4% rule failures?

[rob1221]

I am not sure why people are adding the inflation rate to the 4% withdraw rate. In my book you can take 4% of your net assets per year. If your investment decisions are good your net worth will increase about the rate of inflation even after the 4% annual payout to yourself

 

[rescueme]

Heck, DW/me at are at a 6% forecast SWR and doing fine (what's the problem?) ...

 

[Onward]

I am not sure why people are adding the inflation rate to the 4% withdraw rate. In my book you can take 4% of your net assets per year.

Rob, if any meaningful part of your portfolio is in stocks, taking x% of the total each year will lead to a very, very volatile level of income. It could easily swing 30% or more from year to year, and you'd need a very flexible lifestyle. Most people can't handle those swings in their post-retirement income, but if you can, I salute you!

 

[kat]

During the downturn, and realizing I am still young enough to encounter more downturns, I opted to early semi-retire instead for ten years or so. It's not that 4% failed, but I decided I did not want to test it.

 

[FUEGO]

I am not sure why people are adding the inflation rate to the 4% withdraw rate. In my book you can take 4% of your net assets per year. If your investment decisions are good your net worth will increase about the rate of inflation even after the 4% annual payout to yourself

You misunderstand the "4% rule". It says you can take inflation adjusted withdrawals from your portfolio in the amount of 4% of your initial portfolio value. And keep doing the 4% of initial value every year for 30 years (adjusted for inflation) and have a high chance of success (~95%).


edited to subtract discussion of variable withdrawal rates based on end of year portfolio balances due to errors in calculations.

 

[rwc356]

I have been looking at a similar withdrawal concept. To help deal with the withdrawal volatility I am considering using a average balance of the rolling last 2 years (i.e., average of Dec 2009 and December 2010 balances used for calculating 2011 withdrawal) to compute the annual withdrawal amount. I'm not sure how it would impact the FIREcalc results but it should help smooth out the withdrawals.

What percentage of stocks were you using in your FIREcalc computations?

 

[bamsphd]

The bottom line is this - if you are willing to accept a small chance of a few years of slightly lower than ideal spending, then you can have a large chance of much better spending for most of your years.

During the FIRE planning stage, I think one should keep working until the 4% + inflation rule is projecting that your retirement should go well. (I'm still trying to get to that point, my target keeps moving .)

However, once retired, I think one should switch to some system which feeds your actual portfolio value back into the calculation of how much you can allow yourself to spend going forward.

One variant of that is the fixed percentage of current portfolio withdrawal rate. Another variant is the interest and dividends withdrawal rate. Another variant is splitting the portfolio into essential (inflation adjusted percent of initial retirement portfolio) and variable (fixed percentage of current portfolio) withdrawals. Other variants create buckets of assets to be spent in different years. The variations are endless.

However, I would not want to simply tell the trustee of some blind-trust, I'm retiring today and my portfolio is currently worth $X,XXX,XXX. So send me 4% inflation adjusted of $X,XXX,XXX every year minus your fee until the money runs out or I die. Don't bother to tell me my portfolio's value ever again, because it doesn't matter, and I don't want to worry about it.

For me, the main upsides of feeding the portfolio value back into your withdrawal calculation are that under most variants you will not run out of money unless you are forced to withdraw more than your plan allows, and you can usually withdraw more money than the inflation adjusted percentage of initial portfolio value plan permits.

The biggest challenge is that variable withdrawals can be painfully variable. I'm confident in my ability to handle upside portfolio volatility. However, I also know that a luxury once sampled becomes a necessity. I lived without a _____ (computer, cell phone, broadband internet connection, air-conditioning, ...) for many years, but ______ is now pretty much a necessity. In my mind the biggest danger of a variable withdrawal rate is that during the boom years I'll convert new luxuries into necessities which I will not be able to afford during the bust years. I know that will be more painful than never sampling the luxuries in the first place.

That is why my current spend plan rules includes:

4. Try to spend at most that much, or try to WORK. However, don't worry too much if during a bear market you spend using a previous year's prediction for a few years.

I frankly have never had anything near perfect control of my annual budget to date, and I don't expect that to change in retirement. However, I have been able to recognize when I should cut back and be more frugal for awhile. So having FIRECALC or some other tool tell me I can spend $XX,XXX this year does not mean I am going to spend $XX,XXX. I might spend a little more, or a little less. I just want regular feedback telling me when I need to step on the brake. I want to press gently, not wait until I panic and believe I need to slam on the spending brakes.

 

[FUEGO]

I have been looking at a similar withdrawal concept. To help deal with the withdrawal volatility I am considering using a average balance of the rolling last 2 years (i.e., average of Dec 2009 and December 2010 balances used for calculating 2011 withdrawal) to compute the annual withdrawal amount. I'm not sure how it would impact the FIREcalc results but it should help smooth out the withdrawals.

What percentage of stocks were you using in your FIREcalc computations?

80% equities. Pretty high by most standards, but I'm hoping to pull the plug around age 35, so there may be much more than 30 years of withdrawals in DW and my future.

 

[youbet]

bamsphd - I don't know how you did it, and I'm sure you didn't mean to deceive intentionally, but you show a quote from FUEGO as being mine. I'm referring to the first quote in your post #57. The quoted words are from FUEGO in post #55. You (or the system) attributes them to me. How did you do that?

Originally Posted by youbet
The bottom line is this - if you are willing to accept a small chance of a few years of slightly lower than ideal spending, then you can have a large chance of much better spending for most of your years.

 

[youbet]

What this means to me is that before I would consider a 3-3.5% "fixed" withdrawal strategy, I would really consider a higher variable withdrawal amount based on a higher percentage of portfolio value each year. It will never fail at all in the sense that withdrawals are zero, and for 95% of scenarios, it would provide more spending (in real terms) EVERY YEAR versus a conservative 3-3.5% fixed withdrawal strategy.

.

I don't think that's correct FUEGO. I don't have time for a lengthly explanation right now, but folks following the thread should check out this statement before assuming it to be fact.

I'm not saying variable withdrawal plans don't have merit, just that the bolded statement above wouldn't necessarily be true.

 

[FUEGO]

I don't think that's correct FUEGO. I don't have time for a lengthly explanation right now, but folks following the thread should check out this statement before assuming it to be fact.

I'm not saying variable withdrawal plans don't have merit, just that the bolded statement above wouldn't necessarily be true.

You know what, I think you are right. I thought I had checked firecalc's output thoroughly. But it looks like what I thought were real dollar amounts from their output spreadsheet are actually nominal amounts.

When I read this: "Open an (unformatted) Excel spreadsheet showing the inflation-adjusted end-of-year portfolio balances for every year in each of the cycles tested by FIRECalc." I thought it meant the end of year portfolio balances were adjusted for inflation to present them in real terms. "Inflation Adjusted End Portfolio [values]" is the way that real values are presented in the companion spreadsheet from the results page. Hmmm... tricky.

As a result, let me just say I'm going to have to revisit these numbers. And I'm going to edit/delete most of my "research" in my previous post since it is based on a flawed understanding of the firecalc outputs.

This is why it is good to be challenged. I want to thank you, Youbet, for pointing this out. This has radically changed my take on variable withdrawal rates, and I'll have to figure out the variability and level of success IN REAL TERMS now. I seemed to be drawing some pretty amazing conclusions, and I'm glad someone called me on it so I would triple check it.

 

[bamsphd]

bamsphd - I don't know how you did it, and I'm sure you didn't mean to deceive intentionally, but you show a quote from FUEGO as being mine. I'm referring to the first quote in your post #57. The quoted words are from FUEGO in post #55. You (or the system) attributes them to me. How did you do that?

TYPO.

I think I originally intended to quote part of your post as well. While I was editing down the quotes I must have deleted everything from just after the open quote block of your message through and including the close quote of your message and the open quote of FUEGO's message. The system thus thought I was quoting you and not FUEGO resulting in a misquote.

Sorry I goofed and did not notice.

Just FYI, to do a multi-quote first click the (") button just to the right of the (Quote) button for every post you might want to quote, then finally hit the (Quote) button. Then you to can create crazy misquotes at will.

 

[FIRE'd@51]

Yes, there is an implicit assumption that A retired earlier, should have (and did) base his initial WR on a longer period. But that was then and this is now. In spite of A getting an earlier start on ER, they have both experienced the same markets over the last 5 years. They are the same age, have the same expenses, portfolio, AA, etc.

Then A would presumably have a lower SWR than B at this point, so his success probability for the remaining 30 years would be higher.

 

[Arnie]

Then A would presumably have a lower SWR than B at this point, so his success probability for the remaining 30 years would be higher.

If you mean suggested future SWR and success probability, they should be the same. If you mean A's SWR up to this point, I don't see the relevance. The A & B example was intended to illustrate that one should be able to periodically use the same tool(s) to evaluate their condition as they did to start their retirement.

 

[Rustic23]

First, I don't depend on Savings as a core part of my retirement.

When the market cratered it went from 14,000 to 7,000. If I had a million dollars in my account when I retired, the 4% rule would say I could live on $40,000 a year. However, if I retired a year later, I would only be able to spend $20,000! I for one, would never feel comfortable continuing to spend as if I had retired with a million.

 

[Moemg]

When the market cratered it went from 14,000 to 7,000. If I had a million dollars in my account when I retired, the 4% rule would say I could live on $40,000 a year. However, if I retired a year later, I would only be able to spend $20,000! I for one, would never feel comfortable continuing to spend as if I had retired with a million.

Not as drastically but that is exactly what happened to a lot of our members including me . My SWR dropped by over ten thousand dollars . Luckily I had a lot of padding in the budget so it all worked out but it was a scary time .

 

[ziggy29]

If the 4% rule existed in 1929 and if the Internet existed in 1932, I wonder if people would be talking about its impending "failure" for folks who retired in '29. (It came close that time, but didn't fail.)

 

[ERD50]

First, I don't depend on Savings as a core part of my retirement.

When the market cratered it went from 14,000 to 7,000. If I had a million dollars in my account when I retired, the 4% rule would say I could live on $40,000 a year. However, if I retired a year later, I would only be able to spend $20,000! I for one, would never feel comfortable continuing to spend as if I had retired with a million.

This is similar to the Three Brothers thread. It's not as apples-to-apples as it seems.

edit - I see what I wrote does not address what you said, so I'm striking it. Although it stands as is, so I won't delete it.

[-]So say you retired with $1M and took 4% ($40,000) with the 'market' at 14,000. If you hypothetically retired a year later instead, with the 'market' at 7,000 you wouldn't have a million. You would have ~ $500,000. So FIRECALC would still say take 4%, and 4% of $500,000 is $20,000 not the original $40,000.[/-]

There is no inconsistency at all regarding FIRECALC, (edit/add: ) - but it is a 'gap'.

As haha puts it - FIRECALC can make no assumptions about the value of your portfolio when you retire, only the amount of $ you enter. And clearly, having a $1M portfolio at the peak of a bubble is not worth as much as still having $1M after the bubble has burst. (edit/add: ) and in your example, the $500,000 is worth about as much as the $1M from a year earlier, so yes, they should be able to spend about the same. I'll venture that in rough numbers, that 'same' is probably best looked at as an average of the two - about 3%.

But FIRECALC is saying that historically, the $1M portfolio survives 95% of the time at 4%. So if 95% is OK with you, and relying on history is OK with you - there ya' go. It's really the $500,000 guy that could go to 8% in this case (if you could 'trick' FIRECALC to skip the first year of downturns, as is what happens in your construct).

Of course it's hard to know where we are when we are in the middle of a cycle, but I think the intro to FIRECALC should touch on this. If you just saw your portfolio rise in value because we just had a few extra good years, you should be extra conservative with the SWR %. Conversely, if we have had several bad years, you might be able to be less conservative. Human nature probably drives people to the opposite conclusion. And we can' bank on ANY of it.

-ERD50

 

[haha]

If the 4% rule existed in 1929 and if the Internet existed in 1932, I wonder if people would be talking about its impending "failure" for folks who retired in '29. (It came close that time, but didn't fail.)

The analogy may not be that helpful. In the summer of '32 Shiller PE10 got just below 6. In November 2010, it stands at just under 22. In fact, current levels are closer to the 1929 peak of 32 than to the bottom in 1932.

I know it is tiresome, but valuation rules. And do not be surprised if valuation once again speaks.

Right now there is a Titanic struggle going on between knowledgeable investors' desire to sell over valued securities and their equally strong or stronger desire to milk the Bernanke cow until she gives out.

Interesting times!

Ha

 

[ERD50]

Related to all this - does anyone know which starting years are the 5% failures in the current data set with the defaults? Keep in mind that the years 1980 on won't be part of a 30 year cycle.

-ERD50

 

[rob1221]

6% of my portfolio is in stocks it will never be higher than 10% you are making my point that stocks are not a reliable form of income and the puny sub 2% dividends will force you to sell stocks or equity funds to pay the bills this can not be masked by a fancy financial planing fomula unfortunately

 

[ziggy29]

The analogy may not be that helpful. In the summer of '32 Shiller PE10 got just below 6. In November 2010, it stands at just under 22. In fact, current levels are closer to the 1929 peak of 32 than to the bottom in 1932.

I know it is tiresome, but valuation rules. And do not be surprised if valuation once again speaks.

Right now there is a Titanic struggle going on between knowledgeable investors' desire to sell over valued securities and their equally strong or stronger desire to milk the Bernanke cow until she gives out.

Oh, I know valuation matters, and even in March 2009 the market wasn't nearly as cheap as it was at the bottom in 1932.

For what it's worth, I've long sought a workable mechanical model that takes valuations into account but it's pretty hard to do without "market timing" even if one tries to use purely mechanical triggers. Plus valuation is partially dependent on the "safe" yield on money, and I'd suggest that not all markets are "identically priced" even with the same PE10 (or its reciprocal, the earnings yield). In other words, the higher the yield on cash, the higher the earnings yield has to be in order to "priced" attractively. A market with an earnings yield of 5% (PE10 of 20) might be more attractively priced with "safe" money earning 1% than when "safe" money is earning 4%. One also needs to consider how much extra earnings yield (plus dividends) they are receiving as compensation for accepting market risk.

 

[rob1221]

junk bonds are better than stocks

Rob, if any meaningful part of your portfolio is in stocks, taking x% of the total each year will lead to a very, very volatile level of income. It could easily swing 30% or more from year to year, and you'd need a very flexible lifestyle. Most people can't handle those swings in their post-retirement income, but if you can, I salute you!

6% of my portfolio is in stocks it will never be higher than 10% you are making my point that stocks are not a reliable form of income and the puny sub 2% dividends will force you to sell stocks or equity funds to pay the bills this can not be masked by a fancy financial planing formula unfortunately...revision, careful reading of my statement will reveal I have 6% in stocks or equities.

 

[haha]

Oh, I know valuation matters, and even in March 2009 the market wasn't nearly as cheap as it was at the bottom in 1932.

For what it's worth, I've long sought a workable mechanical model that takes valuations into account but it's pretty hard to do without "market timing" even if one tries to use purely mechanical triggers. Plus valuation is partially dependent on the "safe" yield on money, and I'd suggest that not all markets are "identically priced" even with the same PE10 (or its reciprocal, the earnings yield). In other words, the higher the yield on cash, the higher the earnings yield has to be in order to "priced" attractively. A market with an earnings yield of 5% (PE10 of 20) might be more attractively priced with "safe" money earning 1% than when "safe" money is earning 4%. One also needs to consider how much extra earnings yield (plus dividends) they are receiving as compensation for accepting market risk.

Definitely I do not want to argue with you- but it can be noted that high PE (low yield) equities have a very long duration, and as such it is not clear to me that they should be compared to contemporaneous interest rates. Andrew Smithers calls this technique "broker valuation".

The other question is -for what purpose is one using valuation? If it is to avoid being blown up, it seems less than prudent to benchmark to historically low interest rates, as interest rates have been known to change.

For myself, pretty much everything I own that can be sold without capital gains taxes has been sold.

Ha

 

[Onward]

the puny sub 2% dividends will force you to sell stocks or equity funds to pay the bills

That's okay. You can sell your stocks or funds and still finance a long retirement as long as you are diversified and keep your withdrawals small (< 4%). That's a safe strategy, if history is any guide.

If history isn't a guide, then all bets are off, and all investements are potentially unsafe.