Beware of incorrect assumptions while planning for early retirement (FIRE)

Published: May 14, 2018 at 12:03 pm

Last Updated on December 28, 2021 at 6:41 pm

As mentioned earlier, I am running a series of posts on financial independence and early retirement (FIRE). In the first part, we considered a set of thumb rules for FIRE with a calculator and android app. In the second part, we shall consider some of the popular yet incorrect assumptions associated with early retirement. A new and simple retirement calculator is also included to highlight the problems.

So when a person starts searching for early retirement, they sooner or later end up in this post: The Shockingly Simple Math Behind Early Retirement. The current version of this post links to a calculator (networthify). In my insignificant opinion, both resources make incorrect and dangerous assumptions, in particular for FIRE aspirants based in India. I made the Excel sheet linked below to point out the flaws and get rid of them (to some extent). In the next part of this series, we shall discuss the assumptions and flaws in the Excel sheet! In case you are interested, I have already taken care of these flaws implicitly in the freefincal robo advisory software template. My aim with this series to check how robust my own assumptions are and how to improve them.

Here are the major assumptions of both the article and calculator linked above.

Article Assumptions:

Join over 32,000 readers and get free money management solutions delivered to your inbox! Subscribe to get posts via email!
🔥Enjoy massive discounts on our robo-advisory tool & courses! 🔥
  • You can earn 5% investment returns after inflation during your saving years
  • You’ll live off of the  “4% safe withdrawal rate” after retirement, with some flexibility in your spending during recessions.
  • You want your ‘Stash to last forever, you’ll only be touching the gains, since this income may be sustaining you for seventy years or so.

Savings rate calculator assumptions

  • Your current annual expenses equal your annual expenses in retirement
  • You will never draw down the principal. Your net worth will never shrink.
  • Current annual income is after taxes
  • Annual return on investment is after taxes and inflation

Regular readers would probably know what would get me worked up!

1: “5% return after inflation before retirement” for Indians would mean a 13-14% portfolio return after tax. Well a touch on the higher side considering one cannot have a 100% stock portfolio at any time, and I have pointed out the limitations of this earlier (see link below) but let us not worry about this now.

2:  “4% safe withdrawal rate” So the withdrawal rate is annual expenses divided by the corpus. Backtesting studies have shown that even when portfolio returns were poor, retirees could have managed by withdrawing no more than 4% from the corpus each year.  Now the assumption here is If the returns are poor, you will simply withdraw less until the tide turns! What a genius strategy! You can eat less dal or vegetables, walk everywhere, get rid of dish TV of the mobile internet until the stock market picks up.

So whatever the return, you will not withdraw more than 4% of the corpus value for annual expenses. If you have never faced (or never seen anyone face) any sudden increase in expenses for good/bad reasons, you will not appreciate how terrible this assumption is. The trouble with these frugal bloggers is that they assume frugality is the answer to everything! Well, the best way to make God laugh is to tell her your plans.

3: “Your net worth will never shrink” You will survive from the interest income and capital gains of the investment, not touching the principal. Yeah, when your portfolio falls by 20%, there are no gains to withdraw, so then you will not have any expenses that year. With these kinds of assumptions, all one can perhaps do is to quit a regular job but freelance or work part-time on the side. So there should be one other source of income present always.

4: Both the article and calculator seem to not worry about inflation before and after retirement. It would simply be impossible to live off gains alone when inflation is considered.  The calculator page says: “When your annual return on investments cover 100% of your expenses you are financially independent …withdrawal rate should be less than your return on investments.” Again impossible if inflation of even 1% is considered.

In spite of these limitations, the calculator does drive home one simple fact: The more you save, the earlier you can retire. It serves as an inspiration to get started, no doubt about that, but for serious FIRE planning, you need to dig a lot deeper. For a start, recognise that no corpus will last forever and it is always better to assume yearly withdrawals are made from it.

So let us run through a simple example. I tried to compare my sheet with the networthify calculator linked above but it seems to only take 50% of the portfolio returns assumed into account. I am not able to understand why. If anyone can help me understand this, it would be great.

Suppose you make 12 Lakh a year after tax with 6 lakh annual expenses and the rest 6 lakh that you can invest for retirement (including mandatory EPF/NPS contributions). Let us first ignore inflation, increase in your income or investing capacity and assume you can earn a portfolio return of 10% after tax before and after retirement.

So we are going to assume nice and smooth 10% returns each year. I have already pointed out how dangerous this is: Want to be financially free? Do not count on frugality! Worry about the sequence of returns risk! However, let us keep going.

So each year we calculate 10% (post-retirement return) x current corpus value. When this is equal to or greater than the expenses 6 Lakh, we shall assume that the corpus is enough to retire. So for these numbers, the excel sheet will tell you that you can retire in 7 years with about 63 lakh.

If you invest in a product that will give you a constant 10% after tax for life, then you have nothing to worry (since your expenses will never increase!!). The 63 lakhs will never diminish in value. If you put it in a mutual fund and start withdrawing 6 lakh a year while the rest grows at 10% a year, it will last you 31 years.  The ridiculous assumptions here should be obvious.

Suppose I include 1% inflation, the 63 lakh will only last 8 years. If you increase the inflation to 8% (this is the minimum I would plan with) then you can retire in 12 years and 1.4 Crore is the corpus required as 1.4 Crore x 10% = expenses in the 12th year. But this corpus will only last for 10 years.

screenshot of the FIRE savings rate calculator

What is my point? If you assume:

When your annual return on investments cover 100% of your expenses you are financially independent

or if you assume

When a 4% withdrawal rate covers 100% of your expenses you are financially independent

Source: oceanaria

Then your corpus will not last long. Even with no inflation, it will not last forever (not even the 70 years assumed above). This is the case with nice smoothly increasing expenses and constant returns! Both of which will be far from true in real life.

So use the above-mentioned article/calculator as inspiration to start saving more. Once you get into that habit, plan for retirement more carefully. When you are ready give my free robo template a try.

Download the FIRE “when can I retire?” calculator

Do share this article with your friends using the buttons below.

🔥Enjoy massive discounts on our courses, robo-advisory tool and exclusive investor circle! 🔥& join our community of 5000+ users!
Use our Robo-advisory Tool for a start-to-finish financial plan! More than 1,000 investors and advisors use this!
New Tool! => Track your mutual funds and stock investments with this Google Sheet!
We also publish monthly equity mutual funds, debt and hybrid mutual funds, index funds and ETF screeners and momentum, low-volatility stock screeners.
Follow Freefincal on Google News
Follow Freefincal on Google News
Subscribe to the freefincal Youtube Channel. Subscribe button courtesy: Vecteezy.
Subscribe to the freefincal Youtube Channel.
Follow freefincal on WhatsApp Channel
Follow freefincal on WhatsApp
Podcast: Let's Get RICH With PATTU! Every single Indian CAN grow their wealth! 
Listen to the Lets Get Rich with Pattu Podcast
Listen to the Let's Get Rich with Pattu Podcast
You can watch podcast episodes on the OfSpin Media Friends YouTube Channel.
Lets Get RICH With PATTU podcast on YouTube
Let's Get RICH With PATTU podcast on YouTube.
🔥Now Watch Let's Get Rich With Pattu தமிழில் (in Tamil)! 🔥
  • Do you have a comment about the above article? Reach out to us on Twitter: @freefincal or @pattufreefincal
  • Have a question? Subscribe to our newsletter using the form below.
  • Hit 'reply' to any email from us! We do not offer personalized investment advice. We can write a detailed article without mentioning your name if you have a generic question.

Join over 32,000 readers and get free money management solutions delivered to your inbox! Subscribe to get posts via email!

About The Author

Pattabiraman editor freefincalDr M. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. He has over ten years of experience publishing news analysis, research and financial product development. Connect with him via Twitter(X), Linkedin, or YouTube. Pattabiraman has co-authored three print books: (1) You can be rich too with goal-based investing (CNBC TV18) for DIY investors. (2) Gamechanger for young earners. (3) Chinchu Gets a Superpower! for kids. He has also written seven other free e-books on various money management topics. He is a patron and co-founder of “Fee-only India,” an organisation promoting unbiased, commission-free investment advice.
Our flagship course! Learn to manage your portfolio like a pro to achieve your goals regardless of market conditions! More than 3,000 investors and advisors are part of our exclusive community! Get clarity on how to plan for your goals and achieve the necessary corpus no matter the market condition is!! Watch the first lecture for free!  One-time payment! No recurring fees! Life-long access to videos! Reduce fear, uncertainty and doubt while investing! Learn how to plan for your goals before and after retirement with confidence.
Our new course!  Increase your income by getting people to pay for your skills! More than 700 salaried employees, entrepreneurs and financial advisors are part of our exclusive community! Learn how to get people to pay for your skills! Whether you are a professional or small business owner who wants more clients via online visibility or a salaried person wanting a side income or passive income, we will show you how to achieve this by showcasing your skills and building a community that trusts and pays you! (watch 1st lecture for free). One-time payment! No recurring fees! Life-long access to videos!   
Our new book for kids: “Chinchu Gets a Superpower!” is now available!
Both boy and girl version covers of Chinchu gets a superpower
Both the boy and girl-version covers of "Chinchu Gets a superpower".
Most investor problems can be traced to a lack of informed decision-making. We made bad decisions and money mistakes when we started earning and spent years undoing these mistakes. Why should our children go through the same pain? What is this book about? As parents, what would it be if we had to groom one ability in our children that is key not only to money management and investing but to any aspect of life? My answer: Sound Decision Making. So, in this book, we meet Chinchu, who is about to turn 10. What he wants for his birthday and how his parents plan for it, as well as teaching him several key ideas of decision-making and money management, is the narrative. What readers say!
Feedback from a young reader after reading Chinchu gets a Superpower (small version)
Feedback from a young reader after reading Chinchu gets a Superpower!
Must-read book even for adults! This is something that every parent should teach their kids right from their young age. The importance of money management and decision making based on their wants and needs. Very nicely written in simple terms. - Arun.
Buy the book: Chinchu gets a superpower for your child!
How to profit from content writing: Our new ebook is for those interested in getting side income via content writing. It is available at a 50% discount for Rs. 500 only!
Do you want to check if the market is overvalued or undervalued? Use our market valuation tool (it will work with any index!), or get the Tactical Buy/Sell timing tool!
We publish monthly mutual fund screeners and momentum, low-volatility stock screeners.
About freefincal & its content policy. Freefincal is a News Media Organization dedicated to providing original analysis, reports, reviews and insights on mutual funds, stocks, investing, retirement and personal finance developments. We do so without conflict of interest and bias. Follow us on Google News. Freefincal serves more than three million readers a year (5 million page views) with articles based only on factual information and detailed analysis by its authors. All statements made will be verified with credible and knowledgeable sources before publication. Freefincal does not publish paid articles, promotions, PR, satire or opinions without data. All opinions will be inferences backed by verifiable, reproducible evidence/data. Contact information: letters {at} freefincal {dot} com (sponsored posts or paid collaborations will not be entertained)
Connect with us on social media
Our publications

You Can Be Rich Too with Goal-Based Investing

You can be rich too with goal based investingPublished by CNBC TV18, this book is meant to help you ask the right questions and seek the correct answers, and since it comes with nine online calculators, you can also create custom solutions for your lifestyle! Get it now.
Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You Want Gamechanger: Forget Start-ups, Join Corporate and Still Live the Rich Life you wantThis book is meant for young earners to get their basics right from day one! It will also help you travel to exotic places at a low cost! Get it or gift it to a young earner.

Your Ultimate Guide to Travel

Travel-Training-Kit-Cover-new This is an in-depth dive into vacation planning, finding cheap flights, budget accommodation, what to do when travelling, and how travelling slowly is better financially and psychologically, with links to the web pages and hand-holding at every step. Get the pdf for Rs 300 (instant download)