Are Asset Allocating Withdrawal Strategies a Reliable Retirement Funding Method?

[haha]

I think the last few weeks' experiences suggest no. Many of us have turned to trying to make predictions about what happens next-like which way does the market go from here?

Much talk about austerity, cutting back spending, etc. Many of us who are not yet retired but who really wanted to retire soon are talking of delaying that.

We talk of having 10 years expenses in cash, etc. A big help if one is normal retirement age. But I am not sure if you are 38 or 42. Look at where Japan's markets are now. And, during good times many of us emphasized how robust Firecalc 4% plans were, in that they supposedly survived the Great Depression as well as the stagflationary crash of the mid-seventies.

I wrote a piece for this board way back in its early days laying out a case that what really counts is the underlying earning power of your investments, and if enough of those earnings is likely to be robust to business conditions and accessible without going to markets to sell equities. This puts an emphasis on a more stable metric, earning power, rather than the clearly fickle one of quoted prices.

This means either dividends, or interest, or flow-through entities like MLPs and royalty trusts.

All these have problems, the major one being that you do not do a very good job of analysis before buying.

I have always had some of these, and bought more during the down markets of the past 6 months. As it turns out, many were cheap but destined to get much cheaper.

I think the biggest challenge to this system is bankruptcies, and we will certainly see more of those. Huge dividend cuts are another, and as some banks for example slash dividends it becomes less stigmatizing for firms that perhaps could continue on without cuts to use this cover to proactively cut their dividend to save cash for uncertain futures.

My idea is that auto-pilot ERs are really not possible without pensions. No matter what strategy we choose, it will have it own set of risks. I know some here follow this cash flow method, I hope people will comment on how you are feeling about it now. Some members have suggested that if you don't have a pension it is easy enough to buy one. I think the turmoil that has engulfed life insurers along with most other financial firms will put this idea to rest, at least for the thoughtful.

Ha

 

[brewer12345]

So you are arguing that "this time it is different?" Not to reduce your thoughtful argument to a simple catch phrase, but either things are completely different than anything in the historical record, or the conclusions that stem from the Trinity study, firecalc, etc. still stand. We will know in 50 years.

 

[haha]

So you are arguing that "this time it is different?" Not to reduce your thoughtful argument to a simple catch phrase, but either things are completely different than anything in the historical record, or the conclusions that stem from the Trinity study, firecalc, etc. still stand. We will know in 50 years.

Brewer, I suppose that may be a logical extension, but what I really mean is that it will be very hard for most of us to live out an AA liquidating strategy if we do not get a rapid snapback rally. Whether it may work out eventually of not, who will want to bet her life on something that is essentially faith?

Ha

 

[brewer12345]

Whether it may work out eventually of not, who will want to bet her life on something that is essentially faith?

Ha

Ha, we all do so every day, like it or not. Every morning when I was commuting to work it was an act of faith that I would not get nailed by an 18 wheeler. Every day it is an act of faith to get out of bed and assume you won't have a heart attack/stroke/spontaneous combustion event. Every Merkin Peso you put into any vehicle, from an FDIC insured savings account to a penny stock, is an act of faith. Life comes with only one guaratee: one day it will end.

And of course every early and not so early retiree went out on a limb when they retired.

 

[Gone4Good]

Building flexibility into a retirement plan is pretty important. People who push the envelop to maximize withdrawal rates by tweaking this assumption or that are playing with fire. Having built plenty of flexibility into my plan, the only thing that has changed is the timing. It is obviously going to take a bit longer to reach my portfolio goals now but my portfolio will be stronger for it.

I also don't see how a 40% stock decline discredits a backcast analysis that includes several such periods. I understand that actually living through it is different than seeing it in a spreadsheet, but nothing that has happened to date has changed any of my fundamental assumptions about how the world works. If anything, I now feel better about my ability to stomach a major market correction like this while sticking with my strategy.

 

[ziggy29]

Brewer, I suppose that may be a logical extension, but what I really mean is that it will be very hard for most of us to live out an AA liquidating strategy if we do not get a rapid snapback rally. Whether it may work out eventually of not, who will want to bet her life on something that is essentially faith?

Not necessarily. If you "bucketize" a la Ray Lucia, you are allocating in a sense.

If you have $1M in your portfolio and you need $40K a year to live on, you may want to have ten years of "safer" stuff which essentially implies a 60% stock allocation. You can let the stocks ride for 10 full years before touching any of it in the worst case.

If you are more conservative and want a 15 year cushion of safer stuff, that's 40% stocks and 60% short high quality bonds and cash.

 

[Gone4Good]

Life comes with only one guaratee: one day it will end.

Yup, the world will only have one end . . . this ain't it. Be of good cheer.

 

[brewer12345]

I also don't see how a 40% stock decline discredits a backcast analysis that includes several such periods.

Which is what I was trying to say amidst all the blather and rotgut poetry. Thank you for the burst of clarity.

 

[haha]

I think I am not a very good advocate for my position. I don't think that a 40% decline, or any other level of decline discredits the database behind Fireclac, or the reasoning of WRs derived from it.

It just think it is psychologically hard to stay the course. I also think that board members have shown zero tendency to panic, a very impressive achievment. Likewise, my emphasis on income has not helped my protfolio to resist the market declines; it has gone down just like any other mostly stock portfolio.

Ha

 

[brewer12345]

I just think it is psychologically hard to stay the course.
Ha

Ah, well that is a horse of a different color. I agree with you on that score, FWIW. Having said that, I find behavioral finance to be a fascinating field and also one of the most useful on a practical basis (exotic derivatives valuation methods amuse the math geeks more, but I don't have much use for such antics in daily life). Why? Because the more one is aware of the idiot fallacies that the human brain leads otherwise intelligent human beings into and the clearer you stick to objective, rational thought, the better chance you have of not making the mistakes. So I think that the study of behavioral finance helps me avoid doing the wrong thing. Everything I have read suggests that selling at this point is historically the absolute worst thing you could do. Since I can't refute the historical evidence (with rational arguments, not panicky gibberish), I canot come up with a reasonable basis for doing otherwise.

 

[audreyh1]

It just think it is psychologically hard to stay the course.

Hence my cash for living expenses account separate from my portfolio. At least I can breathe during insane times like these.

Check back with me in early 2010 when I start planning on how to replenish this "cash bucket". I may be freaking out then - who knows!

Audrey

 

[Gone4Good]

It just think it is psychologically hard to stay the course. I also think that board members have shown zero tendency to panic, a very impressive achievment. Likewise, my emphasis on income has not helped my protfolio to resist the market declines; it has gone down just like any other mostly stock portfolio.

Ha

This above all: to thine own self be true

But in order to do that, you first have to know thy self. What better way to find out if living off of an investment portfolio is for you than to see a good chunk of your net worth disappear in a vertical market? This should be a mandatory pre-ER class. If you get through this thinking "I can't wait to quit and live off my portfolio" you've aced the exam. If not, then you'll be happier with your life of work knowing it couldn't be any other way.

With respect to income . . . stock yields are up! And good times were had by all. But, on the other hand, maybe we've exposed a chink in the high dividend strategy. Over reliance on certain sectors, or only a handful of investments, can blow up a portfolio for good. Instead, my preferred approach is to work with a withdrawal rate of about 3%, which is pretty easily funded from the income thrown off by a hugely diversified portfolio of stock index funds and bonds. Hell, the S&P 500 is yielding 3% now . . . good stuff.

 

[jIMOh]

If you were 44, with 10 years to retirement, and had a cash cushion of 7-10 years expenses and 3-5 years to ER, I would advocate liquidating 1 years cash to put into equities right now.

 

[youbet]

Hence my cash for living expenses account separate from my portfolio. At least I can breathe during insane times like these.

Check back with me in early 2010 when I start planning on how to replenish this "cash bucket". I may be freaking out then - who knows!

Audrey

And even with a separate cash stash, we still have lots of opportunity to need to stomach our portfolios decreasing significantly in value during the withdrawal phase. Even a portfolio and associated AA and withdrawal scheme destined to survive can shrink significantly and test your fortitude during withdrawal.

ERD50 brought this out in an interesting thread a while ago. While a prudent AA coupled with the classic "4%" withdrawal rate over a 30 yr period survives 95%, or so, of the time when tested against historical data, survival is often accompanied by breathtaking dips and/or steady decline in portfolio value. Even though a portfolio is destined to survive, the survival period way be quite a thrill for the faint of heart!

 

[dm]

I think that most that are able to early retire, have to be somewhat flexible. I retired last October at the market highs. I made sure that I had some cushion in my budget and its just normal to cut back some if times get bad. I was thinking of buying a boat and that is easy to put on the back burner. I can always keep my car alittle longer also. I have 3 budgets, the current do what I want budget, the cut back a few things budget, and the cheap but better than going back to work budget.

Budget 1 is $6,000 per month
Budget 2 is $4,200 per month
Budget 3 is $2,200 per month.

All the budget's are after tax and include health care. Budget 1 is assuming a 4% withdrawl rate and receiving Social Securtiy at 62. So far this year we are spending alittle over $5,000 a month and doing pretty much what we want to do. But we will probably cut back on our vacation money and watch things alittle more closely, for a while, even though fircalc says we should be fine.

 

[dex]

Brewer, I suppose that may be a logical extension, but what I really mean is that it will be very hard for most of us to live out an AA liquidating strategy if we do not get a rapid snapback rally. Whether it may work out eventually of not, who will want to bet her life on something that is essentially faith?
Ha

Periods like this it is about "walking the talk". In the pre - ER time we do the research and say yes we understand the risks and are willing to take them. While it is happening our resolve is tested. An emotions can kill you - I am my own worst enemy when it comes to this. I don't like to think about how much money I lost myself. That is why I surprised to my reaction to what is happening.

As to the AA liquidating part and the pension you mention - I think the two aspects that that is not discussed enough here are:
1. Cash flow - having a budget - subtracting dividends/interest and then determining the amount needed to liquidate
2. Growth rates in an individual's financial projections - I'm guessing they have been and are too high; even ignoring recent action. (I'm working on mine and post them in another thread.)

 

[samclem]

Haha,
I understand the emotional value of having a steady "flow" of dividends or interest that can be relied upon without need to sell depreciated assets in a downturn, but I wonder just how useful this really is. As you note, companies can and do cut their dividends when business is off--just as the prices of stocks fall. The buyer of that stock purchased it based on the expectation of a particular dividend, and when it is cut the stock suffers a real loss in value. So, though the retiree investor may be telling himself that he's only lost a little bit of income flow each month, the truth is that his portfolio has suffered a hit just as real as if he'd owned a different stock that was priced with the assumption of a more modest dividend but higher expected price appreciation.

 

[youbet]

I think that most that are able to early retire, have to be somewhat flexible. I retired last October at the market highs. I made sure that I had some cushion in my budget and its just normal to cut back some if times get bad. I was thinking of buying a boat and that is easy to put on the back burner. I can always keep my car alittle longer also. I have 3 budgets, the current do what I want budget, the cut back a few things budget, and the cheap but better than going back to work budget.

Budget 1 is $6,000 per month
Budget 2 is $4,200 per month
Budget 3 is $2,200 per month.

All the budget's are after tax and include health care. Budget 1 is assuming a 4% withdrawl rate and receiving Social Securtiy at 62. So far this year we are spending alittle over $5,000 a month and doing pretty much what we want to do. But we will probably cut back on our vacation money and watch things alittle more closely, for a while, even though fircalc says we should be fine.

dm..... what do you use for triggers to jump from one budget to the other? Decreases/increases in net worth? Or? If you haven't jumped to Budget 2 or Budget 3 in the crummy market of the past year, what would it take to trigger you to make the jump?

 

[haha]

Haha,
I understand the emotional value of having a steady "flow" of dividends or interest that can be relied upon without need to sell depreciated assets in a downturn, but I wonder just how useful this really is. As you note, companies can and do cut their dividends when business is off--just as the prices of stocks fall. The buyer of that stock purchased it based on the expectation of a particular dividend, and when it is cut the stock suffers a real loss in value. So, though the retiree investor may be telling himself that he's only lost a little bit of income flow each month, the truth is that his portfolio has suffered a hit just as real as if he'd owned a different stock that was priced with the assumption of a more modest dividend but higher expected price appreciation.

This is important but it remains true that dividends are amuch less volatile series than stock prices.

I think there is value in that alone.

Ha

 

[ats5g]

haha,

I'm not trying to be too patronizing here, but you do realize that spending the dividend from the stock or selling shares of a stock is essentially the same thing. A dividend is just a forced sale of part of the company. I always have trouble understanding why people can't get past this little mental accounting trick. I'm not saying that dividends are a good or bad thing, just that not reinvesting the dividend or selling shares is more or less the same thing.

- Alec

edited to add: After reading what I posted, that did sound pretty confrontational. Apologies in advance. It was a tough day with the kids [who are lucky they're still alive].

 

[haha]

haha,

I'm not trying to be too patronizing here, but you do realize that spending the dividend from the stock or selling shares of a stock is essentially the same thing. A dividend is just a forced sale of part of the company. I always have trouble understanding why people can't get past this little mental accounting trick. I'm not saying that dividends are a good or bad thing, just that not reinvesting the dividend or selling shares is more or less the same thing.

- Alec

I hope you are content with being just somewhat patronizing, rather than "too patronizing".

I am not going to debate this point with you- be happy with your approach, and I'll be happy with mine.

But it should be quite clear that dividends are not the same as selling a little bit of stock, for several reasons. One is cost. The other is that they are not dependent on the market price of the stock, but only on the condition, liquidity and cash flows of the business.

Ha

 

[Gone4Good]

Periods like this it is about "walking the talk".

"One day Neo, you are going to realize just as I have that there is a difference between knowing the path, and walking the path."

 

[clifp]

haha,

I'm not trying to be too patronizing here, but you do realize that spending the dividend from the stock or selling shares of a stock is essentially the same thing. A dividend is just a forced sale of part of the company. I always have trouble understanding why people can't get past this little mental accounting trick. I'm not saying that dividends are a good or bad thing, just that not reinvesting the dividend or selling shares is more or less the same thing.

- Alec

But as Ha Ha said the volatility of the dividend income (not the underlying securities) is far less. This last year I've had 21 companies raise dividends (some more than once) with increase ranging from 2% to 20%. I've also had two dividend cuts BAC .64 to .32 and CSE from .60 to .05 (they changed from REIT to a bank). I haven't factored in the BAC cut, but my income is only down modestly this year.


In contrast, the average stock in my portfolio has seen a peak to trough difference of ~100% over the last 52 weeks even among blue chips like GE, CAT, MMM, INTC, UPS. Even among broad based ETFs we see a huge swing VV (Vanguard large cap) 88% VEU (Vanguard total international) 115% We won't even talk the monthly volatility of financials, pipelines, energy related etc. Depending on when I decided to sell my 4% or 5% (which as you say is just an accounting trick) my income would easily vary 100% this year. (Not to mention transaction costs.)


I certainly have flexibility in my budget but not 100%

 

[ats5g]

I hope you are content with being just somewhat patronizing, rather than "too patronizing".

I am not going to debate this point with you- be happy with your approach, and I'll be happy with mine.

But it should be quite clear that dividends are not the same as selling a little bit of stock, for several reasons. One is cost. The other is that they are not dependent on the market price of the stock, but only on the condition, liquidity and cash flows of the business.

Ha

You're right. That was too patronizing. My apologies.

 

[FIREd]

This is a very interesting question. In light of what happened this week, I think that my approach to retirement has shifted, though I am still on the learning curve and it is hard to say what impact, in the end, this crisis will have on my retirement plans.

I am a big proponent of dividend income and overall my investment income has gone up so far this year despite the big drop in the market and the drop in interest rates. But I am also learning how fast dividends can go away and if this crisis persists much longer, I will probably start seeing my investment income drop. This is a very good rehearsal for me (I am still in the accumulation phase), and I want to see how my investment income is going to fluctuate throughout this crisis. Will I see a reduction and how much of a reduction will that be...

I now know that my wife and I have a natural tendency to tighten our belts when we perceive that we are going through tough times. This year, without much effort or sacrifices on our part, we have been able to reduce our expenses by 10-15% (we didn't have to,we just don't feel like spending money right now). So if our dividend income stays pretty stable and doesn't drop more than 15% during this whole crisis, then I think that it will convince us that a diversified income-producing strategy is the right way to go. But if our investment income craters during the next few years, then I think we will have to look at a different model, perhaps buckets, with a 5-10 year cash reserve.