Virtual case study: Ana

With this article I would like to start a semi-regular series of virtual case studies to illustrate working with the simulator using tangible examples. Any resemblance to living persons would be purely coincidental, I am mainly interested in illustrating a certain problem or phenomenon.

Therefore, let us start today with Ana. Ana has just turned 25 and successfully finished her college degree a few weeks ago. She is now starting her first “real” job as a project manager in a large corporation. Due to the somewhat “shaky” pension system in Germany, Ana is a little bit concerned about how to provide sensibly for the future and therefore wants to invest part of her salary in a broadly diversified stock ETF from the very beginning. From her already decent starting salary, she would like to automatically invest $500 per month as a savings plan and sets up a suitable securities account and a savings plan for this purpose. Although Ana is just at the beginning of her career, she is also interested in the topic of FIRE and would like to better understand whether she really has a chance of retiring before the “normal” retirement age of 67 (in Germany) or if this is just a distant dream.

Ana uses the simulator on Predict-FI.com to get to the bottom of this question. As usual, I would now recommend all readers to open the simulator in a new browser tab and simply “play through” the case while reading in parallel. If you want to start with the “final” analysis you can find the download link at the end which you can easily import via “Load Analysis”.

Ana’ current portfolio value is still at zero, since she was barely able to finance her studies up to now. So unfortunately the 480,000€ value from the Trinity start example goes away and is replaced by a 0. The monthly savings rate should be $500, as described at the beginning. Ana enters this in the field “Savings until FI”. Next to it, an annual dynamic can be entered. Ana is quite ambitious and would like to take a few more steps on her career ladder in the future. She therefore expects corresponding salary increases, which she would also like to use to steadily increase her savings rate. For this purpose she carefully sets an increase of 2% per year and enters this as well. She leaves the fields “Expenses from FI” as well as “Cap. Preservation” at their default level.

She wants to start the simulation in July 2022, so she can leave the field unchanged. With the field “Simulation Over” she hesitates. The average life expectancy is rising continuously due to medical advances, and after a brief Google search Ana finds out that women born in 1997 like her have a purely statistical life expectancy of just under 95 years. Ana therefore decides to set the simulation period to 95 minus her current age, i.e. 70 years.

A look down now shows a rather scary portfolio development in the worst case scenario, but Ana has not yet set the most important slider for her question. She is not planning to retire with her empty portfolio today, but would like to know what the situation will look like when she starts thinking about FIRE at the age of 50, for example. For this purpose, she now sets the “FI Date” to July 2047, i.e. 25 years into the future until she is 50. In other words, she plans to keep her savings plan running consistently for the next 25 years and hopes that the stock market will continue to yield an average return of around 6% per year after inflation. With an investment horizon of 25 years, she also should be able to neglect any temporary ups and downs in the stock market. An early market crash would even play into Ana’s hands, because she can then buy even more shares of her ETF for her monthly $500 due to the so-called cost-averaging effect. Her parameters now look like this:

Let’s now take a look at the resulting situation:

Let’s start with the overview of withdrawals, earnings and expenses: We see now for the first time the monthly savings rates in green, which run until June 2047. From July 2047, the monthly expenses (in the default case still left at $1,600) start, which from then on are completely covered by withdrawals from Ana’s portfolio. At first glance, the result looks a bit sobering: In the worst-case scenario, inflation ensures that in 2047, instead of the original $1,600, almost $4,500 per month are now nominally necessary if one wants to maintain the purchasing power of the $1,600. Ana’s portfolio in this scenario in July 2047 is still worth $448,289, i.e. even in this worst of all possibilities Ana would be at least almost a half millionaire at the time of her 50th birthday. But unfortunately, this portfolio is not enough to actually allow Ana to have inflation-protected withdrawals of $1,600€ per month until her 95th birthday; rather, in the worst case, she would be broke starting in November 2062.

However, if we look at the median as an overview over all scenarios, we see that it is still positive at the end of the simulation period, i.e. there is a probability of more than 50% that Ana could stop working on her 50th birthday and still be able to withdraw the $1,600 until her statistical end of life of 95 years. And so far we have not taken into account any other income streams such as pensions.

But now we can run through some scenarios. What if Ana would work until 55 instead of 50? To do this, she sets the “FI Date” to July 2052 instead. The results are immediately updated for all histories and we now already get a completely different picture:

The final value of all scenarios are now completely above the zero line. Even the worst-case scenario would end up with a final portfolio value of over 3 M$! Ana’s heirs would certainly be very happy about this, but of course we let Ana optimize her own situation first. I.e. Ana now looks at the corresponding exactly calculated withdrawal rates on the 2nd tab:

Ana could withdraw $1,974 monthly with a bankruptcy probability of 0%. We now enter this value again in the field “Expenses from FI” and see the following overview:

Let us briefly summarize where we are: Ana starts investing $500 per month in a broadly diversified stock ETF at the age of 25. At the age of 55, Ana would very likely be in a position to retire, as she can withdraw almost 2000€ per month purely from the stock portfolio, inflation-protected, until the end of her life.

However, we have left out one more aspect that improves the picture even more. At least in Germany, Ana will have made monthly contributions into the pension fund during her working life. The resulting pension points in the German system are calculated from the average salaries, i.e. if Ana were to receive exactly the average earnings, she would be credited with exactly one pension point per year. As a project manager, Ana should actually earn above average, so for this case study we assume 1.5 pension points credited to Ana each year. For our non-german readers: These 1.5 points would translate into an additional monthly pension allowance of $54 each year. We enter this in the horizontal tab “Input pensions and additional cash flows”, which we expand to do this. (Details about this tab can also be found in the following article: FI Simulator 3 - Additional Cash Flows). We enter the following income there, since Ana currently has no pension points and will receive the unreduced pension at 67, thus from July 2064:

After pressing “Process cashflows and pensions” the picture changes again significantly:

Ana sees that from the start of the pension, a large part of the expenses are now covered by the pension and the withdrawals from the portfolio can therefore become significantly smaller. This leads to the fact that even in this worst case scenario shown, the portfolio is still at 3.5M$ in the end. We can therefore see, after another look at the exactly calculated withdrawal rates in the 2nd tab, that Ana can even withdraw $2,563 per month from 55 instead of $1,974 due to the later pensions. We enter this back into the overview and come to the conclusion of our analysis:

Even in the worst of all cases, therefore, Ana could still be relatively comfortable considering FIRE from 55 with a monthly withdrawal of around $2563. In all likelihood, however, Ana will even find herself in one of the better options. After this analysis, Ana is absolutely certain to start the savings plan as she intended to do. Of course, she does not yet know now whether she will actually start thinking about retiring at the age of 50 or 55. But by starting the savings plan early, at 25, she has laid the foundation for thinking about such scenarios at a later stage. In any case, she will not be forced to continue working until the start of the pension at 67, but will in all likelihood have the financial freedom to think about other alternatives earlier, whatever they may be.

If you want to replay this analysis you can find the json file here. If you want to be notified about new posts, please use your favorite RSS reader and subscribe to this blog using the RSS link in the main navigation bar or through this link.