A more optimistic look at SWRs

[donheff]

Michael Kitces has posted a look at SWRs that is a bit more optimistic than a lot of what we have been hearing lately. It is really nothing new. He just points out that the SWR literature is based on historical worst case scenarios, not historical averages. Thus, even if we face a low "new normal" for the coming decades there is no reason to assume we are on track for a new worst case scenario. Looking at the historical data he points out that, assuming our bond market will remain as is (essentially negative with respect to inflation - comparable to historic worst cases), then:

if you expect the coming safe withdrawal rates from here to be worse than anything seen in history, you need to assume not just below-average returns; you need to assume that the stock market cannot generate more than 1% real returns between now and 2027 given a 15-year real bond return of 0% at todays rates, and that if inflation increases from here that equities will fail to increase dividends dollar payouts, grow earnings, or provide any effective hedge to inflation whatsoever.

Given this reality, it's notable that merely getting 'new normal' returns of low single digits would actually represent not a risk to historical safe withdrawal rates; it would actually be an upside surprise that would result in materially higher lifetime spending! It would only be appropriate to assume a safe withdrawal rate lower than the historical 4% - 4.5% rate if you believe that equities will fail to deliver even a 1% real return over the next 15 years, implying (given current dividend and inflation levels) that the S&P 500 price level will be lower in 2027 than it was in 2007 (which would also be lower than it was in 2000, resulting in no appreciation for 27 years!).

As I said, no new data but a more optimistic perspective than some of the 2-3% SWR proponents put forward.

 

[FIRE'd@51]

It would only be appropriate to assume a safe withdrawal rate lower than the historical 4% - 4.5% rate if you believe that equities will fail to deliver even a 1% real return over the next 15 years, implying (given current dividend and inflation levels) that the S&P 500 price level will be lower in 2027 than it was in 2007 (which would also be lower than it was in 2000, resulting in no appreciation for 27 years!).

Remember, it was the high inflation of the late 70's and early 80's that lead to the Firecalc failures. If you look at the 15-year periods beginning in years 1964-1969, the real return on the S&P 500 was less than 1% in all of them, and in 4 of the 6, the real return was negative.

 

[Lsbcal]

I like the fact the FIRECalc has a lot more of those up and to the right lines then declining ones. So if I'm going to have to choose between pessimistic SWR projections and optimistic, I'll choose the later. Might as well go to my end in a happy state.

 

[REWahoo]

So if I'm going to have to choose between pessimistic SWR projections and optimistic, I'll choose the later. Might as well go to my end in a happy state.

Bah!

Haven't you heard optimism is out of fashion? All that pollyanna, whistling-past-the-graveyard, pie-in-the-sky thinking is avoiding the fact we're all doomed. Wake up and smell the embalming fluid!

 

[Lsbcal]

Repeat after me "Up and to the right !!! ".

 

[haha]

Bah!

Haven't you heard optimism is out of fashion? All that pollyanna, whistling-past-the-graveyard, pie-in-the-sky thinking is avoiding the fact we're all doomed. Wake up and smell the embalming fluid!

Wahoo, I think you are kind of a cheerleader for the everything is rosy outlook, and a reliable critic of doubters. A neutral position would appear to be that there are many poroblems, but the US has a strong history, so who knows?

Why is this?

Ha

 

[W2R]

Wahoo, I think you are kind of a cheerleader for the everything is rosy outlook, and a reliable critic of doubters.

No, no, that is ME, not REWahoo! .

Doom and gloom sells and is a good way for a "journalist" to keep working, but no way am I going to act on what the doom'n'gloomers say.

 

[REWahoo]

Wahoo, I think you are kind of a cheerleader for the everything is rosy outlook, and a reliable critic of doubters. A neutral position would appear to be that there are many poroblems, but the US has a strong history, so who knows?

Why is this?

Ha

My naturally sunny disposition?

I certainly don't think that everything is rosy, but my observations have led me to the conclusion things are rarely as bad as the grumbling Grinches of gloom & doom would have us believe. I refuse to waste my life surrounded by artwork painted only in shades of black.

While we are on the subject, you seem to be far less upbeat than the ha I first interacted with nine years ago.

Why is this?

 

[MasterBlaster]

My naturally sunny disposition?

I certainly don't think that everything is rosy, but my observations have led me to the conclusion things are rarely as bad as the grumbling Grinches of gloom & doom would have us believe. I refuse to waste my life surrounded by artwork painted only in shades of black.

While we are on the subject, you seem to be far less upbeat than the ha I first interacted with nine years ago.

Why is this?

It's not required that one espouse like nattering nabobs of negativism...

But it helps.

 

[MichaelB]

There have always been problems, and there always will be. Until we learn to see into the future, there will always be uncertainty. Is it any different now?

 

[Midpack]

There have always been problems, and there always will be. Until we learn to see into the future, there will always be uncertainty. Is it any different now?

Nope, there will always be uncertainty. But it does seem worthwhile to point out that the 4% SWR rule (with assumptions) has a historical 5% probability of failure and a 95% chance you could have withdrawn more and/or you'll leave a significant estate/bequest. We do see people here from time to time who seem to think SWR rate methodology is a 50/50 proposition - they've lost site of what the "S" stands for, statistically (very) safe. Timely post donheff, thanks...

However, the 2-3%ers are not necessarily out of line since this is an early retirement forum. I'm surprised (not that it matters one whit) by how many posts I see here from folks planning to retire at 45-55. As we all know, 4% is based on retiring at 65, not early by most definitions, and planning for 30 years.

 

[FUEGO]

However, the 2-3%ers are not necessarily out of line since this is an early retirement forum. I'm surprised (not that it matters one whit) by how many posts I see here from folks planning to retire at 45-55. As we all know, 4% is based on retiring at 65, not early by most definitions, and planning for 30 years.

This concern describes us. We are hoping to pull the plug in our mid 30's. So we have to have a safe withdrawal rate adequate to get us through two 30 year periods (although the second thirty year period will likely see us getting some level of SS income).

I am a few years away from being ER-eligible and still don't have a SWR nailed down. Current thinking is 3.25% to 4% of portfolio value each year, with an extra bucket of fixed income/cash worth about 2 years of expenses.

With our portfolio yielding close to 3% right now, it is hard to convince myself that much less than 3% SWR makes sense with an equities heavy portfolio that one needs to have the best chance of portfolio survival for 60 years. Of course I am more of a merely belts and suspenders and clean underwear guy. No reason to don kevlar body armor and an armor plated vehicle too.

 

[haha]

My naturally sunny disposition?

I certainly don't think that everything is rosy, but my observations have led me to the conclusion things are rarely as bad as the grumbling Grinches of gloom & doom would have us believe. I refuse to waste my life surrounded by artwork painted only in shades of black.

While we are on the subject, you seem to be far less upbeat than the ha I first interacted with nine years ago.

Why is this?

As regards economics, you are correct. When we first met I thought we had a few years of almost guaranteed gains, once I saw how interest rates were being pushed down.

I am neither pessimistic nor optimistic, but my outlook is mostly driven by my tentative assessment of where we are in the world, and how much confidence I have in that opinion.

I also would not characterize a negative economic ouutlook as "gloom and doom", anymore than I would call optimism "blind optimism". Nor do I think that most people are so global in their thinking and emotions that they see the world darkly, just because they feel that economics and politics are in a down spiral.

If you look back, one thing about my spoken opinions is that they are not often way off of subsequent events.


Ha

 

[REWahoo]

If you look back, one thing about my spoken opinions is that they are not often way off of subsequent events.

Ha

I have to give you credit for finding a very diplomatic way of saying, "I told you so".

 

[teejayevans]

There have always been problems, and there always will be. Until we learn to see into the future, there will always be uncertainty. Is it any different now?

Yes, because
1.we have the internet, CNBC, FoxBus, Bloomberg, etc
2.many don't have the safety net of pensions

TJ

 

[David1961]

For those under 55, like me, FIRECALC does have a setting where you can say how many years you need the money to last. Obviously, the SWR for a 50 yr time period is less than for a 30 yr period. Would be interesting to see a comparison - I'm sure it's been done. If you assume 4% is safe for 30 years, what is safe for 50 yrs?

 

[dtbach]

I think each individual has to set SWR's dependent on many factors so most suggestions are essentially meaningless. For me, I plan to adjust through the years. For now until 2017, I will be taking over 5%, mainly to enjoy traveling with my kids before they go into college. But then I can throttle it back some as my retired military pay will kick in at full pay and I can file and suspend SS and have my wife take it. Then in a few years more, the mortgage is paid off, the kids out of college and both of us will be drawing full SS. At that point maybe just 2.5% will do.

 

[REWahoo]

If you assume 4% is safe for 30 years, what is safe for 50 yrs?

http://www.early-retirement.org/forums/f28/is-there-an-unlimited-duration-swr-54608.html

 

[Cut-Throat]

Remember, it was the high inflation of the late 70's and early 80's that lead to the Firecalc failures. If you look at the 15-year periods beginning in years 1964-1969, the real return on the S&P 500 was less than 1% in all of them, and in 4 of the 6, the real return was negative.

While this is true, remember that you would have to have been unlucky enough to start your Withdrawals in 1966 for the 4% to fail for a 30 year retirement. Starting 5 years before and there is no problem with the high inflation for a 4% SWR. I think even Hoc*s admitted here that if you did not hit one of these worst case situations in your first 8 or 9 years of retirement, you were pretty much home free.

Also, I am a big proponent of Variable withdrawals in retirement. IOW - taking 4% of remaining portfolio with no inflation adjustment. This will protect you from Market downturns. In reality, this is what most retirees do anyway....I doubt that anyone here would take an inflation adjusted 4% into the teeth of a severe bear market. Would this mean that you might have to severely curtail your spending?....Yes....That is why I also maintain that your SWR initially should be twice of what you need, otherwise don't retire..

There has to be some flexibility in your budget to cut back if necessary. (e.g. Vacations, Entertainment, Dining out). I came up with a formula for having 'Enough' $$$ to retire. (The constant of '2' is there to cut expenses by 50%, if need be)
Nest Egg = (( Non Discretionary Budget * 2) - Annual Pension Amts) * 25
For example Lets Say that you have to have $30K minimum per year to survive in your current living situation (No eating out, entertainment, Vacation etc.) - Let's say you also get $15K in Social Security.

So Nest Egg = (($30K * 2) - $15K) * 25
Which Calculates to Nest Egg = ($60K - $15K) * 25
And Nest Egg = $45K * 25
And Nest Egg = $1.125 Million to retire for about a 30 year retirement.

 

[MasterBlaster]

CT:

I suppose that your formula is as good as any of them. They give you some sort of ballpark idea for what kind of money you need to ER.

I also suppose the following questions will arise from such a model.

1) what's a Non discretionary budget ? Is it a Bangladesh style lifestyle budget ? Or something more than that ?

2) many ER's retire way before Social Security sets in. How does that play into the formula ?

3) A 4% variable withdrawal rate always leaves a big unspent nest egg at the end. perhaps there is a better way to utilize that.


By the way, I haven't seen you posting much. haven't you been away for years ? How's the fishing life ?

 

[Cut-Throat]

CT:

I suppose that your formula is as good as any of them. They give you some sort of ballpark idea for what kind of money you need to ER.

I also suppose the following questions will arise from such a model.

1) what's a Non discretionary budget ? Is it a Bangladesh style lifestyle budget ? Or something more than that ?

2) many ER's retire way before Social Security sets in. How does that play into the formula ?

3) A 4% variable withdrawal rate always leaves a big unspent nest egg at the end. perhaps there is a better way to utilize that.


By the way, I haven't seen you posting much. haven't you been away for years ? How's the fishing life ?

Your questions answered....

1.) minimum per year to survive in your current living situation (No eating out, entertainment, Vacation etc.) ...If Bangladesh is your lifestyle, then yes. You actually can define this for youself. It's for whatever you need.

2.) Here is what I did on Social Security. I am taking it at age 70...I set aside 10 years of Social Security $$ in Cash and don't count it in my portfolio or asset allocation. I withdraw 1/10 every year until Social Security kicks in.

3.) If you look at Variable Withdrawal formulas, the percentage ramps up as you age....there are various methods, but an example would be 5% at age 70, 6% at age 75, 7% at age 80 etc. etc...... There are various methods out there. The 4% was a starting withdrawal rate.

4.) Yes I have been enjoying life and Fishing a lot....Wintering in Florida. Just booked an African Safari for next June.

 

[donheff]

3.) If you look at Variable Withdrawal formulas, the percentage ramps up as you age....there are various methods, but an example would be 5% at age 70, 6% at age 75, 7% at age 80 etc. etc.....

Yeah, if everything works out well I start flying first class when I am 70.

 

[Cut-Throat]

Yeah, if everything works out well I start flying first class when I am 70.

Actually I started in my 40s.......But, you are missing the point....The percentage may be increasing, but the amounts may not be.

 

[Midpack]

Also, I am a big proponent of Variable withdrawals in retirement.

Who suggested otherwise? So do all the credible SWR studies, for example:

One scenario backtested in the [1998] Trinity study suggests that a retiree with a suitably allocated $1 million portfolio could withdraw $40,000 the first year, give herself a cost-of-living adjustment every year afterwards, and have a 98% chance of the portfolio lasting at least 30 years.

Taken literally, such a plan has been criticized as unrealistic. Even if the tests showed that the plan had a 98% success rate over all past time periods, would a prudent person blindly go on steadily increasing withdrawals in a prolonged bear market? It also leads to apparent absurdities. Say that retirees A and B have saved $1 million in 2008, and the market crash reduces their portfolios to $800,000 in 2009. A, however, retires in 2008 while B waits until 2009. The Trinity study bases withdrawals the dollar value of the portfolio at the start of retirement. The value fluctuates with the vagaries of the stock market. Thus, even though their situations are almost identical, in the Trinity scenario, retiree A, by virtue of having retired in 2008, is allowed to withdraw $40,000 plus COLA in 2009; while retiree B, despite being in an almost identical situation, would be allowed only $32,000.

The authors of the paper, however, did not mean for their scenarios to be applied rigidly or uncritically. The article makes this very important statement:

The word planning is emphasized because of the great uncertainties in the stock and bond markets. Mid-course corrections likely will be required, with the actual dollar amounts withdrawn adjusted downward or upward relative to the plan. The investor needs to keep in mind that selection of a withdrawal rate is not a matter of contract but rather a matter of planning.
​

 

[Cut-Throat]

Who suggested otherwise? So do all the credible SWR studies, for example:

Not FireCalc. As well as most of the other SWR Calculators.

However, I agree with you that it is foolish to NOT have a Variable Withdrawal Plan, although many have suggested otherwise.