Is there a formula for this?

[spncity]

Hi All

Do I understand this correctly? The calculation of 25X expenses gives you a 4% safe withdrawal rate for 40-50 years with an approximate 60/40 stock/bond mix while preserving the portfolio (with the chance that the portfolio could grow if the market does well).

So, if leaving a chunk of change for heirs after you die is "not" a goal, is there a calculation or formula that is _____ X expenses = _____ withdrawal rate for 40 years using essentially all principal?

spncity
-----> not a math major
-----> not sure if this question makes sense
-----> wondering if willingness to use principal makes our FIRE target a lower sum and thus an earlier date
-----> I understand this is not a "fail safe" strategy, but as a backup plan, healthy spouse could be [-]sent[/-] coaxed back to into workplace at least part-time in a prolonged "down" market, heh-heh.

 

[rmark]

The early withdrawal studies that can be roughly summarized as having centered on

- 60/40 market weight portfolios, 25 year withdrawals, U.S. market returns and volatility
- Arriving at 4% of initial portfolio value + annual inflation withdrawal, without resetting
- Lower starting withdrawals or overweighting of equities for longer withdrawal periods

http://www.afcpe.org/doc/Vol1014.pdf is best overview I've found.

 

[rmark]

Divide after tax fixed pensions and mixed portfolios annually over IRS life expectancy. This will provide a annually increasing withdrawal similar to the inflation adjusted version, but with a late life spend down as life expectancy shortens.

 

[REWahoo]

Hi All

So, if leaving a chunk of change for heirs after you die is "not" a goal, is there a calculation or formula that is _____ X expenses = _____ withdrawal rate for 40 years using essentially all principal?

No formula or rule of thumb that I'm aware of.

The 4% rule, based entirely on history, would use up almost all your principal in a worst case situation. Any increase above the 4% (other than the annual increase for inflation) would show situations where your principal went to 0 at some point.

 

[aenlighten]

The worst case is 4%

and you may or may not have anything left over at the end. It actually takes something more like 3.3% to maintain a portfolio's value, but most of time (if you weren't starting out in 1966 or 1929) it would be higher.

 

[Alan]

My first response to the question is how can there be a formula when the nature of the stock and bond market is so uncertain, as is an individual's life expectancy ?

Although I think there is good formula that gives a high chance you will expire just as your principal expires I remembered that are some rules you can follow to increase your withdrawal rate above the 5% and minimize your legacy when your investments are doing well.

Have you seen this study on variable withdrawal rate.


I extracted and summarized the rules for when I ER.

The capital preservation rule applies when a current year's withdrawal rate—using the decision rules in effect—has risen more than 20 percent above the initial withdrawal rate.The capital preservation rule expires 15 years before the maximum age to which the retiree wishes to plan; for example, a retiree assuming she would not live beyond age 100 would discontinue the capital preservation rule after age 85.Under the capital preservation rule, is the current year's withdrawal is reduced by 10 percent. The other decision rules in effect are then applied to this decreased withdrawal amount.This decreased withdrawal becomes the basis for determining the following year's withdrawal amount.

Portfolio Management Rule
Following years where an asset class has a positive return that produced a weighting exceeding its target allocation, the excess allocation is sold and the proceeds invested in cash to meet future withdrawal requirements.Portfolio withdrawals are funded in the following order: (1) overweighting in equity asset classes from the prior year-end, (2) overweighting in fixed income from the prior year-end, (3) cash, (4) withdrawals from remaining fixed-income assets, (5) withdrawals from remaining equity assets in order of the prior year's performance.No withdrawals are taken from any equity following a year with a negative return if cash or fixed-income assets are sufficient to fund the required withdrawal.

Inflation Rule
Yearly withdrawals increase by the annual rate of inflation as measured by the Consumer Price Index (CPI) except when the withdrawal rule freezes the withdrawals.The maximum annual inflationary increase is 6 percent.There is no "make-up" for a "capped" inflation adjustment

Withdrawal rate
Withdrawals increase from year to year in accordance with the inflation rule, except that there is no increase following a year where the portfolio's total return is negative and when that year's withdrawal rate would be greater than the initial withdrawal rate.There is no "make-up" for a missed increase.Prosperity RuleThe prosperity rule applies in years with a withdrawal rate more than 20 percent below the initial withdrawal rate.Under the prosperity rule, the current year's withdrawal is increased by 10 percent. The other decision rules in effect are then applied to this increased withdrawal amount.This increased withdrawal amount becomes the basis for determining the next year's withdrawal.

 

[cute fuzzy bunny]

In short, if the future is the same as the past, spending more than 4% can be done if you're willing to take on more risk of running out of money at the end...when you'll be a little too old to do much about it.

No free lunch.

Given theres a possibility that the future isnt as good as the past, even 4% might be too much.

But you can probably squeeze the budget a bit if it gets tight.

Providing we dont hit something like the two horror show scenarios (the depression and the 65-75 period) you could probably get away with 5-5.5%.

I guess the good question is whether you'd rather improve your quality of life earlier, and take on perhaps a 20% chance of spending your last ten years sitting in a little rented room eating bread and cheap soup?

 

[Nords]

I extracted and summarized the rules for when I ER.
The capital preservation rule applies when a current year's withdrawal rate—using the decision rules in effect—has risen more than 20 percent above the initial withdrawal rate...
The capital preservation rule expires 15 years before the maximum age to which the retiree wishes to plan...
Under the capital preservation rule, the current year's withdrawal is reduced by 10 percent...
This decreased withdrawal becomes the basis for determining the following year's withdrawal amount...
Following years where an asset class has a positive return that produced a weighting exceeding its target allocation, the excess allocation is sold and the proceeds invested in cash to meet future withdrawal requirements...
Portfolio withdrawals are funded in the following order:No withdrawals are taken from any equity following a year with a negative return if cash or fixed-income assets are sufficient to fund the required withdrawal...
Yearly withdrawals increase by the annual rate of inflation as measured by the Consumer Price Index (CPI) except...
The maximum annual inflationary increase is 6 percent...There is no "make-up" for a "capped" inflation adjustment..
Withdrawals increase from year to year in accordance with the inflation rule, except...
There is no "make-up" for a missed increase.
The prosperity rule applies in years with a withdrawal rate more than 20 percent below the initial withdrawal rate.
Under the prosperity rule, the current year's withdrawal is increased by 10 percent...
This increased withdrawal amount becomes the basis for determining the next year's withdrawal.

Yikes, gimme a plain ol' simple nuclear-reactor startup checklist any day. I know those can be completed in less than eight hours.

I wonder how much we'll enjoy working with this system when we're 92 years old. Or else we'll have a Guyton portfolio spreadsheet that'll trigger our credit card's miniature speaker when we whip it out, saying "I'm sorry, Hal, I can't do that..."

 

[Alan]

Yikes, gimme a plain ol' simple nuclear-reactor startup checklist any day. I know those can be completed in less than eight hours.

I wonder how much we'll enjoy working with this system when we're 92 years old. Or else we'll have a Guyton portfolio spreadsheet that'll trigger our credit card's miniature speaker when we whip it out, saying "I'm sorry, Hal, I can't do that..."

Oh yes, this is definitely the nuclear option. I should have just stuck to the simple reply "there is no formula"

 

[rmark]

Starting with the early withdrawal studies that can be summarized as centering on

- 60/40 market weight portfolios, 25 year withdrawals, U.S. market returns and volatility
- Arriving at 4% of initial portfolio value + annual inflation withdrawal, without resetting
- Lower starting withdrawals or overweighting of equities for longer withdrawal periods

So it appears that you divide your portfolio over initial life expectancy while maintaining a market weight portfolio, keeping the higher stock allocation to offset lower returns due to volatility. No high stock allocation then no late life growth to offset inflation – a point often overlooked in many suggested allocations. Using the above formulation, a 33 year withdrawal starts at 3%, a 20 year at 5%. Or you can overweight equities praying (not planning) irregular capital gains pay regular bills.

Two problems – small sample size used in development plus investor costs and actions
- Almost all other countries had lower returns, higher volatility, and longer bad runs
- More conservative investors, lower dollar weighted returns, actual investing costs
This suggests the offsetting growth is rarely realized in real life, leaving only the initial life expectancy equivalent withdrawal rate – you’re likely just dividing money over life.

(using “Triumph of the Optimists” as a proxy for market data, the commonly used 1926 – 2000 U.S. period is only 5% of years in their 15 country sample, or 6.7% of countries.)

Most of the more recent research seems to center on mining parts of the already limited U.S. sample to generate complicated spending rules of dubious validity. Or they try to drive the withdrawal rate up using small stock allocation – never noting that the average small stock investor likely has near average returns due to lower dollar weighted returns.
----------------------------------------------------
So this is in fact what I plan on -

Divide after tax fixed pensions and mixed portfolios annually over IRS life expectancies, spending the lesser of the new division or the previous yearly + inflation, averaging these together to reduce annual spending changes. Portfolio unneeded for withdrawals used as retirees savings. Maintain adequate insurance to protect portfolio against personal losses.

More complicated withdrawal rules are likely spurious patterns due to small sample size.

 

[kumquat]

I may get crucified for mentioning this but:

If you have no one you want to leave any residual to, you can buy an annuity at some point and make sure you do not run out of money before you run out of time.

 

[Nords]

I may get crucified for mentioning this but:

It's not the annuities themselves but rather the slimy tactics, glittering generalities, and half-truth exaggerations used to sell them.

An AIG-backed annuity from Vanguard is probably worth considering for some investors. It'd be an even better deal if it came from a more reputable insurance company at lower fees.

 

[clifp]

Hi All

Do I understand this correctly? The calculation of 25X expenses gives you a 4% safe withdrawal rate for 40-50 years with an approximate 60/40 stock/bond mix while preserving the portfolio (with the chance that the portfolio could grow if the market does well).

So, if leaving a chunk of change for heirs after you die is "not" a goal, is there a calculation or formula that is _____ X expenses = _____ withdrawal rate for 40 years using essentially all principal?

spncity

Actually there is a formula for what you are trying to do. I don't know the exact detail on the formula but if you are turning 50 this month and want a fixed annuity with inflation adjustment Vanguard will give you 4.09% on your investment. If you are turning 60 the rate increases to 5.16%

Assuming the underlying insurance company (AIG) doesn't go out of business this will guarrantee that you'll always have income and your heirs will get nothing.

I am certainly not advocating this but it is an option, and perhaps not a bad one for some people.

 

[windsurf]

It's not the annuities themselves but rather the slimy tactics, glittering generalities, and half-truth exaggerations used to sell them.

An AIG-backed annuity from Vanguard is probably worth considering for some investors. It'd be an even better deal if it came from a more reputable insurance company at lower fees.

Not to mention the fact that insurance companies sometimes belly up leaving policy holders at the mercy of their state's guarantee association (fractional protection).

 

[clifp]

Not to mention the fact that insurance companies sometimes belly up leaving policy holders at the mercy of their state's guarantee association (fractional protection).

I am somewhat curious about this. How often has this happened in the past, and what happened to the holders of the annuities. Anybody have some links or good stories?

 

[cute fuzzy bunny]

Very infrequently AFAIK. In fact, many insurers continued to pay through the Depression. Although i'm sure there are plenty of shady, poor rated insurers that defaulted on their payments.

That having been said, while you dont "leave a big pot and the end", you also get paid less than the 4% SWR by the insurance company throughout, so its a moot point.

I'd rather keep the money, take the 4%, and if I needed a bunch of cash for LTC or some other dire emergency late in life, still have it.

If someone can find a solid annuity from a solid insurer that pays 4%, adjusts for inflation, and doesnt wallop you with taxes and has survivors benefits in the instance of having a spouse, please point it out.

 

[cute fuzzy bunny]

Yep, vanguard lifetime annuity in my circumstances (45yo, 45yo spouse) with CPI adjustment and joint survivor pays about 3.3%. Single without the inflation adjustment looks pretty good at 6.4%, but I'll bet that doesnt look so hot in 20-30 years after inflation has degraded it to bread and soup levels.

 

[clifp]

Well CFB that is because you are too young and married live in California and want your spouse to receive a 100%.

The numbers I quoted were for a single man.A 65 year old couple with the survivor getting 75% of the benefits (not unreasonable) gets just under 5% on their money.

I certainly agree with you that I rather keep the money and depend on asset allocation to earn 4% real returns but annuities aren't the dumbest thing to do for folks who are comfortable with stock market investing.

 

[cute fuzzy bunny]

Perhaps. After 3 days of baby watching duty I sure as heck dont feel too young.

I do note that vanguard now offers medical underwriting if you think you can make a case that you might drop dead sooner than scheduled. I dont think I saw that option when I last ran the numbers.

 

[ferco]

Why not best of BOTH worlds to hedge your bets. 1/2 in an annuity (drawing 4% return) and 1/2 in remaining funds(eg., Roth IRA) drawing down 4%. That way the Roth is your "cushion" for any funny stuff that may occur along the merry way.

Anyone have the numbers for a million dollar portfolio for a 60 y/o with 500k in a Vanguard life-time annuity and 500k in a Roth IRA (60/40 split), drawing 4% over 30-40 yrs.

 

[jIMOh]

Hi All

Do I understand this correctly? The calculation of 25X expenses gives you a 4% safe withdrawal rate for 40-50 years with an approximate 60/40 stock/bond mix while preserving the portfolio (with the chance that the portfolio could grow if the market does well).

So, if leaving a chunk of change for heirs after you die is "not" a goal, is there a calculation or formula that is _____ X expenses = _____ withdrawal rate for 40 years using essentially all principal?

spncity
-----> not a math major
-----> not sure if this question makes sense
-----> wondering if willingness to use principal makes our FIRE target a lower sum and thus an earlier date
-----> I understand this is not a "fail safe" strategy, but as a backup plan, healthy spouse could be [-]sent[/-] coaxed back to into workplace at least part-time in a prolonged "down" market, heh-heh.

The higher the expenses multiplier, the more likely you can leave something for heirs.
The lower the SWR, the more likely you can leave money to heirs.

For example, if you save 33X expenses, then you will more than likely have money left over. If someone else saved 50X expenses, they would probably have more left than you did.

If you withdraw 4%, you might leave something behind. If I withdraw only 3%, I would probably have more lying around. If someone else only withdrew 2%, they would have more left in the end than either of us.

 

[spncity]

Thank you for replies!

Now, does anybody know where I can get a time machine - because I do an amazing job of retrospective stock picking...!

 

[cute fuzzy bunny]

I'd rather have a crystal ball...

 

[kcowan]

If you withdraw 4%, you might leave something behind. If I withdraw only 3%, I would probably have more lying around. If someone else only withdrew 2%, they would have more left in the end than either of us.

That is the LBYM strategy. But if you invest like a VC and do it successfully, you can leave a big legacy. Most advice you will find here is related to LBYM and most efficient conservative investing. But that is not the only strategy.

However it does require a lot of work and living outside you comfort zone.

 

[chinaco]

My first response to the question is how can there be a formula when the nature of the stock and bond market is so uncertain, as is an individual's life expectancy ?

All one can do is use probability (math to develop expected ranges) of outcome (based on the past) which can be used to extrapolate a possible future. If we do not have world-wide collapse of the financial markets or extraordinary events, it is likely to be a reasonable guide for the future.

Although, a guide is like a road map. It indicates that the road should be there and in good working condition. However, as you drive down that road, you might find construction or obstacles that requires a temporary detour. You may need to adjust your expected speed and arrival time. The guidelines you outlined from the Financial Planning Whitepaper are similar to making travel adjustments... You may need to adjust your spending habits to govern the outflow of money to match your Portfolios expected inflow of capital (i.e., growth). Your expected portfolio performance (like your visibility when driving) is very near to you... the current performance. Similarly, you can only see so far ahead in your car.

If you use reasonable judgment and spending habits... and we do not have extraordinary events (that are catastrophic)... the 4% will work just fine. If things get bad, you will naturally tighten the belt and get by on less. In my book, it is better to tighten the belt early (and make a proactive decision) rather than have it forced on me by running out of money.

This is the risk we take.