For the past few days, I’ve been trying to write a post about challenges in achieving FIRE (financial independence, retire early), comparing the situation of those who live in developing countries versus the experiences of people who live in developed, Western countries.
It seems obvious that our experiences in developing countries will be different from the experiences of people in the West but I want to still write these challenges down to serve as food for thought for people like me who are on this FIRE journey, as well as to start a discussion.
This is not that post.
Although I was able to come up with around 8 differences in FIRE-ing in a developing country versus FIRE-ing in a developed country, a large part of that post became concentrated on 1 particular factor that I decided to dedicate an entire article to it instead.
If you’re not familiar with the FIRE movement, you can read this primer I wrote first before you proceed.
The FIRE movement started and gained momentum in the West, specifically in the USA. It was spread to the rest of the world by bloggers like Mr. Money Moustache, JL Collins, Big ERN of Early Retirement Now, and many others like them who were able to achieve FIRE by following more or less the same principles.
A very general summary of the current FIRE strategies of well-known FIRE personalities reveals that they:
- Have high savings rates
- Eliminated debt
- Invest in US index securities, specifically, in low-cost index funds or ETFs
- Follow the 4% safe withdrawal rate guideline
These general guidelines are followed by people who want to achieve FIRE, no matter where they are in the world.
People follow them as a matter of course and base their projections on these basic principles. There seem to be very few people who question these basic principles (that I know of, at least online), or even ask if these are even applicable outside of the USA.
Non-US FIRE blogs that I follow – in Canada, Europe, and even in the Philippines – all base their FIRE projections on the 4% safe withdrawal rate rule.
In practical terms, we calculate our annual expenses and multiply that number to 25 to come up with THE NUMBER.
THE NUMBER is the amount that we should have in our investment portfolios so that we can FIRE.
According to the 4% safe withdrawal rate rule, we can sustainably withdraw 4% from our portfolios annually to fuel our FIRE and be able to leave the principal amount to our heirs when we pass.
THE TRINITY STUDY
The 4% safe withdrawal rate rule is based on the paper Retirement Savings: Choosing a Withdrawal Rate That Is Sustainable, also known as the Trinity Study because its writers are based in the Trinity University in Texas.
Some of the key conclusions of the Trinity Study (verbatim from the study but emphasis supplied) says:
- The presence of bonds in the portfolio increases the success rate for low to middle-level withdrawal rates. However, the presence of common stocks provides upside potential and holds the promise of higher sustainable withdrawal rates. In other words, the addition of bonds helps increase certainty but at the expense of potentially higher consumption. Most retirees would likely benefit from allocating at least 50% to common stocks.
- For stock-dominated portfolios, withdrawal rates of 3% and 4% represent exceedingly conservative behavior. At these rates, retirees who wish to bequeath large estates to their heirs will likely be successful. Ironically, even those retirees who adopt higher withdrawal rates and who have little or no desire to leave large estates may end up doing so if they act reasonably prudent in protecting themselves from prematurely exhausting their portfolio.
- For short payout periods (15 years or less), withdrawal rates of 8% or 9% from stock-dominated portfolios appear to be sustainable. Since the life expectancy of most retirees exceeds 15 years, however, these withdrawal rates represent aggressive behavior in most cases. By definition, you have a 50% chance of living beyond your actuarially determined life expectancy, so it is wise to be conservative and add a few years.
In short, a portfolio made up of at least 50% common stocks, with a withdrawal rate of 3% to 4%, will help retirees keep the value of their investments until death.
Amazing right? Just allocate at least 50% of your portfolio in common stocks through equity index funds then put the rest in bonds, and you should be able to safely withdraw 3-4% from your portfolio annually and you can have a sustainable retirement.
UNDERLYING ASSUMPTIONS OF THE TRINITY STUDY
Is it that simple though? Reading the Trinity Study would reveal that the 4% safe withdrawal rate is based on the following underlying assumptions:
- Examining the withdrawal rates is based on 1998 value analysis and historical average rates of returns.
- Stocks are based on the valuation of the Standard and Poor’s 500 index (S&P 500)
- Long-term, high-grade US corporate bonds were used to represent bonds
Now that these underlying assumptions are brought up, we realize that our current reliance on the 4% safe withdrawal rate is faulty. Very few of us in developing countries are invested in the S&P500 and long-term, high-grade US corporate bonds, let alone be 100% invested in these instruments.
Most of us are invested in our national capital markets or are invested in totally different assets like real estate. The 4% safe withdrawal rate is specific to the S&P 500 and long-term, high-grade US corporate bonds.
How about in other countries? Is the rule applicable to other developed or Western countries?
HOW DOES THE 4% SAFE WITHDRAWAL RATE FARE INTERNATIONALLY?
Just to get more information about this issue, I tried to look for more studies about the sustainability of the 4% rule in other countries. It’s possible that other capital markets outside of the USA are able to support the 4% safe withdrawal rate, right? Luckily, I found a paper which studied 17 developed countries.
The paper, An International Perspective on Safe Withdrawal Rates written by Wade Pfau (blog version available here for easy viewing of tables), revealed that outside of very few developed countries, the 4% safe withdrawal rate is not sustainable.
The paper reveals that:
- Internationally, the 4% real withdrawal rate is risky.
- Even in overly optimistic assumptions (example: perfect foresight in allocating instruments), the 4% withdrawal rate only provided “safety” only in 4 out of the 17 countries. These countries are Canada, Sweden, Denmark, and the USA.
- For 50% stocks/50% bonds allocation, none of the 17 countries included in the study achieved the 4% perfect withdrawal rate.
The 4% withdrawal rate provided “safety” only in 4 countries only in overly optimistic assumptions! This basically translates to zero countries because nobody has perfect foresight.
If you’re curious to know which countries are included in the study, its Australia, Belgium, Canada, Denmark, France, Germany, Italy, Ireland, Japan, Netherlands, Norway, South Africa, Spain, Sweden, Switzerland, United Kingdom, and the United States.
Except for Japan and South Africa, the countries in the study are all developed Western countries. And none of these countries are able to achieve the 4% perfect withdrawal rate. (P.S. This is not my conclusion, okay? This is Pfau’s conclusion so don’t come for me about this. I did not conduct the study, I’m just citing it. Thanks.)
I hate to be the bearer of bad news but, for those of us who are in developing countries, the 4% safe withdrawal rate does not apply. To recap:
- Even in developed countries, only 4 (Canada, Sweden, Denmark, and the USA) are able to support 4% withdrawal ONLY under overly optimistic conditions.
Now, I know a lot of personal finance experts have successfully FIRE’d using the 4% rate.
My current favorites are FIRECracker and Wanderer of Millennial Revolution, who are Canadians and recently released a book, which I looooooove (review coming up). I won’t be weighing in about the sustainability of the 4% rule in the US and Canada because, well, it’s not my horse, so to speak.
So far, there are no studies about the sustainability of the 4% withdrawal rate in developing countries, because, come on!
We’re supposed to labor until retirement or death, whichever comes first. But, we can assume that if the capital markets of developed countries cannot sustain 4% withdrawal, then the capital markets of developing countries will be unlikely to sustain 4% withdrawal as well since the latter markets are more volatile.
Let’s say that you think Pfau’s study is simply incorrect and that you’ll still follow the 4% withdrawal rule. Keep in mind that for it to work:
- You have to be invested 100% in the US capital markets, at least 50% in the S&P 500 and the rest in US bonds.
If you’re not invested in the US capital markets, you’d have to rethink your strategy since the Trinity Study does not apply to you.
If you want to invest in the US stock markets, you’d have to open an online brokerage account. I personally have one with TD Ameritrade and you can read my experience about opening an account with them here. If you want to learn more about the tax implications, you can read this related article.
What can we do about it? Frankly, I don’t have an answer for you. Do you know of other alternatives to achieve a sustainable FIRE for those who live in developing countries (as citizens and not as a means of taking advantage of geographic arbitrage)? Please share in the comments.
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part of FIRE-ing, i suppose, is in knowing that having enough of enough is enough. fatFIRE cannot be sustainable for all of us to achieve. sustainability here goes beyond the financial sense; it must transcend especially into environmentalism. although buying a used car is more sustainable than buying a new one, ditching it altogether for a used bike is the far better option (less carbon footprint and, who would’ve thought, cheaper and healthier).
the next question to answer then would be, “what is enough?” it’s a subjective yet philosophical one. while i don’t have the complete answer myself, i think having enough means not worrying about food, shelter, health, transportation, communication.
Thanks for your thoughtful response, oi.
Thanks for your post,
You mentioned that
“Keep in mind that for it to work:
You have to be invested 100% in the US capital markets, at least 50% in the S&P 500 and the rest in US bonds.”
However, how do we diversify? I was planning to do
US stocks, International Stocks, Emerging Market stocks, Bonds, Reits, etc.
Also, does it have to be S&P 500? It won’t work with US Total market ETF funds?
To diversify, you can follow the Boglehead’s Three Fund Rule and put your money in these index funds – US S&P or Total Market index, International Stocks, and Bonds,
The study that came up with the 4% rule was using S&P 500. But other Bogleheads also use the Total Market Index.
I am curious if there is a FIRE community here in the Philippines