Sunday, September 19, 2004

FireCalc

I just tried a very interesting tool: FireCalc.

This tool lets you enter some data about your starting portfolio, annual withdrawals after retirement, withdrawal changes along the course of your retirement.

I did enter my data and found that my chances of success were about 78%. Quite low. I looked back at the data to see what was going on. There is a flaw in the use of this program before retirement. While the program adjusts figures to inflation, it considers you are retiring tomorrow. For instance, when you enter the value of the house you will sell 10 years after retirement, you enter the value of the house today and the program automatically adjust this value to take inflation into account. Right. But what the program doesn't consider is that if you retire in 8 years, the value of the house should be adjusted for 18 years (8 years from now, 10 years after retirement), not only 10. Thus, the value I did enter, 85 000, was undervalued by about 15 000 $.

The same apply to the other values entered: my social security pension that I will get from age 65 (that is, 28 years after my early retirement at 37) is undervalued by about 20%, since the value when I will retire is larger than the value retirees receive today.

In order to use FireCalc, thus, remember that what the program considers as being "Today" refers actually as if today was the first day of your retirement. Then, adjust these values to inflation for the number of years before you retire.

After the modifications, my chances of success according to FireCalc raised to nearly 92%, with a mean balance after 43 years of retirement at about $600 000.

19 Comments:

Blogger Rob Bennett said...

Jack:

I urge you to be careful in your use of FIRECalc. Its safety claims are way off the mark of what you get when you perform an analytically valid examination of what the historical data says re safe withdrawal rates (SWRs).

The problem is that FIRECalc does not make adjustments for changes in valuation levels. The data shows that the valuation level that applies at the date a retirement begins is the single most important factor determining the SWR. So failing to take that factor into account causes the numbers reported as safe to be way off the mark.

That's not to say that there is zero value in FIRECalc. It is fun to put in different scenarios and see what numbers come up. I like using it for that purpose. Just please do not use the FIRECalc numbers in a serious effort at putting together your investing strategy for retirement.

I recommend that you take a look at the Early-Retirement-Planning-Insights.com site to get valid reports on the safe withdrawal rate for stocks and other asset classes. The research presented at that site does take the critical valuations factor into account.

Please let me know if you have questions about the SWR topic. I am writing a book about recent developments in SWR research, and I often report on SWR-related investing insights at my blog at PassionSaving.com.

Rob Bennett

6:02 AM  
Blogger Jack said...

Hi Rob,

What do you mean by "valuation level"?

I think I understand a bit intuitevely what you mean. In a previous post on this blog, I was saying that I should only retire ahead of the plan only if I succeeded doing so after a bear market, which might translate to low valuation level.

I'm not a specialist, and my intuition is likely only partly true, but what I wanted to say was that it wouldn't have been wise to retire 5 years earlier than planned after the dot.com boom, for instance, since everybody should have known that there were more place for the market to go down than to go up in the mid term.

Is that what you mean by "valuation level"?

Jack.

10:03 AM  
Blogger Rob Bennett said...

Jack:

Yes, that's right. It's really just a common-sense observation to note that stocks are not likely to provide the same long-term returns starting from a time when they are overvalued as they would from a time when they are fairly valued. Unfortunately, common sense is sometimes hard to come by at the tail end of monster bull markets.

Stocks are a great long-term investment. Stocks are my favorite asset class. But the methodology used in the FIRECalc calculator just ignores the effect of valuation levels altogether; it reports the same safe withdrawal rate for all possible valuation levels. That's dangerous, expecially in a retirement planning tool.

The concept behind FIRECalc is a good one, for the reasons I noted in my earlier response. it's both fun and educational to play with how things would work out in different historical scenarios. The tool provides a false sense of security to many in the way it is currently structured, however. An adjustment needs to be added for the effect of changes in valuation levels. You get very different answers to the question "What withdrawal rate is safe?" when you make an adjustment for changes in valuation levels.

Rob
The Financial Freedom Blog
www.PassionSaving.com

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I would caution you about listening to Rob. He's well known as a troublemaker.

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