I think I first read about this comparison on the Booglehead forums earlier this year. The principal is incredibly simple. Forever X dollars you save you get $1 every year for the rest of your life. It all depends on your rate of return and what you deem a “safe” withdrawal rate. Note the quotations everyone. But before we get into figuring out your magical forever dollar amount lets back up a little bit.
The Magical Forever Dollar has some assumptions. The first is that the money is being invested into a vehicle that gives returns i.e. stocks, bonds, CDs, REITS etc. The second is that you have you have a set withdrawal rate that you are going to use for the rest of your life (which we all know isn’t true; humans react to stimuli and therefore can determine what they can afford to withdraw.) Third is the return of your investment OVER TIME after inflation is greater than your withdrawal rate OVER TIME. For example, your return during 2008 may have been -20% but you still needed 4% of your nest egg to live for the year. If your average rate of return has been greater than 4% than you are still safe because it is still greater than your 4% withdrawal rate you’ve been using. It is important to look at averages over significant period of times to determine if your plan is successful otherwise you may pull the plug too early. Also, this number isn’t gospel. I just find it to be a fun way to track my investments and make wise choices while I am saving money.
Examples of my Forever Dollar
I like to use 4% as my safe withdrawal rate. Because when you use 4% then $25 today is equal to 1 magical forever dollar. Dinner out for 2? That’ll be 2 to 4 forever dollars. The difference between a new and used car? 400 forever dollars hidden in the seat cushions. Year-end bonus? I’ll take those 100 forever dollars straight to Vanguard thank you.
Another cool thing about growing my portfolio of forever dollars right now is I have the advantage of time. My investment will continue growing until I begin to start taking my 4% withdrawal at whatever annualized rate of return I am getting. In case you are still confused here is chart breaking down the way I like to view my investing strategy.
|Event||Money Invested||Forever Dollars Created|
|Don’t Go out to Dinner||$50||$2|
|Year- End Bonus||$2,500||$100|
|Used Car vs New Car||$10,000||$400|
Now everyone has different risk tolerances, asset allocations and withdrawal rates they deem safe. However, time in the market will always beat timing the market. I find this is a quick and fun way to conceptualize investment performance and the impact investing can have. The other important thing to remember is when you don’t use your forever dollars they can create more forever dollars for you!(i.e. compounding interest).
So now my question turns to you guys, how do you keep investing ‘fun’? Do you like to visualize and make games out of your investments or do you prefer the spreadsheet approach? Let me know in the comments below.