Don’t take FIRE rules for granted, especially if you’re not in the US.

So there I was… listening to an episode of a popular FIRE podcast yesterday and the topic of the Rule of 72 came up, and I had a thought..

The Rule of 72, if you’re not familiar, is the idea that you can calculate the number of years it will take a fixed amount of money to double when earning a fixed rate of interest. The way it works is you divide 72 by the interest rate you earn, and the result if the number of years it will take for the money to double:

Number of Years to Double = 72 / Interest Rate

Therefore, according to the rule, it would take 8 years to double a given amount of money at an interest rate of 9%/year. 72/9=8

The concept was not new to me, or so I thought. I had often read of the concept in the FIRE blogosphere.

Here is the thought I had: That ‘rule’ of FIRE breaks down if your interest rate is 72%.

72 divided by 72 (the later representing the theoretical rate of return in this thought exercise) equals 1, implying that it would take 1 year to double your money. However, $1 at a 72% rate of return is worth only $1.72 after a year, not $2.

Clearly there’s a breakdown at some point. How relevant is the rule? When is it accurate?

This is the line of thinking that led me to dig deeper on, what I had previously thought of, as a rule of FIRE.

Now, to be fair, I don’t know that anyone said it is a rule, or it was originally presented to me as a rule, but when you hear something so often, and it is written about or said with so much conviction, it gets taken for granted in one’s mind as a fact. The rule is not questioned. Details are not sought.

A quick google search on the topic led me to a more complete definition curtesy of Investopedia. According to the article the Rule of 72 provides a rough estimate of the result. The article goes on to provide a more exact formula.

And here’s what I was looking for:

“The rule of 72 primarily works with interest rates or rates of return that fall in the range of 6% and 10%.”

Ahhh ha! That makes more sense after my quick thought exercise. The article goes on to say:

“When dealing with rates outside this range, the rule can be adjusted by adding or subtracting 1 from 72 for every 3 points the interest rate diverges from the 8% threshold. For example, the rate of 11% annual compounding interest is 3 percentage points higher than 8%.

Hence, adding 1 (for the 3 points higher than 8%) to 72 leads to using the rule of 73 for higher precision. For a 14% rate of return, it would be the rule of 74 (adding 2 for 6 percentage points higher), and for a 5% rate of return, it will mean reducing 1 (for 3 percentage points lower) to lead to the rule of 71.”

So, let’s see how these details from Investopedia pan out with my original thought exercise.

First, I need to find the correct dividend for the equation based on a theoretical interest rate of 72%. The Rule of 72 is most accurate at 8% and for every 3% interest change from 8%, adjust 72 by 1 in the corresponding direction of the rate.

72% – 8% = 64%

64% / 3 = 21.33

72 + 21.33 = 93.33

For a rate of 72% I need to be using the “Rule of 93.33”, which is not nearly as catchy.
[“Rule of”] 93.33 / 72% [theoretical interest rate] = 1.296 years to double

That sounds much more accurate. Let’s try it out.

What I did to test this (Disclaimer: I’m not a scientist or mathematician or anything) is I then searched “compound interest calculator” and found this one from The Calculator Site. Seems legit.

Since the Rule of 72 works on interest compounded annually, and my result was not 1 year or 2 years, but 1.3 years, I had to adjust a bit to account for the 0.3 years.  My idea was I could calculate the interest for 2 years, then take the 2^nd year of interest and multiply it by 0.296 to approximate the interest for the remaining 1/3 of the year. This is supposed to be just a quick test, so stick with me.

I filled in the calculator as such:

And here’s the result:

For 2 years, a $1 investment turns into $2.96 at an interest rate of 72% compounded annually. Not I need to convert that to 1.3 years. Note in the table at the bottom of that screen shot it shows the interest earned in year 2 is $1.24.

So, I took the $1.24 and multiplied by 0.296. The result is $0.36 interest, and when added to the 1st year result of $1.72 you get $2.08.

Pretty close to double, but definitely not exact.

What’s the point?

Ok, here we are. Information I had largely taken for granted as a law, may not be a law of personal finance after all. I explored my assumption, and by doing so, learned I need to be more careful than back-of-the-napkin math when planning for the rest of my life. After all, moving to a foreign country is not a career booter, so my future earning power given my current circumstances is suspect at best.

Perhaps in your own enthusiasm for FI, you have also taken certain information for granted. Maybe you came across a story you think is repeatable, and you’ve modeled your efforts after those of someone else’s. Maybe that person’s path to FI isn’t right for you. Maybe they’ll fail; and maybe you will too.

Whooo, whooo… slow down. Sorry. Not trying to squash your dreams or anything. Mainstream FI, is currently working for many.

But you’re here. You’re reading this blog, and as such, I’m going to make certain assumptions. I assume you’re interest in using international relocation to obtain the advantage of geoarbitrage as part of your strategy. Or perhaps you’re working towards FI anywhere other than the US. That means you’ve largely learned about FI principals based on US data and US practices.

For example, the 4% rule. It’s standard practice for FI. If you want to know how much you need to save for your money to last 30 years, you need to save enough where you only draw 4%, inflation adjusted, form your investments per year. That comes to 25x of your yearly spend.

Now, for the person relocating to a foreign land, or residing in another country, that “rule” is based on US stock market and bond data. The inflation adjustments are based on US inflation. You’re not going to live in the US so it doesn’t apply to you. Even if you keep your investment stockpile in the US, and transfer what you need, it doesn’t take into account exchange rate fluctuation or the inflation in your location.

So, let’s think this through. If you move your money all at once from the US, or your investments exist in another market, those investments will not necessarily have the same performance as US companies and US bonds.

If you keep your investments in the US (or move them there) to more closely emulate the investment results of the 4% rule, you still have issues of local inflation and exchange rate risk. What if the US dollar falls in value relative to your currency? Those transfers of 4% of your assets will produce fewer units of your currency. Alternatively let’s say inflation runs hot in your country. Same issue, you receive ‘X’ number of units of currency for your dollars but you need more of those currency units to buy the same number of goods and services. Let’s say both the inflation runs hot and the dollar loses value. That’s an issue for the foreign 4% rule practitioner.

Digging deeper

International geoarbitrage can be a powerful tool to work towards financial independence faster. No doubt. But.. it’s a path less followed. That means YOU need to take caution; don’t make assumptions. I hope I’ve outlined why.

I have a couple of recommendations.

#1 Dig deep. Big ERN blog, if you’re not familiar, is most famous for research on the safe withdrawal rate for period longer than 30 years. Important for the aspirational early retiree. Mr. ERN also looks like safe withdrawal rates for current market conditions. If your portfolio is based on historically high-priced assets, it may not last as long as if your portfolio is based on historically low-priced assets.

Here’s another example. I’m in Brazil. Obviously, the US data does not apply to the markets here. First, we have oversized bond rates. A super-high real rate of return (the following headline is a bit dated, but you get the idea).

Here’s a corresponding study on real rates.

We have a stock market closely linked to commodities cycles. Etc etc etc.

My investment allocation will be much different. I’m basically 75% bonds, 25% stocks. 4% rule is 40/60 as I recall, and based on US assets, of course.

Also, Brazilian companies pay HUGE dividends. Here’s an extreme-ish example (again dated, but to give you an idea):

So, maybe I don’t need 4%.  Maybe I can draw 10% safely.  Or maybe 2% is better.  This will not be an analysis of safe withdrawal rate for Brazil.  For that, check out this Blog (in Portuguese, but you can use your browser’s translate feature if needed).

 #2 Use common sense.  This closely aligns with recommendation #1.  Learn all you can, then try to apply it to your circumstances.  

What you learn may not be an exact fit.  I learned, based on US financial independence teachings I need 25x my spending to retire.  I further learned that is based on US historic market data.  Based on that I tried to learn about US historic market conditions, and see which of those conditions apply to my circumstances.  Since I can’t rely on commonly available safe withdrawal rate data, I’m focusing on income.  I don’t want to draw down my assets, because they may fluctuate in an unpredictable way. I’d rather have a base of assets that grows inflation adjusted and live off the income they produce.

For example, I have long term government bonds, indexed to inflation, which pay out interest above the rate of inflation every 6 months.  This gives me a stable base of passive income, which will return a consistent purchasing power over a long period of time.  

In addition, I have a portfolio of stocks mostly related to utilities.  These utilities pay outsized dividends, and they’re stable, because everyone needs water and electricity. I also own real estate; which serves as a fallback position.

Those strategies may not be available to you.  Adapt to your circumstances.  Remember you’re walking the path less followed.  You may need to learn along the way, walk with extra caution, and learn to navigate without the same tools as everyone else.

Another example: I’m not counting on future US social security income.  Why? Well, a lot of reasons; maybe you can guess.  I’m not going to harp on how the US social security system is underfunded, although that is all legit.  But for the person retiring to a foreign land, with different currency, you may not be able to predict how local inflation and the USD:[your currency] exchange rate will affect the purchasing power those social security checks buy you.

In summary, for the international geoarbitrage retiree, you may not want to retire of the knifes edge of FIRE.  Lean FIRE may not be for you. Or maybe it’s the perfect strategy to live Fat FIRE on a Lean FIRE budget.  Either way, don’t rely on mainstream FIRE info based on US data.  You need to dig deeper.

-Sirsandals