The following are the first two of 12 Scenarios of common strategies to achieve financial independence and retire early (commonly referred to as FIRE).
Or, copy the first Scenario Renting with 60%/40% Stocks and Bonds into your Real Estate Financial Planner™:Copy Scenario into my Real Estate Financial Planner™ Software
Renting with 60%/40% Stocks and Bonds with 3 Accounts, 0 Properties, 2 Rules, 1 Goal
Or, copy the second Scenario 5% Down Payment Owner-Occupant with 60%/40% Stocks and Bonds into your Real Estate Financial Planner™:Copy Scenario into my Real Estate Financial Planner™ Software
5% Down Payment Owner-Occupant with 60%/40% Stocks and Bonds with 3 Accounts, 1 Property, 3 Rules, 1 Goal
Check out the other parts of this series:
- Part 2: FIRE with Jassen Bowman - Scenarios 3 and 4
- Part 3: FIRE with Jassen Bowman - Scenarios 5 and 6
- Part 4: FIRE with Jassen Bowman - Scenarios 7, 8 and 9
- Part 5: FIRE with Jassen Bowman - Scenarios 10, 11 and 12
Or, check out the transcript of the video below.
Transcript of Video
Jassen: Good evening James, how are you?
James: I’m doing amazing. How are you?
Jassen: I am amazing as well. Even more amazing because we’re about to learn all about Scenarios and The Real Estate Financial Planner™.
James: I’m actually really excited. This is like the first video tutorial we’ve given of the software and we’re going over some new things that you and I are kind of joint venturing doing a little book on some of this stuff and I’m really excited about it. I think. I think you’re really gonna like it and I think there’s some interesting things you’re going to pull away from this, which you might not have expected.
Jassen: Yeah. When you originally sent me the first little table of results throughout these Scenarios, I was shocked at several things that relate to the FIRE Scenarios in particular because that is what we’re talking about and, and how you can model the acceleration of your financial independence. You know, retire early date.
Jassen: By some of the things that we’ll be talking about over the course of these trainings.
James: Yep. Absolutely. So one of the things we’re doing, we’re recording this. Um, you and I are just on and we’re doing the recording. We will probably try to publish this to The Real Estate Financial Planner™ blog. Um, and then we will be taking the information in these 12 different Scenarios. I think we’re only going to get to like two, maybe three tonight is my best guess as to what we will get to, but you’re going to take these and put them into book form, which you’re going to kind of Co author with me. I think you’re going to do most of the writing and I’ll do most of the Charts and stuff like that and I think it’s how we’ve kind of worked it out.
Jassen: Yeah. This is, you know, the whole idea behind this book is how to model an early retirement financial independence lifestyle through comparing different Scenarios of how to get there..
James: Yeah, I think that’s true. So why don’t we jump into it because I’m sure we’re going to have a bunch of questions, uh, you know, you and I back and forth as we go through this and then we’ll kind of clarify and overtime maybe we’ll come back and we’ll do the rest of these as we kind of do the book because you and I are going to go over these whether we do it on recording or not and I think people will get a lot out of the recording and maybe we will publish it and you can send it out to some of the CPA’s and accountants, you know, and see what feedback we get, what questions they want answered so we know what to write and include in the book for them and everything else as well.
James: All right, cool. So let’s just jump right into it. So I’m, I’m on the Scenarios page and Jason, feel free to interrupt if you’ve got questions or if I say something you don’t understand because you’re kind of, I’m the voice of the audience tonight, the voice of the public to kind of clarify some stuff. So these are Scenarios when you’re in The Real Estate Financial Planner.com™ And you can basically create your own Scenarios. We’ve created 12 in advanced, so I’ve got 12 already made. Each one of these blocks is a different kind of investment Scenario. And by Scenario I mean a group of Accounts and the Accounts can be anything. You invest money in stocks or bonds or cash, um, a group of Accounts or group of Properties. Properties can be anything like single family homes, duplexes, triplexes, industrial buildings, apartment buildings, anything that is a real estate piece of Property and then Rules and Rules, manipulate Accounts and Properties.
And I’m going to go through kind of how we set up the modeling of the first one, which is basically renting someone who’s renting a Property. They’re not an owner occupant and they are deciding to invest the amount of money that they make and they have after all their expenses, 60 percent in stocks and 40 percent bonds. And we’re going to see how that does and how quickly they can achieve retirement. Kind of doing that model. Does that make sense? So far?
Jassen: Absolutely. Love it.
James: And so, you know, a lot of these Scenarios, we’re going to try to start with some commonalities and so, all 12 of them are based on the same person earning the same amount of money each month. And so I’m going to click into and I’m going to drill down as to what that means for us. So I’m going to scroll down here to Rules into paycheck and personal expenses and I’ll show you exactly what this means.
James: So we use Rules to kind of manipulate the parts of the, uh, of the Scenario like Accounts. And so we have a Rule that says, hey, send me a paycheck and subtract my personal expenses. And this Rule is going to run for the entire duration of the Scenario. You can kind of see the screen share. Some of you will probably listen to the audio of this. You won’t be able to see this, but it starts in month zero and ends in month zero, which means run for the entire time. And we’re gonna apply this to this particular Scenario, renting with 60 percent, 40 percent stocks and bonds. And then we’re going to deposit our paychecks to the stock Account and then we going to withdraw our personal expenses from the stock Account and the amount of our paycheck. So you and I decided we were going to pick a, an arbitrary amount of money for a paycheck. Someone who is a typical average American and so came up with $5,500. Do you remember what the calculation was that we came up with that? Was it based on something,
Jassen: I believe it was the national median income for a household.
James: Okay. And if it’s not exact, it’s pretty close. So $5,500 divided by two. If it’s you know two spouses kind of working together divided by, uh, you know, whatever they work about 160 hours a month or so. So that’s like $17 an hour somewhere in that ballpark. Or You could think of it as closer to minimum wage with people working a job and a half or something like that.
Jassen: Right, right.
James: So the paycheck is $5,500 per month and that’s gross. And then we are actually using 18 point five, four percent for their tax rate. So we’re going to take $5,500, we’re going to subtract 18 point five, four percent of that from their tax rate. And I came up with that by going to, you know, just a website and looking up what the percentage of the person’s overall income would be for an income of $66,000 a year. Which if my math is right, is 5,500 times 12, does that seem reasonable to you Jassen? You’re more in the accounting CPA world than I am.
Jassen: Yeah. Yeah. So just for anybody watching it, seeing this and go, there is no 18 percent tax rate. Well this is an effective tax rate because we use a progressive tier tax system. And so it’s the hybrid rate, um, that you’re effectively paying, um, uh, not necessarily representative of your actual quote unquote tax bracket.
James: Yeah. It’s not your top tax bracket. It is like the percentage of your overall paycheck that you paid in taxes going through all the tiers. Okay. And so basically we’re subtracting the 18 point five, four percent of the $5,500 and then because we’re renting our personal expenses for running, this particular person’s household is a $33, 80 a point three zero, so $3380.03 per month is what it costs for them to live including rent. Okay?
Jassen: So some people might want to question why you’re showing a depositing the paycheck to an Account
labeled stocks at eight percent. Can you explain that?
James: Yeah. So in this particular model, we’re trying to simplify things so we’re saying, we only have one bank Account
and it’s our stock brokerage Account. And uh, you know, you could put money into a cash Account
and then move that money from the cash Account to the stock. But basically we’re saying, hey, listen, for the sake of this model, we’re going to take their paycheck. We’re going to deposit it into their stock brokerage Account. As we write checks, you know, we’re going to go to Schwab or Fidelity or wherever it is and we’re just going to write our personal checks or use our Schwab card or whatever it is in order to pay our personal expenses. Does that make sense?
Jassen: Yup. Absolutely.
James: Okay. The other thing that’s interesting about this is we’ve marked off this box for inflation adjusted both paycheck and personal expenses. And what that means is the system’s gonna say every month we’re going to see a CPI adjusted inflation amount. And so we’ve basically defined what that is. I can show you where we do that here in a second, but for our modeling, we’ve used three percent per year, but it does adjust monthly. So it figures out what it needs to be each month in order to hit three percent for the year. And it’s compounded. Um, so basically it’s not exactly three percent divided by 12. It’s a little bit less than that because you have a compound effect and it’s going to increase the paycheck. So $5,500 and then it’ll be, you know, one twelfth of three percent approximately, um, added to the paycheck for the next month. And personal expenses also increase as well. So that’s what we’re going to do there. And I’m going to show you some Charts about that. Why don’t I just jump right into that right now. So if we go back here to the Scenarios, I’m going to go ahead and look at this Scenario. I’m going to click on the Chart button to open it in a new tab and the tab that comes up, it’s going to be all the kind of Scenario wide things. And so there’s a whole bunch of different Charts we can go and look through. I’m going to pull up. The first one is, let’s see here Gross paychecks.
James: So before we talked about how um, you know how much we are making, and we said in month one it was $5,500 and you could see if I hover over month one, we’re making $5,500, but you can see that it’s actually increasing so that every month we’re being paid more. What’s interesting though about this is it’s really just inflation and if we actually click the button here to say adjust for inflation, you’ll see that it actually is a fixed line at 5,500 across the whole thing. And you may say to me, so how are you doing this inflation adjustment? We can look at what an inflated dollar is worth by looking at inflation rate. We’re using three percent inflation rate for the entire 720 months. And that means that an inflated dollars value in month one, you could see it’s worth a dollar.
James: So a dollar in today’s value is worth a dollar. However, over time a dollar becomes dollar and a penny dollar, two cents, dollar, three cents. And it keeps increasing over time until it becomes very expensive. At the end, let’s see what it ends up being. If we look at the whole thing, at the very end, a dollar is actually worth $5 and eighty eight cents 60 years in the future, 720 months in the future. Does that make sense to you, Jassen?
James: Okay, so whenever we do inflation adjusted though, it actually takes whatever number is shown in the Chart and it divides by whatever the value of a dollar is at that point in time. So if we click inflation adjusted on the inflated dollar value shows that it’s a dollar all the way across. And if we go this.
Jassen: One real quick aside here, I’m sure people watching are going to ask why on earth are you going out 60 years?
James: That’s actually a really good question. So normally when I do my modeling, I like to go out about 40 years. However, there’s a couple interesting things that happened when we did this. Number one is we were seeing that people were not actually hitting their financial freedom number, you know, their ability to retire in a 40 year period. So in some of these models, and I think this is one of them, the one we’re going to see right now, people actually do not have enough money saved up, saving the amount of money that they’re saving to retire within 40 years. Right. And so I said, let’s extend out the time and show how long it will take for people to actually retire. And so we arbitrarily picked 60 years. Now from a practical standpoint, if you’ve got clients that are just out of college, you know, they’re young professionals and I’m a real estate broker, I’ve got lots of clients that are uh, you know, in that 22, 23, 24 kind of range is a 60 year time horizon kind of planning for their retirement, an unreasonable thing.
Jassen: Not really. I mean, given the increased life expectancy is today, you know, everything like that. It’s not. Yeah.
James: Yeah. So I, I don’t think it’s unreasonable to kind of plan into your eighties and there was a, you know, the famous trinity study, which we’re not going to give them to you tonight. Um, you know, they only modeled the 30 year time horizon for, they’re kind of like modeling of safe withdrawal rates and basically they were saying, hey, listen, if you retire at 60 or 65 or 70, you know, you don’t expect to live beyond 30 years at the time that they were doing some of these studies, but now life expectancy is significantly increased and I don’t think those numbers are valid anymore, And if people are retiring early, you need to plan for more than a 30 year time period anyway.
James: Okay. So what I’d like to do, Jassen, with your permission, is let’s just go through some of these Charts and as I need to describe, um, you know, what we’re doing here, we’ll kind of go through those together. So effective income tax rate, we’re not using this right now. I’ve already told you the income tax rate we’re using for the paycheck. So we’ve done that somewhere else. The gross paychecks, someone’s earning $5,500 a month and this is the inflation one. If you look at raw dollars, the paychecks are increasing such that by the time they’re, you know, 720 months in, they’re actually earning $32,324.10, it’s crazy, right? We laugh but what is that in today’s dollars?
Jassen: It’s $5,500.
James: That’s exactly right. It’s just because the dollar is inflated, you know, when you tell your grandparents, you know, we’re paying $13 to go see a movie. They’re like $13? I remember we used to be able to go see two movies for a nickel and we’d get change and we’d be able to go get licorice and uh, you know, the soda fountain stuff, you know, afterwards know for a penny. So yeah, it’s like we’re a lot more than, than it is now. And that’s what inflation is. So yeah, we’re basically looking at the raw dollars there and you could see what that is. Inflated dollar value I already showed you what that is. Basically a dollar 60 years in the future it is worth $5.88 more. Inflation. Actually, it’s not five more a dollar today is worth $5.88 in the future is the better way to say that.
James: The inflation rate, we’re using three percent for the entire period. Our modeling does allow us to change inflation rate over time. We’ve decided for the sake of all of these Scenarios, the 12 different Scenarios, we’re going to run through that. We’ve kept inflation rate at three percent for all of them consistently throughout the entire period. So we’ve simplified our discussion, although in the future if you and I decided to do a second book or do additional webinars with, um, you know, different Scenarios, we can vary this. We can say what if we hit a hyperinflation period, or what if we hit a period with negative inflation or what if we hit a period where inflation is zero, how does that actually impact things, you know, what does that make our portfolio do? Do you know, both in stocks and bonds and real estate and otherwise. And so we can model that We’re just not doing it right now.
James: Um, minimum gross monthly income required. This comes into play when we’re trying to calculate what people need to be earning in order to qualify for mortgages for real estate. Since this particular Scenario is someone renting and they’re going to invest the rest of their savings in 60 percent stocks, 40 percent bonds. We do not have a minimum gross monthly income required for any of this so we can skip over that. Mortgage interest rate. If we were going to get mortgages, we could use this to kind of set the mortgage rate. We’re not going to use that even in the other Scenarios. We’re not going to use that. We’re going to set them directly on the Properties we’re buying instead of using the kind of system wide mortgage interest rate. Net worth, okay, this one is appropriate for us so you know, if you go and you invest a certain amount of money, Jassen, how much money at the end of this time period are you going to have?
James: So we can take a look at net worth and we could see what that will be. What I’d like to do is revisit this after we talk about how much people are saving and what they’re investing in so that this becomes more appropriate, like kind of in that kind of context, but right now you could just see very by the time they’re done with their 60 year point, it’s going to be $13.2 million dollars is what they’re going to have in net worth, and since they only invested in stocks and bonds, their net worth is the Account balances.
Jassen: Click that over to inflation adjusted. What does that work out to?
James: Yep, so inflation adjusted number here is about $2.2 million in today’s dollars at that point.
Jassen: Okay, that’s a good reference point I think to start with.
James: Yeah, I think so too. I’m going to turn off inflation adjusted. We’re going to go continue on, but may come back to that later. Number of Properties owned. In this case, this particular person is renting so they don’t own any real estate, so number of Properties is zero. Paychecks after tax. So you remember how much they were earning $5,500 per month. This is the amount of their paycheck after we pay income tax on it. So this is that minus 18.54 or whatever that number was that we were doing the $5,500 minus that and they’re left with $4,480.30 in the first month after they pay. Does that make sense?
James: And if we do inflation adjusted, you’ll see that it flat lines at that number. So it’d becomes basically stuck at that number if we do that, turn it off. Uh personal expenses excluding real estate. So these are their personal expenses and since they’re renting it automatically includes their rental but if we were looking at this and looking at their personal expenses and not including any real estate that they own, we would look at this Chart. In this particular case, it’s going to be the same as their personal expenses including real estate because the rent is already included in that.
James: So if we do inflation adjusted, we could see what that number is basically. Oops, forgot a button. The amount of their personal expenses is that $3,380.30 and it stays consistent throughout the whole 720 months when you think about it in inflation adjusted numbers. So of course it does increase in raw dollars. Okay. And so basically they’re expenses are $19,000 and high change by the time they get to year 60. Okay. Now here’s an interesting one. So one of the things we’re looking at in this kind of like looking at the 12 different Scenarios, this, we’re trying to figure out when someone reaches the point where they can retire.
James: And so for us, we need to determine how much money do you need to have, what’s your target monthly income in order to be able to retire? And this is something that we define. So if we go in here and we click on the Scenario itself, it’s one of the input fields on the Scenario itself. So basically we set the, we set the inflation rate, the mortgage interest rate and this is the one that we’re talking about here, the target monthly income in retirement and what we decided to do when we set up this kind of like 12 different Scenarios to run as we said this person, you could do these 12 different things, but here’s what they are basing it on. They make $5,500 per month in income, but they’re saving 20 percent of their income. So the way we think about it is, they make $5,500, they’re going to set aside $1,100 a month toward their saving whatever they’re going to invest in stocks or bonds or real estate, in this case, 60 percent stocks, 40 percent bonds, but they’re really living on $4,400 per month.
Jassen: The other 80 percent of their income.
James: That’s right. The other 80 percent of their income. That’s what they’re living on. And so for us to say, how much does this person need to be earning in retirement? We don’t have to send it to be the same that they were making from their paycheck. We don’t have to set it to be $5,500 because they’re really not living on $5,500. They’re living on $4,400 and they’re saving 20 percent of the 5,500. Does that make sense?
Jassen: Love it. Yep.
James: Okay, so I’ll go back to this Chart now. So basically we’re saying, hey, listen, we want you to be targeting $4,400 per month as your target monthly income in retirement and this graph just shows you what that number is.
Jassen: Basically we’re just assuming that into retirement, they’re maintaining the exact same standard of living and lifestyle that they had before retirement.
James: That’s a really good way of putting it. Yes. They’re maintaining their same standard of living after their savings rate. Uh, so total “Cash Out Refi Equity”. They don’t own any real estate, so they don’t have any equity and Properties. Total “Sell with Real Estate Agent Equity”. They don’t have any Property, so they don’t have any equity. Their total Accessible “Cashout Refi Equity”. They don’t have any equity, so it doesn’t apply, and then total Accessible “Sell with Real Estate Agent Equity”, they don’t have any of that either. Okay. These are all things that you’d deal with, if you had real estate that we’ve talked about. No real estate in this particular example, so nothing to look at. Total of all the Account balances. So if we sum up the stock portfolio Account that they have and their bond portfolio Account, this gives you a single number showing you the sum of all those Accounts and you could see it. They basically start off, and this is an assumption we made to, to kind of set the Scenarios up we said everyone is going to be starting with essentially $30,000 in the bank and then in month one they also saved $1,100. So in this example you can see that the total amount of all their Account balances at the end of month one is $31,100. Now the $30,000 is just defined as that’s what their opening Account balance was, the $1100, is that 20 percent that they’re saving from their paycheck.
James: Okay. And you can see that this increases over time. The method have an Account balance because you have the stock market Account balance growing, you have the bond market, the, uh, the bonds, the Account with the bonds in it growing and you had them adding to their savings. So this is kind of growing over time and if we look at the full period, by the time they get to the very end, they have that $13.2 million dollars in the bank where they were. Now if we adjust for inflation, that’s that 2.2 million before that you wanted to see.
James: This number, what’s interesting about this for this case and this case only is that because they are basically saving their money in stocks and bonds, the sum of their Account balances is their net worth. They don’t have any other real estate.
James: Makes Sense?
James: Okay. Total cash flow with depreciation. They don’t have any rental Property, so they have no cash flow from that. Total cumulative cash flow versus Property management fees. They don’t have any Properties, so that’s not appropriate. Total cumulative cash flow. This is how much they’ve accumulated. Total cumulative cash flow after capital expenses with depreciation of just the Property management fees, the total true cash flow. These are all real estate related Charts so we can skip all those in this case. Total equity, again, is a real estate Chart, a total monthly rents. Again, there’s no monthly rents because there’s no real estate. Total monthly mortgage payments on the rentals. That’s also not appropriate here. Total Property management fees, not appropriate, but total saved is appropriate. Let’s look at that. So this shows us how much money per month that this particular person is saving and we have it in inflation adjusted dollars here. So it’s that same $1,100 in inflation adjusted dollars for the entire duration from month one all the way through months 720. If we look at it in raw dollars, so it’s increasing every month. Why is it increasing? Do you know Jassen?
Jassen: Well, you’re contributing plus you’re also getting returns, dividends.
James: So this is not the returns or dividends, this is just paycheck after inflation and taxes minus personal expenses, not including un-rented homes or including un-rented homes.
James: So this is your inflation adjusted savings contributions.
James: That’s exactly right. So basically your paycheck is going up by whatever the inflation rate is and your personal expenses are going up by whatever inflation is and the difference between those two is actually going up with inflation as well. So we are saving a little bit more each month. We start off $1,100 by the time we get to year seven, year 60 rather, it’s $6,000 or so and change per month that we’re saving. Okay, so this total saved from paycheck, that’s what we just looked at before. Just a different way to look at it. Total true cash flow. We don’t have any rentals, so that’s not appropriate.
James: True cash flow versus Property management fees. We don’t have any rental, so that’s there. Now yearly safe withdrawal rate. So we’re not going to get into a lot of discussion on this. We probably should write an entire book just on safe withdrawal rates, honestly. However there is, there’s been studies, the Trinity study being one of the more famous ones where they say, you know, if you are, if you’re withdrawing four percent of your entire portfolio over a very large number of test cases for a 30 year period then that, that seems to be a pretty safe withdrawal rate for being able to, um, get to the end and have no money leftover or more than no money left over. Basically, you’ll have at least you won’t go negative on your Account balance if you go 4%. Now, there are other people that have done studies and showed that four percent, so a little bit aggressive and that they’re suggesting closer to 3.25 or so. And so, for the sake of this conversation, we’re using a 3.25 percent safe withdrawal rate. Now, do you want to describe how we are applying the safe withdrawal rate to the calculations so that, uh, you know, people are able to hit their retirement number. So you want to talk about that?
Jassen: Yeah, I believe you’re starting with a static withdrawal rate based on a percentage of the amount of money on the portfolio at the beginning of each year. Is that how you’re doing it?
James: So what we are, what we’re actually doing for this is we’re just saying if you have 3.25%, uh, of your portfolio divided by 12, because we’re looking at a monthly number and that covers that $4,500, then you’ve achieved your Goal. So we’re really not actually pulling any money out with this model. We’re just telling you when you would be able to retire.
Jassen: Okay. So you’re using this as a forecasting tool?
James: Yeah, I’m using it as a, as a way to measure.
James: So in this particular example, we’re saying, let’s say you have a million dollars. If you have a million dollars between your stocks and your bonds. If you pull out 3.25 percent, you’re pulling out basically $32,500 for the year. Okay? Now if $32,500 divided by 12, if that monthly amount is greater than the amount that we said was your target monthly income in retirement, then you are above 100 percent toward achieving your Goal of being able to retire. That make sense? So we’re using that as kind of like a measuring stick to say are you able to retire? And that’s what we’re doing.
James: Okay. So those are kind of like the different Charts we have for the entire Scenario. Let’s jump over to Account and look at a couple different Account Charts. So this now shows you Account balances and we have three different Accounts in this particular Scenario. We have a cash Account which we’re not really using. We have a stock Account which is where we keep our stocks in and that’s earning an eight percent per year return rate and then we have bonds which is earning three percent per year and you could see in this Chart above that we keep a certain amount of stocks and the certain amounts in bonds. Now we decided that this particular investment strategy is going to be a 60 percent bonds, I’m sorry, 60 percent stocks, 40 percent bonds mix, and each month we go in there and we re-balance them, basically move money between the stocks and the bonds Accounts so that 60 percent of our portfolio is in stocks and 40 percent is in bonds and so you can look at this and you could see that they’re always 60, 40 split.
Jassen: I think it’s important to emphasize to any, you know, CFPs or, or PFSs or Bogleheads type people that might be watching this, that to reemphasize, you said monthly re-balancing. You’re doing this every single month in when you run the Scenario.
James: We are and you know, let’s, let’s kind of talk about that for a second. So if I go back here and I look at my Scenario and I go into the details of it, we have a Rule for re-balancing. So basically we’re saying every month it starts at the beginning of the Scenario and runs to the end. On this particular Scenario itself. Uh, when do we want to do it? Which month? Every year you could say, only do this January every year, February, March, April, May, June, December, or you could set it up to do every month, every year and that’s what it’s going to use for doing the re-balancing. And then we’re basically saying we want 40 percent in bonds, 60 percent stocks, and that’s what we’re going to do our distributions. Now, when you save this Rule, every time it runs that month, it’s going to redo a balance and do that.
Jassen: You might want to mention the, um, how it bounces off the um cash Account if we were using that. When it does the re-balancing and if that count goes to zero.
James: Yeah. So this is an interesting kind of like a situation that can come up. If you’re doing your kind of Scenario here. If you are, if you will basically have three different Accounts which we do in this. We have a bonds Account, we have a stock Account, we have a default cash Account. The default cash Account’s kind of a special Account in our, in our software, the The Real Estate Financial Planner™ software, because it is sort of the Account, it’s the only Account that can go negative and it’s the only Account that has to have a zero percent return and the way that we think about this Account is it’s sorta like the money you’d need to add to the system. So let’s say you know you, you have a rental Property and it has really negative cash flow and you’re trying to make deposits into the stock market Account and the stock market Account does not have enough money in order to support that Property.
James: What do you do? Do you have a negative balance in your stock market Account? And so in order to deal with this, we said no, you can never have a negative Account balance your stock market Account. Here’s how the system works. If you have a negative balance, it basically brings the Account balance down to zero. Then it goes to the default cash Account and it subtracts money from there and if the cash Account goes negative, that’s fine. What that tells us though is we needed to add money to the system in order to make this work.
James: Okay. So you can look at your default cash count and if you have a negative balance as, oh, I needed to add money to this whole kind of like modeling in order to make this kind of Scenario work. So what becomes interesting then when we’re re-balancing is let’s say you want to do a 60 40 split, 60 percent bonds, 40 or 60 percent stocks, 40 percent bonds, and you have a negative balance in your cash Account. The system basically says, hey, you’re telling us that you want 60 percent stocks and 40 percent bonds and that you want zero in your default cash Account. So we need to bring the default cash Account back to zero first. So before it does the 60 40 split, it actually moves money from whatever you had it in and pays off the negative balance in the cash Account and then it does the 60, 40 split of whatever’s leftover between stocks and bonds.
James: Does that make sense?
Jassen: Yep. I just figured. I just thought that was an important thing to cover. Um, and talking about how the cash Account works too. That was a good, good point as well.
James: Yeah. Awesome. I appreciate that. So basically here now we can go see the different Account balances we have. We can look at the cash Account which basically has nothing. See, it’s basically a zero the whole way. So I’m going to turn that off. We can look at the stocks Account, you can see the balance of that. And then we can look at the bonds Account and you can see that. And you can see that these are about 60 40 split. So if you kind of do the math, that’s about 8 million and 6 million.
Jassen: Which is where we’re supposed to be.
James: Yeah. Which I think is where we’re supposed to be. Okay. And so it’s doing that adjustment each time that it does that. Now, if you look at some of these other things, we’re not going to go into a lot of detail here, but this shows you how much you’ve actually added, where your cumulative deposits were, how much you received in returns, what your cumulative returns were.
James: Kind of looking at both those on the same Chart so you can kind of see them together. Um, you know, how much you withdrew, what your net cumulative deposits were, and then the total Account balance before you did returns. Only one I’m going to show you on here is the yearly rate of return. And these are defined in the Accounts section. So if we’re looking down here and we go back to the Scenarios and we go down to the different Accounts, you could see these two different Accounts that we have as part of the Scenario. So the stock market Account one, that eight percent basically tells you right here, it’s earning eight percent or bonds at three percent. You can go click and edit these if you wanted to just pull them up in another window and you can actually show what the opening balance was. And then what the yearly rate of return is. So you set this, okay, and we’ve set them at eight percent for stocks and we’ve set them at three percent for bonds.
Jassen: I do want to point out the obvious, you know, the stock market doesn’t return eight percent. Bonds don’t return three percent consistently, um, but you, you have programmed in for, for this, um, a way to run Monte Carlo simulations where you’re actually throwing in kind of random market corrections, uh, and, and other factors that can impact the overall, um, you know, the, the ultimate number where you end up your, your net worth.
James: Yeah, we can, we can set the stock market return, uh, to be different each month and we could use a normal distribution curve that says, you know, most of the time it’s about eight percent, but it can be anywhere from, you know, plus 16 to minus 12 or whatever else you want to do. We could actually model that based on whatever you decide to use with Rules. For the sake of these 12 different Scenarios that we’re running. We’re trying to do a simplified comparison of 12 Scenarios. But all of the stock market returns are all going to be the same for them, all the bond returns are going to be same and we’re not taking into Account things like sequence of return, risk and, and things of that nature, which we can model. We’re just not doing it right now.
James: Yup. So right now you can basically look, the cash Account is getting zero percent. The stock Account’s get an eight percent and it’s fixed for the entire thing for month one, your month, 720. And the bonds one is doing three percent. So you can kind of see all those returns on there just to see this. Okay?
James: Last thing on here. All these things relating to the Properties you own since you don’t own any Properties, we’re going to skip that completely. What the last one I want to show you is probably the most important one. And that is what your safe withdrawal rate is. Um, basically how close you are to achieving your Goal of being able to retire. And what we do is we basically say, take the safe withdrawal rate, which we are using 3.25 percent and multiply that by the total of all of your Accounts that you have. And if you have real estate that has positive cash flow, add in that positive cash flow as well. But if you sum up one twelfth of that safe withdrawal rate per year and the cash flow you have, how close are you to hitting your retirement number? In this case it’s $4,400 a month, but it adjusts for inflation. So it’s not $4,400 a month in month 360. It’s a lot more than that because it’s inflation adjusted. So this Chart…
Jassen: And what month do we cross the dotted red line?
James: Yes, that’s what, that’s where I was going next. So basically this one shows you, you know, right here, you’re at 1.91 percent towards your Goal of hitting that $4,400 a month. You know, by the time you get 10 years or so in you’re at 10 percent, uh, you know, 20 years or so in here about 24 percent, 30 years or so in you’re at about 45 percent. I don’t even know what the next one is, is that six out of $500 a month. So wherever you get here, it takes you, you know, see this like $600 a month range before you get to the point where you achieve this Goal. This is the 100 percent line is when you actually hit your Goal. Eventually we see our Goal, but it takes us a long time in order to get there. And I have a little table down below that shows you the actual number. Turns out it’s month 609 when you first achieve 100 percent of your Goal. So it takes you 50 years and nine months to achieve your Goal of being able to have your investments, give you 3.2 percent safe withdrawal rate and reach your $4,400 a month inflation adjusted Goal.
Jassen: To put that another way for somebody starting at say the age of 30, it’s going to take them till the age of almost 81.
Jassen: In order to be able to hit their retirement Goal of a 3.25 percent safe withdrawal rate from their portfolio based on a 60 40 stock bond asset allocation.
Jassen: Stocks at eight percent bonds it three percent is long-term averages.
Jassen: Contributing 20 percent of their income every month to savings.
James: Yes. So if you’re super conservative and you’d said 60 percent stocks, 40 percent in bonds, and you know, you just saved 20 percent of your income, uh, it’s going to be forever before you get there. Now, in defense of this plan, you, the safe withdrawal rate we’re using, they’re probably going to have money leftover at the end. You know there, there are going to be 80 years old at this point. They could start tapping in a little earlier than this and probably be fine, right? You’re not going to need to have 3.25 percent. You’re going to be able to do this earlier and do it. And they may actually be able to hit it closer to a more traditional 65, 70 ish retirement age and you know, what else this thing is not modeling is social security. So they’ll probably have some social security.
Jassen: I was just going to say they just forecast than being, you know, starting at age 30, if they start saving, they’d be a full decade past full social security age. Even. So, yeah,
James: And we’re not gonna do it tonight, but we could actually go through here and add in a additional paycheck with no additional expenses to simulate social security starting at a certain age. And you could actually do two different Scenarios side by side one where you do a lower social security kind of thing at 62 ish or you know, a higher uh, social security kind of pay out at 65 or 70 or whatever number, you know, your adviser and kind of talks about doing those to kind of model which one is better for me. You know, is it better if we to take social security early or is it better for me to take social security later? And you can run side by side Scenarios and compare that
Jassen: and you would, you would add social security by creating a Rule within the scenario that starts adding an income source of social work here at a certain number of months.
James: Yeah, that’s right.
James: I think that’s reasonable. So like here’s what the Rule for paycheck and personal expenses, you can add a second Rule and instead of it basically starting at a, you know, running for the entire Scenario, starting at month zero and ending at month zero, you can either use dates and put in, you know, what date you want it to start and then not have an end date or you could say, you know, 480 months from now or 360 months from now, have this thing start and then have not an end date on there. And it will start at that date and then run through. And then down here you basically put another paycheck which is your social security number. And then you’d have expenses. If you’re already covering your expenses elsewhere. Don’t add your expenses second time. Just leave those blank. So it’s like a second paycheck, but your personal living expenses are covered elsewhere and then you can decide whether or not you are going to adjust it for inflation, which I think social security is adjusted for inflation. Yeah. So you’d go and put that on there and then you can put whatever your tax rate you’re paying on that social security income as well.
Jassen: Right. So like you might make that 1800, the personal expenses zero.
James: Yup. And then whatever the tax rate is.
Jassen: Right. Ok.
James: Totally. So that’s how you can model them. So I don’t know how, how far into this are we? Jassen, do you know the time?
Jassen: So yeah, I kind of put a timer on. Uh, we, we realistically have a 15 to 20 minutes left if you want to keep this to roughly an hour.
James: Okay, let’s do this. I really do want to try to go in and compare this Scenario to another Scenario. So let’s go and look at the second Scenario. The challenge with it is we’re not going to be able to go into the detail about the real estate stuff because that’s going to take a lot longer to do, but I would like to show somebody what difference it does make adding just a single owner occupant house and what’s some of the changes are with that. So the first Scenario we did, the person was renting, they didn’t own a property. They basically stick to 20 percent of their income and they were saving it. Sixty percent stocks, 40 percent bonds.
Jassen: Just to be clear, you’re saying they didn’t own a property as in they didn’t own any rentals, nor did they own their own primary residence. They were renting their personal residence this entire time?
James: That’s correct, Yep. That’s correct. That’s the first Scenario we did. Okay. Now we’re going to do is we’re gonna, change it up. We’re gonna say, all right. Instead of renting and investing 60 40 in stocks and bonds, what I’m going to do this time is to say, let’s take part of that $30,000 nest egg that you started with because both of them started with $30,000, in their nest egg in their Account. Let’s instead of instead of actually renting, let’s go ahead and use a five percent down payment to buy an owner occupant Property. You can get five percent down payment Properties all the time, it’s a conventional loan. You will have some PMI in most cases, but you basically go take five percent. You buy a Property and then you do the same thing you just did before. You basically do 20 percent of your income. You’re saving putting 60 percent in stocks, 40 percent in bonds, everything else is identical. The only difference between these two Scenarios is they buy a house with five percent down instead of renting.
James: Okay, so let’s take a look at how this changes some of the Charts.
Jassen: You realize that we’re opening the can of worms on one of the most hotly debated, you know, renting versus owning. This is, we’re going to light the internet on fire with this.
James: Yeah, that seems reasonable to me. The other thing I’m going to do here, I’m gonna compare two Scenarios at the same time. So, um, basically I have the ability to go and add additional Scenarios to these Charts. So we’ll now Chart both of them at the same time. So I’m going to pick the one we just did, Renting with 60 40 stocks and bonds and I’m going to add that. So now it’s showing both of them on the Chart at the same time and you can kind of see the difference between net worth. Okay? Uh, the renting net worth is going to be this lower blue line, the owning the Property net worth is going to be this upper red line.
James: And before people go crazy and say, yeah, but what are the assumptions that you’re using for the Property? Are you using like 10 percent appreciation? Are you, uh, are you assuming that it’s, you know, there they have no taxes and no insurance or their taxes and insurance aren’t going up and they’ll keep pace with inflation or anything like that. I will tell you my numbers are really conservative and we should go into those in detail. Um, you know, maybe we’ll go post them onto the blog or something like that so people can see them or they can copy the Scenario into their own Account. Just go ahead and create a free Account and then you’ll have a link to be able to copy the Scenario and you can go drill down and look at that and I’ll show you where that is so that you could see it basically go into the Scenario itself. And then here it shows you the Properties that are involved. This is a five percent down payment, typical family home and there’s a lot to go through.
James: So we’d be here for another 30 minutes or so if I went into detail here, but we’re using basically a $200,000 Property. You’re putting five percent down, you’re getting a five percent interest rate, which I think is a little bit conservative. We’re able to usually see a little bit lower than that. Right now in our market we’re doing a 30 year loan. Um, we’re, we’re paying one percent closing costs and basically we are saying about $1300 a year in taxes, $800 a year in insurance. And those do keep pace with inflation. And we’re saying that the house is going up at 3% per year and that’s basically it.
Jassen: And just to make that clear, you’re showing appreciation equal to the inflation rate.
James: Yeah. So if you look at Case-Shiller’s historical data over like 100 years, basically he shows that real estate value tends not to beat inflation – It tends to be inflation. Um, so basically if you look at inflation over 100 years, you know, it was, I forget which way it was, it was like inflation was three percent or 3.1 and real estate appreciation over that same time period was three or 3.1. So they were off by like point one percent, one of them was three, one of them was 3.1.
James: So I think they’re basically the same.
James: Okay. And that’s all we’re doing. Now, there’s a couple interesting things that happen here was the first thing I want to show that happens and I think it’s important to point out is the difference in savings. So, um, paychecks after tax, between the two of them, they’re identical. The lines are literally on top of each other. You can’t see the difference. Okay. Toggling on and off.
James: So the amount you earned from your paycheck is identical. However, the expenses you have are different. So let’s look at personal expenses, excluding real estate.
James: So in one of them where you’re renting, we’re including the rent. The one where you’re renting is the upper line, the blue line, that’s over it. So the personal expenses you have when you’re renting a Property or higher because it includes the rents on your Property. However, when you buy a Property, when you own it, I’ve subtracted out the mortgage and the taxes and insurance and your personal expenses are basically the non real estate expenses on it and so the red line shows that your expenses are much lower. However, we do take into Account this because we count your expenses on the Property, your mortgage, your taxes, your insurance, things like that. Um, your maintenance on your Property. All of those get included elsewhere. And so if you look at your personal expenses, including real estate, now you see something really interesting, you see that they start off to be pretty much the same, but over time your rent goes up by three percent a year because it does, but your personal expenses, your, your real estate, the mortgage payment is fixed for 30 years and after 30 years it goes away.
James: Because you pay off your mortgage. That’s what happens here.
Jassen: Just to maybe put that a different way, because you are, when you buy a house to live in, you are fixing quote unquote, your rent quote unquote in today’s dollars.
James: That’s right.
Jassen: And your mortgage payment stays the same even though inflation on everything else is going on around you, you’re paying off a 30 year mortgage 30 years from now, you’re paying it off in 2018 dollars.
James: I don’t like describing it that way. You are paying off parts of it in 2018 dollars. Um, but I don’t know if I like saying it that way. Exactly.
Jassen: Well you’re paying off a 2018 payment amount but you’re paying it off with inflated dollars.
James: Yeah, that’s probably a better way of saying it because basically you’re fixing your principle and interest part of your payment. It becomes static. When you get the mortgage with a lender, they say your monthly payment is going to be this and it’s going to be this for the next 360 months. It does not change. It does not get impacted by inflation at all. And then once you pay it off,
Jassen: Whereas rent is going up.
James: Yeah. So there’s a couple of things going on here and I’m going to zoom in on the Chart just to show you. So this is the first 12 months worth of personal expenses. The blue line’s the one renting the red line is the one that is the, uh, the owner occupant Property. I’m even going to zoom in more and look at just the first three months because I want to show you something very odd that happens that if you don’t know what’s going on your life, James, your math is wrong. Okay? Because I get this objection all the time. So, Jassen, when you get a mortgage, do you make, let’s say you buy a Property on January first, do you make a mortgage payment on January first?
James: Why not?
Jassen: Because if that, if January first is your closing date, you actually at closing are prepaying in your closing costs. The um, the, the next 31 days worth of interest.
James: Wow. I’m so happy you said that. And I hate to do this to you, but you’re actually not right.
James: So here’s, here’s what’s really
Jassen: Pretty sure I see a prepaid interest line whenever I sign for one of these things
James: You totally do. Now I’ll talk to you about the prepaid interest slide. Is remind me, but it’s not what you just said.
James: So how mortgage payments work is mortgage payments are paid in arrears. You need to live in the house for a month so that the lender can say, Oh, you’ve borrowed this money now for 30 days. We want our payments for the interest you now owe for the 30 days prior. So basically you have to live there for 30 days to have 30 days worth of interest be do, plus the principal amount you agreed to pay them. So if you move in on January first the February first payment is actually the interest for January.
James: And when you sell your Property, let’s say you sell your Property on December first and you’re like, okay, why is there a December first payment due when I’m selling, if I’m not living there for December, it’s because the December first payment was for November.
James: So they do catch up with you at the end. Now let’s talk about that prepaid interest thing. Do you know what the prepaid interest actually is?
Jassen:I always thought it was the first month’s interest before the next payment. That’s what I thought was.
James: It’s not, you know what it is, it’s to get you to the first of the month. So basically if you have a 14 day, if you close on like the 15th, you’re paying 15 days worth of interest to get you so that you get to the first month and everything’s caught up so that it happens on the first of the month. So you’re prepaying in order to get it to be the even first of the month payment.
Jassen: Hmm. Okay.
James: So if you think about this, if you close later in the month, you may not have as much of a prepaid interest close earlier in the month. You may have a higher one.
Jassen: And I, I usually tend to close early in the month.
James: Yeah. And if you look at your statement, it’ll tell you the number of days of prepaid interest, you’re paying.
Jassen: Got It.
James: And then do you have a payment holiday? It’ll. You’ll basically get your coupon book. It’ll say your next, your first payment is due a month after you move in or month and a half after you move in.
James: Yep. So getting back to this Chart then, this is what’s happening. What’s crazy is in the, in the one where, it’s blue, you’re renting and so rent is due on the first for the, for the month beforehand you’re basically prepaying rent and so $3380 is your expenses when you’re paying rent. But what happens when you buy a Property the very first month in this Scenario you basically have a payment holiday because the interest isn’t due until next month. So your expenses are much lower that first month because you don’t have a mortgage payment and so the amount you end up saving in that first month is significantly more than the $1,100 that we’ve been talking about. And if we go look at this total saved, you can now see that. Because the amount we saved in the first month is much higher than the amount we did when we rented. When renting it was 1100. When we actually bought a Property it’s $2492.02.
James: So you’re saving like $1,300 from not having to make that mortgage payment that first. Isn’t that crazy?
Jassen: I love it.
James: Yeah. So basically it shows you that um, and what I want to show you, we can kind of go look at, you know, how much you’re saving stuff. I’ll zoom out so you can see the savings rate difference because you end up right here, you end up saving more now when you. And when you get to the point where you’re paying off your mortgage, it bumps up at month 360 a month, 361 technically, but it goes all through here and you can see you end up saving a lot more by owning a house then you did renting. So not only do you get the benefit of having an asset that goes up in value, the piece of real estate, because basically you bought a $200,000 Property and in inflation adjusted dollars it’s still worth $200,000 in 2018 dollars even in 20, even 30, 40, 50, 60 years from now because really it’s just maintaining its value. It’s just keeping pace with inflation. If you think about it that way, however you’ve paid it off. So you’ve saved an extra $200,000 in savings from that. Plus, you no longer have your housing expense except for taxes and insurance and maintenance on your Property once you get to month 360, so you end up saving more towards your retirement than someone who’s renting. So there’s a couple different benefits that people who are owner occupying a Property have over someone who’s renting. Um, you know, your, your payment for your housing is fixed for the first 360 months, then it goes away. So it’s like two benefits right there. Um, and the asset you have itself is increasing in value.
James: Okay. Alright. So Jassen, how big of a difference do you think this matters? This makes when you’re thinking about, you know, being able to hit your retirement numbers.
Jassen: It makes a pretty big difference.
James: Okay. Let’s just look at net worth as a starting point. So the net worth difference between these two, it’s basically almost $20 million if you own a house versus $13 million if you don’t.
James: that’s pretty big, right?
James: Basically it’s 50 percent more.
Jassen: Love it.
James: Right? Okay. So let’s take a look at the Goal. We’re going to go to the Goals Chart and we’re going to pull up the Goals. So here are the two different lines.
James: You could see that the rental one, which is the blue line, you’re, you hit this 100 percent Rule much later at that month 605 number, but you hit the retirement number much earlier with this red line from doing that. Turns out the difference is 518 months versus 609. So here’s another way of saying this, and this is kind of where we’ll wrap up tonight, unless you have some questions, we can do discussion. But if you do nothing else, but you decide I’m going to invest 60 percent stocks, 40 percent bonds, I’m going to get the same return in both cases, but instead of renting, I’m going to buy a house.
James: You can retire seven years and whatever that is, six months or so earlier, seven months earlier. So the difference between 50 years and nine months and 43 and two months, whatever that difference is, that’s how much earlier you can retire by just buying an owner occupant Property.
Jassen: Love it.
James: Yeah, it’s pretty significant difference and that’s the only difference is in one case you bought a house and the other case you didn’t. And we’re saving the same amount of money at the, you know, basically at month two, are we doing about $1,100 a month in savings in both cases. Everything else is identical.
James: Yep. Okay. So, uh, what I’d like to do is wrap up here. We’ve covered two of the Scenarios of the 12 that we’re going to go through. The next one we’ll do and we’ll just kind of add them as we go is we’re going to do renting but not doing bonds. We’re only going to invest 100 percent in stocks. So our risk tolerance is higher. We’re saying forget this three percent bond diversification thing. Um, you know, we’re, we’re young. We have the ability to withstand risk over a long period of time. What difference does changing our portfolio mix from 60 40 to 100 percent at eight percent. One hundred percent in stocks at eight percent make. I’m on kind of those Scenarios. And so we’ll run that one and then we will do renting with stocks, but buy one 20 percent down payment Property as a rental.
James: So we’re not even going to live in a Property ourselves as an owner occupant, we’re just going to invest in stocks and when we have enough to put 20 percent down and buy one rental Property to rent out to someone else, let’s do that and see how those all compare. And then we’ve got like six or seven other Scenarios. Everything you know, including, you know, doing the full nomad model where you buy, you know, a new Property every year where you live in it for a year, you stay there and then you convert it to a rental and do that at which those numbers get pretty crazy. And we’ll look at the difference in net worth and when you achieve retirement by doing that, we can talk about those different things. Do you have any questions before we kind of a break here?
Jassen: No, I think this was a good introduction to not only the software but the, uh, the Scenarios that we’re going to put it into the book. Um, so yeah, this is probably a good stopping point.
James: Let’s go ahead and end it here, but I definitely appreciate it and look forward to our next recording where we continue on talking about renting with stocks and, and a couple of other Scenarios at that point.
Jassen: Great. Thank you, James.
James: You’re very welcome. Thank you.