Join Early Retirement Today
Reply
 
Thread Tools Search this Thread Display Modes
Reverse compounding issue
Old 12-03-2008, 07:44 PM   #1
Thinks s/he gets paid by the post
 
Join Date: Oct 2005
Posts: 4,898
Reverse compounding issue

I'm interested in responses to the reverse compounding issue. In my situation my retirement funds which are locked into an irrevocable trust are down about 30% from the market high. I will be receiving a payout which will now be about 6.6% of the total. I am planning on saving about 1.8% which includes some earnings. But that only reduces my payout to 4.8%. Maybe that will be enough to maintain a lasting retirement fund if the stock market recovers over time.

But I'm concerned. I don't know whether I should be taking drastic action at this point to reduce my expenses. Or should I wait a year or two. That's why I'm asking for opinions.

1. Reverse compounding

During the years you were saving for retirement, compounding played a powerful part in the growth of your money. That's because, as you added to your investments, reinvested dividends and capital gains were added to the principal balance and earned more money through compounding. Now that you're in retirement and withdrawing portions of the assets you've accumulated, it's important to be familiar with the concept of "reverse compounding."
Reverse compounding means that as you withdraw assets in retirement, a smaller pool of principal is left to build upon. This is especially important if you're making withdrawals during a market downturn. As your portfolio value declines, you may be withdrawing a larger percentage than usual, thereby leaving a smaller pool of assets available for future growth. One way to combat reverse compounding is to reduce your spending during market downturns
https://personal.vanguard.com/us/planningeducation/retirement/PEdRetMonitorLookAtPortfolioContent.jsp
__________________

__________________
Zoocat is offline   Reply With Quote
Join the #1 Early Retirement and Financial Independence Forum Today - It's Totally Free!

Are you planning to be financially independent as early as possible so you can live life on your own terms? Discuss successful investing strategies, asset allocation models, tax strategies and other related topics in our online forum community. Our members range from young folks just starting their journey to financial independence, military retirees and even multimillionaires. No matter where you fit in you'll find that Early-Retirement.org is a great community to join. Best of all it's totally FREE!

You are currently viewing our boards as a guest so you have limited access to our community. Please take the time to register and you will gain a lot of great new features including; the ability to participate in discussions, network with our members, see fewer ads, upload photographs, create a retirement blog, send private messages and so much, much more!

Old 12-03-2008, 08:15 PM   #2
Thinks s/he gets paid by the post
charlie's Avatar
 
Join Date: Mar 2004
Location: Dallas
Posts: 1,211
I think it would be better to reinvest the whole payout and live off of
savings as long as you can. It is a real blow to the value of your portfolio if it is drawn down during a down market. By reinvesting the payout in some sort of taxable fund that mimics your trust fund, you would offset the damage to your trust fund. IMHO, Vanguard's new Managed Payout funds are pretty good, but they require a minimum of $25k for entry.
Other good possibilities are Wellesley or Wellington or one of the Target Retirement Funds. If you follow this strategy, you should reiinvest the
dividends and cap gains as long as you don't need the income for current expenses.

This is just my opinion, so do your own due diligence.

Good luck and Cheers,

charlie
__________________

__________________
charlie is offline   Reply With Quote
Old 12-03-2008, 08:23 PM   #3
Thinks s/he gets paid by the post
 
Join Date: Oct 2005
Posts: 4,898
I should have mentioned that the payout is mandatory. I could reinvest it when I receive it but then I would have no income!

As I said I am reinvesting about 1.8%. But I am wondering if that is enough.

Some drastic remedies for the situation include selling my townhome and buying a cheaper one. The remedy could reduce my mortgage by 100K and my mortgage payment by $500. Also, I could w*rk more. Actually I am following up on that. But with all the unemployment now . . .
__________________
Zoocat is offline   Reply With Quote
Old 12-03-2008, 08:32 PM   #4
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
 
Join Date: May 2004
Posts: 11,616
As you probably already know, a 6.6% withdrawal rate is likely to produce a significant failure rate if the withdrawal period is long.

The "reverse compounding" concept seems to best describe the situation one would have with a fixed-interest type of investment. With other types of investments (e.g stocks), it doesn't seem to adequately describe the deleterious effects of selling shares when they are down. If you believe that there is some reversion-to-the-mean in stock prices over time, then selling shares when they have lost significant value (and therefore are more likely to be below the mean and more likely to increase in value) may have a greater impact on the survivability of the portfolio than selling stocks that have recently gone up in value.

Pragmatic impact: Yes, I'd tighten your belt and withdraw less in years your portfolio is down. Of course, you could just take the same amount from the trust fund every year and put the max amount possible into your own investments--same thing (and more control for you in future years).
__________________
"Freedom begins when you tell Mrs. Grundy to go fly a kite." - R. Heinlein
samclem is online now   Reply With Quote
Old 12-03-2008, 08:53 PM   #5
Thinks s/he gets paid by the post
 
Join Date: Oct 2005
Posts: 4,898
Ok, does it make any difference that I will be receiving payouts from cash and fixed income investments in the trust rather than stocks. In other words, no stock funds need to be sold for about 7 years in order to continue the payouts.

Is anyone else in this situation? what are you doing? or am I the only one here with losses significant enough to require some serious do-overs?
__________________
Zoocat is offline   Reply With Quote
Old 12-03-2008, 09:12 PM   #6
Thinks s/he gets paid by the post
charlie's Avatar
 
Join Date: Mar 2004
Location: Dallas
Posts: 1,211
Yes, I think it makes a huge difference! If you can control your trust
fund to draw down cash and or bonds during the down market and not
have to sell stock then you will not have damaged your trust fund's
ability to grow when the market recovers. However, when the market recovers, then you should sell stock to reset your fund to the desired asset allocation. I don't know what flexibility you have in controlling the assets in your trust fund, but drawing cash first, then selling bonds and finally stocks is the correct order. Just pray that the down market does not outlast your cash/bonds.

Cheers,

charlie
__________________
charlie is offline   Reply With Quote
Old 12-04-2008, 04:54 AM   #7
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
 
Join Date: Feb 2007
Posts: 5,072
Here are some studies of withdrawals compliments of Bob

Bob's Financial Website

Much of this you may already know... but he has some nice summaries and illustrations of some popular withdrawal strategies. I sometimes helps to refresh your memory of the issues if you have concern or are thinking of making adjustments.
__________________
chinaco is offline   Reply With Quote
Old 12-04-2008, 05:57 AM   #8
Confused about dryer sheets
 
Join Date: Nov 2008
Posts: 2
i agree with charlie- drawing from your cash and bonds first will prevent selling your equities that are down dramatically this year and give them the proper time to recover. Now you just have to hope the markets will recoup these losses in the next 5 years or so. Good thing you have 7 years of income in conservative investments. I know we should never ask a woman their age but i think that would be helpful hear Oldbabe. If you are in your 50's i would be much more concerned then if you were well into your 70's.
__________________
lebron23 is offline   Reply With Quote
Old 12-04-2008, 09:59 AM   #9
Thinks s/he gets paid by the post
 
Join Date: Oct 2005
Posts: 4,898
Oops! I meant that I am planning on saving 18% of my income this year (not %1.8). But that will be a real cut back and I know that I can't sustain over many years.

ebron23, I'm 59 which is part of the reason I'm so very concerned.

chinaco, thanks for the link! I will take a look at it.

charlie, yes, you're right that it makes a big difference. But the total amount will still shrink unless the market goes up right away. Alas, that is the delimma.
__________________
Zoocat is offline   Reply With Quote
Old 12-04-2008, 10:01 AM   #10
Thinks s/he gets paid by the post
Coach's Avatar
 
Join Date: Nov 2005
Location: Colorado, USA
Posts: 1,127
Oldbabe, I don't think you need to feel rushed -- I think you have time.

Your 6.8% payout was something like a 4.5% payout before the drop in value of your fund. That's likely to be a pretty sustainable payout, and you have enough non-stock assets to last out a pretty long period.

lebron's question about your age is a good one. Also, do you see any financial changes coming? For example, eventually you'll have your townhouse paid off and that will reduce your expenses. Will you at some point be getting Social Security?

You sound like you're being quite responsible now -- I think you can wait a year or two and re-evaluate your situation then.

Coach
__________________
Coach is offline   Reply With Quote
Old 12-04-2008, 10:52 AM   #11
Thinks s/he gets paid by the post
 
Join Date: Oct 2005
Posts: 4,898
Quote:
Originally Posted by Coach View Post
Oldbabe, I don't think you need to feel rushed -- I think you have time.

Your 6.8% payout was something like a 4.5% payout before the drop in value of your fund. That's likely to be a pretty sustainable payout, and you have enough non-stock assets to last out a pretty long period.

lebron's question about your age is a good one. Also, do you see any financial changes coming? For example, eventually you'll have your townhouse paid off and that will reduce your expenses. Will you at some point be getting Social Security?

You sound like you're being quite responsible now -- I think you can wait a year or two and re-evaluate your situation then.

Coach
Coach,thanks for your input. I don't have much SS to count on, about $400/mo at this point. My mortgage has 26 yrs to go! The only thing that might increase my income is employment of one kind or another.

My area in Colorado has experienced only a modest housing price deflation for townhomes/condos. I'm concerned that next year will get worse and that I may be shut out of any possibility of selling. If unemployment rises there will be fewer borrowers, and I will need to continue my tight budget. I wish I had sold last year! I also have HOA concerns that I've posted about in the "Other Topics" section.

I really appreciate the input. This is helping me think through the situation.
__________________

__________________
Zoocat is offline   Reply With Quote
Reply


Currently Active Users Viewing This Thread: 1 (0 members and 1 guests)
 
Thread Tools Search this Thread
Search this Thread:

Advanced Search
Display Modes

Posting Rules
You may not post new threads
You may not post replies
You may not post attachments
You may not edit your posts

BB code is On
Smilies are On
[IMG] code is On
HTML code is Off
Trackbacks are Off
Pingbacks are Off
Refbacks are Off


Similar Threads
Thread Thread Starter Forum Replies Last Post
Reverse SWR utrecht FIRE and Money 26 11-10-2008 07:29 PM
Compounding - Saving early then stopping emi guy FIRE and Money 17 02-23-2007 10:47 AM
Reverse mortgages MRGALT2U FIRE and Money 9 07-24-2005 12:33 PM
SWR and Reverse Mortgages TromboneAl FIRE and Money 6 04-28-2005 05:41 AM
Reverse Annuity? tozz FIRE and Money 6 04-01-2005 08:43 AM

 

 
All times are GMT -6. The time now is 11:25 PM.
 
Powered by vBulletin® Version 3.8.8 Beta 1
Copyright ©2000 - 2017, vBulletin Solutions, Inc.