Almost everyone in the FIRE movement has heard of Mr Money Mustache. He wasn’t the first person to talk about FIRE, but he was certainly one of the people to popularise it with his blog. Perhaps his most famous post is The Shockingly Simple Math Behind Early Retirement.
Essentially this boiled down to assuming that returns are smooth and therefore if you know how much you are saving each year, how much you’ll need in retirement each year, and know that you’re going to get the long term returns of the stockmarket, then you can just use the 4% withdrawal rate rule and will know exactly when you’ll be able to retire and that you will never have to worry about money again!
This is an extremely simple and appealing idea for everyone right? You come up with 3 figures and badda bing badda boom, you get to find out that you can retire in 9.513 years or whatever your magic number is. Here’s the graph from his original post.
Unfortunately however life is not so simple and is instead pretty complex. I’ve written fairly extensively about the problem of sequencing risk, both in accumulation phase as well as withdrawal phase. I’ve written about not being able to know when we’re going to hit FIRE, or how long it will take. I’ve written about the 4% rule.
If you want to read other Aussie bloggers on the subject then Dan at Ordinary Dollar has done some fantastic work on similar subjects. Big ERN at Early Retirement Now has a 28 post series on the subject for the US. Michael Batnick at The Irrelevant Investor has talked about it and called it the hardest problem in finance. Here’s another great post from Fat Tailed and Happy on the same subject.
But what it all boils down to is that early retirement is not simple, let alone shockingly simple. The reason for this is however shockingly simple, it’s that the market doesn’t give you smooth steady returns and instead gives you different returns every year, some good and some bad.
If you get the bad returns when you start saving and you don’t have much invested and then the good ones when you have more money saved that’s fine. If on the other hand you get the good returns when you first start saving and the bad ones when you’ve got a lot of money already invested, then that’s going to delay FIRE for you because the losses on your portfolio are likely to be more than what you’re putting back into it. I showed in this post that depending on the sequence of returns you could end up with double the amount of money in one scenario vs another based on investing $50,000 a year for a period of time.
If you’re already retired then you want the good returns at the start of your retirement period to help boost the amount you have invested and the bad ones at the end when you’ve got plenty of money already.
Even starting retirement just one year apart can make a massive difference. Retire in 1968 with a million dollars (inflation adjusted) all in Aussie equities and you’re up to nearly 5 million as of 2016. Pull the pin in 1969 and you’d have run out of money in 1996. That doesn’t sound simple to me.
It’s not going to be a smooth path up to your FIRE number. There are plenty of historical scenarios where you ended up with less money invested after 10 years of regular contributions than what you’d put in. There are lots more where you would have ended up with less than expected based on an average rate of return over that period.
It’s not going to be a smooth path after hitting your FIRE number. Depending on your withdrawal rate and mix of assets chances are pretty good that at some point after retiring you’re going to be worth less in real terms than what you started with. Perhaps a lot less, and you might even run out of money.
Look, I get it. We all want to hear that it’s a nice simple process with predictable outcomes which are entirely controllable, and maybe if that’s the message more people would get off the hedonic treadmill and start becoming financially responsible. But sooner or later they’re going to run into the fact that reality is complex when they hit a bear market and start losing money. Even worse if they’ve retired and have been drinking the 4% rule Kool Aid without any safety net in place, they might find themselves running out of money at the time when it’s most difficult to get another job.
None of this is to say that we shouldn’t be aiming for FIRE or doing the basic stuff to be financially responsible. We should have an emergency account. We should have personal insurance in place. We should save a big chunk of our paycheck. We should invest those savings in assets that will hopefully grow in value over the long term.
But I think we also owe it to ourselves to be honest about the fact that there is no shockingly simple math behind early retirement. Life is complex. So is early retirement. The sooner we acknowledge that the better.
What are your thoughts? If you enjoyed this post and would like to read more like it then please subscribe!
I’ve never liked the idea of the “Americans 4% Rule” they seem to bang on about. The idea of selling down stocks to fund retirement makes no sense to me.
I would much prefer to live off the dividends as I believe it makes the most sense. I understand us Australians are a little bit luckier in terms of dividend returns but you don’t sell the golden goose.
Just keeping an eye on your portfolio and being completely flexible in your plans is key. So if your retired when there is a downturn like there is now, it would be a great time to start working again and buying up more while you can.
Great article as usual.
Hi Ben, I think the main issue for our american counterparts is that they just can’t easily get that 4% dividend yield like we can, plus they don’t get the benefit of franking credits like we do which makes it more like 5.5% or so. The dividend yield on the S&P 500 is about 2% or so I think, so if you need to live off the dividend income you’d need to build up a portfolio much bigger than an Australian equivalent.
Like you though I’m very much hoping that I’ll just be able to live off the dividend income and will be able to leave the golden goose in peace!
I also agree with never selling the corpus.
Essentially once Australians are old enough to get a pension (and using today’s $ and rules) their assessable assets cannot exceed approx $450K otherwise they will be WORSE off than those with less invested. I know right.
For me it is all about bridging that gap between when I want to retire and when I’m told I can 🙂
The means testing on the age pension certainly makes it a bit more complex that’s for sure! My understanding is that if you have more assets than $450k or whatever the figure is you can be worse off in terms of income, but you could still sell off some of those assets if you want so in real terms you are better off.
The other issue here for me though is that most Australians treat the age pension as something they are entitled to rather than as a form of welfare for those who haven’t saved enough for retirement, which is what it’s supposed to be. If we changed the way the conversation was framed maybe more people would be motivated to save for retirement rather than relying on a welfare program.
I could never get my head around selling off income producing assets – shudder, however I certainly see your point e.g. go on a big holiday and spend money on the house and get it in tip top condition before retiring, thus divesting of surplus money. Nick Bruining recommends this approach in his book.
In fairness, Australians were all taxed specifically so they could have an aged pension – that is how it was sold to them initially when the pension tax was introduced and that is still why it still comes out of our taxes today. Essentially it was Superannuation before there was Superannuation only administered via the taxation system instead of outside of it like it is now. So I respectfully disagree a little with you (and others) on that one. A bit of healthy respectful difference in opinion keeps things fresh hey 🙂
What I actually meant with selling off assets was that if you wanted to boost your income in retirement you could sell off some of those assets. You’re still going to be better off than someone with a lower amount of assets, it’s just that you have to sell some to produce the same amount of income. Which I agree is frustrating and not ideal if you’re in that situation, but that’s the system as it stands.
I think we’ve had compulsory superannuation for about 30 years or so now so it will be interesting to see what effect that will have on how many people claim the age pension and how much of it they are entitled to. And yep, no problems whatsoever with a little healthy difference in opinion, often both parties learn something new out of it!
I loved the MMM post because It gave me something to aim for.
I’m shocking at Maths. Show me a page full of numerals and I freeze.
Yet reading that post gave me a goal to set my sights on. As I get closer to retirement, then more complex considerations come into play. But as a beginning idea, I think it’s really good.
That’s a really interesting perspective Frogdancer, thanks for sharing! I’m a very mathematical/factual person and I love precision and the finer details of things as you can probably tell from this whole series on the subject! But for people who aren’t into that sort of stuff the original MMM post is probably just fine for the purposes of getting you into FIRE and from there so long as you’re happy with things then does it really matter how long it takes to hit it?
Great comment, thanks very much for getting me to think about things differently! Also for those of my readers who aren’t already reading Frogdancer’s blog she has some other great content over at https://burningdesireforfire.wordpress.com/.
Imagine planning for FIRE for ages, selling the dream to your spouse, accumulating the million and retiring in 1969. That sure would have sucked! The devil fools with the best-made plans, so having a Plan B is crucial. For me that’ll be super, as I’m early 40s and probably too late for the RE part anyway. Saving heaps now so I can pull the pin before 50 is the plan, then slowly spend a combination of savings and returns till super kicks in to smooth the ride to the grave. But we’ll see how it goes.
It sure wouldn’t have been a whole lot of fun if you’d retired early in 1969. The good news though is that if you’d done it when you were young you could have gone back to work because after the early 70s it sure didn’t look like the portfolio would have lasted too long. Whereas if you’d just retired at age 65, well you were screwed because you weren’t going back to work in your later 60s or early 70s!
I’m a big fan of Plan B. And Plan C. And Plan D. I wrote about some of the stuff I am doing to have a backup plan in this post https://aussiehifire.com/fire-safety-fire-breaks/.
Pingback: Your heresy shall stay your feet – why you shouldn’t just invest in equities | Aussie HIFIRE
I’ve structured my entire approach around accumulating enough passive income producing investments (a mixture of ETFs, LICs and individual stocks) to retire and live comfortably, with a safety net without having to rely on any capital draw downs. I decided on this strategy early on and probably saw lower returns than had I focused on maximum growth the whole way.
I have some appreciation for others who may have gone the maximum growth route and find themselves at a point where they could FIRE under a 4% (or perhaps 3%) draw down rate. At that point you can’t really change horses to a passive income strategy without paying some CGT which could drag your portfolio below the FIRE point meaning you would have to delay.
An income approach can see you take longer to accumulate the portfolio size needed but for me, I know I will sleep better relying on passive income rather than capital draw down and the stress reduction in retired life is worth it.
I think to a large extent it’s about finding an approach that you feel comfortable with. There is also the issue that if someone were to go with a maximum growth/minimum income approach it’s difficult to do in Australia without picking individual stocks given that our indexes have such large portions of their returns in the form of dividends. So you’d need to invest internationally if you want to use index investing, and doing so introduces a whole new set of risks.