real estate

Are FIRE Naysayers Bad at Math? Yes.

May 2, 2020 by sallyb.zhao No Comments
Notes for BiggerPockets Money Podcast 120
Guest: Michael Kitces
Audio time: 1 hr 23 min
Read time: 2 min
One Line Summary

The 4% rule still works in times of recession because it was modeled for the worst-case scenario over years of historical data, including 3 of the biggest financial crashes in the last century.

Origin of the 4% rule
  • In the past, 7-8% withdrawal rate was considered “conservative”
  • In 1994, Bill Bengen saw that 7% worked on average but might not account for bad years (recessions)
    • Analyzed historical data and found that a 4% withdrawal rate covers most worst-case scenarios
  • 4% is the one rate that worked in the worst historical market sequence
  • Retiring right before financial crisis of 1907
    • Retiring on the eve of Great Depression 1929
    • Retiring in 1966 (had to wait 15 years until 1982 before stock market was back to where it was when they retired)
  • Historical safe withdrawal rates aren’t based on historical averages. They’re based on historical worst-case scenarios
  • What kind of portfolio is assumed? Large-cap US Stocks, intermediate government bonds
  • If you stretch out the time horizon to 40-50 years (pertains to early retirees), withdrawal rate drops to about 3.5%
5 years Cash Cushion: Good or Bad?
  • 5 year cushion hurts more than it helps. In fact, anything more than 2 years is not beneficial
  • If you have a diversified portfolio (including bonds), you shouldn’t need that much of a cash cushion
Bonds: When to Invest?
  • During the “red zone” (5-10 years before and after retirement)
    • This is when your portfolio is the largest and bad markets hurt the most. Good to own bonds during these times.
  • Determine your capacity for risk and tolerance for risk
    • Younger people are usually deemed more risk-tolerant, when in fact, it’s their capacity for risk that is high because they have a longer time horizon
FIRE Adjustments
  • Levers you can pull to move 4% number up or down
    • Time horizon: shorter time horizon → higher withdrawal rate
    • Diversification: lift
    • Taxes: drag
    • Spending flexibility: lift
  • Make small adjustments as you head towards your goal
    • Analogy: flight plan from DC to SF
    • If you head west towards SF, you’ll generally get there +/- 500 miles
    • If you want to hit the nail on the head, you make small adjustments throughout the flight course
    • You don’t want to wait until Nevada to make a sharp turn towards SF
Reaching FIRE
  • FIRE movement has become too much RE and not enough FI
  • Mindset should be: I’m going to accumulate enough money so that what I decide to do with my time is no longer dependent on money.
  • Mindset should not be: I don’t have to work anymore
  • After people endure the last few years of working and reach FIRE, they become bored and end up going back to work (becomes Uber driver just to do something)
    • If they could’ve planned to be making money at retirement, they could’ve FIREd a lot sooner
  • What’s the worst is someone who is currently still working at a job they hate, so they can reach their FIRE number and never work again. If they factor in potentially making money during “retirement” (side hustle, or a job they enjoy that pays little), they could decrease their FIRE number and quit earlier