Safe Withdrawals of up to 6% per year? Part 1

[LawGirl]

Following is an article that appeared in the WSJ today. Normally I try to avoid all discussions of safe withdrawal rates because they tend to get a little combative. Also, frankly, a little boring. Thought I would see what reaction the article gets from the tough crowd on this board!

LawGirl

GETTING GOING
By JONATHAN CLEMENTS

Retirees Don't Have to Be So Frugal:
A Case for Withdrawing
Up to 6% a Year
November 17, 2004; Page D1

Maybe you don't have to order the early-bird special after all.

Many retirees have trimmed their spending during recent years, and it isn't just because of plunging bond yields and tumbling stock prices. Instead, they have been reacting to dire warnings from Wall Street, cautioning them that their portfolios can't sustain the sort of withdrawal rates that used to be considered safe.

Feeling pinched? Don't resign yourself to a lifetime of scrimping and saving just yet.

Boosting income. When advising seniors about their spending, financial experts have grown increasingly conservative. For instance, one influential study found that, if retirees want to be confident their savings will last 30 years, they need to limit their initial withdrawal rate to 4.1%, or $4,100 for every $100,000 saved.

But a new study by Minneapolis certified financial planner Jonathan Guyton, which appeared in October's Journal of Financial Planning, suggests retirees don't have to be nearly so frugal. He analyzed how to generate 40 years of income while surviving brutal market conditions, such as high inflation and a steep market decline early in retirement.

His finding: Retirees may be able to withdraw as much as 6.2% initially, provided they follow three rules. "There's nothing radical to this," Mr. Guyton says. "It's just a matter of being street smart. These are things you would sensibly think about doing after a tough year."

Before we get to the rules, you will need a little background. When experts talk about withdrawal rates, they are typically referring to the percentage of a portfolio's value withdrawn during the first year of retirement.

Thereafter, retirees are assumed to increase their withdrawals along with inflation. Let's say you retired with $600,000, inflation ran at 3% and you used a 6% withdrawal rate. In that scenario, you would withdraw $36,000 in the first year of retirement, $37,080 in year two, $38,192 in year three and so on.

Keep two things in mind. First, you will owe taxes, so not all this money can be spent. Second, if you spend your dividends and interest, these sums count toward the amount withdrawn.

MAKING IT LAST

Here's how to reduce the risk of outliving your retirement savings:

• Clamp down on spending if your portfolio suffers a calendar-year loss or rapid inflation returns.

• Avoid selling hard-hit stock mutual funds.

• Invest part of your bond money in an immediate annuity that pays lifetime income.

• Favor low-cost funds, so you keep more of what you make.

[LawGirl]

Part 2

Following rules. The strategy of increasing withdrawals along with inflation works fine, provided the markets and inflation are moderately well behaved. But if you get hit with either rapid inflation or a devastating market crash, you can rapidly run out of money, as you make larger and larger withdrawals from an ever-shrinking portfolio.

To figure out how to combat that risk while maximizing income, Mr. Guyton analyzed two portfolios, one with 80% stocks and the other with 65%. Both portfolios had the sort of well-diversified mix you could get by buying large-stock funds, small-company funds, foreign shares, real-estate investment trusts, bonds and money-market instruments.

He found that the 80% stock portfolio could support a 6.2% initial withdrawal rate, while the 65% stock portfolio could start at 5.8%. But if you adopt those lofty withdrawal rates and you want to be sure your money lasts 40 years, Mr. Guyton says you need to follow three rules.

• If your portfolio loses money during the year, you can't give yourself a raise the following year. In other words, if you add up your portfolio's year-end value and the money withdrawn during the prior 12 months and this sum is less than your portfolio's beginning-of-year value, you can't increase your next year's withdrawal to compensate for inflation.

• No matter how high inflation gets, your maximum annual increase is 6%.

• You have to avoid selling hard-hit stock funds. Instead, each year, start by lightening up on winning stock funds.

Suppose you had targeted 6% of your portfolio for real-estate investment trusts and REITs have a good year. You would pare back your REITs to 6%, funneling the excess into a money-market fund. This money fund, says Mr. Guyton, should initially account for 10% of your total portfolio.

Next, "rebalance" your bond funds back to their target percentages, again sweeping the gains into your money fund. The proceeds from rebalancing, plus the cash already in your money fund, should cover your spending needs.

What if it doesn't? Mr. Guyton says you should draw down your bonds even further. As a last resort, sell more of your stock funds, starting with the prior year's best performers.

All this, of course, is based on an analysis of historical returns. If we get wacky markets, miserably low long-run returns or you incur hefty investment costs, you may have to withdraw less than Mr. Guyton suggests.

Moreover, because the first and second rules will occasionally limit spending increases, there's a chance that retirees who use Mr. Guyton's strategy will receive less total income over 40 years than if they had started with a lower initial withdrawal rate but got inflation increases every year.

Still, Mr. Guyton's rules make a ton of sense to me -- and I suspect many retirees will find his approach appealing. After all, they get a decent amount of income initially and they may never see the downside, either because they don't live long enough or because the markets prove relatively benign.

As Mr. Guyton puts it, "I wouldn't want to be the financial planner who has to look an 85-year-old client in the eye and explain why he has so much money and why he's had so little fun."

This was discussed in another thread on this forum a couple months ago. And it is completely valid if the future is no worse than the past.

The debate of SWR is usually the folks that are convinced that the future 40 years will be worse than any 40 year period of the last 125 years - against the folks that believe it won't be worse.

We have all agreed that no one can predict the future

[Hyperborea]

Yeah, as CT says we had another thread on the original Journal of Financial Planning article. If you search in the SWR sub-board you should find it. This system is essentially a variable withdrawal system that uses feedback on the market returns & inflation to adjust your withdrawals. If you aren't relying completely on the 6% withdrawal amount for basic living costs then it could work. It does require that you have some slack in your budget - i.e. withdrawing 6% of your $1M portfolio but only really needing $30K for basic costs (food, utilities, taxes, etc.). That way when your system won't let you inflation adjust (or under-adjusts) you'll just have to cut back on luxuries rather than eating dog food.

[Hyperborea]

Ok, here's the other thread though we did veer off topic a bit.

http://early-retirement.org/cgi-bin/...num=1096908815

[ataloss2]

The debate of SWR is usually the folks that are convinced that the future 40 years will be worse than any 40 year period of the last 125 years - against the folks that believe it won't be worse.


Of course there is the debate about having a debate....

Quote:

The debate of SWR is usually the folks that are convinced that the future 40 years will be worse than any 40 year period of the last 125 years - against the folks that believe it won't be worse. Of course there is the debate about having a debate....

But then again, you have to have particpants to have a debate about having a debate.

[Hyperborea]

Quote:

The debate of SWR is usually the folks that are convinced that the future 40 years will be worse than any 40 year period of the last 125 years - against the folks that believe it won't be worse.

I think that the big "if" here is "if the US maintains itself as the main super-power nation and it continues to grow as it has from the time it emerged from third world status". Can it do this? If it can't then perhaps a better model would be to use the stock market return data from Great Britain starting around 1870 or so until the present. This roughly covers the time from when it was about to pass from being the pre-eminent world super-power to the time when it's just another middle-power like most of the other ex-world super-powers (e.g. France, Spain, Netherlands, etc.).

What is the SWR for an investor in the British markets during that time period? Anybody have a good realiable free source for this data?

Quote:

If it can't then perhaps a better model would be to use the stock market return data from Great Britain starting around 1870 or so until the present. This roughly covers the time from when it was about to pass from being the pre-eminent world super-power to the time when it's just another middle-power like most of the other ex-world super-powers (e.g. France, Spain, Netherlands, etc.).

What if the answer you got was an SWR of .5 % - Would you go back to work?

I know I wouldn't - So why bother?

We all know we can concoct a scenario where we are all F*cked, but I think FireCalc provides the basic planning tools for a reasonable chance of survival.

But whatever planning tool you use remember this - We're all dead in the end

My gosh Cut-Throat, excellent post! Just when I am afraid you have caved in to wimpy liberalism, you come up with something thoughtful and insightful.
Kudos are in order!

John Galt

Quote:

My gosh Cut-Throat, excellent post! * Just when I am afraid you have caved in to wimpy liberalism, you come up with something thoughtful and insightful. * Kudos are in order! John Galt

This is liberalism at its best, After all this is the same logic that gave life to Sex, Drugs and Rock and Roll in the 60's.

John you are finally maturing just as Barry Goldwater did in his later years!

[Hyperborea]

Quote:

What if the answer you got was an SWR of .5 % - Would you go back to work? I know I wouldn't - So why bother?

Well, first off I'm not retired yet only on my way. *But it would suggest to me that a better, more diversified asset allocation than S&P500+bonds (the FIRE model) would be prudent. *IIRC Bernstein wrote about the results of having a world diversified portfolio (like Sharpe's papers talk about) and if you had done that you would have had just about the same returns as if you had been able to magically pick out the one market that had done the best over the future. (I wish I could find the reference to this but I can't - if I do I'll post it)

Quote:

But whatever planning tool you use remember this - We're all dead in the end

Yup, but I don't want to leave my wife with $1K in savings at 80 years old even if I am dead.

[Hyperborea]

Quote:

My gosh Cut-Throat, excellent post! * Just when I am afraid you have caved in to wimpy liberalism, you come up with something thoughtful and insightful.

Yeah CT a "good conservative" would just spend without concern for who is going to pay the bills - even if it's his kids who'll have to clean up after them. There's no need for a realistic understanding of finance or history.

Hello Hyperborea! If you are seriously worried about this stuff, you need a lot more help than you will find
at this site.

John Galt

[unclemick]

Yawn!

Start with the SEC yield of the portfolio you have - and adjust accordingly based on 'your ER'.

Continue your learning/education process thru out your ER.

Recency - Bernstein type portfolios have a certain crap element - mainly looking good since 2000. Reading his 90's stuff - his portfolio's were big losers relative to U.S. going into bubbleland. Bernstein stuck to his guns - but recency caused some flack.

I personally fell into the same trap - in the 80's and early 90's - all the AAII stuff convincing me to hold a lot of foreign stocks/bonds looking back - then of course the dollar and America got well and took off and Japan et al went in the dumper.

Quote:

But it would suggest to me that a better, more diversified asset allocation than S&P500+bonds (the FIRE model) would be prudent. IIRC Bernstein wrote about the results of having a world diversified portfolio (like Sharpe's papers talk about) and if you had done that you would have had just about the same returns as if you had been able to magically pick out the one market that had done the best over the future.

Hyper,

I never said that I invested exactly as FIRECalc, I just use it for rough planning.

I am invested in about 10 asset classes per Berstein, And would not change it regardless of the results of a FIRECalc that compared against the British Stock Market.

[newellcr]

Hello folks,

It didn't take long for this thread to deteriorate. Did it? The rigid adherence to the 95% SWR leaves money on the table in about 94% of the cases. Certainly, this alternate withdraw rate can provide a better cash flow for the cases where the 95% SWR leaves too much money on the table. As my retirement time approaches, I'll probably look at various SWR runs (100, 95, 75, 50%, etc) and see what type of cash flows these represent.

Hyperborea,

The powers you mentioned were big fish in a small pond and they all had their own problems. The pond has a defined size now, at least until we expand outside our planet. The US is the super power for the foreseeable future. There are a lot of reasons that we are the super power. We have vast natural resources. We have an educated and skilled population. Our government structure is second to none. Europe will never get the government structure it needs and China is many decades away from being a true peer to the US. China, Europe, and any other conglomeration of countries that have yet to band together will probably want to sell us cars, sneakers, and grain rather than to try to challenge us in some type of dominating way.

If this isn't the order of things, we will probably have bigger problems than a poor investment withdraw rate.

Kind Regards to all,

Chris

Quote:

I'll probably look at various SWR runs (100, 95, 75, 50%, etc) and see what type of cash flows these represent.

Chris,

My guess is that you will continue to run FIRECalc after you're retired also.

Running FIRECalc the day you retire, getting your SWR number, and then committing to that number for 40 years (with Inflation Adjustments) is something that I'm guessing just isn't done!

[Bob_Smith]

Quote:

Recency - Bernstein type portfolios have a certain crap element - mainly looking good since 2000. Reading his 90's stuff - his portfolio's were big losers relative to U.S. going into bubbleland. Bernstein stuck to his guns - but recency caused some flack.

Unclemick, could you expand on that? Are you saying the portfolios Bernstein suggests in Four Pillars would have significantly underperformed a total market approach in the 90s?

I'd be interested in hearing both pros and cons for the Bernstein type portfolio vs total market. I'm on the fence. Currently I have a total market type stock allocation, but I'm leaning toward Bernstein. Then I read Sharpe's comments and I'm not so sure. But then again, I like the higher yields that come with a value tilt, and some other things about Bernstein's approach. I'm usually quite decisive, but there seem to be equally compelling reasons for both approaches. So how did you decide, and how confident are you with your choice?

[haha]

Quote:

The US is the super power for the foreseeable future. *There are a lot of reasons that we are the super power. *We have vast natural resources. *We have an educated and skilled population.

If you are including our colony in Iraq, maybe we have vast natural resources. Bu the colonials seem to have other ideas. But here on the mother-ship we are running low. US oil production peaked in 1970. Gas production has just just peaked or will very shortly. Most of our hydro resources are being exploited. All or almost all our copper mines have closed. No nickel to speak of. We do have iron ore and coal. Coal is a problem, in that people still like to breath. Also, not a great transportation fuel. And the US is a huge spread-out nation of SUV drivers needing lots of transportation fuel.

Nuclear power will happen, but nothing that makes sense happens easily in American politics.

Our allies seem to be wavering. I can't blame them. North Sea oil production is peaking; gas soon will follow. Continental Europe has already peaked in natural gas production. So before long just to stay warm or drive to work in Europe, the pipeline from Russia better be switched on. And soon after, there will be pipelines from the Gulf.

OTOH, what do our allies get from us that they can't get elsewhere? Involvement in politically disastrous wars(eg Tony Blair). Hmm, maybe they'll take staying warm at home to fighting Dubya's wars around the world?

As to our marvelous education system, while our elite universities and quality state schools are very good, our feeder system is horrible. That is why more science and math PhDs are awarded to foreign nationals by American Universities than to American citizens. Our primary and secondary schools are like our health care system- cost a lot, with overall poor results. ( As judged by basic competency in the first case, and life expectancy, infant mortality, etc. in the second.

That leaves finance for last. China and Japan are living below their means, we collectively are living above our means. That is why we go further in debt to them every year. China, as a developing country could be expected to be a large debtor. Instead, they are our biggest creditor. And this is no Switzerland. It's a nation of over 1 billion hard working basically intelligent people who define hardscrabble.

USA OTOH consumes mightily, and produces services many of which we sell to ourselves. I will think that we as a nation have a viable business plan when I figure out how a country that must remain a military power can exist having only a skeleton manufacturing base. I say must be a military power, because of oil. What if China doesn't want to bank with Citicorp? What if Goldman Sachs seems beside the point to them? What if they don't much like Big Macs?

IMO, the US is in run-off from WW2. Ten years from now we will wonder what the hell went wrong.

Cassie