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FireCalc Dips in Net Worth - Anyone Scared?
Old 01-26-2008, 10:59 PM   #1
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FireCalc Dips in Net Worth - Anyone Scared?

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.
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Old 01-26-2008, 11:27 PM   #2
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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.
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Old 01-27-2008, 01:30 AM   #3
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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
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Old 01-27-2008, 06:44 AM   #4
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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.
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Old 01-27-2008, 07:00 AM   #5
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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.
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Old 01-27-2008, 07:21 AM   #6
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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.
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Old 01-27-2008, 07:36 AM   #7
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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%.
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Old 01-27-2008, 07:50 AM   #8
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Originally Posted by FIRE'd@51 View Post
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:

http://www.early-retirement.org/foru...tml#post355267
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Old 01-27-2008, 07:56 AM   #9
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...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...
This is why you need to look at your financial situation at least once a year.

If you all of a sudden figure out in year 15 that you may not have enough to make it, you haven't planned accordingly.

There has to be plenty of fluff in your original retirement budget to allow you to cut down to a leaner budget or even go to bare bones for a while if you feel your net worth has dropped more than anticipated. This requires a regular review every few month, but no less than once a year. For example, I am planning on living on a 4% SWR, but I can live on 3% just by just cutting out my "entertainment" expenses. There are plenty of free things to do to replace the costly travel that I planned on in full retirement.
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Old 01-27-2008, 08:23 AM   #10
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A sudden and severe market drop is one of the weaknesses I see in Ray Lucia's Buckets of Money. He has Bucket 1 and 2 depleted in 14 years before using Bucket 3 to reload them. If the market goes merrily along for 12 or 13 years before reaching 1929 - 1932, there won't be much for replenishing Buckets 1 and 2. That's why my moral equivalent of Bucket 1 is always going to be full of enough cash for my basic living costs.

There was a regular contributor here that used to refer to his "trailer down by the trout stream" as his fallback position. That's a little extreme for me but I don't believe anyone can retire and say "4% SWR from here on." The SWR rate concept is a planning tool and not a religion.
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Old 01-27-2008, 08:33 AM   #11
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another dup ... don't know why it's happening ... except that I just accepted some MSFT updates... be forwarned
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Old 01-27-2008, 08:36 AM   #12
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Does this month's negative returns really mean anything in the long term?

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Old 01-27-2008, 08:37 AM   #13
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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.
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Old 01-27-2008, 08:39 AM   #14
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Does this month's negative returns really mean anything in the long term?

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Absolutely not.
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Old 01-27-2008, 08:54 AM   #15
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There has to be plenty of fluff in your original retirement budget to allow you to cut down to a leaner budget or even go to bare bones for a while if you feel your net worth has dropped more than anticipated. ... For example, I am planning on living on a 4% SWR, but I can live on 3% just by just cutting out my "entertainment" expenses.
R@40, you SAID IT! Buffer, fluff, cushion, whatever you call it is the real answer. This accumulation stuff, AA, and budgeting, although we would like to think it is all math and science ... it isn't .. it's an art.
You have to have the right attitude going into this as well as the ability to deal in atom bomb targeting rather than sharpshooting (IMHO).
If you plan this to the penny and anything goes south on you that you did not expect; ... it's ... hat in hand ... 'uh boss can I have my old j*b back, PLEASE'
... not for me ... I have so many buffers that I can go to 0% swr and I'm still living good (not GREAT, but good) shape ... (I do have the advantage of a moderate sized pension).
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Old 01-27-2008, 08:59 AM   #16
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Does this month's negative returns really mean anything in the long term?

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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!
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Old 01-27-2008, 09:22 AM   #17
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It's insane to debate whether a portfolio can survive under a series of consecutive market declines. It's almost like talking about whether you can survive if a huge asteroid struck the earth or the global economy entered a prolong, say 100 years, depression. We just have to be pragmatic about the world. Can we really identify or prepare for all the worst-case scenarios? The whole what-ifs are endless. I have been designing safety-critical systems, and it has never ceased to amuse me about the infinite number of failures that could occur. Despite enormous mitigations built into the design and manufacturing, failures are inevitable as evidenced by product recalls.

Back to portfolio protection or survival -- the basics still applies. That is, spend less if necessary, spread your money around, reserve a stash for living expenses for whatever number of years that you feel comfortable, postpone ER until you feel that you have enough, return to work, get a part-time job, etc. Most of all, stop worrying about the worst to come and enjoy life while it still lasts. There are countless people who have survived and lived comfortably with a lot less money than the amount posted by most people in this forum.
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Old 01-27-2008, 09:40 AM   #18
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Back to portfolio protection or survival -- the basics still applies. That is, spend less if necessary, spread your money around, reserve a stash for living expenses for whatever number of years that you feel comfortable, postpone ER until you feel that you have enough, return to work, get a part-time job, etc. Most of all, stop worrying about the worst to come and enjoy life while it still lasts. There are countless people who have survived and lived comfortably with a lot less money than the amount posted by most people in this forum.
What Spanky said...
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Old 01-27-2008, 10:31 AM   #19
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There has to be plenty of fluff in your original retirement budget to allow you to cut down to a leaner budget or even go to bare bones for a while if you feel your net worth has dropped more than anticipated. This requires a regular review every few month, but no less than once a year. For example, I am planning on living on a 4% SWR, but I can live on 3% just by just cutting out my "entertainment" expenses. There are plenty of free things to do to replace the costly travel that I planned on in full retirement.
This is where LBYM'ers have a huge advantage over fans of yuppie consumerism. We can cut back pretty easily, especially if it is just for a few years.

I have not been hit by the travel bug, but in your case you could probably really enjoy more inexpensive local travel during years of cutting back. Day trips to out-of-the-way areas just 100-200 miles away can be a lot of fun, and it's amazing how little most of us know about places close to home. Be a tourist in your home town.

As for me, if my portfolio sinks drastically then I can happily spend many hours in a library or going for walks and spend nothing. There are always labor-intensive projects to do around the house, too.

In my case I am not too worried, though I might be if/when my portfolio dropped that badly! I will try to forestall or prevent such drastic changes in portfolio value from occuring in the first place. During times when my portfolio is less than about 80% of its initial value I will probably just automatically revert to deep LBYM mode.

Honestly I do plan for economic conditions to be the worst in history during the years 2010-2020, or perhaps even 2010-2040. I plan for my portfolio to take some serious hits. Then if things aren't that bad, any portfolio gain at all will just be gravy.
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Old 01-27-2008, 10:45 AM   #20
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I handle it by using a straight X% withdrawal rate rather than the inflation adjusted initial 4% rate as used in the original SWR.

This means that I take more out when the market has been good, but it also means that the portfolio is not being depleted at a high percentage rate when performing poorly. Such an approach means you have to be willing to take a pay cut now and then in the interest of preserving the portfolio. I guess this bothers some people, but it doesn't bother me at all.

I never felt comfortable with taking an initial fixed rate + inflation adjustment each year disregarding market performance. This technique was developed for folks who needed a constant "salary" each year mimicking the financial "predictability" of their working years. I would rather react quickly once entering years of poor porfolio performance.

And instead of doing some kind of artificial annual "inflation adjustment", I prefer to let my portfolio grow enough to supposedly beat inflation over the long run and thus keep up with increasing costs of living by whatever my porfolio performance provides.

Dealing with unpredictable and varying withdrawal amounts doesn't bother me. I have a "buffer" - a cash account for living expense in which I carry 1 to 3 years living expenses. If the portfolio has a good year, the buffer gets more in it, a bad year less. Over a 3 year period this reduces the variability. Of course, there is nothing wrong with variability either, because you can time large purchases to wait for a "good year". That more mimics real life expenses than a predictable salary does.

FWIW my WR is in the range 3 to 3.5%. This is pretty conservative.

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