Pareto Principal Malarkey

I read a blog post today abut the topic of how much you need to save. It was a Pareto principal analysis, 20% of the dope gets you 80% of the results. The analysis was a typical FIRE blog analysis which starts at year one (say 30) and ends at year retirement (say 45) and uses the hokey 25 x, or an even safer 30 x. It was 100K/yr and it was decided 2.5M or a safer 3M was enough to get the job done.

Here is the analysis of 3M @ 3% inflation and 5% return a 45 year retirement

A 45 year retirement will cost 9.27M. In this analysis the portfolio fails in year 44 (age 90). The analysis does not include SS with SS it would likely not fail. Let’s see:

This is a guesstimate of SS taken at age 70 and inflation adjusted to age 90, SS=1.1M So you’d wind up with about 700K in the bank at 90.

This is what is wrong with Pareto. This analysis took 10 minutes with explicitly defined assumptions and results. If you Pareto it you end up broke if you work through it you are far clearer in your understanding.

Would you be temped to quit @ age 45 with 2.5M in the bank? Remember this does not account for end of life issues, increasing taxes (note the last year you are in the 32% bracket) or SORR. 2.5M is dicey

Even with SS the portfolio fails in year 35 (age 80). 100,000K x 25 = 2.5M to start. This is why I think it is necessary to plan not from the year of retirement but from the year of presumed death. You can also see the effect of working more years on portfolio longevity and the effect of everything like SS.

Here is a 35 year retirement 2.5M @ 5% and 3% inflation, beginning at age 55 and ending at 90. Notice how the portfolio still fails at age 88 but the longer SS leaves you with 900K in the bank

Would you quit @ 55 with 2.5M in the bank? I’ll leave the consideration up to you but clearly making 25x last 35 years much less 45 years without the safety of SS is nuts. I must admit Pareto got you 80% there BUT 80% WASN’T A GOOD ENOUGH ANALYSIS.

10 Replies to “Pareto Principal Malarkey”

  1. When I thought I “retired” was to have 1.5 M saved, my house paid off and husband training to become a surgeon. I planned to work and make 100K/ year. I did not expect my husband to come out and make so much. I was 36 years old at the time.

    I would have considered retired to go from working 7 days a week to 2 days a week! The thought of giving up my medical license at 36 yrs old NEVER crossed my mind.

    It felt like retiring to work so much less already. I am with you Gasem. Planning anything for 50 years is a heck of a long time.

    I do not think these young FIRE folks realize that kids get MORE expensive as they get older. Even I never knew that until it happened.

    I hear some say they want their kids to have “skin in the game”. I hear that as code for “Oops, I did not save enough for you cause I needed to stop working earlier.”

    I would have never had the heart to pull that one off. Thus we have planned to completely pay for our kids’ education costs. My mother paid for that for me and she worked at minimum waged jobs for Pete’s sake.

    1. The most loving thing you can do is provide your kid with a debt free start to his/her adult life. If they start in debt they are doomed from the start. The proof is the college debt crisis, it’s wrecked millennial productivity. Skin in the game is a stupid concept. Skin in the game IS millennial debt, and merely says you failed as a parent to give your kid adequate motivation and boundaries growing up. My plan for their adulthood started from the day they became mine. The same for my wife’s future. That plan started the day we got married.

  2. Yes, I read that post too.
    There is nothing wrong with Pareto per se. But the conclusions were overly optimistic.
    Spending $100K after tax can be more like $143K before. 33 years of expenses then become more like $4.7M

  3. I would feel uncomfortable pulling plug at age 45 with a $2.5M nest egg. In fact I am 48 and have a little more than a million over that (not including primary home) and I still haven’t pulled the plug.

    I would like to be able to draw $125k/yr (which if I did the 3.5% swr I already am over). But I think I want to pad it even more so once I pull the plug I don’t have to go back ever.

    My partner thinks radiology as a specialty is going to be ending soon with talks of AI etc. So it may be a moot point. But if I can work another 5 years (or even just a couple more) and save like I have been I think I can have a save 45+ yr retirement if I live that long.

    Is there a % withdrawal rate you would feel comfortable at if say retiring at 50? I think my 3.5% is conservative but some have even done 3%. At 3% I think you can withstand some pretty bad sorr

    1. The Monte Carlo generally lists something like 3% +- a dab WR as a perpetual withdrawal rate when hugging the 10% line. I don’t mind living a probable life (since we all do that anyway) so I don’t mind using a statistical model to explore the probabilities and draw probable conclusions. The model does not take into account radical changes in the economy like $15 minimum for everyone, medicare for all, free hot and cold running college, no borders. Those are not creative destruction but simple destruction. So save all you can IMHO.

  4. I left a comment about this on the TPP website.
    He responded:
    “I don’t think I agree.
    Taking $100,000 out from assets is a very different thing than making $143,000 and living on $100,000. Some of the money I pull could come from a taxable account, which is taxed at a much lower capital gains rate (or a Roth IRA account if the SECURE act goes through and abolishes the benefits of the Stretch Roth IRA as an inheritance).
    I think there are a lot of ways to get to that $100,000 number without getting hit by that much tax.
    Also, early retirement only increases that risk if you (1) Don’t save enough before retiring and (2) you experience SORR issues.”

    1. TPP has always been about magic in his analysis, or lack of analysis, so much so I generally avoid his site. He is like a kid with a hammer and everything is a nail. Get an idea, whip out Pareto and Pareto that bastard! The stock market is down 20% of the time, which means it’s up 80% of the time. Pareto would imply that 20% down is responsible for that 80% up aka magic. If you look at a long term chart of the Nikkei 225 you see a much different reality. Clearly the market is a function of the economy, creative destruction, and national productivity not some dumb principal.

      I don’t mean to dis the guy but I have a completely different take on how to do finance. In reading the above response it’s abba dabba. To take money from a Roth assumes you have money in a Roth. How do you get money into a Roth when you’re not eligible beside conversion which has it’s own special brand of progressive taxation. Take money from a TIRA… oops progressively taxed on top of progressively RMD’d Pretty much 20% of the pretax accounts account for 80% of your tax burden in retirement. That means the other 80% of pretax, accounts for 320% OF YOUR TAX BURDEN if you Pareto that bastard! Yes you can take money from a brokerage. A brokerage is taxed as ordinary income (progressive) going in and as capital gains coming out, so where is the low tax advantage? The only way you get an advantage is to take losses. Does taking losses sound like an advantage to you? It merely salves the sting.

      Pareto is a fail in economic analysis IMHO. It is useful in population dynamics which was it’s original insight. An Italian realized 20% of the people owned 80% of the land. It was then studied and found 20% of a work force did 80% of the work. This is a functional description of efficiency and productivity which is dependent on PARTICULAR people operating dynamically within a PARTICULAR system. If you switch to communism as the system 100% of the people do as little as possible. I started to respond but decided to write my own post on how I think about the cost of retirement which is to start at the end and work backwards, not start in the middle and work backwards. The problem is on FIRE time frames (say 10 years accumulation) and FIRE retirements (say 60 years of spend down) there is a monster magnification of error in the spend down leading o the need for excessive leverage to succeed. Leverage = risk and > risk = > failure. It turns out you can Monte Carlo this also using the 50% line as your guide and then see the display of + and – standard deviation for your assumptions. I thought a simple spread sheet analysis might be illuminating.

  5. If Socrates was the gadfly for the Greeks, you are truly the gadfly for the FIRE set, my friend.

    The secret to retirement happiness as you point out is planning for the worst and being pleasantly should that scenario not occur.

    Interesting take on skin in the game as well. I benefited from the parental tuition scholarship and it launched me 5-10 years ahead of those who had debt at graduation, which positioned me for success financially (in no way guaranteed it, but was a key in positioning me to invest when others were digging out). I’ve no doubt that single advantage made all the difference.

    1. Sadly I am a Gadfly not so much by choice but by honesty. I just see a different reality. FI has potential to turn most anyone independent if you work at it long enough and manage to avoid or get out of debt. 40 years of saving 6K/yr in a Roth @ 6% is 1M. If you start at 25 by 65 you’re well set. If you have debt pay that down simultaneously. 6000/52 is 115 bucks a week. 11 hours a week at 10 bucks an hour pretty much gets the job done. Notice this is NOT easy. This is hard but it can be done. If you make 500K/yr it is easy. If you make 150K/yr it’s easy. The median family income is about 80K. If you’re married and have 2 contributions you win faster or you retire more flush, but that is just the reality of the animal.

      The problem with FIRE is it’s sleight of hand. It looks at 1 variable, return, and projects the shooting match from that, ignoring the other variables like SOR, Taxes, Inflation, Disaster, Risk, Human factors like panic selling, Divorce, Children, feeble parents who may need a hand. That list is 10 factors. What about political stability, economic issues like weather war or a bio or nuclear attack, infrastructure failure, cyber attack economic attack. What about getting sick in old age?

      I have 2 friends maybe 7 years older than me. She has Alz and he just copped an ALS diagnosis and the hits just keep on coming. Her life expectancy is 12 years likely with full time memory care maybe 100K/yr. His is 2-5 but a much more expensive course. Both diseases are relentless. Manhattan lost power for 5 hours and it was wall to wall coverage, in the mean time the hurricane devastated several states. All of that matters. Much of it is incalculable. I forgot to mention taxes as a special category of confiscation. The tax risk is diabolical. Snap of the governments finger and you’re out of business aka SECURE act. You only get to keep what the govt says you can keep.

      That’s the kind of stuff that needs to be in an analysis. Some of it probable (everyone is going to die) some of it unlikely but it happens (I got hit by a hurricane 5 weeks after I retired and just racked up a 600K heart surgery bill). And we’ll have fun fun fun till the Daddy takes the T-Bird away. A little farting around with tax dodges by choosing this account or that is not the answer.

      My parents didn’t pay my load but they did what they could. I was resourceful enough to come out of residency debt free. That meant in college I worked 2 jobs, plus classes. Still managed to have a blast. I saved for 5 years for med school but 1981 happened and inflation ate my lunch so went in the Navy for a couple years and became LT Gasem USN MC. Still managed to have a blast in med school and residency. Learned how to do pain in the Navy because they made me the pain doc for all the services in the SE US. Knowing how to do pain made me a lot of money on the side for the next 25 years, still managed to have a blast. I guess RE never rally occurred to me, till I stopped having a blast.

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