Another safe withdrawal rate question

[arandomwalk07]

Hi guys, wonderful forum you have I've learned so much reading through past posts.

I have one question after reading the topics on safe withdrawal rates. I understand that they're just guidelines.

The recommended rate is let's say 4%, and I've noticed people saying that the longer you expect to live/earlier you retire the lower would be your "safe" rate.

My understanding is that the failure events or % in these calculations is typically due to early losses in retirement assets e.g. you retired in 2001 at height of tech bubble.

If I retire early at say 45ish, and great depression mark 2 kicks off a week later (knowing my luck..) I would have time to recover - I could go back to work in my 50s for a few years and stabilise the situation. If the big disaster didn't happen then well and good and continue happily retired. Being a younger retiree I'd have thought would give you more scope to be safe using a higher withdrawal rate (until you reach a later age in which case absolutely return to 4% or so)?

 

[2B]

Welcome to the forum.

Well, if GD II happens you might be early retired anyway whether you like it or not. You may not be able to find a job at 50.

SWR is an emotional subject. The 4% SWR is based on the actual returns of a conservative portfolio using data going back to 1873. If you haven't discovered FIRECalc, I encourage you to go there.

There are other ways to calculate a "SWR" based on other criterea. Bernicke (an option on FIRECalc) says that spending will naturally decrease after age 55 by 3% a year for the next 20 years. Using this approach will greatly reduce the portfolio required to FIRE. It also requires you to admit your taste for expensive vacations will fade away by the time you're 75.

There is another approach by Guyton that says you can start at up to a 6.2% SWR but it requires a willingness to cut spending if the portfolio starts to drop too much. Someone on the forum showed that following Guyton would cause spending to drop by about 50% if someone retired in the early 70's - the worst time ever to retire even if you compare it to GD I. Of course, the Guyton formula had the initial spending 50% higher than the 4% classical SWR.

Bernicke and Guyton let you FIRE sooner but the "risk" is higher or, at least, the margin of safety is lower. Not many of us here say that leaving a multi-million dollar estate is in their goals but that's what will happen if you save too much and spend too little. Your tolerance for risk will also determine how long will will w*rk before retiring.

Some people will have wonderful arguments why they don't believe any of this and will limit their spending to 3% or less. I wish my father had thought that and saved a few million before he retired.

In any event, you have to decide how much you'll have when you "buy your ticket." After that, you take your chances just like the rest of us.

 

[firewhen]

hmmm,

Part of the problem with a lower SWR is that it delays retirement against the small possibility of GD II or another calamity. Even if returns average below past history, like 7 or 8%, most of us will wind up with millions. With a younger retirement, however, you have as I see it these additional risks:

more years without SS or Medicare (especially a problem if no pension or company benefits)
more years having to support yourself (easily could live 50+ years)
more chance over a longer-term horizon of GD II happening

I am one of those who prefers a 2% SWR. Part of the reason is that I should be able to attain that, so it is nice to have the extra security and still be able to ER pretty early. If it meant w*rking until 63 to get the 2%, I might have a different opinion. I still think 3% is a good compromise.

 

[spncity]

Please clarify for me...

Does a Safe Withdrawal Rate of 4% also mean you are hopefully keeping the portfolio intact to leave an inheritance or that you are spending essentially everything. Maybe this is a FireCalc question?

I don't feel compelled to leave an inheritance - I'm just not sure of the intent of the 4%.

I guess what I'm really trying to ask is...

If I don't want to leave an inheritance - does that mean the SWR is higher than 4%? Or is that already the assumption (in which case those who wish to keep the portfolio intact must have a lower SWR?).

Thanks.

 

[2B]

Please clarify for me...

Does a Safe Withdrawal Rate of 4% also mean you are hopefully keeping the portfolio intact to leave an inheritance or that you are spending essentially everything. Maybe this is a FireCalc question?

I don't feel compelled to leave an inheritance - I'm just not sure of the intent of the 4%.

I guess what I'm really trying to ask is...

If I don't want to leave an inheritance - does that mean the SWR is higher than 4%? Or is that already the assumption (in which case those who wish to keep the portfolio intact must have a lower SWR?).

Thanks.

SWR isn't a guarantee of anything. It is only a reflection of the probablility your portfolio will survive a given time period. There are a lot of assumptions you can make. FIRECalc is pretty conservative and, unless you run Bernicke, it assumes a constant, inflation adjusted withdrawl rate. If your portfolio fell 20% in a year, it's likely you'd look at ways to cut back your spending even though the original FIRECalc run said you had a 95% probablility of success.

You may not want to leave an inheritance but you don't know when you will die, what the stock market will do, what bonds interest rates will be, what inflation will be.....

You "buy your ticket" and take your chances.

 

[arandomwalk07]

Part of the problem with a lower SWR is that it delays retirement against the small possibility of GD II or another calamity.

Thanks for repeating newbie territory - I see I have a lot more reading to do!

I suppose that's partly my point - risks to the pot running out are frontloaded, so as a young retiree you would have a chance to recover in the event of a calamity and what may be a "safe" level at 65 would be 4% whereas at 50 it could be 5%. I guess there is a risk in all this of spreadsheet blindness setting in playing over the various permutations

 

[Meadbh]

Hmmm, suppose you retire early and withdraw 4% per annum. All's going well till, five years later, when you discover you have a fatal disease and have 6 months to live. NOW is the time to spend, spend, spend!

 

[spncity]

Thanks for commenting. I was reading other comments about having 25 times the income you want. I realize it's all variable.

Just wondering if the 4% SWR is an attempt to preserve the portfolio or deplete it. (Not ignoring that the market could go either way - just wondering about the intent).

 

[jdw_fire]

Thanks for repeating newbie territory - I see I have a lot more reading to do!

I suppose that's partly my point - risks to the pot running out are frontloaded, so as a young retiree you would have a chance to recover in the event of a calamity and what may be a "safe" level at 65 would be 4% whereas at 50 it could be 5%. I guess there is a risk in all this of spreadsheet blindness setting in playing over the various permutations

I'm thinking you aren't understanding the meaning of "safe" when used in SWR. Safe means that the portfolio won't be exhausted while you take your scheduled WDs. Most often when SWR is used it refers to a percentage of a persons portfolio that will be withdrawn initially and then each yearly subsequent WD is equal to the initial WD increased by the amount of inflation since the initial WD.

Given this definition after you retire if you have to go back work for financial reasons your WR was not safe. Therefore the younger you are when you retire the lower your SWR will probably be. There are exceptions to this for example someone, even if they are younger, retiring into a runaway bull market may getaway with a higher WR being safe than someone retiring into a bear market. The problem is that you don't know if the WR you've chosen is truly safe until your future becomes history.

 

[jdw_fire]

Thanks for commenting. I was reading other comments about having 25 times the income you want. I realize it's all variable.

Just wondering if the 4% SWR is an attempt to preserve the portfolio or deplete it. (Not ignoring that the market could go either way - just wondering about the intent).

A couple of points, first "having 25 times the income you want" is the same as a "4% SWR".

Second, the point of having a SWR is to ensure that you will always have the income to maintain the lifestyle you started retirement having. Therefore any SWR is not strictly an attempt to preserve the portfolio but to preserve income. If you know exactly when you are going to die then you could spend the entire portfolio, but since most people don't, when they pick a truly SWR, upon death there is a portfolio remaining. The one exception I can think of if when the person retired s/he bought a CPI adjusted SPIA with his/her entire portfolio; income for life, zero portfolio at death.

 

[clifp]

Thanks for repeating newbie territory - I see I have a lot more reading to do!

I suppose that's partly my point - risks to the pot running out are frontloaded, so as a young retiree you would have a chance to recover in the event of a calamity and what may be a "safe" level at 65 would be 4% whereas at 50 it could be 5%. I guess there is a risk in all this of spreadsheet blindness setting in playing over the various permutations

While it is true that a long time frame does give you more to recover from an early bear market, pretty much all the historical data shows the earlier you retire the lower you SWR. (At some point with SWRs in low 3% range, and high equity postion 75%+ withdrawal can last forever.) This makes sense because of some the successful scenario occur when you withdraw you last dollar on the last year of your life. In the example you gave a 65 year old may old need to plan on a 25 year withdrawal period (especially for an unmarried, male in poor health), while a 50 year married fifty year old female would need to plan for 40 years worth withdraws. So a SWR for the 65 would be 4.5% assuming a 3% inflation, where as for the 50 year old with 40 year horizion the SWR is only 3.35%.

Another thing worth noting, is that most of us don't actually have portfolio as optimal as shown as in FIRECalc or other calculator, we have have a heavy concentration in company stock or a specific sector, managed mutual funds with higher expenses, money sitting around in your local bank money market.

It doesn't take retiring right before the Great Depression or the stagflation of the 70s to screw up an early retiree.
In my case I retired in Spring of 1999. At the time my porfolio was heavily tech weight (with a big concentration in Intel) and modest amount in bonds. If I had decided that historical stocks earn 7 or 8% so that is my withdrawal rate, hadn't decided to spend 1999 and Jan of 2000 rebalancing my porfolio to reduce risk, or if the tech bubble had burst in spring of 1999 instead of spring of 2000. My retirement situation would be much much worse. FWIW, several people on the Motley fool board early retire board didn't do what I did and ended up going back to work in the same time frame.

 

[REWahoo]

Just wondering if the 4% SWR is an attempt to preserve the portfolio or deplete it.

Suggest you check out this thread on "Best of the Boards" Explain the 4% withdrawal rate

 

[Cut-Throat]

Another thing worth noting, is that most of us don't actually have portfolio as optimal as shown as in FIRECalc or other calculator, we have have a heavy concentration in company stock or a specific sector, managed mutual funds with higher expenses, money sitting around in your local bank money market.

Why Not? - Since this is something you have some control over and understand diversification. Don't just stand there diversify!

No excuse for anyone on this forum for 6 months!

 

[clifp]

Why Not? - Since this is something you have some control over and understand diversification. Don't just stand there diversify

Taxes and interia get in the way. For instance I have about 10% of my assets in Schwab small cap index fund. On a relative basis the fund deserves it 3 star rating with expense (.42%) roughly twice that of a Vanguard small cap index fund or ETF and a performance below 60% of its peers. But on absolute basis the returns on the fund of 9.7% and just under 9% after tax over last 9+ years are quite acceptable.

So I guess I should sell it but really the thought of paying Uncle Sam and the state of Hawaii $25K in taxes just to save .2% in expenses and maybe another .5% in performance... keeps me in the fund.

I know a lot of people have individual stocks, some have actively managed funds (there are fans of DFA funds which are passively actively managed), perhaps some international funds, CDs instead of total bond index fund.
All of these increase expenses, volatility and/or reduce returns compared to the assumptions built in to FireCALc.

Do you have 100% of you money in Vanguard index funds?

 

[Cut-Throat]

Do you have 100% of you money in Vanguard index funds?

Damn near 100% -

- Hey, I learned my lesson. I had $500K in a company stock that went up for over 25 years. In fact the most successful stock in the NYSE. In 2002, I lost over $175K, because I did not want to pay the taxes on the capital gains of the $500K

Guess what the taxes would have been cheaper!

I did not find this forum until 2003.

 

[chinaco]

Damn near 100% -

- Hey, I learned my lesson. I had $500K in a company stock that went up for over 25 years. In fact the most successful stock in the NYSE. In 2002, I lost over $175K, because I did not want to pay the taxes on the capital gains of the $500K

Guess what the taxes would have been cheaper!

I did not find this forum until 2003.

I did the same thing with some stocks during the tech wreck... I kicked myself because I knew I should have done something earlier. Several were purchased during late 1990s. We had one Large none tech stock that I knew we should have sold and diversified because it was several $$$K, but procrastinated... part of it was the tax consideration. Well, the stock cut in half over about a 2 week period. At that time, I felt like a deer looking into headlights. I did not do a knee jerk move. I finally did sell it and put it back in the market in the S&P 500 index (after the tech wreck). That company tracks the S&P (does a little better historically)... So we have recovered most of it.

I learned my tax lesson. I also learned my market timing lesson. Both were expensive educations. Put it like this... What I lost was many times more than the cost of the Engineering Degree and MBA that I hold. If we would have been in the position to need to consume our holdings back then... It would have been awful.

I should clarify though... Much of it was a loss of paper gains. I have lost real wages (used to purchase stocks) on a few equities, but netting it out I have not ever lost money on equity investments. Diversification! Overall I am in the black in a large way. It is just that I would have been better off if I did not get greedy and/or think I could predict the market.

 

[rigel]

The 4% rule is based only on historical market conditions and the future is unknown. The 4% rule is also based on obtaining SP500TR for the 75% of your investments in equities. If you get less than that, then 4% will fail a lot more in historical terms.

The 4% rule is an attempt to find the worse case - the floor. It seems to me, from running hundreds to scenarios over the last 15 years, creating my models, is that the first few years of retirement will tell you if you are in one of the worst case scenarios like the great depression, 1966, or the like. If you don't encounter one of those events early in retirement, your portfolio has time to continue growing. When one of those events happen in the future, you have a higher portfolio value which allows you to weather the storm much easier.

If you don't encounter a bad start to your retirement, then historically speaking, one could take much more than 4% and this have the money last 40 years.

 

[2B]

If you don't encounter a bad start to your retirement, then historically speaking, one could take much more than 4% and this have the money last 40 years.

Being an engineer (anal retentive), I've run various games where you start with more than 4% but if you do the portfolio at the time of the "big drop" determines what your SWR will become.

If you retire with a portfolio of X and take 4% for 3 years, a good market may let your portfolio grow to X+25%. If you then decide to go for 6% of that just as the market tanks, you are in trouble. ESR Bob's approach may be the best (see FIRECalc) but that assumes you can cover minimum living expenses no matter what. If things go bad, you can't spend that month in the south of France -- c'est demage. If thing go bad, you starve -- well that's another story.

 

[youbet]

If you don't encounter a bad start to your retirement, then historically speaking, one could take much more than 4% and this have the money last 40 years.

But this doesn't change the fact that you'd still need approximately 25X the amount you plan to withdraw annually to begin ER.

Few on this board would argue your point that as the future becomes history and you know your actual returns, you may wind up with more, perhaps much more, in your portfolio than planned. And this would support increased withdrawals and spending. But, it doesn't change how much you need at the beginning, when you have zero knowledge of what lays ahead!

edited to add: By withdawing and spending more, I mean increasing the WR vs the original portfolio amount, not a larger than 4% WR of the new increased portffolio amount.

 

[chinaco]

I am thinking of dividing our portfolio up into small portfolios for each decade of retirement. With more dollars of the starting portfolio dedicated to the 55 -75 (2 decades) for 3 reasons:

Note: This might be logical management rather than physically splitting the portfolio ( in other words just manage to the idea)

1) I can move the current decades spending allocation into a greater proportion of less volatile assets and plan for an increased WR rate.
2) I create a barrier between one decade and the next... If we screw up decade 1, we can tighten our belt and not mess up the following decade... or accelerate spending if times are good.
3) Less money is allocated in the further out decades and can be put in growth mode so it can accumulate.

The idea is take a little higher WR early on and have some guides that help me to know if we are jeopardizing the long-term and take action early to mitigate the risk of eating Filet Mignon at 55 and Dog Food @ 79... Think of it as a firewall between the decades of retirement. Hopefully we will not be eating Dog Food @ 64 and back to filet @ 65.

I can get my mind around managing to 10 year periods. I have a tough time managing to a range that may be 25 years to 45 years. I know for sure that we will spend less when we get older. Health care is always a concern... and costs will increase... But I cannot predict that... If we wind up hitting the floor at 95... That is the risk we take. To quote someone in an earlier post. I am not saving to be the richest person in the graveyard!

 

[Rich_by_the_Bay]

I am thinking of dividing our portfolio up into small portfolios for each decade of retirement. With more dollars of the starting portfolio dedicated to the 55 -75 (2 decades) for 3 reasons:

I think many of us will do that via periodic adjustments over time rather than in a more formal or rigid manner.

If you like that approach you may want to read about Lucia's buckets strategy. In essence, his bucket 1 if for 7 years, bucket 2 for 7 years, and then you replenish and restart. You can choose the number of years per bucket.

 

[REWahoo]

If you like that approach you may want to read about Lucia's buckets strategy.

If you do, please remember this: "It's not the size of the buckets in your portfolio, its the size of the portfolios in your buckets."

....I need more coffee.

 

[Jarhead*]

If you do, please remember this: "It's not the size of the buckets in your portfolio, its the size of the portfolios in your buckets."

"My Buckets got a hole in it"
"My Buckets got a hole in it"
"My Buckets got a hole int it"

"I can't buy no beer"

"Well, me and my Baby bought a
Ford and now we sit together on
the Running Board"

"Cause My Buckets got a hole in it"

"I can't buy no Beer."

 

[Rich_by_the_Bay]

If you do, please remember this: "It's not the size of the buckets in your portfolio, its the size of the portfolios in your buckets."

Ahh, bucket all. Who cares.

I actually heard a caller on the Lucia radio show asking how much he should put in bucket 1, 2, etc. It became painfully clear that he really thought he could simply pick a number that worked for him for bucket 1. I mean any number - just decide how much you need, assign it to bucket 1, and voila: FIRE. Never mind that this left him with about $1.17 after 7 years.

Jarhead, I'm getting this image of you doing your best Harry Belafonte imitation. It's scaring me.

 

[youbet]

I am thinking of dividing our portfolio up into small portfolios for each decade of retirement.

Do you perceive this as effecting how much money you need to accumulate in aggreagate to allow you to RE? Will this management methodology have any impact on when you RE?