Say Goodbye to the 4% Rule - tips from the WSJ

[EvrClrx311]

Not really. You can't predict to begin with. At least historically, the 4% SWR rule means you had a 95% chance of success over 30 years no matter when you retired from 1871 thru 2011 (FIRECALC) even if you blindly withdrew inflation adjusted/constant spending. Trying to time market peaks/troughs is not part of the calculus.

The reason people question 4.15% now is because the market has done some things recently outside the 150 year 'norm'

The whole idea behind the rule was to find a target that was safe under all known previous conditions, but we'll never know if the future is an outlier that we've never seen, so it is impossible to answer with 100% certainty. What we can do is get to 98% or 99% probabilities... and what I'm suggesting is that your odds of having a better path ahead are drastically increased if the recent market behind you is bad... not good. Makes perfect sense logically, but in practice most people do the opposite. They pull the plug when they feel most confident, when the market has been rising.

This can be demonstrated with some simple charts that I made a few years ago but am missing the link right now. If you look at every 15 year period in history where the market performed worse than average... the following 30 years were better than the historical 30 year average. If you look at every 15 year period where the market has performed better than average, the following 30 year period performed worse than the historical average. There is an inverse correlation between how equities will do moving forward compared to how they've done in the not so distant past. Regression to the mean. Equities want to straddle a linear path... if they've done really well recently, they'll want to fall back to their long term path. And vice versa.

If markets drop over the next 18 months, 2000-2015 just might end up as the worst 15 year period of performance in equity history. If so, there is a very high probability that 2015-2045 will be one of the best 30 year periods we've ever seen. Not guaranteed, just a very strong bias towards it when looking at history.

Two enduring constants:
A) History tends to repeat itself...
B) There is never a shortage of people suggesting why 'this time' it won't (not suggesting you are one of them; just a generality of the masses/media)

 

[clifp]

I don't know of anyone doing it either, so I guess it's simply an academic discussion.

Can't emphasize this enough. I have been following retirement discussion on the internet since 2000, I have yet to met any retiree who follows the withdrawal method suggested by the Trinity exactly.

Pretty much everyone 'cheats', i.e uses common sense. Tightens the belt when their portfolio gets hurt, fudges a bit on inflation, engages a bit of market timing etc. I don't even have an exact portfolio value when I retired so I couldn't even take 4% if I wanted to

 

[Stanley]

IMHO, the value of the 4% rule is that unsophisticated people can have some general idea of how much they can expect to withdraw every year and still have a fighting chance to make the money last their entire life. No guarantees, no promises.

Inaccurate? To be sure! But, far better than some people I know who suddenly inherit $84,563 and then think "WOW, This is more money that I have ever had in my life! I can retire even though I am only 52." Many, if not most, people have very poor financial skills. The price they pay for blowing off math in school while asking "when is anybody going to use this stuff?"

 

[youbet]

I always thought the 4% SWR studies were more useful as a guide for determining a nest egg target than as an actual withdrawal methodology. But it's nice to know that from 1871 thru 2011 (FIRECALC) if anyone did blindly withdraw 4% in the first year and inflation adjusted thereafter for 30 years, they'd have a 95% probability of success in any year they started. YMMV

Not sure I've seen anyone say "dumb."

Don't you mean 1871 thru 1982? 1982 is the earliest starting year we can test for a 30 year retirement.

 

[photoguy]

what I'm suggesting is that your odds of having a better path ahead are drastically increased if the recent market behind you is bad

I think this is mostly a psychological issue. If the recent market returns are bad then valuations are low and your expected returns going forward are higher. But in return your nest egg is smaller. Conversely, if recent market returns are higher, your portfolio is bigger, but expectations going forward are lower.

If we think of a portfolio in terms of both raw dollars and future expected returns, this would smooth out much of the volatility.

 

[haha]

The 4% rule is still valid for planning purpose. The key is to be flexible or adaptable to market conditions. That is, adjust the withdrawal rate and re-balance the portfolio to the desired AA. Our plan is 2% SWR, however.

How in the world is it a 4% rule if you "adjust the withdrawal rate"?

A 4% withdrawal rate is withdrawing 4%, adjusted annually for inflation. Presumably words still mean something.

Ha

 

[ERD50]

People 'beat up your comments' because your posts rarely if ever do more than scratch the surface. You always tell us you're too busy to add any substance, fair enough.

... Please kindly remember that I still work - have not FIREd yet. Sometimes I post between two patients. ...

And yet, at over 3,000 posts since joining, your posting rate is close to some of the most prolific of us, who are not busy with the kinds of activities you mention?

edit/add: I'm not beating up on you, just trying to provide some perspective.

-ERD50

 

[pb4uski]

....Presumably words still mean something. ....

You didn't get the memo? Words having meaning was jettisoned back in 2008.

 

[Tyro]

....what I'm suggesting is that your odds of having a better path ahead are drastically increased if the recent market behind you is bad... not good. Makes perfect sense logically, but in practice most people do the opposite. They pull the plug when they feel most confident, when the market has been rising.

Would it be that that confidence may, in many cases, be because they've reached their "number" -- the nest egg they've calculated (or been told) they need to be FI and RE?

 

[Tyro]

You didn't get the memo? Words having meaning was jettisoned back in 2008.

I thought it was 1998... with all the arguments over the definitions of "sexual relations", "alone" and most importantly, what the definition of "is" is.

 

[Midpack]

Don't you mean 1871 thru 1982? 1982 is the earliest starting year we can test for a 30 year retirement.

The 30 year period beginning in 1981 would end 2011...but call it 1981 if you like (I don't gather 2012 data has been entered, but not sure).

 

[SJ1_]

I do not know much about annuity. My understanding is that the annuity pays someone a fixed annual amount for life. In order to provide for that, the fixed amount can only be that large, given variation in people's life spans. The amount one receives may be ok initially, but with inflation, the annual amount without adjustment may not be all that large after 25 years.

Also, is the security of the annuity only as good as the company underwriting it? What would happen if you buy an annuity from an insurance company and it went bankrupt? Are annuity holdings separated in an escrow account that even in case of bankruptcy, the creditors cannot take the money as part of the bankruptcy settlement, leaving the retirees in a bind?

I need to read a little more because supposedly it is becoming popular. Am I wrong with my concerns?

I agree with you. An Insurance co. might have a great rating now, but in 20 -30 yrs?

As far as Insurance co. unable to pay annuities, each state guarantees a certain amount of the annuity which is not that much.
see link:

State Guarantee Funds

I always wondered if the economy tanks where will the insurance cos. be investing their money that will produce the income to pay off the annuities?
Stock Market? Real Estate? seems like you can do this on your own with
out all the extra expense.

It also take a long time to "break even" on an annuity.

example: I googled vanguard annuity quote and
$100,000
$550 month life only Male 65 yrs old.

I divided the 100k by $550 per month and it would take 181.8 months to break even (15.1 yrs) AND this does not take into account the money you
could of made on the 100k. If inflation takes off this money that you bought
the annuity with could be making 5% +- while you will be stuck with that annuity.

Plus does anyone trust an Insurance Co.?


JMHO

 

[David1961]

I've always looked at 4% as a "rule of thumb" instead of an ironclad "rule". You never know what the market will do in the few years following your retirement. If you get lucky and retire at a "good" time, you can likely withdraw more than 4% annually. If you are unlucky at when you retire, you will probably need to withdraw less.

 

[pb4uski]

.....I always wondered if the economy tanks where will the insurance cos. be investing their money that will produce the income to pay off the annuities?
Stock Market? Real Estate? seems like you can do this on your own with
out all the extra expense.....

While insurers invest in all of the above and more, their investments are predominately in bonds. For a SPIA, your premium would typically be invested all in bonds. They pick the maturities of the bonds they invest in so that the cash flows from the bonds broadly match up with their obligation to make annuity payments, so to some extent the income to pay off the annuities is somewhat locked in when they invest your SPIA premium. In reality it is much more complicated than what I described but what I describe above is the general idea. In addition, they have additional funds (called surplus) that can be used if for some reason bad things happen to their investments (for example, credit losses in excess of what they assume, etc.)

While a lot of this you can do yourself, what you can't do is provide the longevity benefits that they can by pooling mortality risk. In other words, the premiums paid by others who bought SPIAs and died prematurely are used to provide benefits for those who live longer and that isn't something that you can DIY. However, the quid pro quo for getting this longevity protection is giving up control of your money and effectively contributing to those who live long should you die prematurely.

 

[jclarksnakes]

I see the 4% rule of thumb as just that. It is a rule of thumb. And BTW it has been around a lot longer than since the 90s. I don't know of anyone who has started retirement withdrawing exactly 4% but I know lots of people use 25 times needed income to decide what their retirement number should be. I read the WSJ article. It seems to me that following the tax man's table for someone retitiring in their mid 50s thru mid 60s which is the age that many savvy savers are looking to retire the withdrawal percentages come out reasonably close to the 4% rule of thumb. The other method of pegging withdrawals to stock valuations using the S&P P/E 10 also produces results, at least for recent history that are roughly in line with the 4% rule of thumb. I do not like annuities, DW does, so we have a couple of them.

 

[haha]

The concept of an annuity is very appealing. But buying a non-inflation indexed annuity at a time when the governments of almost every developed country including our own are engaged in full-on attempts to destroy their currencies seems a little funny.

Ha

 

[Livin Large in MT]

Remember there are two kinds of annuities, variable and fixed. Fixed annuities are an easy thing: you tell the company what sort of annual or monthly check you want and for how many years and they give you a lump sum amount based on whatever their actuaries demand.
Variable annuities have all kinds of other strings attached; many have a life insurance feature, and many other features, some of which I am convinced are designed to sound good and also be totally confusing to the prospective customer. Fees on variable annuities are high because they invest in mutual funds (so you pay that fee) PLUS you pay the annuity fee which is anywhere from 1% to 3% in addition per year. I am not a fan.
I am a fan of fixed annuities for those who are nervous...but you do lose the money and I believe most of us on this forum have some confidence in our ability to do what is essentially our own fixed annuity plus if you are lucky and do well investing-wise will leave something to your heirs instead of to some insurance company.

 

[Midpack]

The first deferred annuity I bought last year will generate 12% per year from 62 until I die.

12%! Where do we sign up for that?

Everything I found online was more along these lines...

I certainly wouldn't buy Wellesley if I had a 'deferred annuity bought last year that will generate 12% per year from 62 until you die...'

 

[pb4uski]

12%! Where do we sign up for that?

Everything I found online was more along these lines...

12% must be the payout rate rather than the IRR, but even as a payout rate that sounds quite high. I'm skeptical.

 

[LakeTravis]

....If markets drop over the next 18 months, 2000-2015 just might end up as the worst 15 year period of performance in equity history. If so, there is a very high probability that 2015-2045 will be one of the best 30 year periods we've ever seen. Not guaranteed, just a very strong bias towards it when looking at history.

OR...use 1998-2013 as the basis and we could very well be at the cusp of enjoyable performance over the next 30 years? Works for me!

Either way, I like your logic.

 

[youbet]

12% must be the payout rate rather than the IRR, but even as a payout rate that sounds quite high. I'm skeptical.

The annuity company would have his money for well over a decade before beginning payments. And I'm sure it's the payout rate, not the IRR. It doesn't sound that out of line.

 

[Independent]

IMHO, the value of the 4% rule is that unsophisticated people can have some general idea of how much they can expect to withdraw every year and still have a fighting chance to make the money last their entire life. No guarantees, no promises.

Inaccurate? To be sure! But, far better than some people I know who suddenly inherit $84,563 and then think "WOW, This is more money that I have ever had in my life! I can retire even though I am only 52." Many, if not most, people have very poor financial skills. The price they pay for blowing off math in school while asking "when is anybody going to use this stuff?"

Right.

I was working for a financial megacorp in the late 1990's. We had mutual fund sales people telling their customers that they could roll their 401k balances into IRAs, invest in 100% stocks, and comfortably withdraw 7% per year. After all, the market had averaged more than CPI+8%, so what could possibly go wrong?

The Trinity study and the "4% Rule" was a real aid in getting them to reconsider that advice.

 

[pb4uski]

The annuity company would have his money for well over a decade before beginning payments. And I'm sure it's the payout rate, not the IRR. It doesn't sound that out of line.

I didn't realize the deferral period was that long. Given that, a 12% payout rate on the single premium doesn't sound implausible.

 

[youbet]

I didn't realize the deferral period was that long. Given that, a 12% payout rate on the single premium doesn't sound implausible.

Yeah, obgyn's sig line says he is 47 yo. He's already paid for the annuity. So the insurance co has some "free" time before he turns 62 and starts collecting, about 15 years I guess. 12% payout rate seems possible. I don't where to get an online quote for deferred annuities.

Also, I don't think the bar charts midpack posted above are mundane to the payout rates we are talking about.

 

[ERD50]

12%! Where do we sign up for that?

Everything I found online was more along these lines...

I certainly wouldn't buy Wellesley if I had a 'deferred annuity bought last year that will generate 12% per year from 62 until you die...'

'Generate' is the key word. He didn't say 'return', 'IRR' or anything else. So it appears he bought it ~ age 46, can get 12% of that per year at 62, so the money is sitting idle for 16 years, and I assume that 12% has no inflation factor built in. Is that a good deal? I don't know, but at 3% inflation, a $100,000 investment is down to ~ $62K in buying power. So that 12% is looking more like 7% and dropping each year.

Maybe later, I or someone else could throw together a ss that would compare that with a conservative investment assumed to keep up with inflation (so that washes out). What would $100,000 invested in that manner provide at age 62? I dunno (yet), but longevity insurance w/o an inflation kicker doesn't sound like longevity ins to me. The longer you live the less it buys - that won't help much at 98 YO.

That reminds me of a ss I did a while back. When my (then) 30 year mortgage ended, the inflation adjustments for everything else that year were greater than the mort payment. It wasn't even a blip at that point, just lost in the noise.

-ERD50