My Personal Finance Journey

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Is $1,000,000 Enough?

Contributed by mm | November 5, 2003 2:17 PM PST

I wrote a Monte Carlo model to analysis how much money I should save before I can retire at 40 with a peace of mind. More exactly, the model shows me under a number of various macro and micro circumstances, what's the probability the money pile can survive me and my wife. It's a rigid statistical test of whether a certain amount of retirement fund balance is enough to support a happy early retirement life.

I'm making my model around the following key assumptions:

Assumption #1: I'll retire by the age of 40 by $1,000,000.

This is the goal I stated in the Backgrounder post of the site.

Assumption #2: For every retired year, I need to withdraw $45,000 every year in Year 2003 dollars (adjusted for inflation every year).

$45,000 is 100% of my estimated 2003 household expenses (everything from rent, grocery, entertainment, appliances, mortgage interest, etc., excluding one-time items like house-buying for 2003) so it is a safe bet. I assume 2% inflation from now to my retirement year, so it's around $59,000 in my first retirement year. Inflation rate after my retirement is part of Assumption #5.

Assumption #3: My life expectancy is a normal distribution of N(75,5). Same for my wife.

This is to say each of us has a 95% probability to live to an age within 65 to 85, which is a fair estimate.

Assumption #4: If one of us dies, we can expect to reduce annual withdrawal to 75% as before.

Assumption #5: Annual inflation rate will be a normal distribution N(4.43%,2.97%).

This is based on US inflation history since 1950. (Details)

Assumption #6: The market-average annual pre-tax return for a conservative strategy (like balanced portfolio strongly favoring fixed income) can deliver an above-inflation return as a normal distribution N(5.00%,3.00%).

Assumption #7: I can beat the market-average return by a margin of normal distribution of N(2.00%,5.00%).

Assumption #8: All capital gains will be taxed at an average rate of 10%.

10% is a fair assumption because I anticipate the capital gains will be taxed at 15% for long-term capital gain in brokerage firms, 0% for Roth IRA and up to 15% for 401(k). It also implies that capital gains will be taxed immediately each year, which is conservative. Also, there is reason to believe I don't have to pay capital gain tax if I live in China as a non-resident alien.

Assumption #9: If my return rate is below inflation in a certain year, I can reduce my withdrawal by 35% (in the first five years after retirement) and by 15% (after the first five years after retirement) by seeking some job income and by cutting discretionary expenses or in the same year.

Assumption #10: Exchange rate between USD and RMB is stable or the risk can be cheaply hedged.

Assumption #11: There will be no other income except for withdrawals and potential job income in the first 5 years after retirement (Assumption #9).

I'm using @Risk software from Palisade to conduct the stress test. The result:

- 80% chance I can live only by the withdrawals without any problem.
- 90% chance the plan will work for 27 to 43 years, although I need to take withdrawal cut (Assumption #9) between 2 to 9 years.

I'm very satisfied with the result, especially the fact that the plan works 80% of the time. With all conservative assumptions, I firmly believe $1,000,000 by 2016 (when I am 40) should lead to a comfortable and risk-free retirement life.

This Post Has Received 6 Comments. Share Your Opinions Too.


XTOCb Commented on August 13, 2004

The question is - how do you want to invest after you retire? The guy at retireearlyhomepage.com advocates 75% stocks/25% TIPS mix, if I remember correctly, and says you can allow to withdraw the maximum of (4% of your portfolio) or (last year's inflation-adjusted withdrawal) every year and not have the risk of portfolio being depleted by a serious long-term bear market


mm Commented on August 13, 2004

Well, if you look at assumption #6 and #7, I am assuming an average return rate of 7%, which is not excessive. Also, assumption #9 is the fall-back strategy -- if return is below expectation, I will still take some job or cut expenses.


Matt Commented on March 4, 2005

How do you plan to beat beat the market-average return by a margin of normal distribution of N(2.00%,5.00%)? What will you do when the market takes a dive similiar to 9/11, the great depression. Will you have enough cash in your account to float for a few years.

I think you have a great goal, but I think you will be stressed most of your retirement, because one bad event will put you in a bad financial spot.


Romarkin Commented on March 13, 2005

I just applied to your PFBlog network.

I retired at age 31 with less than $1,000,000 and I've been doing it for 15 years now.

One thing I don't understand about your figures- why withdraw any of the $1,000,000? Why not just live on the interest that would be generated? At 5%, that would be $50,000 per year.


mre Commented on March 30, 2005

What are you early retirees doing for
health insurance?


Jose Anes Commented on June 6, 2005

When do you stop paying mortgage?
Take that into account.


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