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Mutual Fund Fees and the Safe Withdrawal Rate
Old 05-25-2013, 06:14 PM   #1
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Mutual Fund Fees and the Safe Withdrawal Rate

Like many, I assumed you needed to subtract the average expense ratio of your mutual funds (as well as any other fees tacked on) from the classic Safe Withdrawal Rate to figure out what was truly safe to withdraw for personal use from a portfolio of mutual funds with expense ratios.

It turns out, it's not quite that bad. Thanks to AviOren on Morningstar who linked to this 2012 paper from Mike Kitces. It turns out that you just need to subtract 40% of your expense ratio plus fees from the "fee-free" official SWR (which is based on fee-free indexes rather than funds with expense ratios). Kitces also explains why. The Impact of Investment Costs on Safe Withdrawal Rates - Kitces | Nerd's Eye View

Scott Burns also mentions it's not as simple as subtracting the expense ratio, and suggests using firecalc to model your actual expense ratio and fees - AssetBuilder - Will the Real Safe Withdrawal Rate Please Stand Up? - AssetBuilder Inc., Registered Investment Advisor

[Apologies if this was already discussed back in summer of 2012, but I usually see folks here subtracting the expense ratio from SWR, including the recent discussion of the Pfau/Blanchett paper.]
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Old 05-25-2013, 06:22 PM   #2
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This M* interview with Blanchett further muddied the waters: Mind Fees in Your Withdrawal Rate
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Old 05-25-2013, 07:42 PM   #3
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Or with active funds, use a fee of -1% if you're optimistic?
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Old 05-25-2013, 08:22 PM   #4
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Originally Posted by audreyh1 View Post
... I usually see folks here subtracting the expense ratio from SWR, ...
Interesting thanks for posting. It took me a little to get my head around '1% is not 1%', but I see it now. Since in the worst case scenarios, the portfolio is declining, the fees decline as well. But the real question is, how is this relevant?


Let's recall that FIRECALC has an actual Expense Ratio input (0.18% default), so unless there is an error, which would be easy to test, FIRECALC is using that as a percent of remaining portfolio, so a 4% 'SWR' number reflects all this. Or did I miss something?

OK, I just did some runs, and it is about what he claims. Default 0.18% Expense Ratio and 95% success on a $1M portfolio provides a $39,751 WD. And $40,586 at 0% ER. Increase that to 1% ER, and it only drops to $36,665. So ~ $4,000 delta, not a $10,000 delta. Quite a bit less than what I'd expect with the simple math. But again, 10% less to spend each year is not insignificant either, just less of an impact than we might have thought.

Conversely, if we have growth in the portfolio (historically roughly half of the scenarios), that expense ratio should grow in importance, right? Not a threat to our well being, but less assurances for us as we age. It would be comforting to see that we have maintained or grown our buying power, and to have those funds in case we live a long life, or have some added financial issues as we age. Our heirs/charities will benefit from low ERs.

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Old 05-25-2013, 09:48 PM   #5
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Yeah, basically - in the worst case scenarios the portfolio is declining fast, so the expenses are reduced. In the better cases, the fees are growing with the portfolio, so you're paying more - but the portfolio is growing, so you're not going to run out of money!
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Old 05-26-2013, 12:50 AM   #6
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The Impact of Investment Costs on Safe Withdrawal Rates - Kitces | Nerd's Eye View
Excellent article. One of the most useful things I've read in a long time. Thanks for posting.
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Old 05-26-2013, 08:02 AM   #7
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Mike Kitces is a great resource. I check his blog once in a while. M* occasionally interviews him on some relevant topic.
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Old 05-26-2013, 09:12 AM   #8
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Or with active funds, use a fee of -1% if you're optimistic?
LOL!

Actually, I tend to believe that my portfolio, which is much more diversified than the simple ones used in the studies, should support a slightly higher SWR. That could be modeled with Firecalc, I think. Certainly the long-term performance should be slightly improved according to the "efficient frontier" models used to design an AA. But, whatever, I'm not banking on it. I'm not using the classic SWR anyway, so our spending will rise and fall with our portfolio, automatically adjusting for actual portfolio performance after fees.
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Old 05-26-2013, 10:07 AM   #9
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Excellent article. One of the most useful things I've read in a long time. Thanks for posting.
I'm currently reading "Spend 'till the End", where Burns is a co-author with the ESPlanner guy "Kotlikoff". The book is a few years old, but they make some excellent points. Point for this thread is that they call typical SWR stuff a "rules of dumb" (play on "rule of thumb"). Of course, they're trying to pitch consumption smoothing and ESPlanner throught the whole book. But whether you use their stuff, i-orp or your own spreadsheet, I think modeling is the way to go nowadays.
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Old 05-26-2013, 10:17 AM   #10
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That's a very interesting article Audrey, thanks! Especially comforting to those of us paying less than 0.20% expense ratios...
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Old 05-26-2013, 12:04 PM   #11
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After looking at this thread yesterday I did my first analysis of investment expenses in 25 years of retirement.

The spreadsheet totals commissions and fees, weighted expenses of ETF/mutual fund holdings, investment related periodicals (WSJ, etc), advisory subscriptions, and investment books. All together it is 0.24% of my current portfolio value. (This is without the adjustment described in Kitces' paper. I think in normal years it should be less, since I did some opportunistic option trading this year, which at my broker is quite a bit more expensive than stocks.

Another category of expense that I keep an eye on but did not consider is slippage. In most stocks and ETFs it is miniscule in the normal small investor trading amounts, given the common 1 cent bid/ask spread. If I am going to buy a stock with a bigger spread, I must convince myself that I am very unlikely to ever sell it, and that it is trading very cheaply on all criteria I can think of. The last time I did pay more than 1 cent was fall/winter 2008.

I will only use this indirectly, as since coming to ER.org I have tended to use the WR concept as a check on my actual sources of funds which are interest, dividends, royalty payments, etc. In another thread ERD50 mentioned that I might spend capital gains over inflation or something like that. So far, I have re-invested all of those, but it is a good concept for the future if I ever need it.

Overall, I doubt that my spending will ever best the lesser of actual income or 4% of current portfolio value. In any case, I have no clue what my portfolio value was when I retired. Until I came here to this forum I had never heard of SWR, but now I see it's importance.

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