FPA Journal: Withdrawal & capital preservation

[Brat]

For those who don't lurk on FundAlarm: http://www.fpanet.org/journal/articles/2006_Issues/jfp0306-art6.cfm?renderforprint=1

 

[Helen]

Interesting article. Thanks for posting.

"Conclusion

Our analysis using Monte Carlo simulations supports the conclusion that the application of a few simple but powerful decision rules can significantly increase maximum initial withdrawal rates while virtually eliminating the possibility that a "perfect storm" could cause a retiree to run out of money. This analysis generated results consistent with previous research that was based on a 1973 retirement date. In addition, the application of the capital preservation rule in conjunction with the prosperity rule virtually eliminates the possibility of a retiree running out of money at these initial withdrawal rates. These new decision rules also provide for purchasing power maintenance.

Questions about maximum initial withdrawal rates cannot be answered with a single number because retirees have varying thresholds for their financial security and need not adhere to a one-size-fits-all set of trade-offs. For portfolios containing at least 65 percent equities, initial withdrawal rates of 5.2–5.6 percent are sustainable over a 40-year period at the 99 percent confidence standard and rise to 5.7–6.2 percent at the 95 percent confidence standard.
We hope our work will help financial planners and their clients make sound decisions that lead to retirements that are both rewarding and fulfilling."

 

[mickeyd]

Thanks for posting it Brat. I read this a while ago, but reviewing it again is an excellent way to keep my thinking on course.

 

[clifp]

This study made my favorites list as soon as I read it.

I think there are two major flaws to how the 4% SWR rules is being used. First and foremost, I think the 4% SWR should be used as a pre-retirement tool, not as rigid post-retirement cash managment rules. Almost all of the studies involved in coming up with 4% SWR, are looking at historical data and applying it to a theoretical retirees portfolio, not real people. People aren't robots, I doubt there is retiree on this board, who started with a portfolio of $X and has mechanical taken exactly 4% + inflation each and every year. People should pay attention to both their spending and to their portfolio performance, and adjust their spending based on their actual performance.

Secondly, for most people, most of the time 4% SWR is too conservative. If you don't retire right before a bear maket (like me in 1999) or right before a high-inflation period you'll die with a lot of money left over. If you have kids who need the money this isn't a bad thing, but the cost maybe depriving yourself of spending that you would have enjoyed, or more likely working longer than you would have liked to. I like these two studies because they provide some relatively easy to follow guidelines, that are basically common sense, if your portfolio declines in value you don't increase your withdrawal, and a cap on inflation withdrawals. On $1 million portfolio the difference between 4% and 5.2% is $12,000 or $1,000 which is pretty big deal for many people.

 

[Telly]

Brat, thanks for posting that.

I read Guyton's 2004 paper a couple years ago. It was very interesting to see how the idea has evolved in the 2006 paper. Including the dropping of the Inflation Rule.

The Capital Preservation Rule (CPR) method of portfolio rescue gives an interesting metric for determining when a portfolio will be getting into trouble well in advance of the no-return point. And this to me is important... so many people think that they will know when there will be trouble ahead in their portfolio, that it is "obvious". So far, at least to me, he offers the best tested metric for this, that rectifies the problem without slamming on the brakes at every brake-light seen ahead.

Good article, Guyton 2006 is a keeper for me.

 

[Nords]

Good article, Guyton 2006 is a keeper for me.

I wonder if we'd feel the same way if he said the "best" SWR is really 3.1%...

 

[clifp]

I wonder if we'd feel the same way if he said the "best" SWR is really 3.1%...

Telling people that need to save 25X the net amount of their salaries to retire is hard to accept for most people. Telling them the need to save 32X (i.e. 3.1% SWR ) would cause a minor revolt.

 

[modlair]

In the category of **GULP** we probably do have to recognize that this 5.8% number he's quoting is with no Social Security -- that pretty much everyone is going to get in some magnitude greater than zero.

Soooo, **GULP**, the number is actually higher.

 

[youbet]

This study made my favorites list as soon as I read it.

People should pay attention to both their spending and to their portfolio performance, and adjust their spending based on their actual performance.

That's OK as long as when I adjust my spending DW and I still get to do all the things in retirement (travel, new cars, entertainment, spoil the grandkids, etc, etc.) that we planned on!

 

[donheff]

I liked Guyton the first time I read him and continue to like the concepts here. I have set things up so my SWR could be less than 4% but I plan to take 4% (or maybe a little higher based on Guyton) but spend less. I will place the excess in a "spending account" that will be earmarked for balancing our lifestyle during extended bear markets.

 

[modlair]

I liked Guyton the first time I read him and continue to like the concepts here. I have set things up so my SWR could be less than 4% but I plan to take 4% (or maybe a little higher based on Guyton) but spend less. I will place the excess in a "spending account" that will be earmarked for balancing our lifestyle during extended bear markets.

This is clearly the focus of the approach. His rules are really pretty simple. To follow them, and obtain the SWR of 5.8ish%, what you have to do is have a discretionary aspect to your expenditures.

Your necessities cannot equal 5.8% (and grow with inflation) because then you do not have the ability to freeze when necessary.

But in that context, I wonder if his SWR quote is compartmentalized -- meaning can one elevate well beyond 4%, though perhaps not all the way to 5.8%, if one merely follows the withdrawl rules pertaining to where the money comes from? Not the freeze rule. The rule that describes where to withdraw from in what order among the AA niches. How much SWR elevation does just that rule provide?

It would be useful to know that information. With it, one could theoretically elevate necessity spending to that amount and be "immune" to the freeze rule in bad years. It is on discretionary spending that the freeze would apply.

 

[justin]

FYI - for anyone interested in this kind of "variable" component to withdrawals, you can do some analysis with FIREcalc. Set your fixed withdrawal to, say, 2%, then "trick" FIREcalc into giving you a variable withdrawal by increasing the mutual fund expense ratio by the amount of your variable withdrawal (say, 3.5%). I seem to get a 2% fixed + 3.5% variable SWR using this method with ~ 95% certainty.

Something to think about...

 

[mickeyd]

Between DW and I we have 3 pensions and 2 social security income streams. When they are all flowing, we will have almost 100% of the minimum amount of expenses to get by. That said, my plans always refer to a SWR of 4%, but in reality I suspect that my actual withdrawal will be closer to RMD, which is about 3.65% at age 70 (I believe). If I took out 5.8% from my stash, I would really have to scramble to spend it all I think. I just consider this to be a large amount of wiggle room that may allow us to travel more, live it up a bit more than we do now, and allow us other options.

 

[sgeeeee]

I enjoy reading these kinds of studies. Qualatatively they tell us that if we are willing to use a spending model that does not always go up with inflation, then the computed SWR is higher. As Justin mentions earlier in this thread, FIRECalc can be used to do the same thing.

http://early-retirement.org/forums/index.php?topic=2048.0

Quantitatively, they give a ball-park estimate for how much higher that might be for one particular set of rules. The actual values and rules are probably not applicable to any of us, so I wouldn't put too much stock in the final numbers.

No matter how you choose to analyze it, the important thing that comes out of these studies is that the spending model you choose during retirement is one of your most powerful tools to insure against longevity risk.

 

[Gone4Good]

But in that context, I wonder if his SWR quote is compartmentalized -- meaning can one elevate well beyond 4%, though perhaps not all the way to 5.8%, if one merely follows the withdrawl rules pertaining to where the money comes from? Not the freeze rule. The rule that describes where to withdraw from in what order among the AA niches. How much SWR elevation does just that rule provide?

I think he does that in Table 2. The Max withdrawal rate using just the "Portfolio Management Rule" is 3.6% and 3.3% with a 90% and 95% probability of success, respectively. That's a bit more conservative than, but roughly consistent with, FIRECalc results - which is typical of Monte Carlo projections of this kind.

If you work through the tables, he does show you how the decision rules accumulate to the end result - kind of like that "layer cake" analogy used by another FP.

 

[FRPGuy]

FYI - for anyone interested in this kind of "variable" component to withdrawals, you can do some analysis with FIREcalc. Set your fixed withdrawal to, say, 2%, then "trick" FIREcalc into giving you a variable withdrawal by increasing the mutual fund expense ratio by the amount of your variable withdrawal (say, 3.5%). I seem to get a 2% fixed + 3.5% variable SWR using this method with ~ 95% certainty.

FYI, there's a free online Monte Carlo calculator at www.flexibleRetirementPlanner.com that roughly implements the Guyton decision rules.

FRP Guy