FireCalc Dips in Net Worth - Anyone Scared?

[ERD50]

OK, Haha brought this up in 2005 ( Worst Draw-Down ). The recent uncertainty in the markets may make this topic worth re-visiting.

Some people feel pretty comfortable with that '95% Success Rate' on the 30 year plan in FireCalc. I looked at the data in a slightly different way that I think is more tangible.

I used the FireCalc defaults (for convenience, I changed the 30,000/750,000 spend/portfolio numbers to 40,000/1,000,000 so the numbers convert to % with just a decimal shift).

If you think a 4% SWR and 95% is 'good enough', how would you feel if your original $1,000,000 buying power was just $274,000 in 15 years? You could be down 73% and you are only half way in to your 30 years! Could you be calm, and say 'Sure, I blew through almost 3/4 of my nest egg, but history says I should do OK.' BTW, that 95% success rate says that you will run out in year 24 in the worst case year.

Yes, that is the worst case history for the data set, but it happened. And if you look at all the squiggly lines on that chart, that sequence is not an outlier - it has plenty of company in the neighborhood. And the future could be worse.

So, drop your SWR to 3.5%? OK, you could be down 66% instead of 73%. Still pretty unsettling.

Does more weight to fixed income help? OK, go 50/50, and you would be down 70% at a 4% SWR; 64% with a 3.5% SWR.

A few runs and it seemed to show that if you want some assurance that the buying power of your net worth does not drop by more than half, you are looking at ~ a 2% SWR. At that point, time frame doesn't seem to matter much.

And I will also reiterate the point regarding life expectancy tables. Those are medians - if you want a 95% 'success' factor to apply to how long your portfolio needs to last, apply the Vanguard calculator until you get 5% chance of achieving X age for you or you and your spouse.

I was surprised by the results myself. I'm currently around 3.6% SWR, with pensions and SS yet to come, so I'm not shaking in my boots, but I know a 50% drop in NW would have me, ummm.... 'concerned'.

Thoughts?

-ERD50

PS - I will be out most of Sunday, so I won't have a chance to reply to any responses until later.

[SteveR]

Here is a link from the Retire Early website...the Father of FIRECalc and FIRE for me. This link discusses much of what ERD50 is putting forward, i.e., What happens if you retire in a down market and it stays that way for 15 years? How will that affect my SWR?

The Retire Early study on safe withdrawal rates - Millenniam Edition.

[haha]

Several years ago with the old FireCalc I defined the floor value as 1/2 of the starting value. In reality I know I would not stay that long. From this exercise I decided that I needed to keep withdrawal rate at or below 2%. I didn't discuss it much, because this is troll country, and anyway I wasn't getting any feedback that seemed to acknowledge the meaning of these Firecalc trials.

Since then I have moved house and a 2% withdrawal is really not possible without changing my whole approach to the non-financial parts of life.

So I operate as frugally as I can, but also I have moved to a strategy of current income from securities whose payments have a good shot at keeping up with or surpassing inflation, plus a certain amount of trading. This is very similar to what I previously did for many years, but more recently I had allowed myself to drift away from a mostly dividend strategy in favor of "total (hoped for) return".

I really don't know what is correct but Firecalc doesn't lie, and speaking only about myself I know that with no pension I would not want to suffer those deep drawdowns. I feel that I would rather trust my ability to choose individual companies, and to buy TIPS when they are reasonably priced than I want to trust my wellbeing to a strategy that I think may be unrealistic when the human factor is taken into account.

Here is a thread from September 06 that approaches this problem from a different angle.

http://www.early-retirement.org/forums/f28/triumph-optimists-23006.html

I should probably say that I have no intention of changing anyone's approach, or challenging the prevailing consensus. It's all good, really.

Ha

[Sandy]

Thanks guys for bringing this up again.

I am still in the accumulation phase. Each time I read this I understand it a bit better, and seem to get new/renewed insight. It is definately not a black and white issue. Using the phrase "4% SWR" is a quick and dirty and pretty good summary. The rule of thumb works well for most, but not everyone.

Depending on time frame, other sources of income (pension, SS, PT or spouse j*b) , the structure of your savings portfolio, risk tolerance, and the wiggle room in your expenses, the 4% may be good or may not let you sleep at night. It is important to truly understand the underlying assumptions and go in with your eyes wide open.

[2B]

The concept is pretty obvious if you stare at the FireCalc results in detail. A 4% SWR is hyper conservative unless you retire right in front of a major market downdraft (ala 1929) or a longterm flat market (ala 1968) that goes on for a decade or more. If you could somehow "know" you have ten years for retirement before a major market downturn, your portfolio would grow so high that you could take the big hit and not run out of money.

That's why we all need a way of downsizing our spending in retirement if we experience a market fall. My approach is a "base case" living expenses essentially funded with cash/CDs/small pension/SS. This is kept whole by transfers from the equity portion. The equity portion funds a higher lifestyle and extensive travel. If the equity portion shrinks significantly, my retirement plan drops luxury expenditures without cutting the spending for a decent standard of living.

If I went with my "base case" living expenses, my spending would be around 2%. My "plan" is to start at around 5-6% with the belief that Bernicke is right and my desire for travel and luxuries will drop as I and DW age. At no time will I allow my assets to fall below an ultra-safe level for my "base case" living expenses. I would start cutting expenses if the level of assets began to fall significantly.

[ERD50]

Quote:

Originally Posted by Want2retire Amen! As a modeler (of something totally different), I think that often too much burden is put on Firecalc for any model to bear. "All models are wrong; some models are useful" (G.E.P. Box, 1979).

W2R, I've used simulation models in my line of work too, and that quote was also the first thing we were taught in modeling class. However, I just don't think the quote is relevant to FireCalc. FireCalc isn't simulating anything, it is just reporting historical data. When you create a simulation model (generally to interpolate or extrapolate data that you cannot easily obtain), it is best to assume that your simulation model is wrong, that it does not account for every possible interaction, etc. But unless there are actual errors in the data entry, or errors in the calculations in FireCalc, I think we can 'trust' it to report history accurately.

Like the intro to FireCalc - the analogy is to reporting past temperature data for a region. It's just a report, not a simulation of the conditions that led to those temperatures.

FIRECalc: A different kind of retirement calculator

Now, when we take that historic range of outcomes, and try to apply it to the our future - at that point I guess you can say we are running a simulation. But FireCalc isn't doing it - we are. FireCalc was done at that point, and provided a historic baseline for us to use in our planning, as we see fit.

Quote:

Originally Posted by megacorp-firee .... IMO, there is a bit of religious zeal going on re: Firecalc

see above - for me FireCalc is what it is. And it is just one data point to use in the FIRE decision. It can't tell me how long I will live, if I'm going to suffer some cataclysmic financial event, if my expenses will outpace historic inflation rates, if the future will be better/worse than history, etc, etc, etc. So it cannot give me an 'answer'.

That is one of the reasons I use a 100% success rate. I can't think of a single good reason to expect the future to have a distribution of outcomes that is more rosy than the past. As a general rule, as you collect more data (of any kind), it is reasonable to expect to see extremes added to the data set - right?

Plan for the worst, hope for the best?

Again, if those deep drawdown outcomes were outliers, it might be a bit easier for me to write them off as a low probability event. But the distributions of those deep drawdowns look pretty even, so there is a pretty good chance (historically) that we would have experienced a 'bad case' drawdown that is not much better than the 'worst case'.

Quote:

Originally Posted by 2B A 4% SWR is hyper conservative unless you retire right in front of a major market downdraft ... If you could somehow "know" you have ten years for retirement before a major market downturn, your portfolio would grow so high that you could take the big hit and not run out of money.

2B, I know you provided more context for this later, but I wanted to comment on that statement that if we make it past the first few (10?) years without a problem we will be in good shape - I'm not so sure (but one might need to look at the squiggly lines or the spreadsheet data in more detail to check this). Take this scenario:

Default 4% withdraw rate, assume $40K spend, $1M portfolio for easy math. Now, lets just say that after 10 years, your buying power increased by 25% - you are doing well. But if you plug those numbers (same $40K spend, but now a $1.25M portfolio) in for the remaining 20 years, you could see a dip down to $480K - still losing over one-half of your original portfolio.

Now maybe those 'bad case' years only follow big bubbles, and you would be up by more than 25%? I don't know, that would take some more digging in the data. But if it's true, that tells me I may not want to raise my SWR just because my portfolio is growing - I may still have a bad patch ahead of me.

samclam made good points on Monte Carlo vs FireCalc historic analysis, IMO. I suspect that market cycles are not totally random, and that the historic cycles are probably a better guide to the range of outcomes we can expect. Inflation, market returns, fixed returns, etc are related in some ways, they are not totally independent variables, and I think the MC is treating them that way?

-ERD50

[donheff]

Quote:

Originally Posted by ERD50 Default 4% withdraw rate, assume $40K spend, $1M portfolio for easy math. Now, lets just say that after 10 years, your buying power increased by 25% - you are doing well. But if you plug those numbers (same $40K spend, but now a $1.25M portfolio) in for the remaining 20 years, you could see a dip down to $480K - still losing over one-half of your original portfolio. Now maybe those 'bad case' years only follow big bubbles, and you would be up by more than 25%? I don't know, that would take some more digging in the data. But if it's true, that tells me I may not want to raise my SWR just because my portfolio is growing - I may still have a bad patch ahead of me. (Emphasis added)

In a previous thread people talked about the possibility of recalculating the SWR after their portfolios grew. A few of us cautioned that you might just be chasing the "initial downturn." The discussion here of the high number of bad periods that crop up in the Firecalc runs just adds to that caution. Rather than raise your SWR after a huge runup maybe that would be the time to move a substantial portion of your portfolio to fixed income or (horrors) even an inflation adjusted SPIA to cover needs. Then you could aggressively F around with the rest.

[youbet]

Quote:

Originally Posted by ERD50 the distributions of those deep drawdowns look pretty even, so there is a pretty good chance (historically) that we would have experienced a 'bad case' drawdown that is not much better than the 'worst case'.

It seems then that we are at a fork in the road in this discussion........

1. What to do now that the realization has set in that "success" in FireCalc includes "close calls." And, that "close calls" may cause some retirees to be unpleasantly stressed or to alter their lifestyles in undesirable ways, or both. How do we mentally cope with the concept of "close calls?"

2. How do you financially plan for RE (savings amount... AA... deferred or non-deferred... annuities... SS early or delayed... etc... ) and how do you manage the withdrawal phase to not only maximize survivability but also to minimuze mid-course dips or near zero terminal values?

[ERD50]

Quote:

Originally Posted by youbet It seems then that we are at a fork in the road in this discussion........ 1. What to do now that the realization has set in that "success" in FireCalc includes "close calls." And, that "close calls" may cause some retirees to be unpleasantly stressed or to alter their lifestyles in undesirable ways, or both. How do we mentally cope with the concept of "close calls?" 2. How do you financially plan for RE (savings amount... AA... deferred or non-deferred... annuities... SS early or delayed... etc... ) and how do you manage the withdrawal phase to not only maximize survivability but also to minimize mid-course dips or near zero terminal values?

Yes - the pragmatic part of all this, what to do about it? Well, they say 'forewarned is forearmed' - does that help? Hmmm, not really

But I think I have come to look at the following in new light:

A) I know a 50% dip from my start position would be an emotional issue for me. I'm going to look for methods that historically would keep me above that minimum. Hopefully well above.

B) I realize (again historically) that I would have had (guess-timating here) about a 50% chance of doing significantly better, and this may well be a non-issue. But I need to plan for the very real chance of a big drawdown.

C) To Investigate in more detail everything you outline in #2. But with the goal of reducing the drawdown (whenever it may occur), rather than looking at any 'average' numbers or focusing on the ending portfolio balance.

So that might include annuities, spending adjustments (I need to do more FireCalc runs on this - I think people may be over-estimating the effect of modest 'cutting on the dips'), early/delay SS and /or pensions, AA adjustments, and... that option which shall not be named.

So basically, all the things that have been discussed time and again here, but with the focus on that drawdown number. I'll probably be doing a matrix of FireCalc runs for myself, or general ones just to get the feel for the sensitivity of some of these factors on that drawdown. But I'm almost 10 years away from being able to take any SS - I'd like to discount my SS benefits and my pension, so those numbers get pretty foggy. So some of this is still a bit crystal-ball for me.

Probably the biggest 'actionable item' (geez, sounds like some of my old meetings on the job ) that I take away from this is - I'm not going to look at a short term portfolio increase and decide that I can up my spending. I'm going to look at that as something that can offset any future dips. Or, if I see some real 'quality of life' opportunity that I do want to spend that money on, I can weigh that against the 'comfort factor' of protection against dips. As some have suggested, maybe move any 'excess' to a 'safe money' - though, if that does not beat inflation, maybe it isn't 'safe'?

All things considered, it is a 'leap of faith' to retire, I'm just trying to make the best of that.


-ERD50

[lsbcal]

Quote:

Originally Posted by youbet It seems then that we are at a fork in the road in this discussion........ ... 2. How do you financially plan for RE (savings amount... AA... deferred or non-deferred... annuities... SS early or delayed... etc... ) and how do you manage the withdrawal phase to not only maximize survivability but also to minimuze mid-course dips or near zero terminal values?

Yesterday I had a talk with DW and explained that if financial markets fell out of bed a few years in a row we'd have to cutback somewhat in spending. She got me to agree to go out to lunch today ... her idea of cutting back on spending . Still I'm going to repeat this idea until she's used to it -- she really is a good sport.

One somewhat concrete idea for avoiding inflationary periods is to load up on TIPS when they real rates are reasonably high and sell or switch to shorter maturity TIPS when real rates decline (like now). Doesn't solve the equity problem but perhaps helps to balance out a tad. It worked in this last downturn.

[megacorp-firee]

Quote:

Originally Posted by ERD50 see above - for me FireCalc is what it is. And it is just one data point to use in the FIRE decision. It can't tell me how long I will live, if I'm going to suffer some cataclysmic financial event, if my expenses will outpace historic inflation rates, if the future will be better/worse than history, etc, etc, etc. So it cannot give me an 'answer'. That is one of the reasons I use a 100% success rate. I can't think of a single good reason to expect the future to have a distribution of outcomes that is more rosy than the past. As a general rule, as you collect more data (of any kind), it is reasonable to expect to see extremes added to the data set - right? Plan for the worst, hope for the best? Again, if those deep drawdown outcomes were outliers, it might be a bit easier for me to write them off as a low probability event. But the distributions of those deep drawdowns look pretty even, so there is a pretty good chance (historically) that we would have experienced a 'bad case' drawdown that is not much better than the 'worst case'. -ERD50

hmmmm... I can't really tell, ... did you just make the point?
If you did ... amen brother.

However, that was not the point I was trying to make ... it was one of using (or rather NOT USING) FIRECALC as THE (or THE major) factor in deciding whether or not you are ready for retirement.

Apologies in advance if I have mis-read your post.

[megacorp-firee]

another dup ... don't know why it's happening ... except that I just accepted some MSFT updates... be forwarned

[rs0460a]

Does this month's negative returns really mean anything in the long term?

Fidelity Investments

- Ron

[2B]

Quote:

Originally Posted by rs0460a Does this month's negative returns really mean anything in the long term? Fidelity Investments - Ron

Absolutely not.

[megacorp-firee]

Quote:

Originally Posted by rs0460a Does this month's negative returns really mean anything in the long term? Fidelity Investments - Ron

Nope ... not to me ... at least not for at least 5 to 6 years. ... and then maybe not ... over engineering sometimes is a great thing!

[megacorp-firee]

Quote:

Originally Posted by Sandy Thanks guys for bringing this up again. I am still in the accumulation phase. Each time I read this I understand it a bit better, and seem to get new/renewed insight. It is definately not a black and white issue. Using the phrase "4% SWR" is a quick and dirty and pretty good summary. The rule of thumb works well for most, but not everyone. Depending on time frame, other sources of income (pension, SS, PT or spouse j*b) , the structure of your savings portfolio, risk tolerance, and the wiggle room in your expenses, the 4% may be good or may not let you sleep at night. It is important to truly understand the underlying assumptions and go in with your eyes wide open.

Sandy, you're getting it. 4%SWR is an upper bound that allows you to go 30 years or so without running outta dough at a 'decent' reliability rate.
If you want to give yourself some 'wiggleroom', then you make it less.
It's a balance between FIREing early or building a buffer. The longer your accumulate and can do a smaller (say 3% where you never run outta dough) swr, the better.

[REWahoo]

Interesting, isn't it, how the first big dip in the equity and housing markets after several years of solid gains causes one to question the courage of their SWR convictions.

I'm very aware of the thin ice created when retiring into a down market. I consider myself fortunate to have been two and a half years into FIRE before we hit a rough patch, resulting in my portfolio declining to about where it was when I pulled the ripcord. Since that relatively small but steep decline has caused me to question my SWR strategy, I can only imagine what a decline of 25% or more could do towards creating an acute case of insomnia.

That said, I'm far from sleepless at this point. I'm not at all convinced those who forecast gloom & doom for an extended period are any more accurate than those who say the problems with our economy will turn around in a few months. I've chosen an asset allocation that, at least so far, has declined at less than half the rate of the S&P 500 (YTD I'm -3.9% vs. S&P 500 -9.4%). Both DW and I will be eligible for early SS in the next couple of years. But...we've decided to postpone our around-the-world cruise until things look a little better.

[FIRE'd@51]

Here's a rather chilling statistic, which indicates why you would (and should) be concerned if you experienced a significant drawdown. I took ERD50's example in which the portfolio value after 15 years was 274,000. If you then run FIRECALC for 15 years assuming you draw 40,000 per year from a 274,000 nest egg, your chance of running out of money is 99.2%.

[REWahoo]

Quote:

Originally Posted by FIRE'd@51 Here's a rather chilling statistic, which indicates why you would (and should) be concerned if you experienced a significant drawdown. I took ERD50's example in which the portfolio value after 15 years was 274,000. If you then run FIRECALC for 15 years assuming you draw 40,000 per year from a 274,000 nest egg, your chance of running out of money is 99.2%.

Before you have everyone staining their shorts, check out these posts from the "Explain the 4% withdrawal rate" thread on the "Best of" board:

Explain the 4% withdrawal rate

[Jarhead*]

Quote:

Originally Posted by REWahoo Interesting, isn't it, how the first big dip in the equity and housing markets after several years of solid gains causes one to question the courage of their SWR convictions. I'm very aware of the thin ice created when retiring into a down market. I consider myself fortunate to have been two and a half years into FIRE before we hit a rough patch, resulting in my portfolio declining to about where it was when I pulled the ripcord. Since that relatively small but steep decline has caused me to question my SWR strategy, I can only imagine what a decline of 25% or more could do towards creating an acute case of insomnia. That said, I'm far from sleepless at this point. I'm not at all convinced those who forecast gloom & doom for an extended period are any more accurate than those who say the problems with our economy will turn around in a few months. I've chosen an asset allocation that, at least so far, has declined at less than half the rate of the S&P 500 (YTD I'm -3.9% vs. S&P 500 -9.4%). Both DW and I will be eligible for early SS in the next couple of years. But...we've decided to postpone our around-the-world cruise until things look a little better.

ReWah00: My health ins. costs went from 12,000 a year to about 6,000 a year when my wife and i were eligable for medicare. (Getting older, besides a lack of interest in taking a world wide cruise, has some other financial benefits.) (I'm sure you can hardly wait).

Re: Portfolio situation, and not having the stomach to face a 25% loss, is damn sure understandable. Rich & I have discussed this situation a few times on the board, and for me personally, I have put as much distance as I can between feeling a need to tap equities as I can withought changing the way my wife and I approach what it takes to keep us active and involved.

My kids bucket has a small hole in it, but at least at this point, my wife and I are o.k.

Jarhead, who truly believes that U.S.C. had the best college football team in the country this year, and hopes the NCAA will come to their senses, and go to a playoff system in the future.