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Beware the 4% rule
Old 06-25-2010, 11:24 AM   #1
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Beware the 4% rule

I thought you might be interested in this Stanford Graduate School of Business Research: Saving for Retirement? Beware the 4 Percent Rule
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Old 06-25-2010, 12:12 PM   #2
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That is a terrible article.

The 4% is a rule of thumb. The individual then does his due diligence and customization for his situation.

Purchasing surpluses just to reach the 4%? Seriously?

"If a retiree adopts a 4 percent rule, he will waste money by purchasing surpluses, will overpay for his spending distribution, and may be saddled with an inferior spending plan," wrote Sharpe and colleagues Jason Scott"
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Old 06-25-2010, 12:15 PM   #3
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Gee, I didn't know the 4% withdrawal rate was mandatory! I better get to work buying more crap because I'm way behind.
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Old 06-25-2010, 12:16 PM   #4
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Quote from the article...

"Simply put, the rule suggests that the retiree spend an inflation-adjusted 4 percent of his or her retirement assets each year, while keeping the balance of those assets in a portfolio that typically includes both stocks and bonds. That might be a reasonable strategy in a world where stocks aren't risky. But they are, of course. Moreover, there's more wrong with the rule than simply that it discounts the downside of investing in instruments that have an element of risk."


Now, if they can get THIS wrong, no wonder the article gets it all wrong.. change it to below and there is no more article...

Simple put, the rule suggests that the retiree NOT spend any more than an inflation-adjusted 4 percent.....
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Old 06-25-2010, 12:29 PM   #5
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Screwy journalism...

Also left out of the definition of the rule is the fact it is based on spending no more than 4% of the inflation adjusted INITIAL amount of retirement assets.

Oh, and I thought this was one heck of an "academic" endeavor:

Quote:
Sharpe, Goldstein, and Hal Ersner-Hershfield, of the Kellogg School of Management, are currently testing an experiment that will use computer software to change the appearance of photos of test subjects as they make choices about retirement. Here's a rough description of how the experiment will work. As the subject moves a slider to the left, which indicates earning more now and saving less, a photo of the subject as a young person gets happier, while a computer-aged photo of the subject as an older person, gets less happy. The reverse is true as well; saving more for retirement makes the older photo happier and the younger photo less happy. The hypothesis to be tested, says Sharpe, is that a visual representation of outcomes will be more meaningful than a column of numbers.
Whatever happened to good, old-fashioned decision reinforcement like hot-wiring their seats and turning up the voltage if they make "bad" choices.?

Worse than screwy journalism...
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Old 06-25-2010, 12:36 PM   #6
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Wahoo,
How could you say such. Sharpe is a Nobel Laureate and a Professor Emeritus at a major university. He could not possibly be wrong:

Sorry, could not resist. My bad.
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Old 06-25-2010, 12:46 PM   #7
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Be neato if author showed up in thread like that dude with the blog did that one time. Man did that guy take arrows, looked like a pin cushion by page 2.
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Old 06-25-2010, 12:57 PM   #8
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Quote:
Originally Posted by dex View Post
....................Purchasing surpluses just to reach the 4%? Seriously?

"If a retiree adopts a 4 percent rule, he will waste money by purchasing surpluses, will overpay for his spending distribution, and may be saddled with an inferior spending plan," wrote Sharpe and colleagues Jason Scott"
Whew! I'm glad that someone clarified this. My basement is just about full of extra rolls of paper towels and canned beans.
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Old 06-25-2010, 01:07 PM   #9
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Hate to be odd man out, but this is an article about a position, not a white paper. Why should we expect it to be a complete explication of the Sharp et al position?

Also, to me at least it appears that the main thrust of the article is that there is a basic incompatibility in financing a fixed real outflow with gradual liquidation of varying assets. I really don’t think that this should be too controversial, and the next time we have a big downdraft there will be a lot of agreement with this position, even here.

Cavils such as "one doesn't have to spend 4%" are beside the point. Of course if you are well supported by a secure real value pension, you could invest in chicken futures and you still would succeed. If a sub-optimal plan is hugely over financed, it is still very likely to work, and it is for most people still suboptimal. Though not I would assume with ER.orgers.

A mind numbing review of years of threads on the 4% rules, and SWRs in general should show that people’s main question is not “will this cause me to become a mega-consumer trying to spend at least 4% every year”, but "will I never go broke spending what I feel that I want to spend within the upper limit of 4% of initial amount adjusted for inflation.? To say, well my 4% SWR allows me withdraw $60,000 real, but if things really get tight I could live on $22,000, or $12,000, or whatever, do not address the real world problem faced by most people.

Incidentally, it may be a long time coming, but I believe plenty who retired in 1999 or 2000 and stick to 4% annually adjusted with the usually recommended allocations will eventually be up a financing creek of one sort or another. We've put in 10 years and counting from there, perhaps enough to conclude that something fundamental has changed?

Ha
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Old 06-25-2010, 01:08 PM   #10
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Aren't tax-exempt organization with big endowments (e.g. The Getty) required to spend 5% or so of their assets each year to maintain their tax status? If they can expect to exist in perpetuity with this sort of spending, why can't I?

And no endowment jokes!!!
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Old 06-25-2010, 01:09 PM   #11
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Sharpe has been saying this for a long time. Here's one longer paper: http://www.stanford.edu/~wfsharpe/retecon/4percent.pdf

I agree with the notion that it's inherently difficult to fund a flat income from a volatile asset class. Most people on this board deal with that by saying they can live with a variable income.

Unfortunately, I don't think that Sharpe has any great solutions for the problem.
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Old 06-25-2010, 01:12 PM   #12
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Ha, yes, we are all lily-livered pansies when the market takes a dive, but that isn't what we are taking issue with here. You don't see any problem with the article incorrectly defining and misconstruing the 4% rule?
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Old 06-25-2010, 01:17 PM   #13
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When I read the OP and the article, I was torn between replying "No ****, Sherlock", and going outside to enjoy a balmy summer evening with DW and a 20oz jug of margaritas.

I'm so pleased that I chose the latter option, and that everybody else has saved me the bother of commenting on this article. (On the "always attribute to incompetence rather than malice except in the face of overwhelming evidence" principle, I'm going to assume that it's the journalism at fault here and not the original article.)
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Old 06-25-2010, 01:22 PM   #14
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Originally Posted by REWahoo View Post
Ha, yes, we are all lily-livered pansies when the market takes a dive, but that isn't what we are taking issue with here. You don't see any problem with the article incorrectly defining and misconstruing the 4% rule?
Well REW, I don't think that it attempts to give a full essay on 4%. As I read it, it mainly says there is a foundational problem when you finance a fixed real expense with a variable set of assets.

How could a short article explain all the ins and out of the 4% rule(s)? For one thing, it is kind of a slippery concept if threads on this board are any indication. Many many individuals and entrepreneurs have given it their own spin.

It may also be as some have suggested that Prof Sharpe has a business interest to be served here, but in my mind at least though that may suggest caution, even flat out advertinements can contain useful information. Like, "don't go out socializing without using deodorant."

Ha
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Old 06-25-2010, 01:36 PM   #15
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How could a short article explain all the ins and out of the 4% rule(s)?
He didn't try - and he failed to correctly explain (define) even the basic rule itself, and further demonstrated his lack of accuracy by implying it required spending of 4% annually.

By screwing up the simple definition and reasonable application of the rule, he managed to sidetrack a considerable number of his audience and cause them to focus on his inaccuracy rather than his main point - even though that point may be obvious to many of us.
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Old 06-25-2010, 01:43 PM   #16
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Originally Posted by REWahoo View Post
He didn't try - and he failed to correctly explain (define) even the basic rule itself, and further demonstrated his lack of accuracy by implying it required spending of 4% annually.

By screwing up the simple definition and reasonable application of the rule, he managed to sidetrack a considerable number of his audience and cause them to focus on his inaccuracy rather than his main point - even though that point may be obvious to many of us.
OK
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Old 06-25-2010, 01:45 PM   #17
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Old 06-25-2010, 01:46 PM   #18
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Ha,
For me it goes to credibility. Unless Sharpe is misquoted, then his credibility is blown when he implies that the 4% rule is 'Each year you take 4%, adjusted for inflation, from your portfolio and spend it weather you need to or not. Buy 'surpluses' if you have to but spend the 4%'.'

You could quote the rule accurately and still discuss financing a fixed income retirement on a variable income stream, and, he may be correct in his assumptions.

I have always thought of the 4% rule as a rule of thumb. A guideline so to speak as to 'When do I have enough to retire'. I also think most on this board do not plan on testing it. It seems when ever there is a survey 'What is your SWR' the overwhelming response is below 4% .

edit: sorry late post
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Old 06-25-2010, 01:49 PM   #19
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Unfortunately, I don't think that Sharpe has any great solutions for the problem.
To the contrary, in the article you linked, Sharpe does indeed propose a solution. If the Treasury were to issue TIPS with the maturity payment stripped-off so that you could purchase the coupon stream at auction, you could very easily implement Sharpe's proposal. Sharpe is talking about what is basically a 2-bucket approach, where one bucket (the stripped TIPS coupon stream) would fund your 4% inflation adjusted withdrawal for 30 years. The present value of the stripped-off maturity payment (approximately 9% of your portfolio's current value) would be invested in risky assets (e.g. the S&P 500), and would be left untouched for 30 years. Presumably, over such a long time period the stock market would return close to it's long-term historical average of about 6.5% per year real; and at your horizon, would have grown to a large enough value so as to fund the rest of your retirement years. IMO, the beauty of this approach is that you would never have to cut back from your 4% spending rule out of fear that you would run out of money, only to end up with a large surplus on your dying day.
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Old 06-25-2010, 01:51 PM   #20
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How do we define optimal spending anyway? Sharpe seems to be advocating having the minimum "left over" when you croak. (I admit that I didn't read the longer article.) You know the old joke about your last check bouncing.

OK, but you don't know what future real returns are going to be, and you don't know when you are going to kick off, or whether you have enormous medical expenses awaiting.

One could try to collect statistics on (all?) such scenarios and build a model, but the track record of models based on Gaussian (or other) statistics and random walks haven't been good. Cauchy distributions anyone? (Anybody remember Long-Term Capital Management?)

Eek! Just thinking about it makes my head hurt.

But even if somebody nailed it, I wouldn't/couldn't have faith enough in it to bet my retirement. Could you be confident enough in any model (and your understanding of it) to be sanguine in the face of a dwindling stash if the model insisted that you were doing fine?

Maybe this is a case of ignorance is bliss, or perhaps the only way to real happiness is self-delusion. I just know that my comfort level requires ample assets relative to our spending, and a decided lean toward lowering volatility.
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