In this post we are going to look at a more hypothetical example since your situation will not be the same as ours. We wanted to show how you could use the retirement simulator to simulate both pre and post retirement situations. We are close enough to our retirement where our savings is not as critical to our retirement spending plans, but those just starting out your savings rate is key.
We are going to review the full simulation exercise for estimate savings rates and retirement success rates using our Retirement Simulation tool. If you have not reviewed previous articles, the retirement simulator uses a Monte Carlo engine to estimate 1,000’s of life time scenarios to determine the probability of success, your money will not run out.
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Early Retirement Scenario
The scenario is based on a situation a young professional may find themselves. It is not counting on a huge 6 figure salary. The example assumes someone who has gone to engineering school and makes an average salary. You don’t need this level of income either, can make this work at almost any salary and all depends on expenses, savings, and time to retirement.
If you are interested in Financial Independence and/or Early Retirement, there is no better time to start planning then right now, unless of course you are already on your journey! It’s never too late to start! We came to the FI/RE ideals later in life than others and are finding our way to make it work.
Let’ use Joe, he is a 25-year-old engineer who makes $90,000 per year. He likes his job but has dreams of spending time outdoors and not locked behind his computer for another 40 years.
Joe has been financially responsible and has not suffered from too much lifestyle inflation. He is able to save a good percentage of his salary and recently paid down his student loans, having no debt. His current 401k balance is $50k and that is the majority of his savings for retirement.
One key thing for your journey is to get your finances in order, pay down your debt, and put together a budget so your money has a goal and works for you. This example assumes a good budget exists to estimate current spending and future income needs.
Joe has recently started reading some of the early retirement blogs like many of us and wondered if he could retire early. He is willing to adjust his savings up to 50% of his pre-tax income between his 401k with company match, his Roth IRA, and non-deferred savings. Anymore that that would be a stretch, but he may be able to dig a little deeper.
In retirement, Joe thinks he can live on 80% of his pre-retirement spending rate (including taxes). He is interested in being Financial Independent in 10 years, and his goal is to retire by his 40th birthday.
Joe’s Initial Plan
|Savings Rate (50%)||$45,000.00|
|Planned Retirement Income, Today’s $ (80%)||$36,000.00|
|Retirement Goal||Stretch Goal is 35, real plan is 40|
|Expected life||Age 90|
Since we have such a long window we set the inflation rate to the longer-term average of 3.0% (1.0% SD) and we used a more aggressive pre-retirement investment strategy (~90% stock) and a more conservative post retirement (~50% stock).
Note: The simulation does increase the annual savings by the calculated inflation. A future version may allow selection of a different income / savings growth rate.
Let’s Simulate! Retire at 35
Let’s go to the retirement simulator excel tool. Our first trial we will use the basic assumptions made above and see how things look.
A link can be found in the menu above for version 8 of the Retirement Simulator. If you subscribe to our blog, we will send you a link to the latest version as well as future updates. The version used in this example is the latest version (9.0) and has some extra features compared with version 8 that can be downloaded from the website. We are still in Beta testing with our Retirement Simulator and would love some feedback.
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Note: A bug was found in the Simulation Tool where the average investment performance was fixed to 9.5% with a standard deviation of 8.9% for both pre and post retirement simulations. This was roughly about 50/50 stock/bond performance using 50 years of historic data. Results are still valid, just note the portfolio ratio is not as shown below.
Running for 1000 simulations, we come up with the following result: Only about a 52.3% chance of success. Not great so let’s look at the data.
At time of retirement, the average savings is only about $845k and the average income needed adjusted for inflation is $48k for a 5.7% withdrawal rate. From prior work, we know we need to aim for about 4% or less for a good target safe withdrawal rate especially at longer retirement lengths.
We also estimate the distribution of savings that could achieve the 4% rate based on the average income need of and based on the savings and investment performance we see less than 1% chance of achieving this goal. You can see the histogram below for the estimated savings at retirement. (This is a new feature for version 9.0)
Interesting, even with such a high withdrawal rate there is still a 53% chance of success. To be honest that is better than I would expect given that in 99% of the cases the withdrawal rate was above 4%.
By age 35, these numbers would put Joe firmly in the Financial Independent zone but not fully ready to commit to retire early.
Can Joe Retire by 40?
Adjusting the simulation to retire at 40 and adjust retirement window to 50 years, we see the chance for success goes up to 92% which is not bad. Just 5 more years of savings makes a huge difference.
Note: based on the averages, the withdrawal rate is only 3.5% which should be enough for a longer retirement window of 50 years, but the probabilities show there is only a 69% chance the savings will be enough to meet a 4% Safe Withdrawal Rate (SWR). Be careful with averages!
Since there is 15 years to adjust, this may be a reasonable probability, but Joe would like to reach a 95% change of success (i.e. his money will last till he is 90).
In this case we have a few areas we can adjust:
- Save More
- Spend Less
- Retire Later
Joe really wants to head to the mountains while he is still young enough to enjoy an active lifestyle, so option 3 is not attractive. He decides a little more pain today is worth having a better change to retire by 40 so he reviews his budget.
Increasing Joe’s Chances
Joe went back to You Need a Budget (YNAB – We are big fans of this tool) and reviewed his budget and spending habits. He found another $2.5k of savings and also figured he can cut his income needed for retirement to $35k.
Note: Our model does adjust savings rate by inflation, assuming annual raises would keep up with at least inflation. Higher income growth above inflation which a younger person could expect would also help but not currently modeled.
Joe’s Updated plan
|Savings Rate (50%)||$47,500.00|
|Planned Retirement Need, Today’s $||$35,000.00|
|Retirement Goal||Stretch Goal is 35, but by 40|
|Expected life||Age 90|
Running the simulation with the new numbers shows we now have an 81% change to achieve the 4% Safe Withdrawal Rate and an overall 95% chance of success!
Joe is happy with this risk level and feels comfortable with his plan to retire by 40. He will do an annual review to check his performance and continue to test his plan since over 15 years a lot can happen in your life like meeting the perfect mate and maybe having kids. So, you will need to adjust your plan and re-evaluate your priorities as time goes on.
As we have shown in other simulations, there is a 95.7% chance the money will outlive Joe and a 94.7% chance his savings will be more than his starting value! We do tend to focus on the worst case outcome but should not ignore the potential upside.
This is not a set and forget activity and these plans should be reviewed during the savings phase to ensure success but also spending rates should be reviewed during retirement since there is a high probability Joe could spend more in his retirement than his initial needs.
This is just one example we used to show how you can use the retirement simulator for your own needs. What is your goal? Try the retirement simulator and send us some feedback on how it works for you!
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The link in the menu is for version 8 of the Feeding Our Fire Retirement Simulator. If you subscribe to our blog, we will send you a link to the latest version as well as future updates. We may not post the future versions of the Excel file for public access. The version used in this example is the latest version (9.0) and has some extra features compared with version that can be downloaded from the website. We are still in Beta testing with our Retirement Simulator and would love some feedback.