Join Early Retirement Today
Reply
 
Thread Tools Search this Thread Display Modes
Smart guys question 4% SWR strategy
Old 04-17-2008, 12:49 PM   #1
Moderator Emeritus
Rich_by_the_Bay's Avatar
 
Join Date: Feb 2006
Location: San Francisco
Posts: 8,827
Smart guys question 4% SWR strategy

This article is way over my head, but it intrigues me. Sharpe offers alternatives which use, in part, laddered TIPs plus total market. I got this from the diehard board where it's the third message on this page.

The abstract:

The 4% rule is the advice most often given to retirees for managing spending and investing. This rule and its variants finance a constant, non-volatile spending plan using a risky, volatile investment strategy. As a result, retirees accumulate unspent surpluses when markets outperform and face spending shortfalls when markets underperform. The previous work on this subject has focused on the probability of short falls and optimal portfolio mixes. We will focus on the rule’s inefficiencies—the price paid for funding its unspent surpluses and the overpayments made to purchase its spending policy. We show that a typical rule allocates 10%-20% of a retiree’s initial wealth to surpluses and an additional 2%-4% to overpayments. Further, we argue that even if retirees were to recoup these costs, the 4% rule’s spending plan often remains wasteful, since many retirees may actually prefer a different, cheaper spending plan.

You thoughts?
__________________

__________________
Rich
San Francisco Area
ESR'd March 2010. FIRE'd January 2011.

As if you didn't know..If the above message contains medical content, it's NOT intended as advice, and may not be accurate, applicable or sufficient. Don't rely on it for any purpose. Consult your own doctor for all medical advice.
Rich_by_the_Bay 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 04-17-2008, 01:22 PM   #2
Give me a museum and I'll fill it. (Picasso) Give me a forum ...
REWahoo's Avatar
 
Join Date: Jun 2002
Location: Texas Hill Country
Posts: 42,152
Quote:
Originally Posted by Rich_in_Tampa View Post
You thoughts?
I'll get back to you in about 20 years with some first-hand evidence.
__________________

__________________
Numbers is hard

When I hit 70, it hit back

Retired in 2005 at age 58, no pension
REWahoo is offline   Reply With Quote
Old 04-17-2008, 01:39 PM   #3
Moderator Emeritus
Martha's Avatar
 
Join Date: Feb 2004
Location: minnesota
Posts: 13,212
I tend to think that few people follow the 4% rule religiously. Most would not be able to stomach taking the full amount in a substantially down year. Even this year I am more conservative in spending because of volatility. And maybe a good year is when you incur that large expense, like a new vehicle or large home repairs.
__________________
.


No more lawyer stuff, no more political stuff, so no more CYA

Martha is offline   Reply With Quote
Old 04-17-2008, 01:54 PM   #4
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
haha's Avatar
 
Join Date: Apr 2003
Location: Hooverville
Posts: 22,387
Did you notice that this involves annuities? Have look at the recent annuity thread for help in seeing how this will be a definite non-starter on this board.

And TIPS ladders? Isn't harping on TIPS ladders what got Rob Bennet subjected to nasty personal attacks and ultimately banned?

For the first year that I posted on here I wrote long pieces explaining why I thought that the 4% rule underestimated risk, given volatile portfolios.

Most responses were "So what? or just automatic incantations of the 4% catechism. Or yeah, but I will cut back if that happens. Or praise of 100% equity portfolios, often from fully COLA'd government retirees. To question FireCalc as an absolute test for one's hoped for retirement success was often met by "You think things could get worse than the Great Depression?" A non-sequiter if there ever was one.

The difficulty is in decoupling attitudes toward financial plans from recent emotional experience. The last big market break was during the time that most on this board were still working, and also it was limited to tech, dot-com and large S&P companies. Many "old economy " stocks were quite cheap, as were foreign stocks.

So the thesis wasn’t tested, not was our resolve as self-funded retirees.

IMO, if flaws are present in the heavy allocation to equities for retirement funding, we will mostly discover them when it is too late to react.

This article does show a way to increase spending, still keeping funding more conservative. But it would not work as well using today's TIPS rates, or for a very young retiree, let alone a young family.

Anyhow, we are here for Happy Talk and Entertainment. This type of article is a downer.

Ha
__________________
"As a general rule, the more dangerous or inappropriate a conversation, the more interesting it is."-Scott Adams
haha is offline   Reply With Quote
Old 04-17-2008, 02:01 PM   #5
Thinks s/he gets paid by the post
 
Join Date: Apr 2006
Posts: 1,487
seems the deficiencies noted with the 4% rule have all been discussed on this board, but it's not clear to me from reading the paper exactly what is being suggested as the alternative. could someone clue me in?
__________________
d is offline   Reply With Quote
Old 04-17-2008, 02:03 PM   #6
Thinks s/he gets paid by the post
jIMOh's Avatar
 
Join Date: Apr 2007
Location: Milford, OH
Posts: 2,085
I will post some excerpts

Quote:
A typical rule of thumb recommends that a retiree annually spend a fixed, real amount
equal to 4% of his initial wealth, and rebalance the remainder of his money in a 60%-
40% mix of stocks and bonds throughout a 30-year retirement period. For example, a
retiree with a $1MM portfolio should confidently spend a cost of living adjusted $40K a
year for 30 years, independent of stock, bond, and inflation gyrations.
Confidence in the
plan is often expressed as the probability of its success, e.g., in nine of ten scenarios, our
retiree will sustain his spending. Modifications to this basic example include changing
the amount to withdraw, the length of the plan, the portfolio mix, the rebalancing
frequency, or the confidence level. However, all these variations have a common
theme—they attempt to finance a constant, non-volatile spending plan using a risky,
volatile investment strategy. For simplicity, we refer to this entire class of retirement
strategies as 4% rules, the sobriquet of its first and most popular example.

So far so good

Quote:
Supporting a constant spending plan using a volatile investment policy is fundamentally
flawed. A retiree using a 4% rule faces spending shortfalls when risky investments
underperform, may accumulate wasted surpluses when they outperform, and in any case,
could likely purchase exactly the same spending distributions more cheaply.
Bold statement. Let's see what follows.

Quote:
First Larry Bierwirth (1994), and then William Bengen (1994) argued that since actual
asset returns and inflation rates were historically quite volatile, retirement plans based on
their averages were unrealistic. Bengen proposed an alternative strategy that retained the
basic investment and spending strategies inherent in the mortgage calculation. In
particular, he assumed that a retiree’s assets were invested in a mix of stocks and bonds
and annually rebalanced to fixed percentages. Further, he assumed that in terms of real
dollars, a retiree’s annual spending was constant and financed by a year-end, inflation
adjusted withdrawal from the portfolio. Hence, choosing a stock-bond mix and a
withdrawal rate—the ratio of annual, real spending to initial wealth—specified a
retirement plan. Now, for a given horizon, some of these plans would have historically
performed better than all the other possibilities. So, Bengen collected scenarios of past
asset returns and inflation rates, simulated a number of plans under these scenarios, and
identified the best performers.
that was history. some more history

Quote:
Cooley, Hubbard,
and Walz (1998, 20, Table 3) reported a 95% historical success rate for a 30-year
horizon, a 4% withdrawal rate, and 50%-50% mix of stocks and bonds. This success rate
increased to 98% when the percentage of stocks was increased to 75%. This paper is
often cited as the Trinity Study—all three authors are finance professors at Trinity
University in San Antonio, Texas.
Quote:
Our market model is similar to those used by investment consultants for asset allocation
and asset liability studies. A 2% risk-free real rate is broadly consistent with the historic
record for U.S. Treasury STRIPS and TIPS investment returns. In addition, our market
portfolio assumptions imply a Sharpe ratio of 1/3, a fairly typical choice. While the actual
market values of bonds and stocks vary over time, on average, bonds contribute about
40% of the value of the market portfolio and stocks 60%. Thus, a strategy that invests
100% in the market portfolio can be thought of as a 60% equity strategy.
An investor can guarantee a real dollar every year for thirty years by purchasing a series
of zero-coupon, risk-free bonds. The cost of this investment is the sum of the discounted
prices8 $1/(1.02) + $1/(1.02)2 + … + $1/(1.02)30, which amounts to a little less than
$22.40. Alternatively, if a retiree invests in a risk-free bond portfolio, he can safely
withdraw at a yearly rate that is a bit more than $1.00 / $22.40 » 4.46%. This withdrawal
rate—the guaranteed rate—is the maximum withdrawal rate that can be guaranteed to
never fail. This risk-free strategy is analogous to Eric’s strategy and is a special case of
the 4% rule—the limit of zero investment volatility. This version of the 4% rule never has
a surplus, never has a shortfall, and is the cheapest way to receive a constant, guaranteed
payout every year. If a cheaper investment were to exist, then there would be an arbitrage
opportunity.
Quote:
Conclusion
The 4% rule and its variants finance a constant, non-volatile spending plan using a risky,
volatile investment strategy. Two of the rule’s inefficiencies—the price paid for funding
its unspent surpluses and the overpayments for its spending distribution—apply to all
retirees, independent of their preferences. For a typical rule, we used a market model to
estimate that between 10%-20% of a portfolio’s initial wealth is being allocated to
surpluses, and an additional 2%-4% is going towards overpayments. If the spending
distribution of the 4% rule is inconsistent with a retiree’s preferences, then the costs can
be much higher. All in all, any retiree that adopts a 4% rule pays a high price.
Our approach can be easily extended to investigate other retirement rules of thumb and to
use alternative market models. If a retirement plan generates unspent surpluses then our
approach can price the surplus. A scatter plot of spending amount versus cumulative
market return will quickly reveal whether a strategy is least cost. Strategies with
overpayments will generate a cloud of points (Figure 1), while least cost strategies will
generate a non-decreasing curve (Figure 2).
Many practical issues remain to be addressed before advisors can hope to create
individualized retirement financial plans that maximize expected utility for investors with
diverse circumstances, other sources of income, and preferences. While we still may be
far away from such an ideal, there appears to be no doubt that a better approach can be
found than that offered by combinations of desired constant real spending and risky
investment. Despite its ubiquity, it is time to replace the 4% rule with approaches better
grounded in fundamental economic analysis

I read the conclusion twice and still don't know what he's talking about.
__________________
Light travels faster than sound. That is why some people appear bright until you hear them speak. One person's stupidity is another person's job security.
jIMOh is offline   Reply With Quote
Old 04-17-2008, 02:08 PM   #7
Give me a museum and I'll fill it. (Picasso) Give me a forum ...
REWahoo's Avatar
 
Join Date: Jun 2002
Location: Texas Hill Country
Posts: 42,152
Quote:
Originally Posted by haha View Post
Anyhow, we are here for Happy Talk and Entertainment. This type of article is a downer.
Maybe I'm reading more into your post than you intended, but I think I detect a hint of bitter sarcasm in your remarks.
__________________
Numbers is hard

When I hit 70, it hit back

Retired in 2005 at age 58, no pension
REWahoo is offline   Reply With Quote
Old 04-17-2008, 02:10 PM   #8
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
brewer12345's Avatar
 
Join Date: Mar 2003
Posts: 16,391
Quote:
Originally Posted by REWahoo View Post
Maybe I'm reading more into your post than you intended, but I think I detect a hint of bitter sarcasm in your remarks.
Nah, that's just the scent of fried fish.
__________________
"There are three kinds of men. The one that learns by reading. The few who learn by observation. The rest have to pee on the electric fence for themselves."



- Will Rogers
brewer12345 is offline   Reply With Quote
Old 04-17-2008, 02:13 PM   #9
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
 
Join Date: Nov 2007
Posts: 7,533
From reading the abstract, I think there might be something to the article. I'll read the entire thing and comment if I have anything to say.

I will say that most folks don't seem to plan on taking the 4% rule literally. "4% rule" being defined as 4% of initial portfolio balance plus CPI inflationary increases in the withdrawal each year. I'm still a good bit from RE, but it seems crazy to think I would take my same 4% if we saw a 30%+ correction in worldwide equity prices and things still looked bleak.
__________________
FUEGO is offline   Reply With Quote
Old 04-17-2008, 02:14 PM   #10
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
haha's Avatar
 
Join Date: Apr 2003
Location: Hooverville
Posts: 22,387
Ok guys, touché. I'll cop to sarcasm, but pass on the bitter.

Martha has cautioned us against excessive sarcasm. That word excessive can be a real term of art.

Ha
__________________
"As a general rule, the more dangerous or inappropriate a conversation, the more interesting it is."-Scott Adams
haha is offline   Reply With Quote
Old 04-17-2008, 02:17 PM   #11
Thinks s/he gets paid by the post
 
Join Date: Dec 2007
Posts: 4,764
Whats the alternative? Save more, spend less, work longer? You will never get rid of risk.
__________________
Notmuchlonger is offline   Reply With Quote
Old 04-17-2008, 02:19 PM   #12
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
FinanceDude's Avatar
 
Join Date: Aug 2006
Posts: 12,484
How bout we keep it simple: If your portfolio doesn't get a return of at least 4% above inflation and before taxes you can't take 4% that year......
__________________
Consult with your own advisor or representative. My thoughts should not be construed as investment advice. Past performance is no guarantee of future results (love that one).......:)


This Thread is USELESS without pics.........:)
FinanceDude is offline   Reply With Quote
Old 04-17-2008, 02:28 PM   #13
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
cute fuzzy bunny's Avatar
 
Join Date: Dec 2003
Location: Losing my whump
Posts: 22,697
Quote:
Originally Posted by haha View Post
And TIPS ladders? Isn't harping on TIPS ladders what got Rob Bennet subjected to nasty personal attacks and ultimately banned?
Nope. I think it was 13 page schizophrenic monologues written into every thread whether they had anything to do with his monologue or not. He didnt even recommend TIPS at their current prices but was happy with the 4% versions he had bought.

His all fixed income strategy has forced him to sell his house and last I heard had him heading for divorce court. So it seems that his strategy wasnt so good.

I'm also pretty sure the other 12 boards that banned him and the one that went out of business due to his antics werent just similarly "poorly cultured".

For goodness sakes, two entire discussion groups (raddrs and diehards) were formed by people who couldnt stand him and formed those communities with him pre-banned, and an entire early retirement community web site was turned into a shrine to make fun of him (retireearlyhomepage).

BTW, I'm pretty sure that excessive sarcasm doesnt get you banned either. It looks to me like you have to be a jerk for six months to get that benefit awarded.
__________________
Be fearful when others are greedy, and greedy when others are fearful. Just another form of "buy low, sell high" for those who have trouble with things. This rule is not universal. Do not buy a 1973 Pinto because everyone else is afraid of it.
cute fuzzy bunny is offline   Reply With Quote
Old 04-17-2008, 02:31 PM   #14
Thinks s/he gets paid by the post
retire@40's Avatar
 
Join Date: Feb 2004
Posts: 2,670
Quote:
Originally Posted by FinanceDude View Post
How bout we keep it simple: If your portfolio doesn't get a return of at least 4% above inflation and before taxes you can't take 4% that year......
The general rule is that you can take 4% for that year. That's the whole point of the 4% rule. Over time, the 4% compensates for up and down markets, based on historical worst-of-time scenarios.

Also, the general rule is that taxes are included in the 4%.
__________________
No man is free who is not master of himself. --- Epictetus
Enjoy Yourself (It's Later Than You Think). --- Guy Lombardo
retire@40 is offline   Reply With Quote
Old 04-17-2008, 02:34 PM   #15
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
cute fuzzy bunny's Avatar
 
Join Date: Dec 2003
Location: Losing my whump
Posts: 22,697
Back to the topic at hand...

Mechanically the 4% rule has worked for the last 100 years. My problems with it are many, but I think the 4% and portfolio of 25x your annual spending rules are decent rules of thumb.

I think someone who follows it religiously in both up and down years, spending more than they need or making unnecessary expenditures in down markets, may be carrying it to extremes.

Look at it from the other direction. Most balanced portfolios have long term average returns in the 8% range. Inflation runs about 3%. Taxes around 1%. 4% left over.

Things may not be so good in the future. Or they might be better. Or they might be just average. 3% might be pretty conservative. 6% might be a little liberal.

Who was it who says "agile, mobile, hostile"?
__________________
Be fearful when others are greedy, and greedy when others are fearful. Just another form of "buy low, sell high" for those who have trouble with things. This rule is not universal. Do not buy a 1973 Pinto because everyone else is afraid of it.
cute fuzzy bunny is offline   Reply With Quote
Old 04-17-2008, 02:39 PM   #16
Moderator Emeritus
Rich_by_the_Bay's Avatar
 
Join Date: Feb 2006
Location: San Francisco
Posts: 8,827
Quote:
Originally Posted by REWahoo View Post
Maybe I'm reading more into your post than you intended, but I think I detect a hint of bitter sarcasm in your remarks.


Who, Ha?
__________________
Rich
San Francisco Area
ESR'd March 2010. FIRE'd January 2011.

As if you didn't know..If the above message contains medical content, it's NOT intended as advice, and may not be accurate, applicable or sufficient. Don't rely on it for any purpose. Consult your own doctor for all medical advice.
Rich_by_the_Bay is offline   Reply With Quote
Old 04-17-2008, 02:47 PM   #17
Give me a museum and I'll fill it. (Picasso) Give me a forum ...
REWahoo's Avatar
 
Join Date: Jun 2002
Location: Texas Hill Country
Posts: 42,152
Quote:
Originally Posted by Rich_in_Tampa View Post

Who, Ha?
Hoo-hah right back at you, Doc.
__________________
Numbers is hard

When I hit 70, it hit back

Retired in 2005 at age 58, no pension
REWahoo is offline   Reply With Quote
Old 04-17-2008, 02:52 PM   #18
Moderator Emeritus
Rich_by_the_Bay's Avatar
 
Join Date: Feb 2006
Location: San Francisco
Posts: 8,827
Quote:
Originally Posted by REWahoo View Post
Hoo-hah right back at you, Doc.
Texan for "my shorts are a little tight."
__________________
Rich
San Francisco Area
ESR'd March 2010. FIRE'd January 2011.

As if you didn't know..If the above message contains medical content, it's NOT intended as advice, and may not be accurate, applicable or sufficient. Don't rely on it for any purpose. Consult your own doctor for all medical advice.
Rich_by_the_Bay is offline   Reply With Quote
Old 04-17-2008, 03:51 PM   #19
Recycles dryer sheets
 
Join Date: Apr 2006
Posts: 143
Quote:
Originally Posted by Notmuchlonger View Post
Whats the alternative? Save more, spend less, work longer? You will never get rid of risk.
I subscribe to the "three buckets" approach to retirement financing:
  1. Bucket #1 (cash) -- Enough cash to pay the next year or two of living expenses. This lets you sleep well at night.
  2. Bucket #2 (income) -- Dependable income sources such as pensions, social security, and high-quality bonds and dividend-paying stocks. You own these assets for the dependable income they provide so that it helps to restore the cash you need in bucket #1.
  3. Bucket #3 (appreciation) -- A diversified portfolio of stocks and other investments that are expected to appreciate over the long term, but may be highly volatile over the short term of a few years. The 4% safe withdrawal rate applies to this bucket, so when there are a few lean years, the other two buckets pick up the slack.
When you do withdraw from bucket #3 (volatile appreciation assets), add the amounts to bucket #1 (cash) to restore its balance to a year or two of living expenses; otherwise, use the money to buy more assets in bucket #2 (dependable income assets).
__________________
rogersteciak is offline   Reply With Quote
Old 04-17-2008, 03:54 PM   #20
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
 
Join Date: Sep 2005
Location: Northern IL
Posts: 18,300
I didn't read the whole thing, just the excerpts provided above, but I interpret this to mean....

Quote:
Alternatively, if a retiree invests in a risk-free bond portfolio, he can safely
withdraw at a yearly rate that is a bit more than $1.00 / $22.40 » 4.46%. This withdrawal
rate—the guaranteed rate—is the maximum withdrawal rate that can be guaranteed to
never fail. This risk-free strategy is analogous to Eric’s strategy and is a special case of
the 4% rule—the limit of zero investment volatility. This version of the 4% rule never has
a surplus, never has a shortfall, and is the cheapest way to receive a constant, guaranteed
payout every year.
that at the end of 30 years of a 'guranteed' 4.46% SWR, you are also 'guaranteed' to have zero dollars left.

Is that correct? That is how I interpret 'never has a surplus'. If you assume a fixed % return (I don't know how he predicts future returns, or does he just buy 30 year bonds?), you can simply self-annuitize that over 30 years. Is that what the article is saying?

Fine approach - at the same time I can call and have my gravestone carved at today's wages with the year '2038' on it.

edit/add:
Quote:
A 2% risk-free real rate is broadly consistent with the historic
record for U.S. Treasury STRIPS and TIPS investment returns
OK, I can go plug that into a SS, but 4.46% sounds right if you self-annuitize and assume a 2% real return.

-ERD50
__________________

__________________
ERD50 is online now   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
SWR Investment Strategy and Horse Race Betting Systems are the samething Hydroman FIRE and Money 12 06-11-2006 01:37 PM
Bond strategy question Van FIRE and Money 17 05-17-2006 09:03 AM
Another SWR Question? mb FIRE and Money 14 01-06-2006 08:55 AM
Car question for smart people Arin38 Other topics 11 11-15-2005 11:33 PM
Question For Financial Whiz Guys..... Cut-Throat FIRE and Money 16 01-18-2004 04:00 AM

 

 
All times are GMT -6. The time now is 12:45 PM.
 
Powered by vBulletin® Version 3.8.8 Beta 1
Copyright ©2000 - 2017, vBulletin Solutions, Inc.