4% of what?

[RatherBeFishn]

ERSBob,

You make some good points about cash and short-term bonds. I'll have to think that over a bit, but I'm 46 so I have a few years before I do this. I definitely want to sleep at night, but outliving my money would keep me awake too. I have 4 pillars on my bedside table (the book that is 8)), but haven't cracked it yet. I'll do some reading and adjust as needed.

I did want to followup on this comment though:

"With 4% withdrawal you also need to set aside another 3% for inflation."

I'm not sure I follow. Of course I know inflation is a factor, but is your comment only true if I'm taking a 4% SWR from the initial balance (which won't change)? I was thinking of doing 4% of current balance, which will vary depending on portfolio value changes. During the lean years, I spend less. Fat years, more etc. If we have a run of either I can adjust between 4% of initial and 4% of current as the endpoints on a range. I've got 2 numbers in mind for what I need to draw; what I'd prefer to maintain my current lifestyle (with travel, toys and fun) and my survival number; what I need to pay the bills and eat.

TH...I've wanted to start this post for awhile but didn't for all the reasons the regulars on this board know about. So, yes it IS nice to have some give and take and insight on SWR without it turning into a &#$%&^

[Jarhead*]

Quote:

The scary thing is that I'm pretty sure you meant "E" instead of "EE"!

????????

[Eagle43]

I have some "E" Bonds from Aug 1977 on. They were only $25/bond, but were listed as worth about 8/9times face value.

I think they keep earning interest for 30 years, so I have another couple of years until I will cash them....

[ESRBob]

Quote:

ERSBob, I did want to followup on this comment though: "With 4% withdrawal you also need to set aside another 3% for inflation." I'm not sure I follow. Of course I know inflation is a factor, but is your comment only true if I'm taking a 4% SWR from the initial balance (which won't change)? I was thinking of doing 4% of current balance, which will vary depending on portfolio value changes. During the lean years, I spend less. Fat years, more etc. If we have a run of either I can adjust between 4% of initial and 4% of current as the endpoints on a range. I've got 2 numbers in mind for what I need to draw; what I'd prefer to maintain my current lifestyle (with travel, toys and fun) and my survival number; what I need to pay the bills and eat.

Rather B. Fishin'
I see that what I posted could be confusing. I think you know all this, but in case anyone else is reading who is new, I hope this makes it crystal clear what I believe is the right way to look at keeping a portffolio inflation-adjusted over the long term.

What I mean is that your overall portfolio rate of return must be 7.5% or so in order to allow you to take 4% for your SWR, give half a percent to the money managers (and let's not forget the spreads and commissions charged and never seen when your funds buy and sell securities), and still have your portfolio grow by 3% in order to keep the real value intact against inflation.

That allows your next year's portfolio, assuming you started with a million on Jan 1 of this year, and earned the average 7.5% in 2005, to begin 2006 at 1,030,000, the same real value as you had on Jan 1 2005 (assume 3% inflation, the long run average). (You earned 75k, you spent 40k and gave the managers 5k, leaving you with 30k of increase).

That means that when you take your 4% next year, you'll be taking 4% of 1,030,000, which means you not only have kept the million dollar portfolio up with inflation, but you also will keep your 2006 withdrawal even with inflation, too. You'll get to spend 4% of 1,030,000 which is $41,200, an inflation adjusted 40k.

Of course the 7.5% is an average and it will never actually occur in any given year except by fluke chance, but at least, on average, you'll be keeping up over the long run with your withdrawal, fees, and inflation.

The problem occurs when people aim to only have a portfolio deliver 4% returns, which they take as their SWR and think, "I'm home free". Fees and inflation will whittle that down and the real value will be something like one half of its current value in 25 years.

People who hold all-bond portfolios fall into this trap if they don't take the first 3% of their yield and reinvest it every year -- spending the whole coupon means you won't keep up with inflation.

[RatherBeFishn]

Ah...I understand now.

[gayl]

Quote:

No something your doing is wrong. Your pension reduces your withdrawal. So you enter your nestegg and then enter 5% of that as a withdrawal, and then you enter your pension as a negative amount, which which should reduce your 5% withdrawal. Where does the 21% number come from? *Slow down and try it again.

Man do I feel dumb! There is a box way to the bottom that I did not see before. Left check [default] it takes my pension plus withdrawal out the first year. Uncheck it and I have a 100% success ratio even if I modestly increase my ratio.

[Hyperborea]

Quote:

What I mean is that your overall portfolio rate of return must be 7.5% or so in order to allow you to take 4% for your SWR, give half a percent to the money managers (and let's not forget the spreads and commissions charged and never seen when your funds buy and sell securities), and still have your portfolio grow by 3% in order to keep the real value intact against inflation.

This covers the simple analytical case. However, if this is the average return of your portfolio you may still end up using principal if the volatility of that return is anything but zero. In years in which the return is less than the average you will be withdrawing principal. So if that return is 3.5% one year then you have covered inflation and fees but your entire yearly spending of 4% is coming from principal. On the other side if you have returns of 11.5% one year then after you've covered your 7.5% (inflation + fees + yearly spending) you've added 4% to your portfolio.

Whether you actually do use up the principal over the long term life of the portfolio (your 30, 40, 50, etc year plan) depends on the sequence of those variations around the average return. If you get a lot of lower than average returns in the early years then you will start using up principal early in your plan. These are generally the withdrawal scenarios from the historical data that cause the portfolio to end the withdrawal period (30 years etc.) with no money left.

This indicates that it is a good idea for a FIREee to trade some average return for a lower volatility. How much average return should be traded off for how much volatility reduction? I'm not sure and I think that is an open question. It obviously, from ESRBob's explanation above, wouldn't be wise to go below 7.5% average return if you expect a 4% withdrawal. I would probably even suggest shooting for a little higher average return to balance against higher inflation (I think the average for the 20th century was 3.5%) and to provide a buffer.

[Nords]

Quote:

????????

I haven't heard about E bonds in years, which I thought was a nice touch for your joke about th's dad's shoebox. I wonder how many of the posters on this board have even SEEN an E bond.

In my spouse's family it was E bonds in paper grocery bags... and this was in the late '80s.

[unclemick]

88 year old Mom, 1973 -1978 E bonds. Getting her down to the bank to cash the ones past 30 years is more fun than pulling teeth. The Great Depression mentality dies hard.

She pisses and moans about having to pay taxes.

[RockMiner]

Quote:

This covers the simple analytical case. However, if this is the average return of your portfolio you may still end up using principal if the volatility of that return is anything but zero. In years in which the return is less than the average you will be withdrawing principal. So if that return is 3.5% one year then you have covered inflation and fees but your entire yearly spending of 4% is coming from principal. On the other side if you have returns of 11.5% one year then after you've covered your 7.5% (inflation + fees + yearly spending) you've added 4% to your portfolio. Whether you actually do use up the principal over the long term life of the portfolio (your 30, 40, 50, etc year plan) depends on the sequence of those variations around the average return. If you get a lot of lower than average returns in the early years then you will start using up principal early in your plan. These are generally the withdrawal scenarios from the historical data that cause the portfolio to end the withdrawal period (30 years etc.) with no money left. This indicates that it is a good idea for a FIREee to trade some average return for a lower volatility. How much average return should be traded off for how much volatility reduction? I'm not sure and I think that is an open question. It obviously, from ESRBob's explanation above, wouldn't be wise to go below 7.5% average return if you expect a 4% withdrawal. I would probably even suggest shooting for a little higher average return to balance against higher inflation (I think the average for the 20th century was 3.5%) and to provide a buffer.

Hyperborea,

Good post! Isn't it correct to say that if one uses a large enough TIPS component in a portfolio, the SWR becomes much more predictable, though it causes faster erosion of principal?

If you were certain about maximum life span, you could almost eliminate risk of portfolio failure in some cases (assuming the TIPS inflation adjustment was accurate) if you are willing to accept a terminal value of zero. I forget who posted this observation...

[cute fuzzy bunny]

That was one of the wonder twins.

You have two problems with that method.

One is the observed principal erosion vs improvements in medical technology. I sure as hell will be upset if I got to 80, am still in excellent physical condition, but ate my portfolio and have to go stand in a walmart for 10 hours a day to eat.

The second is the presumption that CPI=inflation. I dont buy into that, and a lot of smart money people dont either. Every reasonable analysis I look at says CPI falls a percent short of actual inflation. That means in 30 years you'd lose a third of your buying power.

Just as you run out of money after having to downgrade from eating porterhouse steaks to pasta halfway through your retirement, you fondly remember cures for heart disease, cancer and high cholesterol being developed 10 years prior.

I'll take on a little more risk for the improved upside, thanks.
Even the target retirement and wellesley income funds keep a stock component and non tips bonds.

[cute fuzzy bunny]

I agree. Looking at 'target retirement income', theres a stock piece, a TIPS piece, a regular bond piece...once again good asset allocation makes sense.

[Hyperborea]

Quote:

Isn't it correct to say that if one uses a large enough TIPS component in a portfolio, the SWR becomes much more predictable, though it causes faster erosion of principal? If you were certain about maximum life span, you could almost eliminate risk of portfolio failure in some cases (assuming the TIPS inflation adjustment was accurate) if you are willing to accept a terminal value of zero. I forget who posted this observation...

As has been said the lifespan issue is the real problem here. *If you know what it is exactly then sure this should work. *Though if you are young enough you will drive your SWR pretty low. *What's the SWR from an all TIPs portfolio for 50 years? *Are TIPs even going to be available in 30 years and what will the fixed rate on them be then? *Enough to survive on? *It seems pretty foolish for a really early retiree to plan on seriously spending down their portfolio for the early years.

[MRGALT2U]

I guess one reason I pay so little attention to SWR is that we are nearing SS and it seems to me we could live
just fine on our 2 SS checks and nothing else. In fact,
our combined estimated SS beneifits just about equal what we live on now, and we live pretty well. Of course, we actually have a significant income beyond SS. The 2
big unknowns are inflation and health problems.
But, you really can't cover all the potential troubles,
or at least we can't. Not on our budget.

JG

[treypar]

Why can you not take 5% out annually? It seems that should be reasonable.

[retire@40]

Quote:

Why can you not take 5% out annually? It seems that should be reasonable.

Read the few hundred posts on SWR prior to yours and they should answer your question.

[BigMoneyJim]

Well, it's worth a summary.

Quote:

Why can you not take 5% out annually? It seems that should be reasonable.

Way oversimplified: Assuming you mean 5% of your initial portfolio, inflation and historical returns indicate you had a chance of running out of money that way in the past if you adjust the yearly withdrawal for inflation. Not adjusting for inflation could run you short on spending money. If you mean 5% of the current balance each year your yearly withdrawal may be much higher or much lower than you need or want for that year.

If we knew future returns or even when we will die this would all be academic.

[Hyperborea]

Quote:

Why can you not take 5% out annually? It seems that should be reasonable.

There are answers to this on multiple levels. The first level is that using the historical data from 1870 to the present that if you took more than about 4% there were periods that you would run out of money before 30 years were over.

If you go deeper and want to know why that would be so when the long term expected return is 10.5% for equities then the reason is volatility.

[treypar]

Suppose that you had a large portfolio and could take 5% and get buy for 10 to 15 years. Then start drawing down on the principal for the next few years.

[preben]

Atl; it all depends - what time periods are you talking about? What budget? What size nest egg? What is your flexibility in budget in case you instead follow a 5% of total value each year (without adjusting for inflation) Etc.

As such 5% is not impossible - 4% is the historical worst case scenario for a 30 year period without running out of money for a fairly low diversified portfolio (75% SP500/25% bonds).

Cheers!