Retirement Readiness Ratio (e.g. Funding Ratio)

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WoodSpinner
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Retirement Readiness Ratio (e.g. Funding Ratio)

Post by WoodSpinner » Sun Nov 24, 2019 7:16 pm

Awhile back I read a thread by bobcat2 on the Funding Ratio. I really liked how this one metric could be used to assess Retirement Readiness and help model Asset Allocation. While I thought the thread was interesting, I was a bit put off by using an Immediate Annuity to help drive the calculations. No doubt this could be useful but I was really looking for a metric I could seamlessly calculate as part of my Retirement Cashflow Model. I already had a projection of my Income, Expenses and Taxes throughout Retirement and really wanted a simple way to signal if I was on-track or needed to adjust.

I would like to use this post to start a discussion on using a variation of this metric which I am calling the Retirement Readiness Ratio (RRR).

Proposed Metric:
Retirement Readiness Ratio = Current Portfolio Value/PV(DiscountRate, (Income-(Expenses+Taxes))

Essentially this is a ratio of the Current Portfolio Value to the currently valued Cashflow needs throughout Retirement. I see this as one of many signpost metrics I can use before or during retirement to gauge my readiness and provide some insights around the question of how much risk do I need to take.

In my mind it is a much better metric than some of the other frequently discussed metrics e.g. 25x times expenses since it accounts for the Income as well as Expense and isn't tied to an assumed Retirement duration (e.g. 30 years).

Link to Retirement Readiness Ratio Spreadsheet

Key Questions:
1. Is this a useful Ratio to use? By whom? At what point in their planning?
2. Am I making a reasonable assumption that BHs interested in Retirement planning would have the Inputs and Cashflow Model?
2. What are the key insights we can gain from the Ratio? What have I missed?
3. Is the fundamental logic correct?
4. What gradations in the RRR need to be better understood? For instance, I don't think the step function implemented works well when the RRR ratio is between .9 and 1.1.
5. What needs to be clarified to make this useful to the BH community?

My thinking is that this RRR Ratio is useful as a point-in-time signpost to quickly assess the over all health of the Retirement Plan. Many things can happen in the future that may change things -- but for today we can make an assessment. I think RRR would be useful closer in the range of <Retirement - 10 Years> to <End of Life>.

Thanks in Advance for your Insights and Suggestions!

Insights Provided by the Model:
Retirement Readiness Ratio
RRR Ratio under 1 -- Not Ready, continue Saving, Increase Retirement Income or Decrease Expenses
RRR Ratio between 1 and 2 -- Ready but Monitor enjoy retirement
RRR Ratio greater than 2 -- In Excellent Shape for Retirement, relax

Present Value of Cashflows
PV of Cashflows > 0 –-In Excellent Shape for Retirement. Portfolio NOT even needed to fund expenses

Equity Allocation

Suggested Maximum Equity Allocation -- Assuming that Equities can drop by the percentage provided, what is the highest equity allocation I can use and not go below a RRR Ratio of 1.
Maximum Suggested Equity Allocation < Minimum Portfolio Equity Allocation –-Monitor Retirement closely your Equity Portfolio may not keep up with inflation.

Funding Ratio -- Alternative Analysis
Suggested Monthly Immediate Annuity and COLA to price if using the traditional Funding Ratio approach
Not enough money in Portfolio to Purchase Immediate Annuity -- There is not enough money in the Portfolio to Purchase an Immediate Annuity to meet Cashflow needs

Inputs:
Image

Cashflow Model
Image

Insights:
Image

Alternative Analysis -- Traditional Funding Ratio
Image

AlohaJoe
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Re: Retirement Readiness Ratio (e.g. Funding Ratio)

Post by AlohaJoe » Sun Nov 24, 2019 7:41 pm

WoodSpinner wrote:
Sun Nov 24, 2019 7:16 pm
Insights Provided by the Model:
Retirement Readiness Ratio
RRR Ratio under 1 -- Not Ready, continue Saving, Increase Retirement Income or Decrease Expenses
RRR Ratio between 1 and 2 -- Ready but Monitor enjoy retirement
RRR Ratio greater than 2 -- In Excellent Shape for Retirement, relax
I couldn't quite follow how you determined these boundaries. Why, for instance, does >2 mean "excellent shape for retirement" and not >1.8 or >2.5? And does "excellent shape for retirement" mean "retire today"? Does >1 mean "you can retire today"? Should someone retire the moment their funded ratio crosses from 0.9 to 1.0? Should they wait until it gets to 1.1? How much is risk reduced when they wait from 1.0 to 1.1?
Last edited by AlohaJoe on Sun Nov 24, 2019 8:06 pm, edited 1 time in total.

GrowthSeeker
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Re: Retirement Readiness Ratio (e.g. Funding Ratio)

Post by GrowthSeeker » Sun Nov 24, 2019 8:02 pm

But if one is at or near retirement, and no pension or annuity, one expects, say, 20 years of expenses > income. So wouldn’t the PV then be negative, and thus the ratio negative? Or if you had a huge pension, income > expense by a lot then the ratio would be a small positive number.

If I recall, using the PV function in Excel was always hinkey wrt a minus sign.

Can you clarify how you (or the spreadsheet) is defining the calculation of PV?
Just because you're paranoid doesn't mean they're NOT out to get you.

KlangFool
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Re: Retirement Readiness Ratio (e.g. Funding Ratio)

Post by KlangFool » Sun Nov 24, 2019 8:21 pm

WoodSpinner wrote:
Sun Nov 24, 2019 7:16 pm

I would like to use this post to start a discussion on using a variation of this metric which I am calling the Retirement Readiness Ratio (RRR).

Proposed Metric:
Retirement Readiness Ratio = Current Portfolio Value/PV(DiscountRate, (Income-(Expenses+Taxes))

In my mind it is a much better metric than some of the other frequently discussed metrics e.g. 25x times expenses since it accounts for the Income as well as Expense and isn't tied to an assumed Retirement duration (e.g. 30 years).
WoodSpinner,

Please state your reason why do you think this is better. I disagreed that it is better. This ratio is based on many more assumptions: Discount rate, future income, and future taxes. If one or more those assumed numbers are wrong, the whole ratio would be wrong.

In my opinion, 25 times expense works very well for folks with annual expenses at or below 60K. At the annual expense of 100K or above, no simple ratio would work.

KlangFool

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WoodSpinner
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Re: Retirement Readiness Ratio (e.g. Funding Ratio)

Post by WoodSpinner » Sun Nov 24, 2019 8:27 pm

GrowthSeeker wrote:
Sun Nov 24, 2019 8:02 pm
But if one is at or near retirement, and no pension or annuity, one expects, say, 20 years of expenses > income. So wouldn’t the PV then be negative, and thus the ratio negative? Or if you had a huge pension, income > expense by a lot then the ratio would be a small positive number.

If I recall, using the PV function in Excel was always hinkey wrt a minus sign.

Can you clarify how you (or the spreadsheet) is defining the calculation of PV?
It essentially sums up the cashflow (positive or negative).

If the expenses exceed the income the PV will be negative. I adjust to insure the ratio is positive since this makes more sense to me.

If the income exceeds the expense the PV is positive. In this case the ratio is not important since the portfolio is not needed to fund the cashflow.

WoodSpinner

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WoodSpinner
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Re: Retirement Readiness Ratio (e.g. Funding Ratio)

Post by WoodSpinner » Sun Nov 24, 2019 9:14 pm

KlangFool wrote:
Sun Nov 24, 2019 8:21 pm
WoodSpinner wrote:
Sun Nov 24, 2019 7:16 pm

I would like to use this post to start a discussion on using a variation of this metric which I am calling the Retirement Readiness Ratio (RRR).

Proposed Metric:
Retirement Readiness Ratio = Current Portfolio Value/PV(DiscountRate, (Income-(Expenses+Taxes))

In my mind it is a much better metric than some of the other frequently discussed metrics e.g. 25x times expenses since it accounts for the Income as well as Expense and isn't tied to an assumed Retirement duration (e.g. 30 years).
WoodSpinner,

Please state your reason why do you think this is better. I disagreed that it is better. This ratio is based on many more assumptions: Discount rate, future income, and future taxes. If one or more those assumed numbers are wrong, the whole ratio would be wrong.

In my opinion, 25 times expense works very well for folks with annual expenses at or below 60K. At the annual expense of 100K or above, no simple ratio would work.

KlangFool
I made my thinking clear in the quoted section above. I don’t think future income is too difficult—especially closer to retirement. Taxes could be skipped if you find it too difficult. OTOH, having some estimate for retirement is pretty important. It doesn’t have to be 100%, just a reasonable guess.

Discount Ratio should be close to the expected return you are expecting from the assets that fund retirement cashflow — be conservative. It won’t make a huge difference to the ratio.


Feel free to use what works for you.

WoodSpinner :sharebeer

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WoodSpinner
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Re: Retirement Readiness Ratio (e.g. Funding Ratio)

Post by WoodSpinner » Sun Nov 24, 2019 9:27 pm

AlohaJoe wrote:
Sun Nov 24, 2019 7:41 pm
WoodSpinner wrote:
Sun Nov 24, 2019 7:16 pm
Insights Provided by the Model:
Retirement Readiness Ratio
RRR Ratio under 1 -- Not Ready, continue Saving, Increase Retirement Income or Decrease Expenses
RRR Ratio between 1 and 2 -- Ready but Monitor enjoy retirement
RRR Ratio greater than 2 -- In Excellent Shape for Retirement, relax
I couldn't quite follow how you determined these boundaries. Why, for instance, does >2 mean "excellent shape for retirement" and not >1.8 or >2.5? And does "excellent shape for retirement" mean "retire today"? Does >1 mean "you can retire today"? Should someone retire the moment their funded ratio crosses from 0.9 to 1.0? Should they wait until it gets to 1.1? How much is risk reduced when they wait from 1.0 to 1.1?
AlohaJoe,

To be honest I took WAG at them and this is one of the reasons I started the thread. In theory it should be similar to the Funding Ratio and could use some insight and advice on how to structure the analytics. I couldn’t get to many of the paper mentioned in bobcat2’s post (I do not have a corporate or student email) and could have easily missed some insights on the subject.

Any suggestions?

WoodSpinner

AlohaJoe
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Re: Retirement Readiness Ratio (e.g. Funding Ratio)

Post by AlohaJoe » Mon Nov 25, 2019 5:08 am

WoodSpinner wrote:
Sun Nov 24, 2019 9:27 pm
To be honest I took WAG at them and this is one of the reasons I started the thread.

Any suggestions?
I think a first step is to figure out the relationship between funded ratios using your discount rates and success rates.

Something we can do easily: what's the NPV of 30 years of expenses of $40,000 a year?

Code: Select all

=NPV(3.53%, [....])
=$733,107
So that's the denominator of the Funded Ratio in our scenario. We can then pick different numerators and see what kind of withdrawal rate falls out from that. Here's what I mean:

A numerator of $733,107 means a Funded Ratio of 1.0. Withdrawing $40,000 from a $733,107 portfolio means a withdrawal rate of 5.4%. We can look up in the Safe Withdrawal Rate research what that means for our plan.

On the other hand, if we pick a numerator of $1,466,215 we have a Funded Ratio of 2.0. Withdrawing $40,000 from a $1,466,215 portfolio means a withdrawal rate of 2.7%.

Of course, this is a relatively simple analysis but it can done with just a simple spreadsheet or financial calculator as a starting point for exploration.

GrowthSeeker
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Re: Retirement Readiness Ratio (e.g. Funding Ratio)

Post by GrowthSeeker » Mon Nov 25, 2019 10:10 am

I downloaded your spreadsheet, added many columns to the right to extend to 30 years.
I then put in my numbers except changed the initial year's expenses to a formula so I could plug in various withdrawal rates. [edit, I made it so the withdrawal rate was the opposite of my first year's cash flow divided by portfolio size.] For me, [already retired] my only income is SS, and I increased that with inflation. I put in my percent stock which is 40%. I also increased the annual expense according to inflation.
Here is what I got for various withdrawal rates:
[Edit: numbers corrected, had not copied all the rows to the right]

Code: Select all

For a 30 year period
w/draw 	RR Ratio
4.00%	0.97
3.75%	1.03
3.50%	1.11
3.25%	1.19
3.00%	1.29
2.75%	1.41
2.50%	1.55
2.25%	1.72
2.00%	1.94
Note: I extended this for 30 years. It makes a huge difference to the final ratio how many years you include. I think for the ratio to have any meaning at all, there must be some convention about how many years in the future one should include. Perhaps to their life expectancy?
Last edited by GrowthSeeker on Mon Nov 25, 2019 4:39 pm, edited 1 time in total.
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marcopolo
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Re: Retirement Readiness Ratio (e.g. Funding Ratio)

Post by marcopolo » Mon Nov 25, 2019 3:30 pm

KlangFool wrote:
Sun Nov 24, 2019 8:21 pm
WoodSpinner wrote:
Sun Nov 24, 2019 7:16 pm

I would like to use this post to start a discussion on using a variation of this metric which I am calling the Retirement Readiness Ratio (RRR).

Proposed Metric:
Retirement Readiness Ratio = Current Portfolio Value/PV(DiscountRate, (Income-(Expenses+Taxes))

In my mind it is a much better metric than some of the other frequently discussed metrics e.g. 25x times expenses since it accounts for the Income as well as Expense and isn't tied to an assumed Retirement duration (e.g. 30 years).
WoodSpinner,

Please state your reason why do you think this is better. I disagreed that it is better. This ratio is based on many more assumptions: Discount rate, future income, and future taxes. If one or more those assumed numbers are wrong, the whole ratio would be wrong.

In my opinion, 25 times expense works very well for folks with annual expenses at or below 60K. At the annual expense of 100K or above, no simple ratio would work.

KlangFool
Curious why you think 25x does not work for higher expenses.

I would think it is simple scaling. If anything, I would think it is more likely to work since someone with higher expenses likely also has higher percentage of expenses that is discretionary.
Once in a while you get shown the light, in the strangest of places if you look at it right.

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Re: Retirement Readiness Ratio (e.g. Funding Ratio)

Post by KlangFool » Mon Nov 25, 2019 3:37 pm

marcopolo wrote:
Mon Nov 25, 2019 3:30 pm
KlangFool wrote:
Sun Nov 24, 2019 8:21 pm
WoodSpinner wrote:
Sun Nov 24, 2019 7:16 pm

I would like to use this post to start a discussion on using a variation of this metric which I am calling the Retirement Readiness Ratio (RRR).

Proposed Metric:
Retirement Readiness Ratio = Current Portfolio Value/PV(DiscountRate, (Income-(Expenses+Taxes))

In my mind it is a much better metric than some of the other frequently discussed metrics e.g. 25x times expenses since it accounts for the Income as well as Expense and isn't tied to an assumed Retirement duration (e.g. 30 years).
WoodSpinner,

Please state your reason why do you think this is better. I disagreed that it is better. This ratio is based on many more assumptions: Discount rate, future income, and future taxes. If one or more those assumed numbers are wrong, the whole ratio would be wrong.

In my opinion, 25 times expense works very well for folks with annual expenses at or below 60K. At the annual expense of 100K or above, no simple ratio would work.

KlangFool
Curious why you think 25x does not work for higher expenses.

I would think it is simple scaling. If anything, I would think it is more likely to work since someone with higher expenses likely also has higher percentage of expenses that is discretionary.
marcopolo,

At a higher expense level, taxes during retirement becomes a significant issue. Then, the answer would be highly dependent on the retirement portfolio placement in terms of taxable versus Roth versus tax-deferred.

At around 60K or below expense level, the taxes during retirement is close to zero or insignificant.

<< someone with higher expenses likely also has higher percentage of expenses that is discretionary.>>

I disagreed. As far as I can tell from all the threads that were posted, a significant portion of the 100K and above expenses are tied to housing/mortgage.

KlangFool

marcopolo
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Re: Retirement Readiness Ratio (e.g. Funding Ratio)

Post by marcopolo » Mon Nov 25, 2019 4:11 pm

KlangFool wrote:
Mon Nov 25, 2019 3:37 pm
marcopolo wrote:
Mon Nov 25, 2019 3:30 pm
KlangFool wrote:
Sun Nov 24, 2019 8:21 pm
WoodSpinner wrote:
Sun Nov 24, 2019 7:16 pm

I would like to use this post to start a discussion on using a variation of this metric which I am calling the Retirement Readiness Ratio (RRR).

Proposed Metric:
Retirement Readiness Ratio = Current Portfolio Value/PV(DiscountRate, (Income-(Expenses+Taxes))

In my mind it is a much better metric than some of the other frequently discussed metrics e.g. 25x times expenses since it accounts for the Income as well as Expense and isn't tied to an assumed Retirement duration (e.g. 30 years).
WoodSpinner,

Please state your reason why do you think this is better. I disagreed that it is better. This ratio is based on many more assumptions: Discount rate, future income, and future taxes. If one or more those assumed numbers are wrong, the whole ratio would be wrong.

In my opinion, 25 times expense works very well for folks with annual expenses at or below 60K. At the annual expense of 100K or above, no simple ratio would work.

KlangFool
Curious why you think 25x does not work for higher expenses.

I would think it is simple scaling. If anything, I would think it is more likely to work since someone with higher expenses likely also has higher percentage of expenses that is discretionary.
marcopolo,

At a higher expense level, taxes during retirement becomes a significant issue. Then, the answer would be highly dependent on the retirement portfolio placement in terms of taxable versus Roth versus tax-deferred.

At around 60K or below expense level, the taxes during retirement is close to zero or insignificant.

<< someone with higher expenses likely also has higher percentage of expenses that is discretionary.>>

I disagreed. As far as I can tell from all the threads that were posted, a significant portion of the 100K and above expenses are tied to housing/mortgage.

KlangFool
Taxes should be factored in, and be included in the 25x target.

Do most people carry mortgages in retirement? That would surprise me, especially amongst people on this forum.
Once in a while you get shown the light, in the strangest of places if you look at it right.

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Re: Retirement Readiness Ratio (e.g. Funding Ratio)

Post by KlangFool » Mon Nov 25, 2019 4:21 pm

marcopolo wrote:
Mon Nov 25, 2019 4:11 pm

Taxes should be factored in, and be included in the 25x target.

Do most people carry mortgages in retirement? That would surprise me, especially amongst people on this forum.
marcopolo,

If you say this, it meant your current annual expense is more than 60K per year. For people with lower expense level, the taxes while they retire is close to zero or too insignificant to matter.

<<Do most people carry mortgages in retirement? That would surprise me, especially amongst people on this forum.>>

If you ask around, it would take a mortgage for many households to spend more than 100K during retirement.

KlangFool

smitcat
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Re: Retirement Readiness Ratio (e.g. Funding Ratio)

Post by smitcat » Mon Nov 25, 2019 4:29 pm

KlangFool wrote:
Mon Nov 25, 2019 4:21 pm
marcopolo wrote:
Mon Nov 25, 2019 4:11 pm

Taxes should be factored in, and be included in the 25x target.

Do most people carry mortgages in retirement? That would surprise me, especially amongst people on this forum.
marcopolo,

If you say this, it meant your current annual expense is more than 60K per year. For people with lower expense level, the taxes while they retire is close to zero or too insignificant to matter.

<<Do most people carry mortgages in retirement? That would surprise me, especially amongst people on this forum.>>

If you ask around, it would take a mortgage for many households to spend more than 100K during retirement.

KlangFool
"If you ask around, it would take a mortgage for many households to spend more than 100K during retirement."
I cannot speak for anyone else but we have plans to spend higher discretionary dollars without having a mortgage.
We do factor in taxes and Roth conversions to our plans.

KlangFool
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Re: Retirement Readiness Ratio (e.g. Funding Ratio)

Post by KlangFool » Mon Nov 25, 2019 4:31 pm

smitcat wrote:
Mon Nov 25, 2019 4:29 pm
KlangFool wrote:
Mon Nov 25, 2019 4:21 pm
marcopolo wrote:
Mon Nov 25, 2019 4:11 pm

Taxes should be factored in, and be included in the 25x target.

Do most people carry mortgages in retirement? That would surprise me, especially amongst people on this forum.
marcopolo,

If you say this, it meant your current annual expense is more than 60K per year. For people with lower expense level, the taxes while they retire is close to zero or too insignificant to matter.

<<Do most people carry mortgages in retirement? That would surprise me, especially amongst people on this forum.>>

If you ask around, it would take a mortgage for many households to spend more than 100K during retirement.

KlangFool
"If you ask around, it would take a mortgage for many households to spend more than 100K during retirement."
I cannot speak for anyone else but we have plans to spend higher discretionary dollars without having a mortgage.
We do factor in taxes and Roth conversions to our plans.
smitcat,

Am I correct to assume that your annual expense is significantly more than 60K per year?

KlangFool

smitcat
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Re: Retirement Readiness Ratio (e.g. Funding Ratio)

Post by smitcat » Mon Nov 25, 2019 4:33 pm

KlangFool wrote:
Mon Nov 25, 2019 4:31 pm
smitcat wrote:
Mon Nov 25, 2019 4:29 pm
KlangFool wrote:
Mon Nov 25, 2019 4:21 pm
marcopolo wrote:
Mon Nov 25, 2019 4:11 pm

Taxes should be factored in, and be included in the 25x target.

Do most people carry mortgages in retirement? That would surprise me, especially amongst people on this forum.
marcopolo,

If you say this, it meant your current annual expense is more than 60K per year. For people with lower expense level, the taxes while they retire is close to zero or too insignificant to matter.

<<Do most people carry mortgages in retirement? That would surprise me, especially amongst people on this forum.>>

If you ask around, it would take a mortgage for many households to spend more than 100K during retirement.

KlangFool
"If you ask around, it would take a mortgage for many households to spend more than 100K during retirement."
I cannot speak for anyone else but we have plans to spend higher discretionary dollars without having a mortgage.
We do factor in taxes and Roth conversions to our plans.
smitcat,

Am I correct to assume that your annual expense is significantly more than 60K per year?

KlangFool
Our basic annual expenses in retirement will be a bit less than 60K per year - no mortgage though.

KlangFool
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Joined: Sat Oct 11, 2008 12:35 pm

Re: Retirement Readiness Ratio (e.g. Funding Ratio)

Post by KlangFool » Mon Nov 25, 2019 4:34 pm

smitcat wrote:
Mon Nov 25, 2019 4:33 pm
KlangFool wrote:
Mon Nov 25, 2019 4:31 pm
smitcat wrote:
Mon Nov 25, 2019 4:29 pm
KlangFool wrote:
Mon Nov 25, 2019 4:21 pm
marcopolo wrote:
Mon Nov 25, 2019 4:11 pm

Taxes should be factored in, and be included in the 25x target.

Do most people carry mortgages in retirement? That would surprise me, especially amongst people on this forum.
marcopolo,

If you say this, it meant your current annual expense is more than 60K per year. For people with lower expense level, the taxes while they retire is close to zero or too insignificant to matter.

<<Do most people carry mortgages in retirement? That would surprise me, especially amongst people on this forum.>>

If you ask around, it would take a mortgage for many households to spend more than 100K during retirement.

KlangFool
"If you ask around, it would take a mortgage for many households to spend more than 100K during retirement."
I cannot speak for anyone else but we have plans to spend higher discretionary dollars without having a mortgage.
We do factor in taxes and Roth conversions to our plans.
smitcat,

Am I correct to assume that your annual expense is significantly more than 60K per year?

KlangFool
Our basic annual expenses in retirement will be a bit less than 60K per year - no mortgage though.
smitcat,

How much annual taxes would you be paying?

KlangFool

GrowthSeeker
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Re: Retirement Readiness Ratio (e.g. Funding Ratio)

Post by GrowthSeeker » Mon Nov 25, 2019 4:46 pm

There might be some value in plotting out a graph of this ratio vs Number Of Years of future Cash Flow being considered. (RR Ratio vs Time)
Say someone has 10 years of work and income remaining before they retire, then they want to plan for a 30 year retirement. During the first 10 years, income > expenses, so the RR ratio if you just look at those 10 years is undefined. If they project their finances some years into retirement, at some point, the negative cash flow of retirement will overcome the positive cash flow they had while still accumulating; and the ratio will then have some meaning. Then as you continue to look farther into the future, you get different values for the ratio.
OTOH, for someone who is already retired and has income < expenses, the ratio IS defined even for year 1 (and if using the present value of just this one year's cash flow, I think the ratio is identical to the 25x factor everyone is accustomed to using).
Typically this curve would slope downward the more one takes it into the future; unless withdrawal rate is particularly low and/or investment growth is particularly high.
Just because you're paranoid doesn't mean they're NOT out to get you.

smitcat
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Re: Retirement Readiness Ratio (e.g. Funding Ratio)

Post by smitcat » Mon Nov 25, 2019 4:57 pm

KlangFool wrote:
Mon Nov 25, 2019 4:34 pm
smitcat wrote:
Mon Nov 25, 2019 4:33 pm
KlangFool wrote:
Mon Nov 25, 2019 4:31 pm
smitcat wrote:
Mon Nov 25, 2019 4:29 pm
KlangFool wrote:
Mon Nov 25, 2019 4:21 pm


marcopolo,

If you say this, it meant your current annual expense is more than 60K per year. For people with lower expense level, the taxes while they retire is close to zero or too insignificant to matter.

<<Do most people carry mortgages in retirement? That would surprise me, especially amongst people on this forum.>>

If you ask around, it would take a mortgage for many households to spend more than 100K during retirement.

KlangFool
"If you ask around, it would take a mortgage for many households to spend more than 100K during retirement."
I cannot speak for anyone else but we have plans to spend higher discretionary dollars without having a mortgage.
We do factor in taxes and Roth conversions to our plans.
smitcat,

Am I correct to assume that your annual expense is significantly more than 60K per year?

KlangFool
Our basic annual expenses in retirement will be a bit less than 60K per year - no mortgage though.
smitcat,

How much annual taxes would you be paying?

KlangFool
I do not understand the question - taxes for home(s)?
Taxes related to 'income' will be greatly variable and somewhat controlled by us.

marcopolo
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Re: Retirement Readiness Ratio (e.g. Funding Ratio)

Post by marcopolo » Mon Nov 25, 2019 5:19 pm

KlangFool wrote:
Mon Nov 25, 2019 4:21 pm
marcopolo wrote:
Mon Nov 25, 2019 4:11 pm

Taxes should be factored in, and be included in the 25x target.

Do most people carry mortgages in retirement? That would surprise me, especially amongst people on this forum.
marcopolo,

If you say this, it meant your current annual expense is more than 60K per year. For people with lower expense level, the taxes while they retire is close to zero or too insignificant to matter.

<<Do most people carry mortgages in retirement? That would surprise me, especially amongst people on this forum.>>

If you ask around, it would take a mortgage for many households to spend more than 100K during retirement.

KlangFool
Regarding taxes, if you always factor it in, then it does not matter if it 0, or something higher, either way you have accounted for it. Even people with 60k in expense might have taxes due to other reasons (like Roth conversions, or RMD, pension, SS, beyond what they spend).

You are talking about 25x, so presumably based on the SWR studies establishing 4% as a reasonable withdrawal rate. Those studies included ALL expenses, including taxes, and even investing expenses (such as mutual fund expense ratios). You can use whatever accounting that makes you happy, but taxes are an expense, whether you want to account for them that way or not. If you treat them as expenses, then 25x expenses should work the same whether your expense are 60k or 600k.

Regarding retirees carrying mortgages, and it taking a mortgage to have 100k in expenses. This might be true for the population at large, but i doubt it is the case for people on this forum. I am retired, do not have a mortgage, and have expense above $100k. I am quite certain I am not the only one. Reading many threads here, i sometimes feel like a miserly pauper.
Once in a while you get shown the light, in the strangest of places if you look at it right.

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Re: Retirement Readiness Ratio (e.g. Funding Ratio)

Post by KlangFool » Mon Nov 25, 2019 5:32 pm

smitcat wrote:
Mon Nov 25, 2019 4:57 pm
KlangFool wrote:
Mon Nov 25, 2019 4:34 pm
smitcat wrote:
Mon Nov 25, 2019 4:33 pm
KlangFool wrote:
Mon Nov 25, 2019 4:31 pm
smitcat wrote:
Mon Nov 25, 2019 4:29 pm


"If you ask around, it would take a mortgage for many households to spend more than 100K during retirement."
I cannot speak for anyone else but we have plans to spend higher discretionary dollars without having a mortgage.
We do factor in taxes and Roth conversions to our plans.
smitcat,

Am I correct to assume that your annual expense is significantly more than 60K per year?

KlangFool
Our basic annual expenses in retirement will be a bit less than 60K per year - no mortgage though.
smitcat,

How much annual taxes would you be paying?

KlangFool
I do not understand the question - taxes for home(s)?
Taxes related to 'income' will be greatly variable and somewhat controlled by us.
Taxes for income.

KlangFool

KlangFool
Posts: 14119
Joined: Sat Oct 11, 2008 12:35 pm

Re: Retirement Readiness Ratio (e.g. Funding Ratio)

Post by KlangFool » Mon Nov 25, 2019 5:43 pm

marcopolo wrote:
Mon Nov 25, 2019 5:19 pm
KlangFool wrote:
Mon Nov 25, 2019 4:21 pm
marcopolo wrote:
Mon Nov 25, 2019 4:11 pm

Taxes should be factored in, and be included in the 25x target.

Do most people carry mortgages in retirement? That would surprise me, especially amongst people on this forum.
marcopolo,

If you say this, it meant your current annual expense is more than 60K per year. For people with lower expense level, the taxes while they retire is close to zero or too insignificant to matter.

<<Do most people carry mortgages in retirement? That would surprise me, especially amongst people on this forum.>>

If you ask around, it would take a mortgage for many households to spend more than 100K during retirement.

KlangFool
Regarding taxes, if you always factor it in, then it does not matter if it 0, or something higher, either way you have accounted for it. Even people with 60k in expense might have taxes due to other reasons (like Roth conversions, or RMD, pension, SS, beyond what they spend).

You are talking about 25x, so presumably based on the SWR studies establishing 4% as a reasonable withdrawal rate. Those studies included ALL expenses, including taxes, and even investing expenses (such as mutual fund expense ratios). You can use whatever accounting that makes you happy, but taxes are an expense, whether you want to account for them that way or not. If you treat them as expenses, then 25x expenses should work the same whether your expense are 60k or 600k.

Regarding retirees carrying mortgages, and it taking a mortgage to have 100k in expenses. This might be true for the population at large, but i doubt it is the case for people on this forum. I am retired, do not have a mortgage, and have expense above $100k. I am quite certain I am not the only one. Reading many threads here, i sometimes feel like a miserly pauper.
marcopolo,

A) In summary, your retirement expense is above 100K. Hence, taxes during retirement matters to you.

B) You do not have a mortgage.

So, I am 50% correct.

KlangFool

marcopolo
Posts: 2492
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Re: Retirement Readiness Ratio (e.g. Funding Ratio)

Post by marcopolo » Mon Nov 25, 2019 5:53 pm

KlangFool wrote:
Mon Nov 25, 2019 5:43 pm
marcopolo wrote:
Mon Nov 25, 2019 5:19 pm
KlangFool wrote:
Mon Nov 25, 2019 4:21 pm
marcopolo wrote:
Mon Nov 25, 2019 4:11 pm

Taxes should be factored in, and be included in the 25x target.

Do most people carry mortgages in retirement? That would surprise me, especially amongst people on this forum.
marcopolo,

If you say this, it meant your current annual expense is more than 60K per year. For people with lower expense level, the taxes while they retire is close to zero or too insignificant to matter.

<<Do most people carry mortgages in retirement? That would surprise me, especially amongst people on this forum.>>

If you ask around, it would take a mortgage for many households to spend more than 100K during retirement.

KlangFool
Regarding taxes, if you always factor it in, then it does not matter if it 0, or something higher, either way you have accounted for it. Even people with 60k in expense might have taxes due to other reasons (like Roth conversions, or RMD, pension, SS, beyond what they spend).

You are talking about 25x, so presumably based on the SWR studies establishing 4% as a reasonable withdrawal rate. Those studies included ALL expenses, including taxes, and even investing expenses (such as mutual fund expense ratios). You can use whatever accounting that makes you happy, but taxes are an expense, whether you want to account for them that way or not. If you treat them as expenses, then 25x expenses should work the same whether your expense are 60k or 600k.

Regarding retirees carrying mortgages, and it taking a mortgage to have 100k in expenses. This might be true for the population at large, but i doubt it is the case for people on this forum. I am retired, do not have a mortgage, and have expense above $100k. I am quite certain I am not the only one. Reading many threads here, i sometimes feel like a miserly pauper.
marcopolo,

A) In summary, your retirement expense is above 100K. Hence, taxes during retirement matters to you.

B) You do not have a mortgage.

So, I am 50% correct.

KlangFool
I was more interested about your comment that 25x expense does not for people with $100k in expenses. Do you agree that taxes are an expense?
That expense might be low, or near 0, for less income, but that does not change the fact that it is an expense, right?

If we agree on that, then do you agree that 25x would work the same (setting aside whether it works at all argument, i am sure we will get form some) regardless of the absolute expense level?
Once in a while you get shown the light, in the strangest of places if you look at it right.

KlangFool
Posts: 14119
Joined: Sat Oct 11, 2008 12:35 pm

Re: Retirement Readiness Ratio (e.g. Funding Ratio)

Post by KlangFool » Mon Nov 25, 2019 6:24 pm

marcopolo wrote:
Mon Nov 25, 2019 5:53 pm

I was more interested about your comment that 25x expense does not for people with $100k in expenses. Do you agree that taxes are an expense?
That expense might be low, or near 0, for less income, but that does not change the fact that it is an expense, right?

If we agree on that, then do you agree that 25x would work the same (setting aside whether it works at all argument, i am sure we will get form some) regardless of the absolute expense level?
marcopolo,

<<I was more interested about your comment that 25x expense does not for people with $100k in expenses. Do you agree that taxes are an expense?>>

1) Your retirement expense is more than 100K.

2) The taxes are significant for you.

So, let me ask you some questions:

A) How much of your taxes are voluntary? Aka, you do not need the money to pay for your annual expense but you do more Roth conversion because you save taxes in the long-run.

B) How much of your taxes are involuntary? You need to pay those taxes because of pension/social security income and/or you need to generate that income to pay your bills.

So, do you consider both (A) and (B) as expenses? Or, only (B)?

It gets very complex for folks with annual expenses above 100K due to the tax consideration. I do not believe any simple rule of thumb will work. It looks like you disagree with me.

KlangFool

marcopolo
Posts: 2492
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Re: Retirement Readiness Ratio (e.g. Funding Ratio)

Post by marcopolo » Mon Nov 25, 2019 6:40 pm

KlangFool wrote:
Mon Nov 25, 2019 6:24 pm
marcopolo wrote:
Mon Nov 25, 2019 5:53 pm

I was more interested about your comment that 25x expense does not for people with $100k in expenses. Do you agree that taxes are an expense?
That expense might be low, or near 0, for less income, but that does not change the fact that it is an expense, right?

If we agree on that, then do you agree that 25x would work the same (setting aside whether it works at all argument, i am sure we will get form some) regardless of the absolute expense level?
marcopolo,

<<I was more interested about your comment that 25x expense does not for people with $100k in expenses. Do you agree that taxes are an expense?>>

1) Your retirement expense is more than 100K.

2) The taxes are significant for you.

So, let me ask you some questions:

A) How much of your taxes are voluntary? Aka, you do not need the money to pay for your annual expense but you do more Roth conversion because you save taxes in the long-run.

B) How much of your taxes are involuntary? You need to pay those taxes because of pension/social security income and/or you need to generate that income to pay your bills.

So, do you consider both (A) and (B) as expenses? Or, only (B)?

It gets very complex for folks with annual expenses above 100K due to the tax consideration. I do not believe any simple rule of thumb will work. It looks like you disagree with me.

KlangFool
Due to a portfolio with a lot of tax diversity (including 529 to pay for kids education), I can control my taxes in any given year. So, they are both voluntary (in any given year), but also involuntary over the long run. It is a balancing act.

I agree with you that taxes, especially optimization, is very complex.

But, we are talking about level of asset to decide financial independence, not actual annual withdrawal.

In that regard, I assume a certain percentage of annual withdrawals will be needed for taxes, I include that as part of annual expenses when thinking about multiple of expense (25x, 30x, or whatever one chooses). That does not mean I will actually spend that amount on taxes in each year. Just like many other expenses.

Nothing really that special about taxes, it is just another expense that needs to be planned for the best you can.
Once in a while you get shown the light, in the strangest of places if you look at it right.

KlangFool
Posts: 14119
Joined: Sat Oct 11, 2008 12:35 pm

Re: Retirement Readiness Ratio (e.g. Funding Ratio)

Post by KlangFool » Mon Nov 25, 2019 6:47 pm

marcopolo wrote:
Mon Nov 25, 2019 6:40 pm

Due to a portfolio with a lot of tax diversity (including 529 to pay for kids education), I can control my taxes in any given year. So, they are both voluntary (in any given year), but also involuntary over the long run. It is a balancing act.

I agree with you that taxes, especially optimization, is very complex.

But, we are talking about level of asset to decide financial independence, not actual annual withdrawal.

In that regard, I assume a certain percentage of annual withdrawals will be needed for taxes, I include that as part of annual expenses when thinking about multiple of expense (25x, 30x, or whatever one chooses). That does not mean I will actually spend that amount on taxes in each year. Just like many other expenses.

Nothing really that special about taxes, it is just another expense that needs to be planned for the best you can.
marcopolo,

If you assume that expense/taxes are voluntary, then, it is not necessarily needed. Why should that be included for FI (25X or 30X)? It is "nice to have".

KlangFool

marcopolo
Posts: 2492
Joined: Sat Dec 03, 2016 10:22 am

Re: Retirement Readiness Ratio (e.g. Funding Ratio)

Post by marcopolo » Mon Nov 25, 2019 6:48 pm

KlangFool wrote:
Mon Nov 25, 2019 6:47 pm
marcopolo wrote:
Mon Nov 25, 2019 6:40 pm

Due to a portfolio with a lot of tax diversity (including 529 to pay for kids education), I can control my taxes in any given year. So, they are both voluntary (in any given year), but also involuntary over the long run. It is a balancing act.

I agree with you that taxes, especially optimization, is very complex.

But, we are talking about level of asset to decide financial independence, not actual annual withdrawal.

In that regard, I assume a certain percentage of annual withdrawals will be needed for taxes, I include that as part of annual expenses when thinking about multiple of expense (25x, 30x, or whatever one chooses). That does not mean I will actually spend that amount on taxes in each year. Just like many other expenses.

Nothing really that special about taxes, it is just another expense that needs to be planned for the best you can.
marcopolo,

If you assume that expense/taxes are voluntary, then, it is not necessarily needed. Why should that be included for FI (25X or 30X)? It is "nice to have".

KlangFool
It is only voluntary in any given year, they are just deferred, not avoided.
Once in a while you get shown the light, in the strangest of places if you look at it right.

KlangFool
Posts: 14119
Joined: Sat Oct 11, 2008 12:35 pm

Re: Retirement Readiness Ratio (e.g. Funding Ratio)

Post by KlangFool » Mon Nov 25, 2019 7:08 pm

marcopolo wrote:
Mon Nov 25, 2019 6:48 pm
KlangFool wrote:
Mon Nov 25, 2019 6:47 pm
marcopolo wrote:
Mon Nov 25, 2019 6:40 pm

Due to a portfolio with a lot of tax diversity (including 529 to pay for kids education), I can control my taxes in any given year. So, they are both voluntary (in any given year), but also involuntary over the long run. It is a balancing act.

I agree with you that taxes, especially optimization, is very complex.

But, we are talking about level of asset to decide financial independence, not actual annual withdrawal.

In that regard, I assume a certain percentage of annual withdrawals will be needed for taxes, I include that as part of annual expenses when thinking about multiple of expense (25x, 30x, or whatever one chooses). That does not mean I will actually spend that amount on taxes in each year. Just like many other expenses.

Nothing really that special about taxes, it is just another expense that needs to be planned for the best you can.
marcopolo,

If you assume that expense/taxes are voluntary, then, it is not necessarily needed. Why should that be included for FI (25X or 30X)? It is "nice to have".

KlangFool
It is only voluntary in any given year, they are just deferred, not avoided.
marcopolo,

In any case, the bottom line is it is very complex. I do not think a simple rule will work. This is when someone needs to work out a spreadsheet and calculate their specific circumstances.

KlangFool

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WoodSpinner
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Re: Retirement Readiness Ratio (e.g. Funding Ratio)

Post by WoodSpinner » Mon Nov 25, 2019 10:47 pm

@AlohaJoe -- I like your idea of doing some further analysis and mapping the Retirement Readiness Ratio to a Withdrawal Rate Calculation. Thanks for the suggestion!

Here is a graph of the Relationships:
Image

and the chart it is based on:
Image

The details of the analysis can be found in the SWR Analysis tab of the Retirement Readiness Ratio Spreadsheet.

Based on this, it seems I should update the Insight Rules. Need to think about this a bit since the SWR is dependent on the Asset Allocation and the Length of Retirement.

Does anyone have a good link to a chart of SWR that I can use? I know I have seen it but can't seem to find it now that I am looking for it.

Other Thoughts?

WoodSpinner

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Topic Author
WoodSpinner
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Re: Retirement Readiness Ratio (e.g. Funding Ratio)

Post by WoodSpinner » Mon Nov 25, 2019 10:53 pm

GrowthSeeker wrote:
Mon Nov 25, 2019 10:10 am
I downloaded your spreadsheet, added many columns to the right to extend to 30 years.
I then put in my numbers except changed the initial year's expenses to a formula so I could plug in various withdrawal rates. [edit, I made it so the withdrawal rate was the opposite of my first year's cash flow divided by portfolio size.] For me, [already retired] my only income is SS, and I increased that with inflation. I put in my percent stock which is 40%. I also increased the annual expense according to inflation.
Here is what I got for various withdrawal rates:
[Edit: numbers corrected, had not copied all the rows to the right]

Code: Select all

For a 30 year period
w/draw 	RR Ratio
4.00%	0.97
3.75%	1.03
3.50%	1.11
3.25%	1.19
3.00%	1.29
2.75%	1.41
2.50%	1.55
2.25%	1.72
2.00%	1.94
Note: I extended this for 30 years. It makes a huge difference to the final ratio how many years you include. I think for the ratio to have any meaning at all, there must be some convention about how many years in the future one should include. Perhaps to their life expectancy?
GrowthSeeker,

Can you take a look at the SWR Analysis tab in my spreadsheet. Our analysis differs and I am not sure why.

One thought is that you should not have increased SS for inflation since this is all in Real Dollars but I am not sure that is the culprit. I also extended the table to cover a longer retirement period (2019-2050).

Let me know if you spot anything that looks suspicious.

Thanks

Joel

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Topic Author
WoodSpinner
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Re: Retirement Readiness Ratio (e.g. Funding Ratio)

Post by WoodSpinner » Mon Nov 25, 2019 11:16 pm

WoodSpinner wrote:
Sun Nov 24, 2019 9:14 pm
KlangFool wrote:
Sun Nov 24, 2019 8:21 pm
WoodSpinner wrote:
Sun Nov 24, 2019 7:16 pm

I would like to use this post to start a discussion on using a variation of this metric which I am calling the Retirement Readiness Ratio (RRR).

Proposed Metric:
Retirement Readiness Ratio = Current Portfolio Value/PV(DiscountRate, (Income-(Expenses+Taxes))

In my mind it is a much better metric than some of the other frequently discussed metrics e.g. 25x times expenses since it accounts for the Income as well as Expense and isn't tied to an assumed Retirement duration (e.g. 30 years).
WoodSpinner,

Please state your reason why do you think this is better. I disagreed that it is better. This ratio is based on many more assumptions: Discount rate, future income, and future taxes. If one or more those assumed numbers are wrong, the whole ratio would be wrong.

In my opinion, 25 times expense works very well for folks with annual expenses at or below 60K. At the annual expense of 100K or above, no simple ratio would work.

KlangFool
I made my thinking clear in the quoted section above. I don’t think future income is too difficult—especially closer to retirement. Taxes could be skipped if you find it too difficult. OTOH, having some estimate for retirement is pretty important. It doesn’t have to be 100%, just a reasonable guess.

Discount Ratio should be close to the expected return you are expecting from the assets that fund retirement cashflow — be conservative. It won’t make a huge difference to the ratio.


Feel free to use what works for you.

WoodSpinner :sharebeer
To elaborate a bit further on the 25X expense metric (or 33X expense et. al.)....
1.The metric as stated ignores Income in Retirement which may lead to significant over saving. Perhaps rephrasing it to 25X Cashflow needs would be more accurate.

2. 25x is really tied to the assumptions around a 4% SWR which many people don't account for. They include:
- Asset Allocation
- Length of Retirement

My proposal for the Retirement Readiness Ratio is simply an additional metric than can help assess the health of your Retirement plan. I see no reason why you shouldn't use multiple metrics to get a quick assessment. After all Retirement Planning is a very personal thing -- there is a lot of variation to account for.

WoodSpinner

AlohaJoe
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Re: Retirement Readiness Ratio (e.g. Funding Ratio)

Post by AlohaJoe » Mon Nov 25, 2019 11:21 pm

WoodSpinner wrote:
Mon Nov 25, 2019 10:47 pm
@AlohaJoe -- I like your idea of doing some further analysis and mapping the Retirement Readiness Ratio to a Withdrawal Rate Calculation. Thanks for the suggestion!
I spent some time running more numbers on Funded Ratios, just to see what would fall out.

The long version is here: https://medium.com/@justusjp/connecting ... c3c0a9d4c5

Image

My takeaways:
  • Using a higher discount rate (somewhat obviously) requires you to use a higher Funded Ratio to be safe.
  • The safety of a given Funded Ratio (e.g. 1.2) varies depending one's age. 1.2 is safe if you retire at age 40 but not safe if you retire at age 70.
  • Going back to your original red, yellow, green zones: I'd pick numbers like: red is <1.25; yellow is 1.25-1.4, green is >1.4

smitcat
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Joined: Mon Nov 07, 2016 10:51 am

Re: Retirement Readiness Ratio (e.g. Funding Ratio)

Post by smitcat » Tue Nov 26, 2019 8:37 am

KlangFool wrote:
Mon Nov 25, 2019 5:32 pm
smitcat wrote:
Mon Nov 25, 2019 4:57 pm
KlangFool wrote:
Mon Nov 25, 2019 4:34 pm
smitcat wrote:
Mon Nov 25, 2019 4:33 pm
KlangFool wrote:
Mon Nov 25, 2019 4:31 pm


smitcat,

Am I correct to assume that your annual expense is significantly more than 60K per year?

KlangFool
Our basic annual expenses in retirement will be a bit less than 60K per year - no mortgage though.
smitcat,

How much annual taxes would you be paying?

KlangFool
I do not understand the question - taxes for home(s)?
Taxes related to 'income' will be greatly variable and somewhat controlled by us.
Taxes for income.

KlangFool
"Taxes for income."
Not sure what you are looking for here and what value it may have because there is no one answer.
I am sure you are aware of these but here are a few variables that affect income taxes when retired:
- performance of funds
- where funds are held
- choices of Roth , withdrawals , charities etc
- age of demise of 1st spouse
Many of these we have very little control of.
As an example only our income taxes for first year retied could be anywhere from $0 to over $95K dependent upon the exact path we would take.

smitcat
Posts: 4307
Joined: Mon Nov 07, 2016 10:51 am

Re: Retirement Readiness Ratio (e.g. Funding Ratio)

Post by smitcat » Tue Nov 26, 2019 8:41 am

KlangFool wrote:
Mon Nov 25, 2019 7:08 pm
marcopolo wrote:
Mon Nov 25, 2019 6:48 pm
KlangFool wrote:
Mon Nov 25, 2019 6:47 pm
marcopolo wrote:
Mon Nov 25, 2019 6:40 pm

Due to a portfolio with a lot of tax diversity (including 529 to pay for kids education), I can control my taxes in any given year. So, they are both voluntary (in any given year), but also involuntary over the long run. It is a balancing act.

I agree with you that taxes, especially optimization, is very complex.

But, we are talking about level of asset to decide financial independence, not actual annual withdrawal.

In that regard, I assume a certain percentage of annual withdrawals will be needed for taxes, I include that as part of annual expenses when thinking about multiple of expense (25x, 30x, or whatever one chooses). That does not mean I will actually spend that amount on taxes in each year. Just like many other expenses.

Nothing really that special about taxes, it is just another expense that needs to be planned for the best you can.
marcopolo,

If you assume that expense/taxes are voluntary, then, it is not necessarily needed. Why should that be included for FI (25X or 30X)? It is "nice to have".

KlangFool
It is only voluntary in any given year, they are just deferred, not avoided.
marcopolo,

In any case, the bottom line is it is very complex. I do not think a simple rule will work. This is when someone needs to work out a spreadsheet and calculate their specific circumstances.

KlangFool
"This is when someone needs to work out a spreadsheet and calculate their specific circumstances."
They could just use the extended IORP or the RPM or both as a method to view the variations that interest them

smitcat
Posts: 4307
Joined: Mon Nov 07, 2016 10:51 am

Re: Retirement Readiness Ratio (e.g. Funding Ratio)

Post by smitcat » Tue Nov 26, 2019 8:44 am

WoodSpinner wrote:
Mon Nov 25, 2019 11:16 pm
WoodSpinner wrote:
Sun Nov 24, 2019 9:14 pm
KlangFool wrote:
Sun Nov 24, 2019 8:21 pm
WoodSpinner wrote:
Sun Nov 24, 2019 7:16 pm

I would like to use this post to start a discussion on using a variation of this metric which I am calling the Retirement Readiness Ratio (RRR).

Proposed Metric:
Retirement Readiness Ratio = Current Portfolio Value/PV(DiscountRate, (Income-(Expenses+Taxes))

In my mind it is a much better metric than some of the other frequently discussed metrics e.g. 25x times expenses since it accounts for the Income as well as Expense and isn't tied to an assumed Retirement duration (e.g. 30 years).
WoodSpinner,

Please state your reason why do you think this is better. I disagreed that it is better. This ratio is based on many more assumptions: Discount rate, future income, and future taxes. If one or more those assumed numbers are wrong, the whole ratio would be wrong.

In my opinion, 25 times expense works very well for folks with annual expenses at or below 60K. At the annual expense of 100K or above, no simple ratio would work.

KlangFool
I made my thinking clear in the quoted section above. I don’t think future income is too difficult—especially closer to retirement. Taxes could be skipped if you find it too difficult. OTOH, having some estimate for retirement is pretty important. It doesn’t have to be 100%, just a reasonable guess.

Discount Ratio should be close to the expected return you are expecting from the assets that fund retirement cashflow — be conservative. It won’t make a huge difference to the ratio.


Feel free to use what works for you.

WoodSpinner :sharebeer
To elaborate a bit further on the 25X expense metric (or 33X expense et. al.)....
1.The metric as stated ignores Income in Retirement which may lead to significant over saving. Perhaps rephrasing it to 25X Cashflow needs would be more accurate.

2. 25x is really tied to the assumptions around a 4% SWR which many people don't account for. They include:
- Asset Allocation
- Length of Retirement

My proposal for the Retirement Readiness Ratio is simply an additional metric than can help assess the health of your Retirement plan. I see no reason why you shouldn't use multiple metrics to get a quick assessment. After all Retirement Planning is a very personal thing -- there is a lot of variation to account for.

WoodSpinner
"To elaborate a bit further on the 25X expense metric (or 33X expense et. al.)....
1.The metric as stated ignores Income in Retirement which may lead to significant over saving. Perhaps rephrasing it to 25X Cashflow needs would be more accurate."

The 25X metric on fund withdrawals was always meant to be applied after any other incomes were realized - many may have enough income with SS , pensions, Annuities, or other income streams to not require further funds for retirement.

KlangFool
Posts: 14119
Joined: Sat Oct 11, 2008 12:35 pm

Re: Retirement Readiness Ratio (e.g. Funding Ratio)

Post by KlangFool » Tue Nov 26, 2019 8:47 am

smitcat wrote:
Tue Nov 26, 2019 8:37 am

"Taxes for income."
Not sure what you are looking for here and what value it may have because there is no one answer.
I am sure you are aware of these but here are a few variables that affect income taxes when retired:
- performance of funds
- where funds are held
- choices of Roth , withdrawals , charities etc
- age of demise of 1st spouse
Many of these we have very little control of.
As an example only our income taxes for first year retied could be anywhere from $0 to over $95K dependent upon the exact path we would take.
smitcat,

<<- performance of funds
- where funds are held
- choices of Roth , withdrawals , charities etc>>

It is the person's decision to harvest the gain or not. Ditto on Roth, withdrawal and so on. At a low expense level, that decision can be voluntary.

<<Many of these we have very little control of.>>

With the exception of RMD, pension and so on, many of them are voluntary.

<<As an example only our income taxes for first year retied could be anywhere from $0 to over $95K dependent upon the exact path we would take.>>

That is the point. It is your decision on how much taxes to pay. So, do you consider this kind of tax as an expense?

KlangFool

KlangFool
Posts: 14119
Joined: Sat Oct 11, 2008 12:35 pm

Re: Retirement Readiness Ratio (e.g. Funding Ratio)

Post by KlangFool » Tue Nov 26, 2019 8:48 am

smitcat wrote:
Tue Nov 26, 2019 8:44 am
WoodSpinner wrote:
Mon Nov 25, 2019 11:16 pm
WoodSpinner wrote:
Sun Nov 24, 2019 9:14 pm
KlangFool wrote:
Sun Nov 24, 2019 8:21 pm
WoodSpinner wrote:
Sun Nov 24, 2019 7:16 pm

I would like to use this post to start a discussion on using a variation of this metric which I am calling the Retirement Readiness Ratio (RRR).

Proposed Metric:
Retirement Readiness Ratio = Current Portfolio Value/PV(DiscountRate, (Income-(Expenses+Taxes))

In my mind it is a much better metric than some of the other frequently discussed metrics e.g. 25x times expenses since it accounts for the Income as well as Expense and isn't tied to an assumed Retirement duration (e.g. 30 years).
WoodSpinner,

Please state your reason why do you think this is better. I disagreed that it is better. This ratio is based on many more assumptions: Discount rate, future income, and future taxes. If one or more those assumed numbers are wrong, the whole ratio would be wrong.

In my opinion, 25 times expense works very well for folks with annual expenses at or below 60K. At the annual expense of 100K or above, no simple ratio would work.

KlangFool
I made my thinking clear in the quoted section above. I don’t think future income is too difficult—especially closer to retirement. Taxes could be skipped if you find it too difficult. OTOH, having some estimate for retirement is pretty important. It doesn’t have to be 100%, just a reasonable guess.

Discount Ratio should be close to the expected return you are expecting from the assets that fund retirement cashflow — be conservative. It won’t make a huge difference to the ratio.


Feel free to use what works for you.

WoodSpinner :sharebeer
To elaborate a bit further on the 25X expense metric (or 33X expense et. al.)....
1.The metric as stated ignores Income in Retirement which may lead to significant over saving. Perhaps rephrasing it to 25X Cashflow needs would be more accurate.

2. 25x is really tied to the assumptions around a 4% SWR which many people don't account for. They include:
- Asset Allocation
- Length of Retirement

My proposal for the Retirement Readiness Ratio is simply an additional metric than can help assess the health of your Retirement plan. I see no reason why you shouldn't use multiple metrics to get a quick assessment. After all Retirement Planning is a very personal thing -- there is a lot of variation to account for.

WoodSpinner
"To elaborate a bit further on the 25X expense metric (or 33X expense et. al.)....
1.The metric as stated ignores Income in Retirement which may lead to significant over saving. Perhaps rephrasing it to 25X Cashflow needs would be more accurate."

The 25X metric on fund withdrawals was always meant to be applied after any other incomes were realized - many may have enough income with SS , pensions, Annuities, or other income streams to not require further funds for retirement.
+1,000.

KlangFool

smitcat
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Re: Retirement Readiness Ratio (e.g. Funding Ratio)

Post by smitcat » Tue Nov 26, 2019 9:06 am

KlangFool wrote:
Tue Nov 26, 2019 8:47 am
smitcat wrote:
Tue Nov 26, 2019 8:37 am

"Taxes for income."
Not sure what you are looking for here and what value it may have because there is no one answer.
I am sure you are aware of these but here are a few variables that affect income taxes when retired:
- performance of funds
- where funds are held
- choices of Roth , withdrawals , charities etc
- age of demise of 1st spouse
Many of these we have very little control of.
As an example only our income taxes for first year retied could be anywhere from $0 to over $95K dependent upon the exact path we would take.
smitcat,

<<- performance of funds
- where funds are held
- choices of Roth , withdrawals , charities etc>>

It is the person's decision to harvest the gain or not. Ditto on Roth, withdrawal and so on. At a low expense level, that decision can be voluntary.

<<Many of these we have very little control of.>>

With the exception of RMD, pension and so on, many of them are voluntary.

<<As an example only our income taxes for first year retied could be anywhere from $0 to over $95K dependent upon the exact path we would take.>>

That is the point. It is your decision on how much taxes to pay. So, do you consider this kind of tax as an expense?

KlangFool
"That is the point. It is your decision on how much taxes to pay. So, do you consider this kind of tax as an expense? "
Of course it is an expense - how you plan to manage that expense is up to you.
Not sure what this has to do with the original post.
BTW - your situation could easily have taxes generated as well.

KlangFool
Posts: 14119
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Re: Retirement Readiness Ratio (e.g. Funding Ratio)

Post by KlangFool » Tue Nov 26, 2019 9:21 am

smitcat wrote:
Tue Nov 26, 2019 9:06 am
KlangFool wrote:
Tue Nov 26, 2019 8:47 am
smitcat wrote:
Tue Nov 26, 2019 8:37 am

"Taxes for income."
Not sure what you are looking for here and what value it may have because there is no one answer.
I am sure you are aware of these but here are a few variables that affect income taxes when retired:
- performance of funds
- where funds are held
- choices of Roth , withdrawals , charities etc
- age of demise of 1st spouse
Many of these we have very little control of.
As an example only our income taxes for first year retied could be anywhere from $0 to over $95K dependent upon the exact path we would take.
smitcat,

<<- performance of funds
- where funds are held
- choices of Roth , withdrawals , charities etc>>

It is the person's decision to harvest the gain or not. Ditto on Roth, withdrawal and so on. At a low expense level, that decision can be voluntary.

<<Many of these we have very little control of.>>

With the exception of RMD, pension and so on, many of them are voluntary.

<<As an example only our income taxes for first year retied could be anywhere from $0 to over $95K dependent upon the exact path we would take.>>

That is the point. It is your decision on how much taxes to pay. So, do you consider this kind of tax as an expense?

KlangFool
"That is the point. It is your decision on how much taxes to pay. So, do you consider this kind of tax as an expense? "
Of course it is an expense - how you plan to manage that expense is up to you.
Not sure what this has to do with the original post.
BTW - your situation could easily have taxes generated as well.
smitcat,

1) The involuntary portion is insignificant to me.

2) I do not consider the voluntary portion as an expense.

<<Not sure what this has to do with the original post.>>

OP's funding ratio includes forecasting taxes during future retirement 30 years later. In my opinion, it is a non-starter.

KlangFool

smitcat
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Re: Retirement Readiness Ratio (e.g. Funding Ratio)

Post by smitcat » Tue Nov 26, 2019 9:26 am

KlangFool wrote:
Tue Nov 26, 2019 9:21 am
smitcat wrote:
Tue Nov 26, 2019 9:06 am
KlangFool wrote:
Tue Nov 26, 2019 8:47 am
smitcat wrote:
Tue Nov 26, 2019 8:37 am

"Taxes for income."
Not sure what you are looking for here and what value it may have because there is no one answer.
I am sure you are aware of these but here are a few variables that affect income taxes when retired:
- performance of funds
- where funds are held
- choices of Roth , withdrawals , charities etc
- age of demise of 1st spouse
Many of these we have very little control of.
As an example only our income taxes for first year retied could be anywhere from $0 to over $95K dependent upon the exact path we would take.
smitcat,

<<- performance of funds
- where funds are held
- choices of Roth , withdrawals , charities etc>>

It is the person's decision to harvest the gain or not. Ditto on Roth, withdrawal and so on. At a low expense level, that decision can be voluntary.

<<Many of these we have very little control of.>>

With the exception of RMD, pension and so on, many of them are voluntary.

<<As an example only our income taxes for first year retied could be anywhere from $0 to over $95K dependent upon the exact path we would take.>>

That is the point. It is your decision on how much taxes to pay. So, do you consider this kind of tax as an expense?

KlangFool
"That is the point. It is your decision on how much taxes to pay. So, do you consider this kind of tax as an expense? "
Of course it is an expense - how you plan to manage that expense is up to you.
Not sure what this has to do with the original post.
BTW - your situation could easily have taxes generated as well.
smitcat,

1) The involuntary portion is insignificant to me.

2) I do not consider the voluntary portion as an expense.

<<Not sure what this has to do with the original post.>>

OP's funding ratio includes forecasting taxes during future retirement 30 years later. In my opinion, it is a non-starter.

KlangFool
"1) The involuntary portion is insignificant to me."
There are methods to plan around this and modify it - so there is reason to keep it in the 'significant' category.

"2) I do not consider the voluntary portion as an expense."
Interesting view - if you do not see it then it does not exist? What happens if one spouse passes on and some of this voluntary becomes involuntary?
what happens when both souses pass and there may be an inheritance left Does this portion now warrant planning?

Very interesting - you choose to ignore and we choose to plan. YMMV

KlangFool
Posts: 14119
Joined: Sat Oct 11, 2008 12:35 pm

Re: Retirement Readiness Ratio (e.g. Funding Ratio)

Post by KlangFool » Tue Nov 26, 2019 9:34 am

smitcat wrote:
Tue Nov 26, 2019 9:26 am

"1) The involuntary portion is insignificant to me."
There are methods to plan around this and modify it - so there is reason to keep it in the 'significant' category.

"2) I do not consider the voluntary portion as an expense."
Interesting view - if you do not see it then it does not exist? What happens if one spouse passes on and some of this voluntary becomes involuntary?
what happens when both souses pass and there may be an inheritance left Does this portion now warrant planning?

Very interesting - you choose to ignore and we choose to plan. YMMV
smitcat,

1) The amount is too small for me to care.

2) If one spouse passes, the annual expense goes down even more.

3) Inheritance? I intend to spend away most of my money.

<<Very interesting - you choose to ignore and we choose to plan. YMMV>>

A) You have a pension. Hence, you have more taxes to worry about.

B) I plan to early retire before 62 years old and I have no pension. Hence, I could Roth convert most of my tax-deferred account. And, my tax-deferred account is small (600K).

In summary, it is insignificant enough that I can ignore it.

KlangFool

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Re: Retirement Readiness Ratio (e.g. Funding Ratio)

Post by GrowthSeeker » Tue Nov 26, 2019 10:00 am

WoodSpinner wrote:
Mon Nov 25, 2019 10:53 pm
GrowthSeeker wrote:
Mon Nov 25, 2019 10:10 am
I downloaded your spreadsheet, added many columns to the right to extend to 30 years.
I then put in my numbers except changed the initial year's expenses to a formula so I could plug in various withdrawal rates. [edit, I made it so the withdrawal rate was the opposite of my first year's cash flow divided by portfolio size.] For me, [already retired] my only income is SS, and I increased that with inflation. I put in my percent stock which is 40%. I also increased the annual expense according to inflation.
Here is what I got for various withdrawal rates:
[Edit: numbers corrected, had not copied all the rows to the right]

Code: Select all

For a 30 year period
w/draw 	RR Ratio
4.00%	0.97
3.75%	1.03
3.50%	1.11
3.25%	1.19
3.00%	1.29
2.75%	1.41
2.50%	1.55
2.25%	1.72
2.00%	1.94
Note: I extended this for 30 years. It makes a huge difference to the final ratio how many years you include. I think for the ratio to have any meaning at all, there must be some convention about how many years in the future one should include. Perhaps to their life expectancy?
GrowthSeeker,

Can you take a look at the SWR Analysis tab in my spreadsheet. Our analysis differs and I am not sure why.

One thought is that you should not have increased SS for inflation since this is all in Real Dollars but I am not sure that is the culprit. I also extended the table to cover a longer retirement period (2019-2050).

Let me know if you spot anything that looks suspicious.

Thanks

Joel
Our specific ratio results (vs w/drawal ratio) are different mainly I think because in your scenario you have income in the first 2 years and I didn't. This is a feature, not a bug. More income leads to a higher ratio. If I add income to my spreadsheet in the early retirement years of similar relative magnitude, I get similar ratios.
One minor formatting detail on the graph (centered about W36, SWR Analysis tab) is that it starts drawing the graph at (0,0) whereas it should start at the first data point.

But the essence of the other point I was making was about time; the number of years into the future you look when adding up how many years of cash flow needs.

In the following data, I took a $1M portfolio, I put SS at 25,000 and did not increase it (I'm not sure why, since SS gets a COLA every year), and then adjusted the first year's expense so that the first year's withdrawal was exactly 40k; a 4% withdrawal rate. But then I made a new row so that the PV of Cash Flows becomes an entire row (one cell for each future year). For example, in my new row, the formula for column F would be =NPV(DiscountRate,$B26:F26). For column Z it would be =NPV(DiscountRate,$B26:Z26). Then I use that as a denominator for Portfolio Value/abs(NPV of cash flows):

Code: Select all

Years	RR Ratio
1	25.88
2	12.96
3	8.65
4	6.50
5	5.21
6	4.35
7	3.73
8	3.27
9	2.92
10	2.63
11	2.40
12	2.20
13	2.04
14	1.90
15	1.78
16	1.67
17	1.58
18	1.49
19	1.42
20	1.35
21	1.29
22	1.24
23	1.19
24	1.14
25	1.10
26	1.06
27	1.02
28	0.99
29	0.96
30	0.93
31	0.91
32	0.88
The ratio is highly dependent on at what future year you are looking at. And, as I expected, if you look at year 1 for a 4% SWR, you get about 25, similar to the familiar 25x.
Just because you're paranoid doesn't mean they're NOT out to get you.

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WoodSpinner
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Re: Retirement Readiness Ratio (e.g. Funding Ratio)

Post by WoodSpinner » Tue Nov 26, 2019 10:13 am

smitcat wrote:
Tue Nov 26, 2019 8:44 am
WoodSpinner wrote:
Mon Nov 25, 2019 11:16 pm
WoodSpinner wrote:
Sun Nov 24, 2019 9:14 pm
KlangFool wrote:
Sun Nov 24, 2019 8:21 pm
WoodSpinner wrote:
Sun Nov 24, 2019 7:16 pm

I would like to use this post to start a discussion on using a variation of this metric which I am calling the Retirement Readiness Ratio (RRR).

Proposed Metric:
Retirement Readiness Ratio = Current Portfolio Value/PV(DiscountRate, (Income-(Expenses+Taxes))

In my mind it is a much better metric than some of the other frequently discussed metrics e.g. 25x times expenses since it accounts for the Income as well as Expense and isn't tied to an assumed Retirement duration (e.g. 30 years).
WoodSpinner,

Please state your reason why do you think this is better. I disagreed that it is better. This ratio is based on many more assumptions: Discount rate, future income, and future taxes. If one or more those assumed numbers are wrong, the whole ratio would be wrong.

In my opinion, 25 times expense works very well for folks with annual expenses at or below 60K. At the annual expense of 100K or above, no simple ratio would work.

KlangFool
I made my thinking clear in the quoted section above. I don’t think future income is too difficult—especially closer to retirement. Taxes could be skipped if you find it too difficult. OTOH, having some estimate for retirement is pretty important. It doesn’t have to be 100%, just a reasonable guess.

Discount Ratio should be close to the expected return you are expecting from the assets that fund retirement cashflow — be conservative. It won’t make a huge difference to the ratio.


Feel free to use what works for you.

WoodSpinner :sharebeer
To elaborate a bit further on the 25X expense metric (or 33X expense et. al.)....
1.The metric as stated ignores Income in Retirement which may lead to significant over saving. Perhaps rephrasing it to 25X Cashflow needs would be more accurate.

2. 25x is really tied to the assumptions around a 4% SWR which many people don't account for. They include:
- Asset Allocation
- Length of Retirement

My proposal for the Retirement Readiness Ratio is simply an additional metric than can help assess the health of your Retirement plan. I see no reason why you shouldn't use multiple metrics to get a quick assessment. After all Retirement Planning is a very personal thing -- there is a lot of variation to account for.

WoodSpinner
"To elaborate a bit further on the 25X expense metric (or 33X expense et. al.)....
1.The metric as stated ignores Income in Retirement which may lead to significant over saving. Perhaps rephrasing it to 25X Cashflow needs would be more accurate."

The 25X metric on fund withdrawals was always meant to be applied after any other incomes were realized - many may have enough income with SS , pensions, Annuities, or other income streams to not require further funds for retirement.
Seems like we are in agreement on the intent.

smitcat
Posts: 4307
Joined: Mon Nov 07, 2016 10:51 am

Re: Retirement Readiness Ratio (e.g. Funding Ratio)

Post by smitcat » Tue Nov 26, 2019 10:17 am

KlangFool wrote:
Tue Nov 26, 2019 9:34 am
smitcat wrote:
Tue Nov 26, 2019 9:26 am

"1) The involuntary portion is insignificant to me."
There are methods to plan around this and modify it - so there is reason to keep it in the 'significant' category.

"2) I do not consider the voluntary portion as an expense."
Interesting view - if you do not see it then it does not exist? What happens if one spouse passes on and some of this voluntary becomes involuntary?
what happens when both souses pass and there may be an inheritance left Does this portion now warrant planning?

Very interesting - you choose to ignore and we choose to plan. YMMV
smitcat,

1) The amount is too small for me to care.

2) If one spouse passes, the annual expense goes down even more.

3) Inheritance? I intend to spend away most of my money.

<<Very interesting - you choose to ignore and we choose to plan. YMMV>>

A) You have a pension. Hence, you have more taxes to worry about.

B) I plan to early retire before 62 years old and I have no pension. Hence, I could Roth convert most of my tax-deferred account. And, my tax-deferred account is small (600K).

In summary, it is insignificant enough that I can ignore it.

KlangFool
I would suggest you run the extended IORP and or the RMP model to confirm all of your thoughts on these issues especially in the outer years.
FWIW - we have no pensions ourselves, we will Roth convert heavily, thoughts on a one spouse survivor are often not well understood if not modeled.
In any case the original question of no mortgage and living at or below about $60 K fixed costs with a much higher desired discretionary budget are all answered.

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WoodSpinner
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Re: Retirement Readiness Ratio (e.g. Funding Ratio)

Post by WoodSpinner » Tue Nov 26, 2019 10:20 am

GrowthSeeker wrote:
Tue Nov 26, 2019 10:00 am
WoodSpinner wrote:
Mon Nov 25, 2019 10:53 pm
GrowthSeeker wrote:
Mon Nov 25, 2019 10:10 am
I downloaded your spreadsheet, added many columns to the right to extend to 30 years.
I then put in my numbers except changed the initial year's expenses to a formula so I could plug in various withdrawal rates. [edit, I made it so the withdrawal rate was the opposite of my first year's cash flow divided by portfolio size.] For me, [already retired] my only income is SS, and I increased that with inflation. I put in my percent stock which is 40%. I also increased the annual expense according to inflation.
Here is what I got for various withdrawal rates:
[Edit: numbers corrected, had not copied all the rows to the right]

Code: Select all

For a 30 year period
w/draw 	RR Ratio
4.00%	0.97
3.75%	1.03
3.50%	1.11
3.25%	1.19
3.00%	1.29
2.75%	1.41
2.50%	1.55
2.25%	1.72
2.00%	1.94
Note: I extended this for 30 years. It makes a huge difference to the final ratio how many years you include. I think for the ratio to have any meaning at all, there must be some convention about how many years in the future one should include. Perhaps to their life expectancy?
GrowthSeeker,

Can you take a look at the SWR Analysis tab in my spreadsheet. Our analysis differs and I am not sure why.

One thought is that you should not have increased SS for inflation since this is all in Real Dollars but I am not sure that is the culprit. I also extended the table to cover a longer retirement period (2019-2050).

Let me know if you spot anything that looks suspicious.

Thanks

Joel
Our specific ratio results (vs w/drawal ratio) are different mainly I think because in your scenario you have income in the first 2 years and I didn't. This is a feature, not a bug. More income leads to a higher ratio. If I add income to my spreadsheet in the early retirement years of similar relative magnitude, I get similar ratios.
One minor formatting detail on the graph (centered about W36, SWR Analysis tab) is that it starts drawing the graph at (0,0) whereas it should start at the first data point.

But the essence of the other point I was making was about time; the number of years into the future you look when adding up how many years of cash flow needs.

In the following data, I took a $1M portfolio, I put SS at 25,000 and did not increase it (I'm not sure why, since SS gets a COLA every year), and then adjusted the first year's expense so that the first year's withdrawal was exactly 40k; a 4% withdrawal rate. But then I made a new row so that the PV of Cash Flows becomes an entire row (one cell for each future year). For example, in my new row, the formula for column F would be =NPV(DiscountRate,$B26:F26). For column Z it would be =NPV(DiscountRate,$B26:Z26). Then I use that as a denominator for Portfolio Value/abs(NPV of cash flows):

Code: Select all

Years	RR Ratio
1	25.88
2	12.96
3	8.65
4	6.50
5	5.21
6	4.35
7	3.73
8	3.27
9	2.92
10	2.63
11	2.40
12	2.20
13	2.04
14	1.90
15	1.78
16	1.67
17	1.58
18	1.49
19	1.42
20	1.35
21	1.29
22	1.24
23	1.19
24	1.14
25	1.10
26	1.06
27	1.02
28	0.99
29	0.96
30	0.93
31	0.91
32	0.88
The ratio is highly dependent on at what future year you are looking at. And, as I expected, if you look at year 1 for a 4% SWR, you get about 25, similar to the familiar 25x.
Thanks for working on this with me. Are you seeing value in this metric?

My thinking is we have some more work to do to make it more useful.

WoodSpinner

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Re: Retirement Readiness Ratio (e.g. Funding Ratio)

Post by WoodSpinner » Tue Nov 26, 2019 10:24 am

AlohaJoe wrote:
Mon Nov 25, 2019 11:21 pm
WoodSpinner wrote:
Mon Nov 25, 2019 10:47 pm
@AlohaJoe -- I like your idea of doing some further analysis and mapping the Retirement Readiness Ratio to a Withdrawal Rate Calculation. Thanks for the suggestion!
I spent some time running more numbers on Funded Ratios, just to see what would fall out.

The long version is here: https://medium.com/@justusjp/connecting ... c3c0a9d4c5

Image

My takeaways:
  • Using a higher discount rate (somewhat obviously) requires you to use a higher Funded Ratio to be safe.
  • The safety of a given Funded Ratio (e.g. 1.2) varies depending one's age. 1.2 is safe if you retire at age 40 but not safe if you retire at age 70.
  • Going back to your original red, yellow, green zones: I'd pick numbers like: red is <1.25; yellow is 1.25-1.4, green is >1.4
AlohaJoe,

Boy do I have a lot to learn. Give me some time to digest this analysis and I will come back.

Thanks

WoodSpinner

P.S. I am in full Thanksgiving dinner prep mode! Just found out the guest list went from 15 to 23 as people’s plans changed. :oops: At least I have some time to react!

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Re: Retirement Readiness Ratio (e.g. Funding Ratio)

Post by GrowthSeeker » Tue Nov 26, 2019 2:39 pm

WoodSpinner wrote:
Tue Nov 26, 2019 10:20 am
Thanks for working on this with me. Are you seeing value in this metric?

My thinking is we have some more work to do to make it more useful.

WoodSpinner
You're welcome, yes I think there may be some value in the RR Ratio or Funding Ratio metric. But compared to something simple like "25x" there is a layer of complexity. And it is not yet clear to me if the hopefully improved understanding provided by this measurement is worth the extra complexity in computing and understanding it.

25x, or whatever it's called (don't we have a name for this often used expression?) is a function of just 2 variables: current portfolio value, and a single year's cash flow deficit. That single year might be this year or some year in the future or simply an estimated average.

The Funded Ratio was based on the price of an annuity, so I think there is the implicit expectation that the number of years is the person's life expectancy. (again, just 2 variables, I think)

But the RR Ratio is a function of current portfolio value, and a EVERY year's cash flow deficit from now until some undefined future year. Since the value of FR changes so much with the number of years, that it almost has no meaning unless you know how many years you're talking about. For the RR Ratio, perhaps the default should be to include cash flows up to the person's life expectancy as well. Or have a designation such as RR15 to mean portfolio value / abs(cash flow deficits for the next 15 years), or RR30, for example.
Just because you're paranoid doesn't mean they're NOT out to get you.

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Re: Retirement Readiness Ratio (e.g. Funding Ratio)

Post by WoodSpinner » Sat Nov 30, 2019 8:51 pm

All,

Apologies for not updating this thread sooner but I got waylaid by the Thanksgiving Holiday ....

I spent some time trying to relate the Retirement Readiness Ratio (RR Ratio) to a Safe Withdrawal rate and met with limited success. My analysis assumed:
- 20 & 30 year retirement
- Portfolio size of $1MM
- SWR of 2% - 5% (varying by .5%)

It turns out the ratio is highly dependent on both the Discount Rate and the Cashflow Requirement. This leads to some difficulty assessing how safe a RR Ratio really is without understanding the Withdrawal Rate associated with it.

I was able to graph a variety of SWRs to demonstrate the issue:
Image

Image

You can see the detail behind the graph in the Analysis Tabs
AlohaJoe wrote:
Mon Nov 25, 2019 11:21 pm

I spent some time running more numbers on Funded Ratios, just to see what would fall out.

The long version is here: https://medium.com/@justusjp/connecting ... c3c0a9d4c5

Image

My takeaways:
  • Using a higher discount rate (somewhat obviously) requires you to use a higher Funded Ratio to be safe.
    Agreed. This can be clearly seen in the graphs provided.
  • The safety of a given Funded Ratio (e.g. 1.2) varies depending one's age. 1.2 is safe if you retire at age 40 but not safe if you retire at age 70.
    Not sure I agree with this conclusion -- see my questions below
  • Going back to your original red, yellow, green zones: I'd pick numbers like: red is <1.25; yellow is 1.25-1.4, green is >1.4
    Not sure I agree with this conclusion -- see my questions below
@AlohaJoe -- I finally had some time to start digesting the analysis you provided. Again many thanks--would love to understand more about how you setup the Monte Carlo Analysis. I have so much to learn.

I do have a few questions:
- I am not sure driving the analysis by age is the right approach. It seems to me that it would be be more useful to use Length of Retirement instead.

- Based on the charts provided a given Funding Ratio (e.g. 1.2) could be safe if the Discount Rate was low enough (assuming its still realistic). For instance using a Discount Rate of 1% and a Funding Ratio of 1.16 would equate to a 2.5% WR for a 30 year retirement. I can't imagine that this wouldn't be considered safe. Did I make an error in my calculations or assumptions? Is there something else going on we need to account for?

- I think the Red, Yellow and Green zones for the Funding Ratio depend on the
* Length of Retirement
* Discount Rate
* PV of Cashflow Requirements (we can infer the WR required from this info)

To be honest I am a bit confused and wondering if I have erred in my analysis?

Your Thoughts and Insights are much appreciated!

WoodSpinner

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Re: Retirement Readiness Ratio (e.g. Funding Ratio)

Post by AlohaJoe » Sun Dec 01, 2019 3:33 am

WoodSpinner wrote:
Sat Nov 30, 2019 8:51 pm
- SWR of 2% - 5% (varying by .5%)
I hadn't considered that this would be important. But I don't really follow what the your chart is saying. The withdrawal rate and the Readiness Ratio are kinda-sorta the same thing -- or at least related -- how do you have them as independent variables in the chart? I don't understand what it means to compare (for instance) "3.5% WR and a 1.0 RR vs 3.5% WR and a 1.1 RR". As a concrete example, let's say we use a discount rate of 2% and plan to spend $30,000 a year for 30 years.

Code: Select all

=pv(2%, 30, -30000, 0, 1)
=685,331.54
Given that, how do I keep the withdrawal rate constant but increase the RR?
@AlohaJoe -- I finally had some time to start digesting the analysis you provided. Again many thanks--would love to understand more about how you setup the Monte Carlo Analysis.
It isn't Monte Carlo, it is backtested using annual historical returns since 1871 for US stocks & bonds. You can get the data from the Simba spreadsheet.
- I am not sure driving the analysis by age is the right approach. It seems to me that it would be be more useful to use Length of Retirement instead.
They're the same thing, really. Since, at least in my scenario, I assume all retirements last to age 97. So saying "retired at age 40" is exactly the same as saying "a 57 year long retirement". In any case, it varies based on length of retirement but hugely. At least when coming up with rules of thumb I think it is okay to ignore the differences, or to create a rule of thumb broad enough to subsume the differences.
For instance using a Discount Rate of 1% and a Funding Ratio of 1.16 would equate to a 2.5% WR for a 30 year retirement.
Hmm, when I calculate this I get:

Code: Select all

=pv(1%, 30, -25000, 0, 1)
=755,907.77
So a RR of 1.0, equates to a WR of 3.3%. If we increase the RR to 1.16 then the portfolio increases from $755,907 to $876,852. But $25,000 from that is 2.8%, not 2.5%.

In any case, I agree with you that it depends on the discount rate being chosen. The red/yellow/green I suggested were based on the (higher) discount rate in your original post.

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WoodSpinner
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Re: Retirement Readiness Ratio (e.g. Funding Ratio)

Post by WoodSpinner » Sun Dec 01, 2019 1:44 pm

AlohaJoe wrote:
Sun Dec 01, 2019 3:33 am
- SWR of 2% - 5% (varying by .5%)


I hadn't considered that this would be important. But I don't really follow what the your chart is saying. The withdrawal rate and the Readiness Ratio are kinda-sorta the same thing -- or at least related -- how do you have them as independent variables in the chart? I don't understand what it means to compare (for instance) "3.5% WR and a 1.0 RR vs 3.5% WR and a 1.1 RR". As a concrete example, let's say we use a discount rate of 2% and plan to spend $30,000 a year for 30 years.

Code: Select all

=pv(2%, 30, -30000, 0, 1)
=685,331.54
Given that, how do I keep the withdrawal rate constant but increase the RR?
You accomplish this by:
- Keeping Portfolio Value Constant (say $1MM)
- Change Retirement Length (for this example lets assume a constant 30 years)
- Increasing the Discount Rate (Essentially this is the expected return rate of the Portfolio you are withdrawing from)

You can see the detail behind the graph in the Analysis Tabs
Image

For this example the Retirement Years are Columns with headings from 1-30
AlohaJoe wrote:
Sun Dec 01, 2019 3:33 am
It isn't Monte Carlo, it is backtested using annual historical returns since 1871 for US stocks & bonds. You can get the data from the Simba spreadsheet.
I have been meaning to check this spreadsheet out -- looks like a very useful tool.
AlohaJoe wrote:
Sun Dec 01, 2019 3:33 am
They're the same thing, really. Since, at least in my scenario, I assume all retirements last to age 97. So saying "retired at age 40" is exactly the same as saying "a 57 year long retirement". In any case, it varies based on length of retirement but hugely. At least when coming up with rules of thumb I think it is okay to ignore the differences, or to create a rule of thumb broad enough to subsume the differences.
I understand -- missed the part of Fixed end of Retirement at 97.
AlohaJoe wrote:
Sun Dec 01, 2019 3:33 am
For instance using a Discount Rate of 1% and a Funding Ratio of 1.16 would equate to a 2.5% WR for a 30 year retirement.
Hmm, when I calculate this I get:

Code: Select all

=pv(1%, 30, -25000, 0, 1)
=755,907.77
I think the difference is I am increasing the Cashflow by Inflation (per the 4% Rule).
AlohaJoe wrote:
Sun Dec 01, 2019 3:33 am
In any case, I agree with you that it depends on the discount rate being chosen. The red/yellow/green I suggested were based on the (higher) discount rate in your original post.
I am slowly coming to the conclusion that the RR Ratio is really not all that useful and simply using the expected Withdrawal Rate is a better signpost for the viability of the Retirement Plan.

OTOH some of this analysis could help you calculate the expected Withdrawal Ratio for your Retirement Plan -- which can be a bit tricky when you factor in lumpy expenses and changes to Income Streams.

Code: Select all

Withdrawal Ratio = (PV of Cashflow/Number of Years with Negative Cashflow)/Portfolio Value
Thoughts?

WoodSpinner

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