Humberto Cruz on variable withdrawal rates

[Nords]

This one's for you, Cut-Throat!

Variable Withdrawals Let Retirees "Live It Up"

... "However, there is another way that may allow you to 'live it up' while still guarding against the risk of running out of money. That is to base your withdrawals on the value of your portfolio each year, spending more if your portfolio has gone up in value and less if it has gone down." ...

 

[TromboneAl]

I currently like that system better than the "adjust-for-inflation" system. Seems more "self-correcting" and natural (that is, doesn't use an artifical, inflation rate). It all depends on being able to live on the amount you get if your portfolio value drops.

Don't know which I'll use when I fully enter the distribution phase.

 

[Cb]

Al, why chose? Hunt around for a post a few months back about "blending" the two approaches in various combinations...say a fixed 2.5% WR for fixed costs, and another variable 1.5 - 2.0% withdrawal for variable costs.

Cb

 

[Cb]

De-cross-posting:

http://www.retireearlyhomepage.com/cgi-bin/yabb/YaBB.pl?board=SWR1;action=display;num=1107790433

 

[Nords]

De-cross-posting:

http://www.retireearlyhomepage.com/cgi-bin/yabb/YaBB.pl?board=SWR1;action=display;num=1107790433

Nah, I don't post there any more.

 

[Zipper]

I've been using this method for years.

It works for me.

 

[Michael]

I don't think the CPI is a very useful planning tool since it was changed a few years back.

 

[ESRBob]

Yeah,
I've been following this method for four years, too, and like it a lot.

I've even modelled some enhancements to it, which I call the 95% Rule, to deal with its worst drawback, which is that if markets tanked 20% one year, it would be hard to adjust your spending down 20% the next year without some serious pain.

The 95% Rule says, in effect, that you can always withdraw at least 95% of the amount you withdrew last year, so if markets tank you have some downward adjustment, made a bit worse by inflation, but you don't have your world turned upside down.

When we modelled this with 75+ years of historical data, the results were encouraging -- it shaved maybe 2/10s of a percent off the Safe Withdrawal Rate. Success rates dropped a few percent in some cases, no change in others.

Overally it seems pretty encouraging.

I also define 'success' as keeping the portfolio intact in real terms, which to me is the gold standard for an early retiree. When you ar 80 you can think about spending down the portfolio, but in the meantime, this works.

Bottom Line, using this method and the 95% Rule and success defined as keeping up the real value of the Portfolio: Gets you to about a 4.3% SWR, with a 5-10% chance of having the real value of the portfolio slip by up to 10% over longer time periods.

Portfolio is all US (didn't have the new international long time series then) with solid value and small tilts, 50% Stock, 50% Bond.

Biggest plus I see with this method is you can conservatively step up withdrawals if you happen to retire into a prosperous time, and you can belt-tighten during hard times which is what an early retiree wants to do anyway. Both ways match your psychology, plus its easy to calculate. Makes it easy to follow for the long run.

 

[cute fuzzy bunny]

I use a variable withdrawal rate. I vary it by how much money I think I want to spend.

If and when the well looks like its running dry, I'll either go back to work or cut back on spending.

 

[cute fuzzy bunny]

Let me ask a different question now (silly rabbit, it appears that having whole thoughts and expressing them for your consumption all at once are old hat)...

Lets say you go through the late 90's. Things are super duper. You're pulling in 80...100...300% returns on your internet and tech stocks (anyone remember the commercial about the guy in the cabin in the frozen tundra who has a stuffed beaver telling him to load up on tech stocks? -20 points for anyone who goes anywhere at all with the words 'stuffed beaver'?).

Ok so there you are, money out the wazoo (another fine commercial)...you buy a boat, a timeshare, your own golf cart and a trailer to take it to the course. Then '00 and the next couple of years hit and you're eating it big time.

How do you reconcile those wild waves of variable life style? There will always be 2-7 year bulls and the same bears...do you just ride them up and down, living the high life while they hit and lamenting the good old days when they're long past, or is some sort of middle ground really a better bet?

 

[moghopper]

(anyone remember the commercial about the guy in the cabin in the frozen tundra who has a stuffed beaver telling him to load up on tech stocks? -20 points for anyone who goes anywhere at all with the words 'stuffed beaver'?).

Anywhere?

Frank: Saayyy, nice beaver.
Jane Spencer: [producing a stuffed beaver] Thanks. I just had it stuffed.

 

[laurence]

Beavis: "Heh, heh, you said, heh, you said beaver!"

Butthead: "Huh, huh, yeah, uh, huh!"

Beavis: "BOYOIYOING!"

 

[cute fuzzy bunny]

Uh oh...I started something....and we have no locker room to send it to...

 

[kramer]

notth wrote: How do you reconcile those wild waves of variable life style? There will always be 2-7 year bulls and the same bears...do you just ride them up and down, living the high life while they hit and lamenting the good old days when they're long past, or is some sort of middle ground really a better bet?

I liked the system that was proposed some time ago by SG, I think. You divide the SWR into two components. One is an inflation-adjusted survival component. This is the lowest you ever want to go. You adjust this low amount for inflation each year.

On top of that is a variable component that fluctuates in proportion with your portfolio.

Let's say you start with a 3.75% SWR. Perhaps, 2.5% is survival. So you adjust that part of your withdrawal for inflation each year. The other 1.25% is simply 1.25% of your whole portfolio, and that is free float, proportional to your total portfolio and changing with your portfolio each year according to portfolio performance. In this case, your withdrawals would not fluctuate very much since the inflation adjusted component is effectively a dampening constant. But simulations show that this method is definitely better than the straight 3.75% inflation-adjusted SWR.

Of all the methods that I have seen, this one appears to be the most realistic. Real life retirees spend less when the port is down, more when it is up, but I believe they dampen their spending a bit, not spending twice as much when their portfolio doubles, not half as much when it is cut in half, for instance.

You could adjust the core inflation-adjusted component based on your willingness to do part-time work, willingness to cut back, etc. This would be a personal decision.

Kramer

 

[ESRBob]

How do you reconcile those wild waves of variable life style? There will always be 2-7 year bulls and the same bears...do you just ride them up and down, living the high life while they hit and lamenting the good old days when they're long past, or is some sort of middle ground really a better bet?

Good questions, TH.
Any SWR model should always be read, "withdraw what you need _up to_ the prescribed percentage.", not "Wahoo -- get a good year and spend spend spend, baby!"

So if you don't need all the $, you just leave it in there, makes your 'base level' higher for every year that follows. Anybody in ER and wanting to stay there is going to be psychologically pretty good at 'banking' the gains if they don't need them. Worst case you use a one-time windfall to fund a one-time purchase, not ramp the lifestyle up on an ongoing spending basis.

Also, with the sort of portfolio we are talking about -- 50-50 mix, widely diversified, you just aren't going to get the rocket launch returns you were thinking about -- 25% gains are probably a once-in-20-years kind of result; 50% plus just seems pretty unthinkable. 'Course the same is true on the downside which is also nice.

 

[REWahoo]

... not "Wahoo -- get a good year and spend spend spend, baby!"

Hey! I'm new at this eR thing, so I'll thank you to leave me out of this discussion until I have a little more experience in this SWR thingamabob, ESR.

REW

 

[ESRBob]

But can you do the Austin Powers groovy hip thing, Wahoo? Shake it around and say, Yeahhh, Baby....

Hey ccongrats on going from wannabe to the real deal. Hope your days are filled with fun and plenty of time to stare out the window and take long walks or whatever you always dreamed of doing.

 

[Zipper]

It's pretty simple really.

Let's say the nest egg is $500 000. On 12 31 you set the bar for the next year at 5% or $25 000.

A year later, after the markets have gone nuts, the stash is worth $600 000.
You take 5% or $30 000.

But oh! oh! The market has a major dump the next year, and after your 5% was deducted, your balance is only $400 000!
You then proceed to take only 5% for the following year or $20 000.

If you have a balanced portfolio, the fluctuations will still be there but staying the course means your ups and downs will be within reason.

Your base, SS or CPP/OAS is a guaranteed safety net.

The 5% keeps you from pigging out in the good times and panicking in the bad times.

 

[TromboneAl]

.

 

[Nords]

Al, did you create this while you were patiently guarding the door at your daughter's graduation party?

 

[cute fuzzy bunny]

Nice beaver, Al.

ROFLLLLLLL

I think we're overanalyzing. Eat, drink, be merry.

Note I said "merry", not "mary".

 

[ESRBob]

It's pretty simple really.

Let's say the nest egg is $500 000. On 12 31 you set the bar for the next year at 5% or $25 000.

A year later, after the markets have gone nuts, the stash is worth $600 000.
You take 5% or $30 000.

But oh! oh! The market has a major dump the next year, and after your 5% was deducted, your balance is only $400 000!
You then proceed to take only 5% for the following year or $20 000.

If you have a balanced portfolio, the fluctuations will still be there but staying the course means your ups and downs will be within reason.

Your base, SS or CPP/OAS is a guaranteed safety net.

The 5% keeps you from pigging out in the good times and panicking in the bad times.

The 95% Rule would liet you spend 95% of 30k in that third year, or 28.5k. It is a lot better than having to drop from 30k to 20k in a year. If markets were still down the second year, you would spend 95% of 28.5k, or $27,070.

Turns out this works historically with very little price to pay in terms of survival rates or SWR. Even in a rough time like 1965-1995, it only 'bit' during 6 years, and the portfolio survived and thrived back to its original levels and indeed 50% above the original real value by 1994.

On the other hand, the normal 4% SWR inflation-adjusted annually etc. ended up with portfolio values about 1/3 as high, while the 5% crashed and burned at every bond/equity blend. (This from the graphs on Bernstein's Intelligent Asset Allcocator, Pages 171-172.

True you get less to spend during those years of high inflation, or years when the markets are sour, but you could tighten your belt or get a bit of part-time work to make ends meet. This would be well worth it if you thereby gained high confidence that your whole portfolio and ER or Retirement plans weren't at risk of flat-lining inside of 25 years, the way the traditional method did for the retiree class of 1965. I don't iknow about you all, but that is the only thing that used to give me shivers about ER. The 4%+ ( 5% seems a bit high based on my research) straight percent withdrawal method, made more livable by the 95% Rule, goes a long way toward fixing that by pushing you to make lots of little adjustments along the way each year when they feel natural and are not so painful.

 

[JPatrick]

Ok I understand the variable WR concept.
What I need now is a calculator that will factor in
portfolio growth- effect of inflation on portfolio.

I want to compute a VWR of 2% with assumed return of 6% and assumed inflation of 3%

Where can I find that?

 

[Nords]

I want to compute a VWR of 2% with assumed return of 6% and assumed inflation of 3%

6%-3% = 3% after inflation (before taxes).

Now take out 2% of (portfoliox1.03).

 

[JPatrick]

6%-3% = 3% after inflation (before taxes).

Now take out 2% of (portfoliox1.03).

Hey Nords, that's the hard way.  I need 40 years worth of data. I was hoping for one of those lazy boy enter the info and push enter calculators.
Wow this ER sure is hard.  Maybe I'll just divide it up into 40 piles for 40 years. With any luck the government will find a way to compute inflation so there ain't none. That would save a lot of work.
Thanks