Originally Posted by donheff
CJKING, thinking about this PE10 approach leaves me a bit confused. How is it much different than simply picking a % (e.g.5%) and taking that much out of the current portfolio each year? I haven't run the numbers but intuitively the PE10 won't change dramatically each year (it is a running ten year average). So, if you were at 3.3% (PE10 = 24) this year and the your portfolio collapsed 50%, PE10 would presumably fall a bit, but no more than about 5% right? So next year you would take maybe 3.5% from a portfolio half as big reducing your spendable income almost by half, correct? What am I missing here?
The way I interpreted his method is different. If your portfolio is correlated 1:1 with PE10, and the S&P suddenly dropped 50%, PE10 would also drop ~50%, as 10 year averaged earnings are very slow moving, but the numerator, the "price"of the S&P has collapsed.
What would not change very much is your allowable withdrawal amount. Your portfolio has dropped 50%, but your SWR has increased proportionately. Essentially, the $ value of your withdrawal is going to be proportional to averaged10 S&P earnings, rather than to the $ value of the S&P. This is a step up from the typcal unvarying all-season SWR idea.
A more direct way to do this is just make your annual withdrawal some portion of what Warren Buffet calls look-through earnings. That is very easy to figure in the case of the S&P, just look at some average of S&P earnings, perhaps 10 years. Depending on S&P earnings growth rates over the 10 years, this may be very close to only spending current year dividends, and based on the same idea-what counts is not quoted price, but earning power. But don't expect many people here or elsewhere to go for this approach. Everone likes some magic to allow larger withdrawals, and sometimes the magic formulas work.
In my opinion, a less complicated and likely safer method is to spend the annual dividend amount of a well diversified group of dividend growers. If you are afraid of having too little to spend during big busts like 08-09, smooth the dividend over several years, and use your cash reserves to smooth your spending.
As soon as you are drawing more than well supported dividends are producing over a short moving average, or better yet in the trailing year, you are liquidating your portfolio, and running all the risks that go with living from a liquidating equity portfolio.