For Full Disclosure

[SaulR80683]

When I wrote the KB a few years ago there were 27 years, from 1989 to 2015 inclusive, and that was a lot of time for compounding to accumulate. As of the end of 2015, I had a 286-bagger on my entire portfolio. As you might guess, now, after the last two years, that total has become more than a 1000-bagger on the entire portfolio (1002-bagger actually). It obviously started small).

For Full Disclosure I should make clear that I currently have nowhere near a thousand times what I started with.

Why not? Well I retired at the end of June 1996 and have been living off the money I make in the market for the last 22 years. I have no other source of income except Social Security, which is a drop in the bucket.

What does that mean? It means for 22 years all expenses: food, paper towels, clothes, computers, telephones, restaurants, automobiles, gasoline, health insurance, uncovered medical expenses, sending my daughter to college and graduate school, paying her living expenses while she was there, paying rent, buying houses, upkeep, repairs, replacing the roof after a number of years, buying furniture, plumbers, electricians, traveling… well you start to get the picture.

And the money that came out isn’t just dollar for dollar. For example, you remember that my portfolio investing has grown to 343% of where it was at the end of 2016, a year and eight months ago. That means that $10 I took out at the end of 2016 doesn’t mean $10 that I don’t have now. It means $34.30 that I don’t have now that I would have had if I had left it in so it could continue to grow. And $100 I spent then would mean $343 I don’t have now.

And going back ten years, $10 I took out at the end of 2008 doesn’t mean $10 that I don’t have now. It means $120 that I don’t have now that I would have had if I had left it in, because my portfolio investing percent has grown 12 times since then.

And going back to the end of 2000, $10 I took out then means $330 that I don’t have now, because my portfolio investing percent has grown 33 times since then.

And going back to the end of 1996, the year I retired, $10 that I spent at the end of that year means $1,040 (!!!) that I don’t have now, because my portfolio investing percent has grown 104 times since then. (And $1,000 I pulled out then, means $104,000 I don’t have now).

That gives you an idea why, although my portfolio size has grown substantially, its nothing like 1000 times of where I started.

How do I calculate my portfolio percentage when I’m regularly withdrawing from it? Here’s the answer, straight from the KnowledgeBase.

Here’s how to calculate your overall returns ignoring cash flow in or out. Say you start the year with $14,000. You want to equate that with 100% and calculate gains and losses from there. So you ask yourself “What number (factor) would I multiply $14,000 by to get 100?”

By simple arithmetic we have 14000 x F = 100

And thus F = 100/14000 = .0071428

Sure enough 14,000 x .0071428 = 100

Now say three weeks later you have $14,740 and you want to see how you are doing, you multiply that number by .0071428 and you get 105.3 (so you are up 5.3%). If you don’t add or subtract money, that factor will work for the whole year.

Now say you add $2300 of fresh money, but you don’t want that to screw up your estimate of how well you are doing.

You add the $2300 to the $14,740 and get $17,040 which is your new balance that you are investing with. That’s your new starting point. It doesn’t affect how you’ve done up to here. You haven’t suddenly done better because you added money. You can’t still multiply by .0071428 because you’d get 121.7 and it would look as if you were up 21.7%, when you are really only up 5.3%.

So you need to change your factor to make it smaller so it will still reflect just the 5.3% gain you’ve made so far. You figure: “What would I multiply my new balance ($17,040) by to get 105.3, to reflect my 5.3% gain so far this year?”

F x 17,040 = 105.3

F = 105.3/17,040 = .0061795

And that’s your new factor. If you multiply it by 17,040, sure enough you get 105.3. Now you continue to see how you will do for the rest of the year.

If a little later you are at $18,000, you multiply 18,000 by .0061795 and you get 111.2, so you know that your investing is now up 11.2% for the year.

Same, if you take money out. You don’t want it to look as if you lost money. You calculate a new factor so you start from the same percentage where you were. If you were at $18,000 and your investing is up 111.2%, and you pull out $1000, you now have $17,000, so you figure what factor times 17,000 will give you 111.2% and you get 0.0065412. Sure enough $17,000 x 0.0065412 still gives you 111.2% and you haven’t messed up your investment growth percentages.

On January 1st of the next year, you write down how you did for the year to keep a record, and start over at 100 for the next year. Simple as that!

And a clue to those of you who plan to live off your retirement. The key is to think of what percent you can reasonably count on making as profit each year, and then make sure you spend less than that, so that your overall portfolio keeps growing. If you spend more than what you make and and start eating away your balance, it will be accelerating disaster.

Best to you all

Saul

For Knowledgebase for this board,
please go to Post #17774, 17775 and 17776.
We had to post it in three parts this time.

A link to the Knowledgebase is also at the top of the Announcements column
that is on the right side of every page on this board

[NCMeatyFool]

Thank you Saul. Your ten-bagger post inspired me to finally amp up my record keeping and analysis - it’s easy to ignore when things are going so well. I began building a spreadsheet to do just that last night. Quickly realized that money in and out was going to be complex if I wanted accurate return figures. Decided to go to bed and sleep on it when a little voice said, “you know Saul covered this in the KB.” Slept well knowing I could find it first thing. Well, what do you know? Saul posts it for me overnight. So I say THANK YOU SAUL, again!

[fdoubleol]

Hey Saul,

And a clue to those of you who plan to live off your retirement. The key is to think of what percent you can reasonably count on making as profit each year, and then make sure you spend less than that, so that your overall portfolio keeps growing. If you spend more than what you make and and start eating away your balance, it will be accelerating disaster.

This is counter to the “4% rule”, meaning you can withdraw 4% from your investments every year, adjust for inflation, and never run out of money.

Of course, that research is based on a 75/25 index fund portfolio and you’re playing an entirely different game.

So, what has your “percentage profit” target looked like over the years? Has it been conservative, say 10%, closer to 20%, etc.?

Thanks,
Chris

[mday1]

SaulR80683:
And a clue to those of you who plan to live off your retirement. The key is to think of what percent you can reasonably count on making as profit each year, and then make sure you spend less than that, so that your overall portfolio keeps growing. If you spend more than what you make and and start eating away your balance, it will be accelerating disaster.

fdoubleol:
This is counter to the “4% rule”, meaning you can withdraw 4% from your investments every year, adjust for inflation, and never run out of money.

The “4% Rule” is based on the stock market returning an average of about 7-8%/year, inflation adjusted. Why is the safe withdrawal rate (4%) so much lower than the stock market’s average growth rate? It’s because of Sequence of Returns Risk.

You might think that you could just pull out 7-8% per year, and your portfolio value would grow with inflation. The issue is that the stock market doesn’t go up by 7-8% every year. Some years it goes up more. Some years it goes up less. Some years it goes down (sometimes a lot!).

The 4% Rule assumes that your withdrawals will grow with inflation, so that you have constant buying power over the years. Specifically, you don’t need to reduce your withdrawals if the market goes down. Suppose you retire and set your withdrawal at 4% of the initial portfolio balance. Then during the next year, the market declines 50%. Now your withdrawal is 8% of your portfolio balance (actually, higher, since you’ll adjust the withdrawal up by the rate of inflation). It may take a few years to recover. During that time, your portfolio value is dropping. It won’t last very long that way. And when the market does recover, your portfolio will resume growing from a smaller base.

The 4% figure was determined by examining historical stock prices, and picking the largest withdrawal rate that would let a portfolio last 30 years – over any historical 30 year period. Note that with most periods, 4% turned out to be very conservative, and the portfolio grew substantially over 30 years. 4% was the most you could withdraw during the worst period (starting right before the crash of 1929). It turns out that 4% is due mostly to dividend yields back then; it actually took 29 years for inflation-adjusted stock prices to recover.

William Bengen’s study that resulted in the 4% Rule happened in the 1980’s. It turns out that there was another 30 year period that was just as bad as 1929-1958. It started in late 1968. Bengen wouldn’t have considered it because it was only 20 or so years ago then. Stock market declines were less severe, but there were several in a row with little to no growth in between one recovery and the next decline. And inflation was much higher than average (in the teens), so withdrawals grew almost as fast as stock prices. Perhaps surprisingly, about 4% was also the maximum for this period, even though dividend yields were less.

Of course, that research is based on a 75/25 index fund portfolio and you’re playing an entirely different game.

Using the S&P 500 (and equivalent data from before the S&P 500 was established), an all-stock portfolio actually has a slightly lower safe withdrawal rate. The 4% Rule assumes annual rebalancing, which causes some stock to be sold at the highs, and bonds to be sold when stocks are low.

I hope to have better average returns than the S&P 500. But I don’t know how much better. And I don’t know how my declines will compare to historically bad declines. So I have no way of trying to simulate an aggressive growth stock portfolio and compute a safe withdrawal rate. Therefore, I use S&P 500 data as a (hopefully very) conservative proxy.

==

Having a few years of cash out of the market allows for a slightly higher withdrawal rate. The idea is to live off that cash when the market is down enough (perhaps 20% or more), and then rebuild the cash when stock prices have recovered. (This is similar to the stock/bond mix and annual rebalancing.)

You can also “ratchet” up your withdrawal amount when your portfolio does well. For example, adjust it up to the maximum of 4% of current portfolio value, or last year’s withdrawal plus inflation. Ratcheting increases the probability that you run out of money after your planned time frame (typically 30 years). That few years of cash reduces the risk from ratcheting.

I retired 22 months ago, at the age of 52. I want to plan for my portfolio to last 40-45 years, not 30. I started with a 4% withdrawal rate (plus 3 years cash out of the market), but realized that was too high for 45 years and S&P 500-like returns. So after the first year, I switched to a 3.5% withdrawal rate. The portfolio grew significantly in the first year, so 3.5% of the new balance was still 20% more than our first year withdrawal. The portfolio has grown significantly again in the second year (so far), so keeping the 3.5% withdrawal rate should result in a significant increase in our withdrawal.

As you can see, I’ve chosen a very conservative withdrawal rate. I really don’t want to run out of money and be dependent upon our daughter, grandson, or the government. And I don’t want to have to cut back significantly in the event of a major decline. But we still get to increase our lifestyle over time if I do a good job of investing. No pressure.

-Mark

[caps4GROWTH]

The lessons never end, you’ve changed the way I think and approach investing. I wish I knew you when I was young, not to be confused with the song of the same title. You’ve positively influenced so many lives, not many people can say that. THANKS!

[SaulR80683]

The lessons never end, you’ve changed the way I think and approach investing. I wish I knew you when I was young… You’ve positively influenced so many lives. Not many people can say that. THANKS!

Thanks so much Caps. That was so nice of you to say.
Best,
Saul

[DaGecko]

I have looked at this post a few times over the past couple of days and at th first reading something seemed wrong but I have not been able to put my finger on why it seems wrong. Let me use Saul’s example and add a little more detail.

1. I start with the $14,000 and it grows to $14,740 and I agree with the calculation that this results in a 5.3% increase.
2. Then we add $2300 for a total of $17,040 in the account. But for the next step let’s keep the two investments apart. One is the $14,000 investment that is worth $14,740 and a $2300 investment that is worth $2300.
3. Later the account is worth $18,000 or an additional increase of $960 ($18,000 - $17,040.) Let’s break up the $960 dollars to the two investments. The $14,000 investment (worth $14,740 when the the $2300 was added) accounts for $830 of the $960 gain (14,740/17040960) and the $2300 investment gets credit for a $130 gain (2300/17040960.)
4. So for the $14,000 investment it is now worth $15,570 (14,000+740+830.) This is an 11.2% increase over the original investment (15570/14000= 111.2 or 11.2%.) However for the $2300 investment that is now worth $2430 the increase is only 5.65%. Now you can not average these two amounts because one investment is much larger than the other. I believe the right way would be 14000/1630011.2 + 2300/163005.65 = 10.42%.
5. Let’s look at another example. Assume I start with the same $14,000 initial investment. Then it goes to $14,740 after 3 weeks for the 5.3% gain. But then assume I get a $100,000 windfall and invest it. By the calculation formula proposed I would get F x 111740=105.3 or an F of .00091773. Now assume at the end of the year the portfolio was flat and it ended at $111,740. Obviously multiplying by the F factor I would get 5.3%. But this would not make sense. No one would claim a 5.3% gain for the year on a $740 gain on that portfolio.

Bottom line Saul has picked a great trend and great companies within the trend. I can see it in the gains I have made and am thankful for the board. But I do not buy into the performance calculation as presented. But hey, I have been wrong before.

Dave

[IRdoc]

In your last example you were up 5.3% after 3 weeks and for the rest of the year that number stays the same which means you made no progress after investing that $100k.

The point of the exercise is to calculate the performance of investments during the time they are invested regardless of actual value. So 5% on $10k is the same as 5% on $10m. For the majority if not all of this board this holds. So yes the 5.3% gained (5.3% on $14k and 0% on $114k) is accurate in that sense.

[NajdorfSicilian]

In your last example you were up 5.3% after 3 weeks and for the rest of the year that number stays the same which means you made no progress after investing that $100k.

Yes, that’s what he stated. You made 5.3% on 14k. Then you added $100k to your portfolio and your portfolio was flat for the next 49 weeks.

The point of the exercise is to calculate the performance of investments during the time they are invested

Yes.

So 5% on $10k is the same as 5% on $10m

A 5% gain is a 5% gain, we all understand that.

So yes the 5.3% gained (5.3% on $14k and 0% on $114k) is accurate in that sense.

No, that’s nonsense!

Your average portfolio size for the year was $108,930.

[You made $740 as agreed above = 5.3% on $14k in 3 weeks.]

Your return for the year was approximately 0.6812%.

[MrTBS]

Hi Dave,

Saul describes a cumulative performance; Najdorf describes an average performance. There is a time and place for each.

For a thought exercise, instead of assuming an additional $100k deposit after 3 weeks, assume a $15k withdrawal. The average return for the year will increase (same total increase divided by a smaller average balance)–my rough estimate went from 0.68% to 1.4%–depending on how you calculate average portfolio size.

Should it change, really? “In reality,” you still made $740 (5.3%) in the first 3 weeks, then you made an additional $0 (0%) for the rest of the year, no matter how big or small the balance was. In the grand scheme, it’s not a huge difference. But if you magically became a better or worse investor because the size of your balance changed either direction (in other words, if your methodology gives you a different answer whether you deposited or withdrew), then consider what you are truly measuring.

Personally, I prefer the cumulative method because I don’t think my “performance” should be impacted negatively by deposits or positively by withdrawals. You’re free to choose whichever reflects what you would rather measure.

I promise I won’t judge your preferred method of calculating your performance, or reporting it if you’re into that. I’ll just be happy for you when you’re up (whatever % that is) … and hate it for you if you’re ever down.

They call me,
MrTBS

[doppelg36]

Dave,
Your calculation looks more like ROI ( Return on Investment ). What Saul is trying to measure is his performance over the year. They are similar, but not the same, especially in a case like you describe.

[captainccs]

How do I calculate my portfolio percentage when I’m regularly withdrawing from it? Here’s the answer, straight from the KnowledgeBase.

As far as I’m concerned the only “proper” way to calculate the CAGR of a porfolio is using the Excel XIRR function applied to the cash flow of all the trades assuming that the last close price is the last sell transaction. I wasn’t sure how to think about additions and withdrawals so I built a spreadsheet to test it. Zero additions and withdrawals beyond the first and last have zero effect on CAGR – makes sense! Small additions and withdrawals have small effects. Large withdrawals in wild bull markets have little effect, the price increse compensates.

One conclusion that I can say with some certainty is that even with wildly successful portfolios a CAGR above 20% is excedingly rare.

Assuming no additions or withdrawals, 20% CAGR over 29 years (1989 - 2018) will produce a 197.5 bagger

Assuming no additions or withdrawals, 26.88% CAGR over 29 years (1989 - 2018) will produce a 1000 bagger.

With additions and withdrawals the relation of CAGR to bags gets complicated. I’m still not sure what the spreadsheet is saying. My first impression is that bags drop faster than CAGR. In the examples above a 34.4% increase (20 → 26.88) in CAGR increased bags five fold.

Denny Schlesinger

[IRdoc]

No, that’s nonsense!

Your average portfolio size for the year was $108,930.

[You made $740 as agreed above = 5.3% on $14k in 3 weeks.]

Your return for the year was approximately 0.6812%.

The idea of the calculation is to normalize returns to your portfolio size at the time of investment. It only matters if you invest the same regardless of how much actual money you have invested. The fact that you had no gains the rest of the year shouldn’t matter whether you had 100m or 10k invested. If you make 1000% returns on $100k and someone gives you $1 billion on the last week of the last day of the year your returns don’t suddenly drop just because the portfolio size is larger.

Everyone is free to keep score however he or she likes. Saul’s method is the best if you want to know how well you do with your portfolio, regardless of current size. Adding or removing money does not make you a better or worse investor assuming you invest the same way.

[DaGecko]

In my post I said I have been wrong before and now I am going to say, I am wrong again. Funny thing is that in the interest of brevity I did not mention that the “preferred” method for comparing one mutual fund manager over another is the use of Time Weighted Rate of Return (TWRR) sometimes referred to as Time Weighted Return (TWR.) Only after looking at Saul’s method have I come to realize that is what he is using but comes to the calculation using a different method than what I am used to seeing. I had to work thru it but found it to be the same result. It will take me some time before I figure out home to get from the formula that I know to the one he presented but in the mean time I wanted to post my retraction.

Although the TWRR is the appropriate method for comparing one fund manager say to another it does give some funny results unless you know what question it is answering. Basically it is by figuring the IRR for each period (period being the time from one inflow or outflow to the next) and then linking them giving equal weighting rather than dollar weighting. This results in determining the rate of return on the first dollar invested. It is not good for determining the absolute growth of a portfolio. The example I gave with no growth after a sizable infusion demonstrates that point.

So apologies for going down a rabbit hole and making an erroneous conclusion.

Dave

[NajdorfSicilian]

The fact that you had no gains the rest of the year shouldn’t matter whether you had…

It certainly is the determining factor when calculating IRR, which should be the goal of the investor.

On Day One, you have $10. You buy stock ABC, and make $2. 20%!

Encouraged by your success, you add $100k to your portfolio on Day Two.

The rest of the Year, you gains and losses net to Zero. You made $2 profit in Year One.

It would be an utter falsehood to state you made 20% on your portfolio in Year One.

You are not being ‘penalized’ by any stretch of the imagination on your adds and withdrawals which you decide.

You are being accurately judged.

People can keep score any way they like - frankly net profit in $$$ seems like a good method* for most people – but if they say they’re reporting method A when they’re reporting method B or C, they should expect to be corrected. Or simply if their math is wrong.

• You can’t eat IRR!

[mauser96]

Actually I no longer bother to calculate percentage return. If when the year is over I bought every tangible thing I wanted to buy and still had substantially more financial assets than when I started the year, that was a good year. Do that for 20 or 30 years, wash, rinse ,repeat, it adds up to a comfy retirement.