Dr. Pfau looks at the 4% rule in an interview

[walkinwood]

I don't understand what it means to not draw down principal when it is in equities.

Equities fluctuate in value - when they go down, does that mean you've drawn down on your principal? When they go up, does that mean you created more principal?

Or do you mean that you never want to have a portfolio worth less than its value at retirement?

[nun]

Quote:

Originally Posted by walkinwood I don't understand what it means to not draw down principal when it is in equities. Equities fluctuate in value - when they go down, does that mean you've drawn down on your principal? When they go up, does that mean you created more principal? Or do you mean that you never want to have a portfolio worth less than its value at retirement?

I plan to have the value of my portfolio grow in retirement. If it's value was to decline I would not sell, I'd live off rent and SS and reduced dividend amounts. I'd only spend my cash buffer and sell equities if those income streams were not sufficient. Here is how I think of principal in the context of my portfolio

Quote:

For me, LBYM (not spending principal) means only spending distributions from the portfolio, dividends, interest etc. It's not a law, but a guiding principle. The growth in the value of the stocks in the portfolio is a way that the dividends will keep up with inflation. If you own stocks that don't produce dividends and the return is only capital appreciation then you'd have to come up with an algorithm to take some of that appreciation as income. Maybe you'd define your principal as the starting value of the stocks multiplied by (1+ annual inflation) and take anything above that as income. I tend to own funds that throw off dividends so I'll take those as income and use any capital appreciation to keep up with inflation.

[RonBoyd]

Quote:

Originally Posted by nun If it's value was to decline I would not sell, I'd live off rent and SS and reduced dividend amounts.

And if the value increased? What would you do with all that excess earnings? Why retire at all if your goal is to "sock away" a vast fortune... for the benefit of select relatives?

[nun]

Quote:

Originally Posted by RonBoyd And if the value increased? What would you do with all that excess earnings? Why retire at all if your goal is to "sock away" a vast fortune... for the benefit of select relatives?

I'd reinvest the excess as I always have. I don't see a reason to change in retirement, as I said before I think it's actually more important to save in retirement because you don't have a wage and are relying on your portfolio. I want to retire so I can concentrate on things other than work; bikes, reading, beer, theater, friends. My goal isn't to amass a big stash, but that will probably be the result given the way I like to live my life.

I'm content with my lifestyle and don't need to spend money to enjoy myself. My question would be "why not pass on money to another generation" and why spend it on things like cruises and expensive hotels when I'm happier riding my bike in Iceland or across America and staying in hostels. Maybe when I'm 70 I'll swap the bike for a car. I have no children so my nieces are the next generation, they work hard and have their own kids now. It would make me happy to help them and their families towards financial independence.

[RonBoyd]

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Originally Posted by nun I want to retire so I can concentrate on things other than work; bikes, reading, beer, theater, friends. ... and why spend it on things like cruises and expensive hotels...

Hmmmmm. Seems like the same thing to me.

Quote:

Originally Posted by nun Maybe when I'm 70 ...

That's gonna happen much sooner then I believe you realize.

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Originally Posted by nun I have no children so my nieces are the next generation, they work hard and have their own kids now. It would make me happy to help them and their families towards financial independence.

Bless you. <truly>

[foxfirev5]

I am slowly learning the total return approach to my investments. My old German upbringing would never allow me to touch the principal. However I'm beginning to grasp the concept of the total return being the real total picture.

[Original Wally]

Quote:

Originally Posted by nun I'm content with my lifestyle and don't need to spend money to enjoy myself.

nun - What's right for you is right for you. What's right for me is right for me. This is not a case where there are indeed absolute right vs. wrong. Like child molesters. Or cauliflower. This is a case of personal choice. I can no more decide for you than you can decide for anyone else what is right. Go forth and enjoy. You have worked for it, do it your way.

[Stanley]

Quote:

Originally Posted by REWahoo The "bottom line" from the above link: Before anyone relying on drawing 4% panics, note this from the article: Using low-cost funds and managing your own investments you can easily cut that 1% fee to 0.2%, allowing that 2.8% to become 3.6% - not far from the traditional withdrawal number. One more example that "cost matters".

Thank you for reminding us of that little factoid. You have proven your worth to this community and I honor you. REWAHOO

[REWahoo]

Stanley, I simply managed to see it before a dozen or two others had a chance to point it out. Lots of folks on this board know the devil is in the details and aren't shy about pointing out some of the interesting facts found when reading beyond the headlines.

[Koolau]

Quote:

Originally Posted by nun +1. LBYM is the mantra when you're working, why does it go out of the window when you retire? My plan is to live off rent, SS and some of the income my portfolio produces. I expect my portfolio to increase in retirement. People will say I'm leaving a lot on the table, but I don't need to spend money on useless cr@p and I'll be able to live just the same as I do now as a wage earner. My estate will go to my nieces so they'll be comfortable. One of them will probably spend it all, the other two will save it like I've done and pass it on to their children. Doing that for a few generations is a way for families to become wealthy. All this 4% rule stuff and spending down of principal is a conspiracy to keep future generations beholden to "The Man". If we truly value financial independence why not pass some of it on to our heirs.

nun, as others have suggested, your plan sounds good for you.

While I too struggle with spending principal, I don't plan to (and have not) LBYM to the same extent as when I was in the accumulation phase. Now that I've ER'd, I have loosened the purse strings appreciably. In fact, I now spend more than I used to earn back in the day. It was part of the plan and I'm trying to follow the plan. I still consider that we LBYM in that we don't spend 4%. We don't buy lots of stuff, but we do (and plan to) live "well" in the last major chapter of our lives. We may (or may not) leave a significant amount behind at our "final retirement" (hope that one's not TOO early, heh, heh). Mostly our remainder goes to the charities that we have supported throughout our w*rking lives and now in our ER years. The kids got good educations and are all independent. If we can, we'll help them from time to time before we depart this temporal plane. We feel no obligation to leave them "well off" when we die. We did our part up front on that score.

Living as frugally in ER as when w*rking did not appeal to us at all. ER was less important to us than "the plan". ER was a secondary goal which we believed we could achieve - but not at the cost of "the plan". We believe we have now achieved both.

I'm certain we all have different view points on the subject and one is no more "right" than another - assuming we're all flexible enough to adjust for the unforeseen. YMMV

[obgyn65]

I believe that a majority of true LBYMers do not plan to spend their principal. I am one of them :-) however, I am prepared to spend part of the principal during retirement only if necessary.

Quote:

Originally Posted by nun For me, LBYM (not spending principal) means only spending distributions from the portfolio, dividends, interest etc. It's not a law, but a guiding principle.

[Midpack]

Quote:

Originally Posted by obgyn65 I believe that a majority of true LBYMers do not plan to spend their principal. I am one of them :-) however, I am prepared to spend part of the principal during retirement if necessary.

I don't know, but I'd guess a majority of the (mostly LBYM) crowd here do plan to spend down principal if necessary. If markets are generous, they won't have to, but they don't plan on placing a priority on protecting principal at least when they get older. You probably read through the recent thread where many members declared their intentions RE: principal http://www.early-retirement.org/foru...own-64992.html. I didn't bother to tally to see where the majority stand.

[rayvt]

We thought long and hard before we bought the BMW Z4. The dealer wanted more for a 3 year old model that just came off a lease than we had paid for our NEW Toyota RAV4.
One day it struck me: Somebody in the family was going to be buying a sexy little sports car with my money. The only question was if it was going to be me or the kids.

[nun]

Quote:

Originally Posted by obgyn65 I believe that a majority of true LBYMers do not plan to spend their principal. I am one of them :-) however, I am prepared to spend part of the principal during retirement only if necessary.

I'd go along with that. Emergencies happen. My "not spending principal" plan can be criticized because I've taken money that many would have saved while working and used it to pay off the mortgage on my home and a rental property. I've also spent money to buy voluntary credits in the UK social security system. Those income streams, along with US SS, will cover all my expenses post 66. My ability to save post retirement has been funded by pre-retirement spending.

[HFWR]

In my case, spending down of principal will be necessary. And, in reality, it's not different than purchasing an <ack> annuity, aside from the "guarantee" an annuity provides.

The yield of my portfolio would not be enough for me to retire any time soon, which is unacceptable! But using 4% or thereabouts, plus SS, plus a small pension,will provide enough for me to live about the same lifestyle as now. And my bare-bones budget is quite a bit lower than my projected income from the aforementioned three-legged stool, so there is some fudge factor in there for "bad" years, and a little extra for some travel or toys and such.

I'm hopeful that there will be some, maybe a lot, to leave to my son, but that's not a primary concern.

As an aside, I have highly subsidized health insurance from a former employer, without which I would likely not be able to retire before Medicare, and also pay for a LTC policy.

I'm reasonably comfortable with this "plan", and, quite frankly, it's all I have...

[audreyh1]

Interesting discussion on the M* forum about this paper. It's a video interview, but I think it's linked to this paper.

Besides the 1% assumption for investment fees, mathematical models (rather than history) were used for some of the predictions. Time for the 3% Withdrawal Rule?

[ERD50]

Quote:

Originally Posted by Midpack Quote: Originally Posted by obgyn65 I believe that a majority of true LBYMers do not plan to spend their principal. I am one of them :-) however, I am prepared to spend part of the principal during retirement only if necessary. I don't know, but I'd guess a majority of the (mostly LBYM) crowd here do plan to spend down principal if necessary.

Exactly. LBYM and not tapping principal are two different concepts. Even a 100% success rate FIRCALC profile will have years that might require tapping principal.

And I think it was discussed in that thread, but how do you define 'principal'? If a fixed income portfolio is not keeping up with inflation, it might just be an illusion that you are not tapping principal. It could be that you gave up some principal to inflation, just to be able to say you are living off divs/interest. It may be a distinction w/o a difference?

-ERD50

[rbmrtn]

Yes, Blanchett was one of the authors with Pfau. The 1% fee was just an input assumption to their model, lots of people have to pay fees for their retirement plan. I think point of the paper was that going forward bond returns, in this environment, may not return the historical averages assumed in many of the planning tools.

[nun]

Quote:

Originally Posted by ERD50 Exactly. LBYM and not tapping principal are two different concepts. Even a 100% success rate FIRCALC profile will have years that might require tapping principal. And I think it was discussed in that thread, but how do you define 'principal'? If a fixed income portfolio is not keeping up with inflation, it might just be an illusion that you are not tapping principal. It could be that you gave up some principal to inflation, just to be able to say you are living off divs/interest. It may be a distinction w/o a difference? -ERD50

I agree that definitions explanation of assumptions are required. Here's how I see principal and LBYM.

For principal [P] I'd use the starting value of the portfolio [V(0)] and multiply it by (1+r) each year, where r is the inflation rate, to account for inflation. I would not include my cash buffer in the value of the portfolio as I might have to spend that....I realize that it's a bit of a semantic decision and smacks of buckets, but it's how I think of my portfolio.

P(0) = V(0)
P(n+1) = P(n)*(1+r)

If n is years and you take an income of I(n) each year then you are LBYM if

V(n) - I(n) > P(n)

If

V(n+1) - V(n) < 0

then the value of the portfolio has gone down and you should do all you can to minimize the income you take out. This is when you reduce expenses, spend down the cash buffer or get a part time job.

Obviously in lean times you need to have sources of income other than the portfolio, like rentals, SS or an annuity. I know that you have to buy the annuity thus reducing the value of the portfolio, but my main goal is to provide a secure base income and preserve or grow the capital of my portfolio. You might also split the portfolio into equities and bonds and apply the same rules.

[Katsmeow]

Quote:

Originally Posted by obgyn65 I believe that a majority of true LBYMers do not plan to spend their principal. I am one of them :-) however, I am prepared to spend part of the principal during retirement only if necessary.

I think it is actually fairly common, for example, that people retiring without a pension and before SS age will take a larger withdrawal until SS (or maybe a pension) kick in which will require spending principal and may even expect that some part of their portfolio will be depleted until SS comes online. As long as there is enough to do that I don't see a big problem with this.