Predicting Retirement Financial Success

One of the negatives to using a Safe Withdrawal Rate (SWR) model, such as the 4% Rule, to predict when early retirement is possible and to guide spending in retirement is that if history repeats you could leave a lot of wealth on the table.  This is because if a conservative SWR is chosen it tends to have very few historic sequence of returns that fail meaning the withdrawal rate you choose is based on some of the worst sequence of returns rather than the best.

Let me demonstrate with an example.  Let’s enter retirement with $1,000,000, a portfolio that is 75% US Equities : 25% Bonds, expenses of 0.18% and a retirement period of 30 years.  Plug that into cFIREsim and you get the following historic sequence of returns:

Click to enlarge, 4% Rule Sequence of Returns for a 75% Equity : 25% Bond Portfolio

After 30 years that $1,000,000 has in Real (ie after inflation) terms become an average of $2,027,248 and a median of $1,531,784 while the highest wealth value is $5,957,932 and the lowest is -$370,926.  So in the one extreme you’re living under a railway arch begging for food and in the other you have nearly six times what you started with.  If history were to repeat could we potentially be more precise than that?

Personal Inflation

When trying to figure out whether or not I can FIRE I’ve needed to understand just how much I spend (along with a few other numbers).  To calculate this properly I started a few years ago to track every penny that I spent.  With this data I can then also make pre to post-FIRE estimates more accurately.  For example, in my case I know I can net off work related costs and rent but I know I have to add on home maintenance costs.  This is what my spending has looked like over the past few years:

Click to enlarge, RIT monthly spending

In 2015 I spent £24,413 and in 2016 I spent £27,001.  If I did nothing 2017 could be around £26,000 but FIRE is coming (could come?) this year so my spending profile will (could?) transition from pre to post-FIRE so that’s not bankable.

The other advantage of tracking spending like this is that you start to understand what your personal inflation is actually looking like which allows you to take action if it’s starting to get out of hand.  It’s no good going into FIRE with a planned spending of £20,000 per annum, which you then plan to increase with published inflation, only to find you’re actually spending £25,000, which is then increasing at a rate greater than inflation.  That’s a road to potentially running out of wealth before you run out of life.

I can smell the sea - 2017 Q1 Review

I couldn’t have asked for a better start to 2017.  From a Mediterranean home research perspective we spent some time on the Costa del Sol exploring from just east of Marbella through to Gibraltar.  We viewed possible homes, walked/ran on the beach, soaked up some sunshine and also took a few days to put some charge back in the batteries in readiness for the final push from FI to FIRE.

All I can say about this part of Spain is that I could very happily grow old in this part of the world.  The final fight between this part of Spain and Cyprus really is on but to be honest I expect I’ll be very happy in either location.  I just feel so fortunate that this is now possible and is really about to happen.

Click to enlarge, The view from one of the properties within our budget

On the financial side of things the world is also good with savings and investment returns putting more icing on the cake by adding another £75,800 to my wealth.  Let’s look at this in a little more detail.

SAVE HARD

I unapologetically continue to define Saving Hard differently than most personal finance bloggers.  For me it’s Gross Earnings (ie before taxes, a crucial difference) plus Employer Pension Contributions minus Spending minus Taxes.  Earn more and one is winning.  Spend less or pay less taxes and you’re also winning.  Savings Rate is then Saving Hard divided by Gross Earnings plus Employer Pension Contributions.  To make it a little more conservative Taxes include any taxes on investments but Earnings include no investment returns.  This encourages me to continually look for the most tax efficient investment methods.  I finished the quarter with a reasonably healthy Savings Rate of 52.2% against a plan of 55.0%.

Click to enlarge, RIT Savings Rate

Saving Hard score: Conceeded Pass.  I can’t give myself a pass as I’ve missed the target but when I’ve saved £51,800 (admittedly including a very healthy bonus) and only spent £6,500 I’m also not going to beat myself up about it too much.

Keep calm and carry on

Over a lifetime of investing we’re going to see a lot of things happen.  The more obvious events will likely be the continual bull and bear markets that have occurred in the past and I wouldn’t bet on not occurring in the future.  Filter the noise by correcting for the continual devaluation of money via inflation then plot on a log chart and they’re clear to see for both the US and the UK.

Click to enlarge, Monthly real S&P500 price

Click to enlarge, Monthly real FTSE100 price

I’m not old enough to have invested through all the FTSE100 cycles shown and I’m certainly not old enough to have invested through all the S&P 500 (or it’s predecessors) cycles that are visible.  Instead I started investing seriously in late 2007 so my early days saw the global financial crisis but I’ve then been able to ride that bull wave.  Today that bull wave has resulted in valuations such as the Price Earnings Ratio (P/E) or even the Cyclically Adjusted Price Earnings Ratio (CAPE) looking high compared to history.  The P/E for the S&P 500 is 26.3 against a long run average of 16.0 and the CAPE is 28.7 against a long run average of 16.7.  The FTSE 100 is in a slightly different state, albeit measured against a data set with a different duration.  It’s P/E today is a silly 30.7 against a long run average of 17.2 while the CAPE is 15.2 against a long run average of 18.0.

Holding pattern musings

2017 so far is starting to feel like I’m in a bit of a holding pattern.  We’re starting to feel excited about the new adventures we are going to face in FIRE, I feel like a small part of me has already left my workplace yet I don’t want to go any further until my 2016 bonus is paid and a longer term incentive also appears.  Not long now.

While in that holding pattern I’ve just continued with my saving hard and investing wisely strategy which has my wealth this year already up £36,000 to £1,155,000.  More than enough to live the lives we want to live in FIRE.  There’s also been a few events and learnings over the period.  Let’s look at a few in brief.

Budget

Philip Hammond delivered his Spring Budget statement, which for people like myself, was just another chance to increase taxes.  Previously, from 06 April 2016 the dividend tax credit was abolished and a new tax free £5,000 dividend allowance was introduced to partially compensate.  Hammond has decided he wants some of that so from the 06 April 2018 will reduce the allowance to £2,000 ‘to address unfairness’.  Dividends above this level will be taxed at 7.5% if you’re on the basic rate, 32.5% if you’re on the higher rate and 38.1% if you’re on the additional rate.

If I stayed in my current grafting up state Hammond would have grabbed another £1,143 from my pocket.  But alas times are a changing.  We’ll be in the Med by late summer with that more and more looking like being Cyprus.  There I’ll use the Cyprus and UK Double Taxation Convention, the Cyprus non-domicile rules and the Cyprus tax laws to pay precisely £0 in tax.  Sorry Mr Hammond not on my watch...