Retrenchment--you can do it later than you think!!

[tarheeljim]

Good morning FIRE-ee's and wannabe's (like me!). I found a great article which discusses when retirees should retrench (i.e. reduce their withdrawals due to a shrinking asset base...for whatever reason). I claim no credit for it, but thought it would be a good thing for all to read. The FPA Journal is THE professional journal for CFP's.

NOTE: it may only be good until September 30, although if you pm me I can scan and email you a copy.

I am a CFP and a CPA by trade, so this stuff naturally interests me!

Here ya go:

When Should Retirees Retrench? Later Than You Think


Hope it's helpful to someone, and Godspeed in your planning!

Jim in NC

 

[OAG]

I feel asleep at about line 200.

 

[REWahoo]

I feel asleep at about line 200.

Retrench and give it another try.

 

[tarheeljim]

Oh yeah, I forgot to say it's kinda dry and technical...

I feel asleep at about line 200.

...but the info is great if you can wade through it.

...please pass the extra-caffeinated coffee...

Jim in NC

 

[Grep]

If there's any useful information in it, it's deeply buried in a droning, repetitive morass of hypothetical scenarios, etc. My advice? Give up now before you wade in too far.

 

[Grep]

I'll spare you. Here's the executive summary:

"Running out of money? No problem. You can stall before reducing your expenditures longer than you think. Hey, you could die earlier than you expect, after all, or there could be a nice big bull market that saves your bacon.

If you don't stall and reduce your expenses down to the 4% rule or similar, you will reduce your standard of living way too much without having all that big an impact on how long your money will last.

We came up with some terms and threw in a table or two that supports this, but it's all far too long and boring to wade through. Don't bother trying. Really.

Took our advice and kept spending, you didn't die, and no miracle occurred, and so you have a bigger problem later in life? Well, we'll fix that in a paper that we haven't written yet. But we figure it probably involves selling your house, buying an annuity and getting a part time job! Sweet!"

 

[CuppaJoe]

The first cup of coffee hasn't hit my bloodstream yet but thanks to this thread, I'm making no changes. The bacon will be the last thing to go, needs no bull market to fry on.

 

[Gotadimple]

It's just a fancy way to determine how much you can withdraw each year based on how well your portfolio performed. One could go through the gyrations, or just use the theory Gummy talks about as "Sensible Withdrawals."

It's also a lot easier to read.

sensible withdrawals

-- Rita

 

[Canadian Grunt]

I have a degree in finance so I have to comment on this article as it peeks my interest.

First, their discount rate of 8% is too high. The discount rate should reflect the risk free rate + 2% when projecting forward with any accuracy. At university we used the risk free rate of return as the discount rate to provide a baseline for equations. It seems they are using historical rates of return from the stock market and subtracting 2%.

This leads me to their second assumption. The likelihood of a substantive bear market is .03, with the last protracted bear in 2000-2002 (details in appendix).

Hmmm. I think their math is flawed.

I agree with the overall assumption that retrenchment is desired when a portfolio nears failure but what problem are they assessing? Was the initial withdrawal rate too high? Is the solution for an unattainable standard of living on withdrawals at 4% to increase risk by moving to a higher standard of living at 7.5%

What was the problem statement?

It appears the second opinion requires a bump from 4% to 7.5% withdrawl from the portfolio. How do they support this level of withdrawals?


I am not impressed with some of the logic that comes out of the Journal of Financial Planning. It appears this submission is garbage from a financial perspective as it is all over the place without the required math to justify statements.

 

[Running_Man]

It is now mid-2007. Adele is 65 and has clearly become worried

As she should be..

Adele has lived in her home for many years and is comfortably situated. But she also has large mortgage and property tax payments. Eliminating such a budget shortfall will clearly require moving to an unfamiliar neighborhood with much cheaper housing. A 4 percent withdrawal from her portfolio of $600,000 will provide $24,000 the first year. That will give her a total income of $44,000 for the coming year. But with current expenses running at an annual rate of $60,000, it is clear that a radical restructuring will be necessary.But how can Adele determine how much she should retrench at present and in the future as events unfold? In contrast to her friend George's opinion, the second opinion by the author advocates doing so by using the Retrenchment Rule developed in this paper. This rule shows that it is reasonable for Adele to withdraw as much as 7.5 percent for the coming year in order to avoid painful retrenchment.
A 7.5 percent withdrawal from her $600,000 portfolio gives her $45,000. With the $20,000 of Social Security this provides a limit on her expected spending in the coming year of $65,000 to avoid painful retrenchment.

Yikes!!! This is how Wal-Mu goes under.Assume for a minute that poor old Adele listened to this advice. She now has a house that is worth 15 percent less than it was a year ago when she should have sold. A balanced index fund such as Vanguard is down 4 percent from a year ago so assuming 545,000 *.96 = $523,000 right now left for her retirement and still with a large mortgage and a horrible time to sell. A 13 percent decline in her portfolio in one year, and Lord knows what the percentage is of the Home equity lost, assuming even a fifty percent equity in '07 results in a loss of 30 percent of the equity balance. At her present withdrawl rate she would need a 9.4 % return from her balanced account to not have the balance drop further!!!

I sure hope she enjoyed that last year, looks like she'll have about 5 or 6 more and then to the studio apartment and watching TV after that.

 

[W2R]

I thought it was interesting and I feel like I know more now about withdrawal rates than I did before reading it.

BUT - - would I risk my retirement by trying this? NO WAY!!! As others have pointed out, the logic is somewhat dubious.

Plus, in my case I really don't need to do this. But I thought it was a very interesting article, and not a bit boring!

 

[Nords]

I feel asleep at about line 200.

Surely this can't be worse than naval message traffic or reactor plant manuals.

Let's see, your portfolio ends at about the same value whether you cut back immediately or cut back over 10 years. These numbers occur because all the simulations (with their assumptions) have a high probability of leaving you with more money than you actually needed. The market may save your retirement unless you accidentally stumble on one of the century's top three bear markets (we'll tell you that after you stumble).

It also matches pretty well with the guy who observed that retiree spending declines with age, especially when retirees get above their mid-70s. So not only will you need to spend less money as you retrench, you'll probably be doing so anyway as your mobility declines (and your senility rises).

Of course there are the usual caveats and disclaimers. Returns are not a log-normal distribution-- heck, they're not even normal. Standard deviation is not, and correlation is not constant. Healthcare costs rise with age but these studies don't account for that issue. End-of-life costs will skyrocket but we sure hope you have good LTC insurance or don't mind a "Medicaid retrenchment".

So the only certainties are to (1) live within your dividends & annuities, or (2) use Gummy's special patented crystal-ball technique.

For ERs planning to consume their principal, success rates over 80% are a waste of effort-- the data and the assumptions are just not good enough to support a higher level of confidence.

 

[Bestwifeever]

So what's your take on this article, Tarheel? Are you planning accordingly for yourself?

 

[rickier55]

I found it interesting, though I didn't entirely follow all of the details. Contrary to most here I thought the premise was reasonable. Although I wasn't sure I agreed in selecting the 8 % discount rate.



Rick

 

[donheff]

Yeah, I like Gummy's approach myself. The bottom line is that if you start at 4% and take a big hit soon (e.g. someone who retired last year with a 4% rate) you get nervous if you learn through experience that you started on one of the simulation tracks that goes down in the early year(s). This article (and Gummy's approach) tell you that you don't need to panic when your withdrawals jump up above 4% -- unless and until the market proves you are on a truly unprecedented track that the simulator didn't count on. Maybe something like a global economic collapse?