This is Scenario 1 of 12 different Scenarios for a book that I am putting together with a friend of mine.
I've outlined the default starting conditions for this model in A Simplified Analysis of Financial Independence, Retire Early with Real Estate, but in this Scenario we will be renting so I want to take a few moments to go over how we model that.
If you recall, we've assumed that we're earning $5,500 per month at the start of this Scenario, and we are trying to save 20% of that income toward an early retirement. We model income and expenses from a job using a special Rule called Paycheck and Personal Expenses.
For that Rule we've used the following assumptions.
This is going to be essentially the same for all the Scenarios in this group for which we are renting. The ones where we buy a Property to live in will have different expenses since the cost of a Property you own is handled elsewhere. For renting though, we're saying we're collecting a paycheck of $5,500 per month and we have expenses of $3,380.30 per month. We've checked the box to adjust these both for inflation so they will increase by 3% per year (applied as about one twelfth of that monthly).
For example, here is a Chart showing the Gross Paychecks (before tax) for each of the first 12 months.
The Gross Paycheck starts at $5,500 per month, but increases so that you're actually getting paid $5,651.06 per month in month 12. If we adjust for inflation though, we're still talking about the same $5,500 per month in every month.
We are reducing the Gross Paycheck by 18.54% to account for income taxes. The 18.54% is based on an estimate from 2017 for a single person earning $66,000 per year. It is the tax as percentage of income. We can look at what the net income is after income taxes in the Chart below showing just the first 12 months.
Your paychecks after tax are increasing with inflation as well.
When renting, we model that your rent is included with your personal expenses. So, the personal expenses start at $3,380.30 per month and increase with inflation. The following is a Chart showing the first 12 months of your personal expenses.
When we model you owning a Property in the other Scenarios, we will reduce your personal expenses so that you're saving the same amount in month 2. Why not month 1? See my blog post about why we match the amount saved to month 2.
For now, realize that since we're renting, you can see how much we're saving from our paycheck as the difference between the income after tax from our paycheck and the personal expenses. And, since the amount we're getting from our paycheck after income taxes are removed and the personal expenses are both increasing by about 3% from inflation, the amount we save each month is also increasing with inflation. That means that even though we are saving $1,130.21 in month 12 as shown in the Chart below, it really is the same $1,100 per month in savings if we adjust back to today's dollars for inflation.
If you really wanted to, we could click the “Inflation Adjusted” button below the Chart in the Real Estate Financial Planner™ software to see this.
In any event, with this Scenario we are taking that $1,100 per month and investing 60% of it in stocks and 40% in bonds.
Stock and Bonds
The rate of return for stocks and bonds (and the default Cash Account for that matter) remain fixed from the very first month through the end in year 60, month 720. I am showing this as three horizontal lines in the Chart below.
Yes, I realize how silly it is to show you that Chart, but this is the simplified analysis. When things get more complicated, you'll be able to pull up this Chart and show how the returns of different Accounts vary over time. For these Scenarios, when we say we're investing in stocks, the stocks are getting a fixed rate of return of 8%. When we say we're investing in bonds, the bonds are getting a fixed rate of return of 3%. When we say we are investing in neither stocks nor bonds and just keeping funds in cash… that's at 0%.
With this Scenario, we are keeping our stocks and bonds at a ratio of 60% in stocks and 40% in bonds. We adjust the balances in those accounts each month back to the 60/40 split. To demonstrate this, the following is a Chart showing the balance in each of the Accounts for the first 12 months.
Over the course of the full 60 years, or 720 months, we continue to add our savings from each month's paycheck into more stocks and bonds and those Accounts continue to grow. Here is a Chart showing the value of each of the Accounts for the full 60 years.
However, really what we'd like to focus on is whether or not we have enough in investments to be able to retire. Using Goals we can see how close we are to being able to do that.
In this Scenario, we have a Goal for achieving our target monthly income in retirement from safe withdrawal rate and any cash flow on rental Property. Since we don't have any rental Properties, this is all about whether or not we have enough invested in stocks and bonds such that if we spent 1/12 of our safe withdrawal rate that it would be at least $4,400 per month. The following Chart of the Goal will reveal the truth.
From the Chart above of the Goal, we can see that it takes this particular Scenario until month 609 (that's 50 years and 9 months) to be able to retire and have the same standard of living (the equivalent of $4,400 per month in today's dollars) withdrawing just 3.25% of their stocks and bonds portfolio.
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But how does this compare to Buying a Single 5% Down Payment Owner-Occupant Property To Live In and Investing 60% in Stocks and 40% in Bonds? Let's find out about that Scenario next.