that historically doing so will have cause our portfolio to last 30 years?

So if we start with $1 million for example:

$1 million x .04 = $40,000.

So we withdraw $40k per year on an inflation adjusted basis?

Is that how it would work?


Let's say inflation was exactly 3% per annum.

You'd take out $40,000 the first year

$40,000 x 1.03 = $41,200 the second year

$41,200 x 1.03 = $42,436 the third year

If you'd like to read the SWR study, see link:

http://www.retireearlyhomepage.com/restud1.html

intercst

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