A simple withdrawal rate question

[Roger_R]

I've been following a few of the recent threads that express some trepidation at a 4% withdrawal rate and are tending to favor 3% or lower. I may be a little new at this but.... Let's say you are 55 and have an expected draw of about 30 more years. If you are keeping equal to inflation you can divide your portfolio by 30 and possibly end up with a withdrawal rate of greater than 3% assuming an end balance of 0. Or if you say, invested in TIPS with a real rate of return of 2%, you are drawing down your principle by 1% with a WR of 3%. So you might end up with maybe 2/3 of your principle at the end of 30 years. Which would make a mainly TIPS portfolio beyond extremely safe at a 3% withdrawal. I must be missing something with all of the elaborate calculators out there? Sorry if this is remedial.

[JohnEyles]

Originally Posted by Roger_R

Or if you say, invested in TIPS with a real rate of return of 2%, you are drawing down your principle by 1% with a WR of 3%. So you might end up with maybe 2/3 of your principle at the end of 30 years. Which would make a mainly TIPS portfolio beyond extremely safe at a 3% withdrawal.

Roger, this is more or less true. I've done a spreadheet of a ladder of 5yr TIPS
with YTM=2.375% than supports 3.6% WR for about 40 years. Even at 4% it
lasts 33yrs or so. I imagine 3% would be close to perpetual. I think most
people believe it should be possible to achieve 4% for at least 30 years though.
But if your situation is such that you can live comfortably with an initial WR of
3%, then I suppose all-TIPS is tempting - but probably not really a great idea,
due to the extreme likelihood of doing way better with some equities - but
perhaps you WOULD want to consider a higher percentage of bonds than typical,
probably including a LOT of TIPS.

If you are all good with Excel, I'd urge you to mess around with some simple
spreadsheets, like I have done. One line per year, with a portfolio balance,
an inflation-adjusted version of your initial withdrawal (or alternatively, a fixed
WR of *current* portfolio value), an inflation value that varies from year to year,
and an overall portfolio return that is either absolute (if that's the right word) and
"real" (above inflation). Mess around and see how long it lasts. You'll tend to
find that if ROR tracks inflation (i.e. real return is constant) that you'll do quite
well with very modest-sounding RORs. The real killer is when the two are out
of sync, that is, you have some poor/negative ROR years where inflation is high.
The thing so appealing about TIPS is that real return IS constant, by definition.

Although you can find much more sophisticated spreadsheets than the ones you
or I might make, I frequently find them too complicated to comprehend. When you
do it on your own, you gain a better understanding, IMHO. Then you can cross check
against some of the calculators and see where you are.

[wabmester]

Originally Posted by Roger_R

I must be missing something with all of the elaborate calculators out there?

The roughly 4% SWR FIREcalc gives you from a 75/25 portfolio is a historical worst case. The historical best case for such an allocation is a WR of 10%.

So, you're right that you can lock in a ~4% SWR with TIPS, but you're essentially locking in the worst case. Most people hope for something better.

As you know, all of these calculations assume that you eat into principal. Again, this is generally only required in bad stock return sequences for 75/25, but it is always required with a 100% fixed income portfolio. Once you start eating into principal, you better hope that your estimated lifespan was correct.

[Peter]

Roger, I'm using a similar approach. Basically, I reckon that if my investments at least keep pace with inflation, then I can withdraw an inflation adjusted 1/n each year, whre n is my life expectancy.

There are two issues to watch: first, your personal inflation rate may be higher than the CPI, so an all-TIPS portfolio won't work; and second, you may live longer than n years.

A third issue would be that the strategy leaves nothing for your heirs, if that's a concern.

Peter

[Zipper]

Just take a set 5% of your year end portfolio balance. Every year. It's worked for me since '97.

[Cut-Throat]

Originally Posted by Zipper

Just take a set 5% of your year end portfolio balance. Every year. It's worked for me since '97.

Yup, you'll never run out of money with this one. - guaranteed!

In fact you could use 6%, 7%, 8% ..............Just don't take 100%

[cute fuzzy bunny]

The 'shave your portfolio' or 'tips real return' strategies work great if your experiential inflation matches the CPI, you die on time, you dont need expensive long term care later in life, or some other crisis hits that taps into your principal occurs.

There are a couple of ways to look at the whole thing...

- Play to not lose too badly (eat your principal and play with inflation adjusted investments)
- Play to break even (some middling balanced strategy and a 4% SWR)
- Play to win and sleep badly (high equity holdings and cash buffers)

[kramer]

Hello Roger,

Just like the other posters here, I don't advocate an all or even mostly TIPs strategy. But I do like to see the SWR figures based on them to develop an intuition about my portfolio. For instance, if someone is retiring early, they can take great comfort in knowing that their SWR is lower than the 45 year SWR for an all-TIPs portfolio at current rates -- and intuitively realize that they don't need to take much risk in their portfolio, even if they decide not to own TIPs at all.

Overall, I am quite skeptical about SWR's derived from purely historical figures because I believe the risk premium has dropped significantly and also most respected experts expect the return of bonds and stocks to be closer in this century than the last (so both the absolute value of the derived SWR is suspect as well as the stock/bond asset mix used to achieve it).

You can find current TIPs rates here (click on US):

http://www.bloomberg.com/markets/rates/

20 year TIPs are currently paying about 2.22% real.

I put the SWR figures for some all-TIPs portfolios below. Keep in mind that with TIPs there is reinvestment risk, tax risk, CPI risk, etc.

Kramer


45 year

TIPS --> SWR

2.0% --> 3.32%
2.2% --> 3.45%
2.4% --> 3.57%


40 year

TIPS SWR

2.0% --> 3.58%
2.2% --> 3.70%
2.4% --> 3.83%


30 years

TIPS --> SWR

2.0% --> 4.38%
2.2% --> 4.49%
2.4% --> 4.60%