Networthify (the blog)
http://blog.networthify.com
2013-01-06 20:05:45 +0000But I want to spend down my nest egg to zero
http://blog.networthify.com/but-i-want-to-spend-down-my-nest-egg-to-zero
2013-01-04<p>The problem with this is you can't predict when you will die. On average,
Americans live until about 80. But thats the average. Half of everyone will
live longer than that. What will you do if you live to age 100? </p>
<p>Despite this, lots of retirement calculators and planning manuals tell
you to enter in your age of death. But you can't predict this. So don't do
your retirement planning like you can. </p>
<p>Instead, build enough of a nest egg that you can live off the return on your
investments without drawing down the principle. This will sustain you
indefinately. </p>
<p>Another thing to consider: If you retire at 50 and live until 80 you will spend
30 years in retirement. Thats a long time. You need to be thinking like a
B-list celebrity. You made a small pile of money, but your career is over and
no one wants to hire you anymore and you need to find a way to make that money
last another 30 - 50 years which will probably include a big recession or even
a depression or two. The way to do that is not spend down your principle. </p>
<p><br>
<img class="src" src="http://farm4.staticflickr.com/3189/2607036664_da729b4bd5.jpg" width="500" height="333" alt="eggs">
<a class="src" href="http://www.flickr.com/photos/wwworks/2607036664/">photo by woodleywonderworks</a></p>
Withdrawal rates
http://blog.networthify.com/withdrawal-rates
2012-12-20<script type="text/javascript"
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<p>Lets say you reach your goal of retirement. You quit your job sit on your
sailboat and eat pineapples all day. The wind is in your hair, you are relaxed
and carefree, and you have pineapple breath. All because you have a formidable
nest egg and can live comfortably off your investment earnings. </p>
<p>But how do you know how much of your nest egg you can withdraw and spend each
year? </p>
<h2 id="toc_0">How to calculate your withdrawal rate</h2>
<p><b>Step 1</b></p>
<p>Calculate how much you spend each year. This step requires actual
effort so people often don't bother. But this step is the <em>key</em> to retiring early
and the key to retiring at all. Happily there are online tools to help you. I
of course will recommend <a href="http://networthify.com">Networthify</a>. But
<a href="http://cashbasehq.com">CashBaseHQ</a> and <a href="http://mint.com">Mint</a> are great
as well.</p>
<p><b>Step 2</b></p>
<p>Divide your annual spending by the size of your nest egg. Thats your
withdrawal rate.</p>
<p>
\[
\begin{aligned}
NestEgg \times WithdrawalRate & = AnnualSpending \\
WithdrawalRate & = \frac{ AnnualSpending }{ NestEgg } \\
\end{aligned}
\]
</p>
<h2 id="toc_1">But...</h2>
<p>But there is a problem. Your withdrawal rate could change dramatically
each year depending on the size of your nest egg each year. For example:</p>
<p><b>A happy scenario</b></p>
<p>Your $1 million nest egg earns 10% returns this year. <br>
Your withdrawal rate could be as high as $100,000.</p>
<p><b>A sad scenario</b></p>
<p>Your $1 million nest egg earns 1% returns this year. <br>
Your withdrawal rate could be as high as $10,000.</p>
<p>Those are radically different outcomes. Living off $10,000 for a year will not
get you to the pineapple breath you were hoping for. Now consider how big a
difference it makes if you have 15 good years when you first retire vs if you
happen to get 15 bad years. It is massive.</p>
<p>If you are starting your career and trying to plan for retirement, all the
calculators out there ask you to input a withdrawal rate. <b>What you now know
is that is impossible to know</b>. It will depend on market conditions,
inflation, and changes to tax law. And none of those is knowable.</p>
<h2 id="toc_2">Solution</h2>
<p>If you are already retired this means you need to be flexible when considering
your withdrawal rate. Each year will be different and you must be especially
careful in your first 10 years of retirement.</p>
<p>But what do you do if you are starting your career and trying to plan your
retirement? Basically we guess. But we do an educated guess.</p>
<p>Researchers like Wade Pfau have discovered that a nest egg that uses a constant
withdrawal rate of 4% survives any period of US stock market history --
including the Great Depression. This is why all of networthify's calculators
default to a 4% withdrawal rate.</p>
<p>That sounds like good news, but remember that past performance doesn't predict
future performance. Most worrying Wade Pfau also ran the numbers using
European historical stock market data and found that in some countries there
were periods when a withdrawal rate of 0 would not preserve your nest egg. </p>
<h2 id="toc_3">More reading</h2>
<p>If you want to learn more, here is a fun <a href="http://www.mrmoneymustache.com/2012/05/29/how-much-do-i-need-for-retirement/">introduction to withdrawal rates</a>
written by Mr Money Mustache. </p>
<p>But the definitive article on withdrawal rates is <a href="http://financialmentor.com/free-articles/retirement-planning/how-much-to-retire/are-safe-withdrawal-rates-really-safe">this one</a>
(its long) at FinancialMentor.com. It is awesome and fascinating and I highly
recommend it.</p>
The best personal finance blogs
http://blog.networthify.com/the-best-personal-finance-blogs
2012-11-24<p>Here is a short list of the very best personal finance blogs on the internet.
All of these websites are constructed entirely of Excellence. They are so good
I read every post in their archives. Each author has found a way to retire in
under 10 years with fairly normal human level salaries and has insightful
things to say about getting to financial freedom.</p>
<p><br></p>
<h2 id="toc_0">Mr Money Mustache</h2>
<p>If I was marooned on a deserted island ... with limited bandwidth and could
only read one blog, this is the one I would choose. I recommend reading this
blog from first post to last. <a href="http://www.mrmoneymustache.com/">Mr
Money Mustache</a> introduced me to the idea of early retirement. Before that
I was adrift, completely uninterested and wanted to spend the rest of my life
working. His persuasive upbeat writing will blow your mind on the subject of
retirement. And thats pretty hard to do considering how boring the subject is.</p>
<p><strong>Defining post:</strong> <a href="http://www.mrmoneymustache.com/2012/01/13/the-shockingly-simple-math-behind-early-retirement/">The shockingly simple math behind early retirement</a></p>
<p><br></p>
<h2 id="toc_1">Lacking Ambition</h2>
<p>My favorite thing about <a href="http://lackingambition.com/">Lacking
Ambition</a> is the thoughtful exploration of the philosophy of work, money,
and time. Its also the story of how one guy found financial independence
through real estate and frugality. I recommend reading it from the beginning.</p>
<p><strong>Defining post:</strong> <a href="http://lackingambition.com/?p=423">A year alone in the desert</a></p>
<p><br></p>
<h2 id="toc_2">Early Retirement Extremist</h2>
<p><a href="http://earlyretirementextreme.com">ERE</a> was the best and most popular
writer in the early retirement community for a long time. Unfortunately he no
longer blogs but I definately found it worth my time to pore over his old
posts.</p>
<p><strong>Defining post:</strong> <a href="http://earlyretirementextreme.com/how-i-live-on-7000-per-year.html">How I live on 7000 per year</a></p>
<p><br>
<br>
Any other great blogs that I should know about?</p>
Welcome people of Sweden
http://blog.networthify.com/welcome-people-of-sweden
2012-09-06<p>Hi and welcome to the site! I'm not sure where all this traffic is coming
today from but it seems to mostly be from Sweden. I'd be grateful if someone
dropped me a hint below in the comments.</p>
<p>Thanks,
Eric</p>
The math behind the calculator
http://blog.networthify.com/math/the-math-behind-the-calculator
2012-08-17<script type="text/javascript"
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<p>Networthify.com calculates how many years you have to retirement. Lots of
people have been curious about how it arrives at the magic number. The answer
to this question is: <em>Math!</em></p>
<p>More specifically the equation which drives the calculator is derived from
two common formulas used for dealing with compound interest. Many people must
have done this before me but I couldn't find an example online and I enjoyed
doing the math anyway.</p>
<p><img class="src" src="http://farm2.staticflickr.com/1228/1443062022_25e5a0a12b.jpg" width="500" height="333" alt="calculator">
<a class="src" href="http://www.flickr.com/photos/brandonshigeta/1443062022/">photo by brandon shigeta</a></p>
<p>Before we start with the math, we have to define retirement or else we can't
calculate how long it takes to get there. This is a bit of a problem because
people will define it differently. But I'll just go ahead do it anyway.</p>
<p>First, I have no idea what my expenses after retirement are going to be but I
decided it can't be that different from my current expenses. After all I will
still need to pay for food, housing, and entertainment. </p>
<p>Also, I don't want to ever draw down my retirement nest egg. I want my wealth
to grow, not shrink. I'm being overly safe, but I don't want to have some bad
luck or unexpectedly live to 120 years old and have to lower my standard of
living. I want my standard of living to go up because thats way more fun.</p>
<p>So this is how I defined retirement:</p>
<p>
\[
\begin{aligned}
currentExpenses & = annualIncome - annualSavings \\
futureExpenses & = withdrawalRate \times futureValue \\
currentExpenses & = futureExpenses \\
\end{aligned}
\]
</p>
<p>where <em>futureValue</em> is my total savings after retirement and <em>withdrawalRate</em>
is slightly less than my average annual return on investment. What we want to
know is how long will it take to save a pile of money equal in size to
<em>futureValue</em>. </p>
<p>Notice there are 2 basic ways to build a pile of money over time:</p>
<ol>
<li>Earn interest earned on our existing and growing pile of saved up money.</li>
<li>Contribute savings from our annual income.</li>
</ol>
<p>Happily there are formulas for calculating this stuff. Lets take a look at them.</p>
<div class="mathHeader">The capital accumulation formula</div>
<p>\[ futureValueA = initialValue \times (1 + interestRate)^n \]</p>
<p>Lets say you have an initial pile of money. And someone is willing to pay you
some interest for it. This formula calculates how big your pile of money will
be in the future.</p>
<p>More precisely: it calculates how much money you will have in the future given
an initial balance which earns interest each time period for n time periods.
The time period I use is one month.</p>
<div class="mathHeader">The future value of a series formula</div>
<p>\[ futureValueB = payment \times \frac{ (1 + interestRate)^n - 1 }{ interestRate } \]</p>
<p>This formula also calculates how much money you will have in the future. But
this time you start with no money and contribute a payment each time period for
n time periods while earning interest on your growing pile of money.</p>
<p>Again I want to use a time period of one month. I'll make a small change and
now this formula calculates what happens when you put some of your salary into
your savings account each month:</p>
<p>
\[ futureValueB = \frac{annualIncome}{12} \times \frac{ (1 + interestRate)^n - 1 }{ interestRate } \]
</p>
<p>But what we really want is a single formula we can solve for n to figure out
how long it will take to reach retirement. So lets start doing some
substitutions:</p>
<p>
\[
\begin{aligned}
currentExpenses & = annualIncome - annualSavings \\
futureExpenses & = withdrawalRate \times futureValue \\
currentExpenses & = futureExpenses \\
\\
futureValue & = futureValueA + futureValueB \\
\\
currentExpenses & = withdrawalRate \times (futureValueA + futureValueB) \\
annualIncome - annualSavings & = withdrawalRate \times (futureValueA + futureValueB) \\
\end{aligned}
\]
</p>
<p>Awesome. So now its a "simple" matter of solving for n. So after doing substitutions for <em>futureValueA</em> and <em>futureValueB</em>,
doing natural log stuff, <em>handwaving</em>, <em>handwaving</em> -- I arrived at the following:</p>
<p>
\[
n = \frac{ln(interestRate \times \frac{\frac{1 - savingsRate}{savingsRate} + withdrawalRate \times initialValue}{withdrawalRate \times initialValue})}{ln(1 + interestRate)}
\]
</p>
<p>And thats the math behind the calculator. Here is more reading for the super duper interested:</p>
<ul>
<li><a href="http://betterexplained.com/articles/demystifying-the-natural-logarithm-ln/">http://betterexplained.com/articles/demystifying-the-natural-logarithm-ln/</a></li>
<li><a href="http://www.patrickschneider.com/blog/2008/03/compound-interest-with-an-initial-balance-and-monthly-contributions/">http://www.patrickschneider.com/blog/2008/03/compound-interest-with-an-initial-balance-and-monthly-contributions/</a></li>
<li><a href="http://en.wikipedia.org/wiki/Compound_interest">http://en.wikipedia.org/wiki/Compound_interest</a></li>
</ul>
Spending money shortens your life
http://blog.networthify.com/saving/spending-money-shortens-your-life
2012-08-14<p>One morning you awake to find the tooth fairy made an accounting error in
your favor. She left $15 million under your pillow. Now you
have some choices to make. Here is one: Would you continue to wake
up each day and go to your current job?</p>
<p>We all have a certain amount of time to live. Every dollar we earn is
given in exchange for time spent working. So whenever we buy a car
or underwear or peanut butter we are paying in dollars but those dollars
represent time. In a very real sense, buying stuff shortens your
life. (And btw that means a charitible donation is literally giving
part of your life to another, taxes are the government redistributing
life, national debt shortens the life of people of the future, etc,
etc.)</p>
<p>The most common response to this problem is: Find a job you love. This
is good advice. The more pleasant your job is, the lower the
opportunity cost. But think about the tooth fairy test.
There just arent very many jobs out there that are going to pass
that test. And unless you love your job enough that you would do it
even if you were financially independent -- then you are still selling
away large pieces of your life.</p>
<p>There is only one escape: save enough money to live off the returns from
your investments. Reach this goal and you will never again need to
trade your time for food and housing.</p>
<p>
<img class="src" src="http://farm2.staticflickr.com/1238/540936323_fc59ef2ce2.jpg" width="500" height="333" alt="Money">
<a class="src" href="http://www.flickr.com/photos/thomashawk/540936323/" title="Money by Thomas Hawk, on Flickr">Photo by Thomas Hawk</a>
</p>