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Reverse compounding issue
12-03-2008, 06:44 PM
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#1
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Thinks s/he gets paid by the post
Join Date: Oct 2005
Posts: 4,898
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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
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12-03-2008, 07:15 PM
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#2
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Thinks s/he gets paid by the post
Join Date: Mar 2004
Location: Dallas
Posts: 1,211
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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
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12-03-2008, 07:23 PM
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#3
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Thinks s/he gets paid by the post
Join Date: Oct 2005
Posts: 4,898
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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 . . .
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12-03-2008, 07:32 PM
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#4
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Give me a museum and I'll fill it. (Picasso) Give me a forum ...
Join Date: May 2004
Location: SW Ohio
Posts: 14,404
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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).
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12-03-2008, 07:53 PM
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#5
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Thinks s/he gets paid by the post
Join Date: Oct 2005
Posts: 4,898
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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?
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12-03-2008, 08:12 PM
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#6
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Thinks s/he gets paid by the post
Join Date: Mar 2004
Location: Dallas
Posts: 1,211
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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
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12-04-2008, 03:54 AM
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#7
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Give me a museum and I'll fill it. (Picasso) Give me a forum ...
Join Date: Feb 2007
Posts: 5,072
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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.
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12-04-2008, 04:57 AM
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#8
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Confused about dryer sheets
Join Date: Nov 2008
Posts: 2
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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.
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12-04-2008, 08:59 AM
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#9
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Thinks s/he gets paid by the post
Join Date: Oct 2005
Posts: 4,898
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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.
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12-04-2008, 09:01 AM
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#10
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Thinks s/he gets paid by the post
Join Date: Nov 2005
Location: Colorado, USA
Posts: 1,127
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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
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12-04-2008, 09:52 AM
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#11
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Thinks s/he gets paid by the post
Join Date: Oct 2005
Posts: 4,898
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Quote:
Originally Posted by Coach
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
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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.
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