Kitces: Preparing for Lower Long-Term Returns

[samclem]

If I understand you correctly wouldn't this be exposing your designated spending money to the same portfolio risk as all the other dollars?

Yes, it does. But we can't know when the market will turn around, and unless you need to spend it all on the way down or at the bottom, leaving the funds in the "big pot" for rebalancing means buying cheaper shares and having more money later when the market bounces back. I understand Audrey's counterargument, and it's just as valid (probably more).

Probably the best way to avoid the set-aside lowering portfolio returns is to spend and enjoy your yearly allocation. Don't let that grow too big as it indicates (perhaps?) a failure of planning for fun. Does this make sense? I'm not entirely sure myself.

It depends on the scenario. To my thinking, we want to maximize the utility (fun, pleasure, etc) of the money over the years. If I buy a first-class airplane ticket for $3K in the "good times" and it means later during a downturn I don't have $3k to spend on a frugal-but-fun 2 week camping trip to a national park, then I haven't maximized the utility of that money. And if the situation is more dire still at a later date, I sure would have preferred to have that $3k to keep the electricity and gas turned on for a year.

 

[Lsbcal]

...
It depends on the scenario. To my thinking, we want to maximize the utility (fun, pleasure, etc) of the money over the years. If I buy a first-class airplane ticket for $3K in the "good times" and it means later during a downturn I don't have $3k to spend on a frugal-but-fun 2 week camping trip to a national park, then I haven't maximized the utility of that money. And if the situation is more dire still at a later date, I sure would have preferred to have that $3k to keep the electricity and gas turned on for a year.

Yes, I can see your point.

I never buy first-class tickets and last year we "should" have spent 4.5% but only wound up spending 3.4%. That included a redesign of our back yard and a long trip to Italy. Yet if we'd spent another 1.1% it would not have made our year much or any better (DW might disagree ).

So how to maximize fun over the long haul? I don't know what I'll want in 10 years (first class tickets?) and I don't know if I'll be around then.

 

[FUEGO]

How many 30+ year periods in the data set start with valuations of both stocks and bonds as high as those currently? I count 0. How many started with just equity valuations above 24x? Basically 2, around 1900 and again in 1928-29.

If we're using data to project for periods where we know the starting conditions lie outside the data set then it is wise to proceed with caution . . . or, at the very least, make adjustments to bring your starting position back in line with the available data.

For stocks at least, there have been more than a few 30 year scenarios that start with PE10's above 20 (most of the 1960's, for example).

I see what you are saying, but I'm not sure that we are far enough outside the historical data set to need to apply a discount to today's starting portfolio value and THEN run the newly discounted values through FIREcalc.

 

[FUEGO]

I never buy first-class tickets...

I'm not sure I could ever justify spending money on first class tickets. If someone offered me a tax free $200 per hour (delta between 1st and coach) simply to sit in a 17" wide lightly cushioned seat (coach class) while drinking half cans of soda and reading a book or watching a movie or sleeping, I'd probably do it.

 

[Gone4Good]

By the tilt I assume you mean selling from equities when they run up, and buying more equities when they correct - but any rebalancing does that.

Not exactly. I guess I was thinking that you'd exclude your "poof fund" from the investment portfolio for rebalancing purposes. That money is technically spent, after all.

In that case you'd have a growing cash balance during up markets that you wouldn't rebalance away from. I kind of like that idea. Almost like an automatic way to lean against bull markets.

But I can see doing it the other way too and just lumping the "poof fund" in with the rest of your portfolio AA.

 

[photoguy]

I think we may be reading something into the data that is not there. We think we see a 15 year out correlation when actually it can be completely explained by these meaningless past "cycles."

That's a reasonable point. Given how little data there is and how many people are analyzing it, it's easy to come up with spurious correlations.

Usually what academics do is replicate the work in other markets/countries/timeframes to help eliminate chance findings. I assume this has been done with similar outcomes but I don't really know for sure (I haven't gone searching for these studies nor read any CAPE studies outside of the US).

Also at least the idea of CAPE makes sense from a logical standpoint. And of course, who doesn't love smoothing.

 

[audreyh1]

Not exactly. I guess I was thinking that you'd exclude your "poof fund" from the investment portfolio for rebalancing purposes. That money is technically spent, after all.

In that case you'd have a growing cash balance during up markets that you wouldn't rebalance away from. I kind of like that idea. Almost like an automatic way to lean against bull markets.

But I can see doing it the other way too and just lumping the "poof fund" in with the rest of your portfolio AA.

OK - I see now. No, the growing unspent cash is not included as part of the portfolio AA or rebalance. Once it is withdrawn, it's a kept separate.

 

[papadad111]

I haven't thought hard about a % of portfolio withdrawal method, but it seems to me a similar concept would apply.

All I'm doing, after all, is calibrating my initial withdrawal rate to the median market valuation. I'd want to do the same thing with my initial withdrawal rate for a percentage of portfolio approach too.

Say you want $40K in living expenses and have a portfolio currently valued at $1MM. If you started drawing 4% today and the market is really over valued you'll face long periods where you're withdrawal amounts are well below what you originally wanted to spend.

One way to guard against that is to mark down your current portfolio to a level reflecting "normal" valuations. If I use my previous calculation to arrive at a "fair value" for my $1MM portfolio of $773,000, then I might want to start with a 5.2% withdrawal rate rather than a 4% rate to make sure I'm still getting my $40K in income if markets mean revert.

Maybe I'm comfortable drawing 5.2% or maybe I'm not. Either way it seems to me this is a reasonable way to calibrate one's initial withdrawal amounts in an over valued market.

Question:
Couldn't you just lower your WR... ? It's the same thing. You're adjusting the portfolio. I'm adjusting the WR. I guess I don't see a difference. Different way of saying the same thing.

Forward SWR ... Dividend yield or 10 year treasury +50bps

 

[hnzw_rui]

It's really simple too. All I have to do is calculate 3% of the Dec 31 portfolio value each year and remove that amount. I rebalance afterwards. That's it.

By the tilt I assume you mean selling from equities when they run up, and buying more equities when they correct - but any rebalancing does that.

The fail-safe - well that has to be qualified a bit. A few bad years in a row mean a combination of market drops and withdrawals. This can lead to a much lower portfolio and thus a drastic cut in income. But if you have excess funds set aside, you should be able to get through it without too much pain, and even have the fortitude to rebalance.

Ah, so you're using % of portfolio method and not really VPW.

No, the growing unspent cash is not included as part of the portfolio AA or rebalance. Once it is withdrawn, it's a kept separate.

This actually seems like a sensible implementation of a tactical asset allocation approach. Might copy this when I retire.

 

[Gone4Good]

Question:
Couldn't you just lower your WR... ? It's the same thing. You're adjusting the portfolio. I'm adjusting the WR. I guess I don't see a difference. Different way of saying the same thing.

I'm not sure I follow.

The comment of mine you quoted was about withdrawing a fixed annual percentage from your portfolio. So if you selected 3% in year 1 and had a $1MM portfolio, you'd have $30K to live on. If in year 2, your portfolio fell to $700,000 you'd have only $21K to spend (3% of $700K)

How does lowering your withdrawal rate help?

 

[papadad111]

I'm not sure I follow.



The comment of mine you quoted was about withdrawing a fixed annual percentage from your portfolio. So if you selected 3% in year 1 and had a $1MM portfolio, you'd have $30K to live on. If in year 2, your portfolio fell to $700,000 you'd have only $21K to spend (3% of $700K)



How does lowering your withdrawal rate help?

I am Sorry. Disregard the post. It seems I was posting on another topic and misread your comments. Apologies !!!

 

[nun]

All this preoccupation about the stock market makes me think that people aren't diversified enough. There was a time before 401ks when very few people would have ever considered retiring on the proceeds from an equity portfolio. Now it seems to be the norm.

 

[Lsbcal]

All this preoccupation about the stock market makes me think that people aren't diversified enough. There was a time before 401ks when very few people would have ever considered retiring on the proceeds from an equity portfolio. Now it seems to be the norm.

Wasn't the Trinity study all about equities and retirement? That came out in 1998. Seems to me quite normal to consider one's stock/bond allocations and equity variations in retirement. It would be wonderful to have a very smooth pension like portfolio but I don't know how to form one that works in the real world today and going forward.

Being realistic, most of us do not fall into your category except for the SS part: Target WR: 0.0% Approx 100% SI (secure income), pension, SS, rent.

 

[papadad111]

Well. Let's see what's changed in the 21st century:

No time in recent financial history have non equities (bonds and savings accounts) paid such low rates of interest than in the past decade or so.

The advent of the 401k increased equity ownership (percent of households) in the USA from the low 20's to what is now around 50 percent.

Never has technology allowed access to equities as it now allows - discount brokers, ETF's, robot advisory services and more ...

The rapid decline and almost extinction of the traditional DB pensions in America over the last 30 years and especially the last 20 years has resulted in far more "self directed" retirements.

Life expectancy has grown and there are more retirees drawing down from a social security fund that will not exist as we know it today for the next generation of retirees. Dependence on such systems is dangerous, thus more self directed plans

The escalating cost of healthcare and the avoidance of socialized free for all medicine (ala Canada, Cuba etc) has caused the need for retirement income to outpace or at least keep up with that form of inflation.

Property has yet to reach pre-crisis levels -- housing is no longer replied upon as a safe and unlimited source of funds.

Finally. People are retiring vs working till they die... Like they did in the first half of the 20th century

The list goes on and on as to why this is happening and why there is interest on a broader scale than "last time"...

 

[Gone4Good]

All this preoccupation about the stock market makes me think that people aren't diversified enough. There was a time before 401ks when very few people would have ever considered retiring on the proceeds from an equity portfolio. Now it seems to be the norm.

That's probably true. But before 401(k)s most people retired on pensions. And before that, most people probably didn't retire at all.

 

[papadad111]

Being realistic, most of us do not fall into your category except for the SS part: Target WR: 0.0% Approx 100% SI (secure income), pension, SS, rent.

I concur. Closest likely to see this side of the border is someone able to live on dividends and perhaps bond interest, likely both with a heavy tilt toward equity dividends with real bond returns about 0 (interest just at the rate of inflation) ... Plus maybe some rental income but to think that most rental income is " secure" is likely underestimating rental income risk. Plus this is an EARLY retirement board so those who are early retirees are not likely even collecting SS yet

 

[nun]

I concur. Closest likely to see this side of the border is someone able to live on dividends and perhaps bond interest, likely both with a heavy tilt toward equity dividends with real bond returns about 0 (interest just at the rate of inflation) ... Plus maybe some rental income but to think that most rental income is " secure" is likely underestimating rental income risk. Plus this is an EARLY retirement board so those who are early retirees are not likely even collecting SS yet

True, no SS for me for 11 years. I'm spending rent and cash until the pension starts at age 55. Rent can be very secure if the house is in a good rental market.

 

[nun]

Wasn't the Trinity study all about equities and retirement? That came out in 1998. Seems to me quite normal to consider one's stock/bond allocations and equity variations in retirement. It would be wonderful to have a very smooth pension like portfolio but I don't know how to form one that works in the real world today and going forward.

Being realistic, most of us do not fall into your category except for the SS part: Target WR: 0.0% Approx 100% SI (secure income), pension, SS, rent.

The Trinity study, and Bergen before it, was really a reaction to the development of 401ks and the shifting of retirement risk from the employer to the individual employee. The late baby boomers born after 1960 are probably the first generation going into retirement without pensions and fully responsible for their own retirement income. I think that most take on too much risk in retirement, even with a 4% WR and a 60/40 portfolio. I believe a mix of stocks, bonds, SS and other income sources is the right one for retirement or semi-retirement and those might be rental income, part time work, annuities, TIPs, CDs or pensions. Some of these might reduce potential retirement income, but come with a lot less volatility than stocks and bonds so you can stop worrying about the stock and bond markets quite so much.

I want a secure income floor that doesn't depend on the Chinese growth rate or what Janet Yellen says one afternoon.

 

[Lsbcal]

The Trinity study, and Bergen before it, was really a reaction to the development of 401ks and the shifting of retirement risk from the employer to the individual employee.

I never heard that but I'll take your word for it.

The late baby boomers born after 1960 are probably the first generation going into retirement without pensions and fully responsible for their own retirement income.

I know I'm not the only retiree on this board that was born well before 1960. "Baby boomers" refers to the post-war generation with a starting date of something like 1946. When I looked it up, the period was 1946 to 1964.

I think that most take on too much risk in retirement, even with a 4% WR and a 60/40 portfolio. I believe a mix of stocks, bonds, SS and other income sources is the right one for retirement or semi-retirement and those might be rental income, part time work, annuities, TIPs, CDs or pensions. Some of these might reduce potential retirement income, but come with a lot less volatility than stocks and bonds so you can stop worrying about the stock and bond markets quite so much.

I don't think one should make a blanket statement about the right amount of risk. And a lot depends on one's overall portfolio size. The larger the size the less risk matters.

Most people would reduce risk if possible. Rental income is nice but carries a lot of risk and maybe best if balanced by other things in ones portfolio. I've had rentals and know of at least one person I was friends with that went bust from rentals. Annuities ... well I won't touch that subject. TIPS are just not a practical income source at the current low real rates. Pensions are not something you pick up later in life i.e. they come with the job choice and are not an investment option. I could go one but each of these deserves a separate thread.

I want a secure income floor that doesn't depend on the Chinese growth rate or what Janet Yellen says one afternoon.

Sounds like you have made good long term choices for you.

 

[Gone4Good]

Rental income is nice but carries a lot of risk . . .

And it's not exactly passive. If I were living entirely on rental income I wouldn't consider my self retired. I'd be self employed.

 

[nun]

And it's not exactly passive. If I were living entirely on rental income I wouldn't consider my self retired. I'd be self employed.

It depends on how you do it. Having multiple rentals is a pain and I imagine is a lot of work. But I chose to just buy a two family home and rent out the downstairs apartment. So I can keep an eye on the place by simply going downstairs. It's been continually rented for the past 19 years and I only have to do deal with issues a couple of times a year. If I can't fix something myself I just get a professional to do it. The rent covers just over a third of my income.

 

[Fedup]

And it's not exactly passive. If I were living entirely on rental income I wouldn't consider my self retired. I'd be self employed.

I have property manager, so is my sister. I have never got involved. I do check on the property occasionally and nudge them to raise rent slowly. Other than that not much. Sometimes, they think they work for the tenants, in which case I've got rid of them. I'm very please with my current property manager.


Sent from my iPad using Early Retirement Forum

 

[ronin]

Edgar Bergen vs. William Bengen, who do you trust to guide your withdrawal rate?

 

[CaliforniaMan]

Edgar Bergen vs. William Bengen, who do you trust to guide your withdrawal rate?

Are we limited to them only? Can I choose Candice Bergen?

 

[ronin]

Are we limited to them only? Can I choose Candice Bergen?

At your own risk!