I’ve been thoroughly enjoying Big ERN’s series on yield shield 29, 30, and 31. In a very even handed way Karsten pretty much demolishes the illusion of SOR “safety” associated with yield based retirements. I think the illusion comes from the way FIRE is sold by the bogglehead crew and others like Mustache. The shockingly simple math is the math of a passbook savings account, not a equity investment account, and given the passbook savings rate even that is far from safe. 1M @ 4% with a 4% WR works fine till the first 4% goes to 3 % or inflation goes to 3.5%.
I was reading another article by a young physician who has 1/2M in the bank and “decided” 3.3M would give him a FI retirement, but now it’s up to 5M. If you actually inflation adjust to just nominal inflation, $150K/yr added to 500K takes 19 yrs to get to 5M. Imagine at high inflation how long it would take. At 3.5% inflation for the same rate of return it now would take 22 years to make that 5M nut and every year after you pulled the trigger your effective WR and “safety” would be less. I’m just playing with shockingly simple 4th grade math here, not calculus or differential equations. Look at these numbers. A cut in the rate of return from 4% to 3%, with a 4% WR wipes you out in 47 years. An increase in inflation from 2% to 3.5% blows you up! These small changes represent SOR. They are what constitute SOR. SOR giveth and SOR taketh away. The yield shield does not take into account SOR because the calculation is based on a constant as in it’s not a variable but life is not based on a constant. SOR by it’s very definition is a variable. It’s a sequence not a constant. Where is the sequence variable in 4 * 25? In 3 * 33? Yet people blindly plan their lives around these variable-less formula and behave as if there is some assurance of success and get all pissed off at Suze O when she dare challenge the illusion.
Lets take the illusion of success and turn it on it’s head using a simple FV calc No fancy Monte Carlo statistics but iterative 4th grade math.
This is a 1M 4% WR 30 year retirement @ 6% return. 2.25% inflation and a 12% tax load. In 30 years your 1M at 6% would generate 2.748M. Taxes, inflation and WR would eat 2.000M. Your have 1.030M of buying power left
Here is the scoop if you make 4% on your 1M instead of 6%. After taxes inflation and WR your 1M has 398K of buying power left.
Here is the scenario at 2% return all else the same. 64K of buying power left. Better hurry up and die! You will notice what we did literally was vary the sequence of return. We turned the constant into a variable, with a pretty dramatic result! THIS is what Suze O knows! She intuitively understands there is a variable in there somewhere to worry about. Ignoring the variable is the face of retirement failure. This retirement is levered to at least 2% rate of return to satisfy the assumptions.
Lets say you get a diagnosis where instead of 40K WR you need 52K WR. For example the drug Repatha costs about $1000/mo
You ran out of money a long time ago. Your Repatha bill killed your portfolio off at 23 years. “Varying” the WR is part of SOR.
Here is a 60 year Mustache retirement. Mustache retired at 30 with shockingly simple math so this calculation takes him to 90.
At 6% Mustache still has 1.8M left in the bank at age 90.
At 4% return he better hurry up and die! Sucka is flat out of dough. 2 variables changed in this scenario SOR and longevity and this portfolio is leveraged to a 4% rate of return for success. This is the problem when you create scenarios like the Yield Shield. If your money is coming from yield your are ignoring growth and growth is your protection against inflation. It’s also the the problem with formula like 4 x 25 where you just pull numbers out of thin air and call it good enough. If Mustache gets a bad diagnosis at 55 or 60, with the above 4% plan the guy is screwed.
2 Replies to “More On the Concept of Yield Shield and 4 x 25”
When I read this stuff, I am glad that I have the option to keep working till I am older. I do not necessarily trust my math…
I tend to review things on a regular basis. This has kept me safe and makes me less prone to dogma.
Hey MB I’ve been reading your blog but for some reason it won’t let me log in so haven’t been able to comment. I don’t trust the math either because the best you can do is a projection, but over time the actual relevant variables and how much control you can exert have become clearer. The answer is you have some fine control maybe even moderate control, but since mistakes compound and torpedoes come out of nowhere projections are not indicative. The best thing is to actually retire and closely track the projection to get some idea of the fidelity between reality and projection, problem is by the time you have that data it’s too late.