Early retirement planning with FIRECalc

For those thinking about retiring early, two of the most frequently asked questions are the following:

  • If I retire today with my current savings, how much can I safely withdraw each year?
  • When can I retire with $40,000 yearly income (or another desired amount) if I continue to save at the current rate?
FIRECalc is a simple web calculator that can help you answer these questions. FIRECalc makes one key assumption to answer these questions, namely, that the future can't be all that different from the past.
According to the Wall Street Journal:
To gauge your strategy's likely success, [FIRECalc] looks at investment returns since 1871. But the calculator doesn't use average historical rates of return. Instead, it analyzes what would have happened if you retired in 1871, in 1872, in 1873 and so on. It then calculates how often your strategy would have panned out historically.
In other words, it uses historical data about the US stock and bond markets to calculate your odds of not running out of money during retirement. It also adjusts for inflation automatically, so you can enter figures in today's dollars.
I will use FIRECalc to answer the two key early retirement questions below, using my own data as posted in my last Net Worth update.
If I retire today with my current savings, how much can I safely withdraw each year?
There are two versions of FIRECalc: standard and advanced. You can answer this question using FIRECalc Standard.
I plugged the following figures into FIRECalc:
  • Retirement savings: $425,736 (the portion of our Net Worth intended for retirement)
  • Asset allocation: 75% equities, 25% fixed income (our target asset allocation)
  • Number of estimated years in retirement: 60 (this assumes that we will live for 60 more years from now)
  • Investing fees: 0.5% (a rough estimate of the average expense ratio for our investments)
You can select a desired success rate, which is the chance that you will not run out of money.
For 95% success rate, I get the following result:
A withdrawal of $14,589 (3.43% of your starting portfolio) provided a success rate of 96.1% (76 total cycles, of which 3 failed).
And for 99% success rate:
A withdrawal of $13,547 (3.18% of your starting portfolio) provided a success rate of 100.0% (76 total cycles, of which 0 failed).
FIRECalc also provides the following chart of my success rate for different yearly withdrawal amounts.

For 100% success, I can withdraw no more than $13,547 (inflation-adjusted) each year. Clearly, my chances of retiring with my current savings are pretty low.
Now for the second question:
When can I retire with $40,000 yearly income if I continue to save at the current rate?
To answer this question, you need FIRECalc Advanced, which provides more options than the standard version.
I used the following figures:
  • Desired yearly income: $40,000 (in current dollars)
  • Retirement savings: $425,736 (the portion of our Net Worth intended for retirement)
  • Asset allocation: 75% equities, 25% fixed income (our target asset allocation)
  • Number of estimated years in retirement: 60 (this assumes that we will live for 60 more years from when we retire)
  • Investing fees: 0.5% (a rough estimate of the average expense ratio for our investments)
  • Total yearly contributions to our retirement savings: $53,750 (based on last year's data)
I have ignored Social security for simplicity, but FIRECalc does allow you to enter estimates for social security payments and other expected sources of retirement money, such as an inheritance.
I selected the option: "What happens if you retire in any of several years between now and 10 years from now?"
FIRECalc produces the following charts. The first one shows my success rate for each target retirement year. The second chart shows three different curves showing my best-case, average and worst-case (from top to bottom) balance at the end of retirement, for each target retirement year.


Based on the above, if we continue to save at the current rates, we have a 100% chance of retiring in 2016 with a $40,000 annual income (in current dollars).
FIRECalc does have some limitations:
  • It ignores the tax status of your accounts, i.e. whether it is taxable or non-taxable. To be on the safe side, I assume that the expected income that I enter in FIRECalc is the pre-tax amount.
  • FIRECalc only includes data for the US market. Considering that global markets are increasingly interconnected, this does not appear to be a big limitation. The data for US markets include the great depression, two world wars and periods of severe inflation, so it represents a wide variety of investment environments.
FIRECalc (both standard and advanced versions) is free for use, but a small donation is recommended.
Related links:

11 comments:

Rohit said...
This comment has been removed by the author.
Rohit said...

I am planning to retire in 2010. Right now my age is 34. I am marriaged and have one 6 years old daughter and expecting next baby next year. I am in canada right now and want to move back to India in Jan. 2010 for retirement. I will have $500,000 CAD cash out of which $250000 I will build own house and planing to buy a showroom in Chandigarh with rest of $250000.00.
From which I will get INR gross Rs.92000.00 per month as rent ( about INR Rs. 65000.00 net after all deductions. )While I will also get about CAD $1400.00 (INR Rs. 56000.00) per month as rent from my property in canada. So this will be about INR Rs 1,20,000.00 per month net. This renatal income should go up every after 3 years for about 10%-15%. I will also start some small business with INR Rs. 20,00,000.00 to pass time from which I am expecting about 10,000 to 15,000 per month.
I am not sure if this income is good for happy retirement in India? I want to send my kids in good school (not in hostel) and will have 2 Tata Safaries & Two Bikes.

Anonymous said...

Look at retirement risk calculators on www.retrian.com. They can add a lot to what FIRECalc does. This includes family retirement planning, glide path, multiple asset classes, longevity factor, unemployment risk, sensitivity analysis and much more.
Retirement planner

sandip said...

After doing a bunch of spreadsheets on this, here's my simple rule of thumb to calculate how much one needs to retire:

Amount you spend per year X Number of years you expect to live.

As an example, if you are 50 yrs old, and can manage a semi-royal lifestyle in India for about $25,000 a year and you expect to live till you are 100 yrs old:

$25,000 * 50 yrs = $1.25 million

Here are my assumptions:
- Investing in equities is always a shaky proposition. The reason you expect more than 10% return on stocks is that there is a inherent real risk that you might make a huge loss at any point of time. For someone planning to live off of a nest egg without becoming an investment manager, equities is a really bad idea. If you fall for historical returns, read the disclosures for any stock or fund or anything else you are planning to invest in.
- Well rated (BBB) fixed income (bonds) are the only way to go. Treasuries don't yield much, corporate bonds is where the sweet spot is. Again, individual equities is out of question for a retiree...think Enron, Worldcom, Bear Stearns...
- For all the brain damage Nigel (no criticism) is trying to do with inflation and FireCALC...there are serious flaws with the logic. A finance person could rip the logic apart by hitting the whole slew of assumptions (unmentioned in the article above) that go with forecasting...especially when you are talking 50 yrs into the future. Statistics is best used with other people's money.
- Before you think you can get a better return because you are smarter than me (since I am chosing to go with bonds with maybe 6% interest), remember that the best of the best investment managers don't even beat the S&P. And they play with other people's money. There's an inherent risk in equities that retirees just cannot take.
- The big yet simple assumption I have taken above, is that you are smart enough to earn enough interest (without taking any risk, knowingly or unknowingly) on your nest egg to neutralize inflation. If you can do better, great !
- Banking on investment returns to cover any gaps is a bad idea, even for investment professionals.
- Lastly, I would ask the people who are hell bent on putting their money in stocks is to bet on indexes only (never on individual stocks) and to learn how to use options instead of stocks to serve the same or similar purpose. You can limit downside with much more confidence.
- The last thing you want to do when you are retired is to worry about investing your money at higher returns than what most professional money managers can get. Consistently. That would be setting yourself up for failure.

Nigel said...

sandip,
I think you misunderstood my post. I was just using my portfolio at that time to illustrate the use of FIRECalc. It is certainly not a portfolio I recommend for a retiree.

You can use FIRECalc to analyze a 100% bond portfolio if you like. By the way, a 100% bond portfolio may actually be riskier than one with some equities in it -- this is a well-known result in Modern portfolio theory.

sandip said...

Nigel,

as I said earlier, this is not criticism for your ideas or logic in any way. I understand that you have more than noble thoughts and sound academics behind what you have presented here.

What I am saying is that there is no logic to any portfolio theory outside of academics. Everyone in Wall Street learns this stuff and then tries to forget it when it comes to actually making money.

Investment, like most things in life, is a technical process...and the rules change every hour. The moment you think you got it, you are walking into a trap.

If you are not on Wall Street watching this stuff happen, it's not if, but when you will lose a lot of money. Even watching the stuff, you can lose a lot of your money. The truly gifted, the lucky few, and the crafty (read the Galleon case, or Maddoff) make money consistently.

I am trying to lay out the simple philosophy that when you are trying to retire (not retire into a investment management job), the only bulletproof logic you can follow with your money is not to count on investment returns to fill any gaps. Have the money upfront and have a passive investment strategy like AAA corporate bond index fund for a safe, reasonably acceptable return to beat inflation by a little bit.

Note that I didn't say bond portfolio...I said specifically AAA Bond Index (use an ETF). Big difference. I don't want to get into a debate on pop portfolio theory. I try to avoid being cheesy, but I will make an exception. When your investments don't go the way "modern portfolio theory" tells you they should go, can you sue anyone to get your money back? Can you walk up to someone's house with a baseball bat?

To the people who think I am throwing a lot of jargon out with ETFs and AAA indexes, and puts and calls, and it's too much trouble, here's my quick advice...put your money under your mattress in gold bars. It will give you a better return.

I apologize if I am coming across as arrogant, but don't forget that I am in the same boat as you, just trying to find a place in the sun a little early. I learnt a lot from this forum around other aspects that I didn't know anything about. But finance is what I understand (somewhat), and the only area on this forum where I can bring some value to the table.

sandip said...

If you are not already doing this, here's another thing folks could look up to hedge the risk of the value of the dollar going down without tying up all your money in Rupees. It's not exact, but it will protect you from big sudden drops. Do this only if you are stressed about the dollar losing its value.

Buy "put options" on the dollar. A long term put. Look it up. Might sound complicated but it's just like buying insurance. You can do this with a simple ETrade or any brokerage account.

A put on the dollar locks in the exchange rate against the main currencies. Because it is a derivative, a couple of thousand of dollars will let you lock in hundreds of thousands of dollars worth of exposure for a year or more. You can't lose more than the couple of thousand that you put in, but if the dollar goes down in value, the puts will gain enormously, offsetting any losses you had in your savings (in $s) with respect to the Rupee.

If you think it's too complicated, always remember that things ARE complicated. You take shortcuts, Murphy's third law kicks in. Not being smart about money is not really an option, especially if you want your money to last you a lifetime.

sandip said...

To clarify my blunders in the previous posts, any bond index ETF which says investment grade (AAA down to BBB rating) is good. AAA rated will give you the least returns because of the super low risk, BBB the most returns with a little more risk, but it's still very very safe. If the index ever comes down (credit worries in the market), it will come back (unlike stocks).

Right now is a great time to buy bond indexes, because they are relatively down because everyone is worried that the world is coming to an end. Well, they might be right, what do I know?

Karun said...

I've recently retired to India (2011, age 41), and I think INR 20,000,000 ($0.5 Million) is good enough to retire in a metro with a middle class lifestyle.

1) You need 75-80 lacs to get a good home/apartment in top 5-6 metros.
2) You need 1 crore to put in a FD/annuity (8%) interest, to fetch you 8 lacs before interest per year. This will be about INR 60,000 per month after tax. This in my opinion is good enough for a family of four(2 school going kids).
3) The remaining 20-25 lacs you put in US or Indian stock market which should give you 10-12% returns compunded. This is your emergency fund too. Let it grow till it can.

Now, future planning...
1) when your first kid goes to 12 grade, you sell your home and downshift into Rishikesh/Vrindvan/Manali/Ooty/Goa etc. This home should be 50% of your current home. Rest 50% of the cash use to cover education expenses of your 2 kids.
2) Both kids gone to college, move to selected locale. This brings your expenses down and compensates for increased expenses on kids in college.
3) You still have INR 60K coming every month, this should keep on sufficing for the next 20 years even with inflation. Kids on their own.
4) Use your emergency and house sale leftover (if any) to cover for marriage expenses for both kids.

I'm not assuming any help from SS and medicare.

PS. If you can have 2.5 crores($0.6 Million) you could have a better emergency and inflatioanry cushion...

let me know your comments ...

Anonymous said...

I spent considerable time reading this last time I visited in2010. I am glad this is still continuing. I felt Karun's post simpler to follow - I did start investing at 40 and haven't got the drive to do it for more than 5 years. I have a own home in Bangalore, I have one child to be college educated and I wish I could stop working. How do you do that when there is 20k in college funds, 75 k in 401k and 52k in loans. I am hoping rent will cover mortgage plus ins,tax if I don't work.

Shankar said...

Sandip,

You have good insight for sure in the investment strategy. However, I dont see why you only consider US instruments. That is, if you invest $100K in a bank in Rs in India, you will get, say, $8K per year interest (around Rs. 35K per month). The big worry I presume is whether your principal is safe since we don't have US FDIC type protection. The equivalent of that is DICGC which is a ridiculous Rs. 1 Lakh. But if banks like SBI go down, then it is nearly as bad as the Govt going down! I dont see the need to invest in stocks if you get 8% return. Anything wrong? Comments? Thanks.