The Four Percent Rule

[NW-Bound]

I have a wide range of outcome in my mind, depending on how the market works out.

Best case: I maintain the two houses I have now, and the motorhome. Each year, I do a 2-month long RV trek, take a 1-month European trip, and a 1-week cruise. My stash grows so much, but I do not know what to do with it despite giving some to charities, so will die rich. Upon my death or DW's, whatever occurs later, my two children immediately enter ER with the money left behind.

Worst case: I lose both houses, and go live in the 25' RV, parked on New Mexico state land for a couple of bucks a day.

The future has to fall somewhere within those extremes. And if I am OK with those two extremes, it should be OK with whatever in between.

Of course, I prefer it to be one case than the other. But that shows the flexibility that I have. Have not discussed it with my wife. No point in worrying her needlessly.

 

[W2R]

It works out OK, so that's a job well done for keeping the surplus invested instead of keeping it in cash.

Now, had the market tanked, then what would happen? You would not even think or look for the dream house, and would have a different set of questions to ask yourself, and not the above question.

What I am saying is if I go back and ask the question of "what if", I would never stop, and would never really know anyway. It's more constructive to take it from here, and see what to do at this point.

Thanks! That makes it so clear. I don't know why I didn't see that. I guess I was lucky that this big expense was actually discretionary, a want rather than a need.

 

[audreyh1]

If I had withdrawn 4% every year and then saved the excess money in a savings account with 0% interest from 2010-2015, that would more than cover the net purchase price of the house plus moving, renovations, and all other house transaction/move/fixup related expenses that are included in the "2015 HOUSE! " entry in the table.

But is that valid? I wonder. What about the value of money in the bank, versus money in my portfolio? In reality the house money was invested for all those years. Luckily my portfolio has grown steadily so I am pretty sure I am OK. But really, I think this could be a huge issue in a declining market. I probably should have segregated that excess money during those years, by moving it from Vanguard to, say, Fido or Schwab and investing it there. But until I found the right dream house, I didn't know for sure that I definitely would be buying a house.

It's just a different way of handling things. You happened to be lucky and the market went up during those years (actually, not a bad bet after a terrible time like 2008-2009). So you realized you could lower your portfolio, accept lower future income, and pay for your dream house. Folks will occasionally do this too - it's perfectly valid as long as you can accept the lower future income.

BTW - excess money doesn't need to return 0% interest unless you are really not paying attention. You can get at least 1%, and probably a little more.

 

[W2R]

It's just a different way of handling things. You happened to be lucky and the market went up during those years (actually, not a bad bet after a terrible time like 2008-2009). So you realized you could lower your portfolio, accept lower future income, and pay for your dream house. Folks will occasionally do this too - it's perfectly valid as long as you can accept the lower future income.

BTW - excess money doesn't need to return 0% interest unless you are really not paying attention. You can get at least 1%, and probably a little more.

Very wise comments, as always. Thanks. Honestly, to me it has seemed very confusing for some reason. Despite that I was determined to buy the house. The lower future income won't be a problem and hopefully I won't be spending like that again for quite a few years.

 

[donheff]

I don't understand why people have problems with audrey1's approach. I have been doing something similar as have other posters. A few of us describe it as generating a "mad money" pool for extravagances or for use during hard times. The only difference I see is that audrey apparentlt literally invests it in a separate real account. I invest keep it in my regular accounts but track it as a pseudo account. Let me explain.

I have been using the Guyton approach (and tracking a few others to see roughly how they would have gone). I initially set the SWR at 3.8 and did a reset and dropped it to 3.0 when I sold my weekend house. I have consistently under-spent my withdrawal amount by between 10-30%. At year end I subtract the unspent amount from the total portfolio on my spreadsheet and add it to the "mad money cell (which I have just adjusted up or down based on the past year's performance). I have another cell labeled "SWR portfolio" tracking the remainder of the portfolio. In essence that cell tracks the portfolio I would have had if I spent my entire withdrawal. I use that cell to calculate calculate the appropriate SWR amount for the coming year applying Guyton rules.

I keep the mad money in a pseudo account because I find it easier to just let it ride in the overall portfolio AA. I view this pile of funds as an "account" to draw on if I want to splurge on something way above my budgeted SWR or to supplement the SWR in bad years if Guyton pulls me down to a level I am uncomfortable with. In the actual event of a major downturn I may very well chicken out and leave the mad money alone. I may also recalculate everything (ratchet up or down) a decade or so further down the line and (hopefully) start splurging on myself and/or gifting the kids/charities.

On the ratcheting question based on a traditional SWR I would simply express caution. A couple of posters correctly (I believe) noted that consistently ratcheting up on peaks slowly but surely eliminates the more optimistic FC scenarios from your actual situation with respect to history. That helps ensure that you won't die with a big pile but also puts you in more risky territory if you live a long time or if historical precedents don't pan out. Many of us have dropped our our SWR amount below 4% based on either the point in the apparent cycle we started or based on worries that the fundamentals have changed. I would be loath to ratchet up soon if I started at a high SWR to start with.

 

[NW-Bound]

I don't understand why people have problems with audrey1's approach...

No, not problems. There are different ways to save the unspent surplus for rainy days, and we were trying to see the pro and con of each.

About drawing 4% of current portfolio value and not spend it all during market good years to save to splurge later, what about going ahead and spend it, but on non-recurring expenses?

It is not bad either to rebalance some of those high P/E stocks into a new roof, a replacement for a clunker, a bucket list item, etc..., with an understanding that one should not develop a habit to spend the same in lean years.

 

[donheff]

About drawing 4% of current portfolio value and not spend it all during market good years to save to splurge later, what about going ahead and spend it, but on non-recurring expenses?

My pseudo account can be addressed toward that. So far I have been lucky enough to be able to cover most non-recurring expenses out of the SWR amount and still have some left over. But, I may remodel the bathroom in a few years. If I decided that was also when I was ready to buy a new car and couldn't get a 0% or other super low interest rate, I would deduct the expenses that exceeded SWR from my mad money fund. Similarly, if some unexpected large expense comes up I would not automatically cancel one of my European bike trips to accommodate the expense, I would tap mad money.

 

[NW-Bound]

I do not keep any spare money separate. Every account is included in Quicken, and added to its bottom line. In order to splurge or not, I look up expenses in past years and mentally see where I am.

I just started tracking my expenses just recently, so only have the past 6 years to look at. The highest year was 50% more than the frugal year. Overall, they are about where I want to spend. So, no surplus to speak of. There should be some in the coming years. No more wedding, big home projects, major illness, etc... On the other hand, the healthcare cost increase may just eat all that up.

 

[NW-Bound]

Two years ago, I sat down to figure out how much SS could help, once and for all. So, I ran SS-provided calculator, and entered the numbers into FIRECalc. Assuming no benefit reduction when I get there, when SS is included FIRECalc says I have been spending only 73% of what I could.

And then just for grin, I selected the Bernicke's spending model. FIRECalc says I can go ahead and spend double what I do now! All the above is for a 30-year run, and I don't think I will live that long. People drop like flies in their 80s. So, I could spend even more. But on what? Still, if I have to go live in a motorhome, it's still not the end of the world. Me worry?

I don't need a lot of money to spend, but I cannot have too much to count. Counting money is fun. And as I am not a passive index investor, it shows me I am doing something right.

 

[audreyh1]

About drawing 4% of current portfolio value and not spend it all during market good years to save to splurge later, what about going ahead and spend it, but on non-recurring expenses?

Well, first - you would have to have something to spend it on. Spending does take effort, at least for me. I like to have good value for my money. And I don't care to accumulate more stuff. I don't just spend it because it's there (no burning sensation in pocket). Our spending is increasing gradually which is how I prefer it.

But the main thing is that I know that even though times are good now, we will get to periods where times are bad. For peace of mind I prefer to have a war chest (as I call my accumulating unspent funds) set aside to help me during those bad times. I can see my portfolio shrink drastically, thus lowering my annual income. But I know I have the war chest to fall back on.

Right now I feel like there is a lot of financial uncertainty. I may need to draw on my war chest for significantly increased health care expenses in the future, for example. It could be a myriad of things. I might need to help family out, who knows! I see my accumulating unspent funds as increasing my financial security which helps my peace of mind.

Non-recurring expenses - the war chest is available for that too. I feel like I can do both. We will purchase a new car soon, and will dip into the war chest for that. I just won't spend all the war chest on non-recurring expenses.

IMO, as long as I have enough invested in my retirement portfolio to meet my withdrawal goals for the next 40 years, my portfolio should survive just fine without returning unspent funds to it or lowering my withdrawal rate. Chances are it will still grow to be quite large when I pass even though my goal is for it to be small without going to zero.

FWIW my withdrawal rate is 3.3% of remaining portfolio, which I consider to be reasonably conservative for a 40 year period, although others may consider that high. You pick your number and try to live with it.

 

[NW-Bound]

I do not have the urge to spend either. If and when I do, I look at what I have spent, and what FIRECalc says I could. The difference is my margin of safety (if it really exists).

People do different things to feel safe. My motorhome is my housing of last resort. Seeing it parked out there makes me feel safe. No bridges or freeway underpasses for me.

 

[samclem]

(Gone4Good quote from another thread)My approach is to discount current markets back to a level that represents the median valuation of the data set used to originally calculate your SWR. If you're using FIRECalc and PE-10, that would mean discounting the current equity market down to a valuation of about 16x from it's current 24x (a 33% haircut).

I'd also do the same thing with the bond market. 10-year treasuries are yielding 1.74% versus a median of 3.89%. Using an average bond market duration of about 6 years, that 200bp lower current yield results in a price discount of about 12%.

So assuming a 1MM portfolio and a 50/50 asset allocation, I'd mark the $500,000 in stocks down by 33% to $333,000 and the bond allocation down by 12% to $440,000.

My resulting $773,000 portfolio puts me right in the middle of the valuations used in our historic data set. Applying a 4% SWR, I get a withdrawal of about $31,000.

That means my undiscounted portfolio can support a withdrawal rate of 3.1%. Said another way, a 3.1% withdrawal today is equivalent to a 4% withdrawal at median valuations.

That seems like a good way to model things. But at the same time, since 4% is supposed to work for (most of) the bad sequences of market returns, it seems too conservative to use for median market valuation cases. Seems like you could use a higher withdrawal percent in those cases - like 5% or higher.

I'll continue the discussion in the previous thread on this (here). But, it looks like the safe withdrawal rate (end-of-year portfolio method) when using this valuation weighting scheme might be somewhere between 4% and 4.4% (assumptions: 30 yr, 50% TM/50% 5yr Treas).

 

[ERD50]

I don't understand why people have problems with audrey1's approach. ...

I'm not sure why you say people are having 'problems with her approach'? The approach is fine, IMO.

The problem I have is the terminology, which makes communication and learning difficult. If you talk about WR% and success/failure of a portfolio, but you took money out of the portfolio, set it aside, and don't include it in those calculations, it just confuses things.

What you are really doing is changing your AA to an increased cash holding. That makes is consistent with other conversations/questions about portfolio survival.

... I don't see how you all can manage with a 4% withdrawal every year and still have enough for a big expenditure that could happen every decade or two ...

People don't have consistent withdraw amounts every year. I think there have been numerous discussions on accounting for lump sum expenditures, new cars, remodels, repairs, etc. Many ways to handle it.

The approach I would take in your case, prior to buying the new home would be simple - estimate what your portfolio balance would be after the reduction for the house, and look at what your WR% would be going forward. A FIRECalc run would be helpful, as you could enter your updated regular expenses, and any changes in income (any pension, SS, tax changes? not div/return changes, that is part of the calculation FC does).

If the post home purchase numbers look comfortable, you are fine (and it looks like you are). If they don't, then re-think the home purchase, or decide that the new home is a reasonable trade-off for a somewhat less conservative WR.

-ERD50

 

[audreyh1]

I'm not sure why you say people are having 'problems with her approach'? The approach is fine, IMO.

The problem I have is the terminology, which makes communication and learning difficult. If you talk about WR% and success/failure of a portfolio, but you took money out of the portfolio, set it aside, and don't include it in those calculations, it just confuses things.

What you are really doing is changing your AA to an increased cash holding. That makes is consistent with other conversations/questions about portfolio survival.

-ERD50

That is not correct. The AA of the portfolio has not changed. The withdrawal rate only applies to the portfolio. What happens outside the portfolio has no bearing on the portfolio AA.

IMO what would be incorrect would be to consider unspent funds magically part of the portfolio again, even though you already withdrew them.

Now if someone chooses to add unspent funds back to their portfolio thus increasing it, and takes withdrawals from the now larger remaining portfolio, that is their prerogative. In practical terms, they effectively lowered their withdrawal rate that year.

 

[Lsbcal]

I think all you regulars here are very well situated even with some variety of approaches. The minor details are just noise. You are probably in the <1% of those with well thought out plans. However, I appreciate the review as it's easy to forget this stuff in all the other everyday trivia.

FWIW, I now have a book entry that accumulates unspent funds in short term investment grade bonds. Over the years, I think ST IG bonds have proven themselves. I am using VPW as a guide. I consider unspent money to be a failure to have enough fun in my ever shortening lifespan.

 

[NW-Bound]

The main thing is to keep one's expenses low. Where you keep the money is secondary to me.

Speaking of cast as a ballast, I accumulated quite a bit in I-bonds, and as the purchasing power is preserved there, it's my floatation device. Then, I always have loose cash in nearly every account, just in the chance there's a fire sale on stocks. And there's that Stable Value fund in my wife's 401k.

With all that cash reserve, I see no need for another pile of cash. And I also thought of that as my war chest. Had I fully deployed it in 2009, I would do a lot better.

So, as we approach SS age, that's another floatation device we can use in case of need. I am slowly redeploying my pile of cash into something with a better yield. I used to have 20% or more in cash. With my wife's 401k rollover to an IRA, I found myself with even more cash to redeploy.

Been buying steadily, and still have more than 40%. Ask me if I mind if stocks or bonds crash, or both.

 

[GTFan]

That is not correct. The AA of the portfolio has not changed. The withdrawal rate only applies to the portfolio. What happens outside the portfolio has no bearing on the portfolio AA.

IMO what would be incorrect would be to consider unspent funds magically part of the portfolio again, even though you already withdrew them.

Now if someone chooses to add unspent funds back to their portfolio thus increasing it, and takes withdrawals from the now larger remaining portfolio, that is their prerogative. In practical terms, they effectively lowered their withdrawal rate that year.

Have to agree with audrey on this - where does it say in the studies that your retirement portfolio is the entire sum of your investable assets? It doesn't, and if you want to keep a separate pool of money (withdrawn from the port or not) there's no need to insist that it's part of the portfolio, for any reason.

It's not confusing to me at all wrt safe WR % and overall success.

 

[ERD50]

That is not correct. The AA of the portfolio has not changed. The withdrawal rate only applies to the portfolio. What happens outside the portfolio has no bearing on the portfolio AA.

IMO what would be incorrect would be to consider unspent funds magically part of the portfolio again, even though you already withdrew them.

Now if someone chooses to add unspent funds back to their portfolio thus increasing it, and takes withdrawals from the now larger remaining portfolio, that is their prerogative. In practical terms, they effectively lowered their withdrawal rate that year.

I believe the accepted definition of one's 'portfolio', and the one used in most communications here, is all invest-able assets.

If you withdraw assets from an account, but don't spend them, they are still invest-able assets. They just aren't in the same account as they were before. A 'portfolio' can, and often does consist of multiple 'accounts'.

You are 'compartmentalizing' the funds you withdrew from one account and placed in another. That transaction didn't change your net worth. It didn't change what you would enter into FIRECalc (other than the AA assignment, if the AA of those accounts were different).

As I said, I have no problem with the approach. I've explained my problem with the terminology, and if you don't agree after this post, I don't think you ever will. So I'm done. But I feel you are doing a disservice to others here if you discuss things like portfolio WR% and portfolio success/failure while using an alternate definition of 'portfolio'. Words have meaning, it's how we communicate.

-ERD50

 

[ERD50]

Have to agree with audrey on this - where does it say in the studies that your retirement portfolio is the entire sum of your investable assets? It doesn't, and if you want to keep a separate pool of money (withdrawn from the port or not) there's no need to insist that it's part of the portfolio, for any reason.

It's not confusing to me at all wrt safe WR % and overall success.

It depends if you are talking about the success/failure of that particular pool of money. But that is not the same as the success/failure of the retiree, who depends on his/her entire portfolio.

I don't see the advantage of talking about the success/failure of a subset of my portfolio, and I do think it confuses things when people are (and should be) looking at the big picture.

An extreme example to illustrate: What if I split my portfolio into two equal sized accounts, one was 100/0 AA and the other was 0/100 AA. And then, in various posts I talked about one, but not the other - that would be confusing and misleading,and make discussion difficult, no? The reality is I would have one portfolio with a 50/50 AA. The separate accounts do not matter.

-ERD50

 

[audreyh1]

I believe the accepted definition of one's 'portfolio', and the one used in most communications here, is all invest-able assets.

If you withdraw assets from an account, but don't spend them, they are still invest-able assets. They just aren't in the same account as they were before. A 'portfolio' can, and often does consist of multiple 'accounts'.

You are 'compartmentalizing' the funds you withdrew from one account and placed in another. That transaction didn't change your net worth. It didn't change what you would enter into FIRECalc (other than the AA assignment, if the AA of those accounts were different).

As I said, I have no problem with the approach. I've explained my problem with the terminology, and if you don't agree after this post, I don't think you ever will. So I'm done. But I feel you are doing a disservice to others here if you discuss things like portfolio WR% and portfolio success/failure while using an alternate definition of 'portfolio'. Words have meaning, it's how we communicate.

-ERD50

No - I disagree. If some folks here are assuming that all investable assets must be counted as part of their retirement portfolio, and subject to the same AA across the board I don't know where they got that assumption. That is not stated in any of the studies of portfolio survival. I challenge any such "accepted" definition in this forum. I have been here a long time, and I am not the only one that does not share that assumption.

What about funds set aside for children's college? What about funds set aside of other things but not retirement such as saving for a new car or house down payment. Prudent financial planning/management recommends compartmentalizing your assets such that each can be invested according to the financial goals and timeframe for each intended purpose. No financial planning recommendation says: all investable assets must be included in your retirement portfolio, and you must apply the same AA and withdrawal rate to all those assets.

 

[NW-Bound]

...You are 'compartmentalizing' the funds you withdrew from one account and placed in another. That transaction didn't change your net worth. It didn't change what you would enter into FIRECalc (other than the AA assignment, if the AA of those accounts were different)...

It depends if you are talking about the success/failure of that particular pool of money. But that is not the same as the success/failure of the retiree, who depends on his/her entire portfolio.

I don't see the advantage of talking about the success/failure of a subset of my portfolio...

I look at this the same as increasing one's cash AA when the market is doing well with both stocks and bonds. When both stocks and bonds do well, there's nothing to do to protect against both doing poorly later, other than going to cash now.

There's no tool to evaluate the enhance safety of this Tactical AA strategy of going to cash, so people just put that money aside, to isolate it from the potential decline of the "regular" balanced portfolio, and feel safer.

Note that FIRECalc allows part of the AA to be in cash or short-term fixed income. However, it is a fix AA, and not a variable cash AA that is allowed to grow when the traditional 60/40 or 50/50 AA's is producing growth exceeding the norm.

 

[daylatedollarshort]

I have a wide range of outcome in my mind, depending on how the market works out.

Best case: I maintain the two houses I have now, and the motorhome. Each year, I do a 2-month long RV trek, take a 1-month European trip, and a 1-week cruise. My stash grows so much, but I do not know what to do with it despite giving some to charities, so will die rich. Upon my death or DW's, whatever occurs later, my two children immediately enter ER with the money left behind.

Worst case: I lose both houses, and go live in the 25' RV, parked on New Mexico state land for a couple of bucks a day.

The future has to fall somewhere within those extremes. And if I am OK with those two extremes, it should be OK with whatever in between.

Of course, I prefer it to be one case than the other. But that shows the flexibility that I have. Have not discussed it with my wife. No point in worrying her needlessly.

Wouldn't your worst case be something more like move to a low cost of living scenic location with a Mediterranean climate like Portugal? An AARP article says in Cascais, "A comfortable life can be had on $25,000 a year; frugal comfort on $20,000 a year. Dinner out: $40 for two."

 

[NW-Bound]

Sure, that sounds like something more fun than a little motorhome in the high plain of New Mexico. I was just using it as a metaphor to show I can cut my expenses drastically, and can still enjoy life.

But moving abroad takes some paperwork and dealing with red tape, compared to just driving my motorhome where I want to go. Hopefully it will never become so dire. I enjoyed my travel in Spain, but have not been to Portugal which has an even lower cost of living. And I want to see Portugal no matter what. That's in the back burner.

 

[ERD50]

No - I disagree. If some folks here are assuming that all investable assets must be counted as part of their retirement portfolio, and subject to the same AA across the board I don't know where they got that assumption. That is not stated in any of the studies of portfolio survival. I challenge any such "accepted" definition in this forum. I have been here a long time, and I am not the only one that does not share that assumption. ...

First, I didn't say (and my example showed this), that all accounts are subject to the same AA. I showed that one should sum all their investible assets, and then look at the total AA in order to see the big picture.

As far as it not being stated - I think it is such a basic concept that it is accepted by default. Look at this from firecalc.com:

FIRECalc can tell you how much you would have needed to insure that you wouldn't have depleted your portfolio if things are as bad as 1973. Or 1929. Or any of the past years for which we have data.

At the right, enter how much you need, how much you have,

It doesn't say anything about a segment of your finances, to see how that segment would do. Your net worth is your whole nut.

What about funds set aside for children's college? What about funds set aside of other things but not retirement such as saving for a new car or house down payment. Prudent financial planning/management recommends compartmentalizing your assets such that each can be invested according to the financial goals and timeframe for each intended purpose. No financial planning recommendation says: all investable assets must be included in your retirement portfolio, and you must apply the same AA and withdrawal rate to all those assets.

OK, for simplicity, you could pull out a known amount for a known upcoming expense, like college education - and then take a look at the portfolio going forward without either the funds or the expense. That's no different from entering it as cash, and entering the expense later, but that's more entries in firecalc.

But that's different from an ongoing strategy of pulling excess based on market returns, taking it out of the equation, and then spending that accumulation on various things in various years, and trying to discuss this in terms of the standard inflation adjusted withdrawals and 'portfolio survival'. Again, not that there's anything wrong with that approach, but as far as making comparisons to how firecalc works, and all those terms, well, it just isn't a part of how it works.

For example, you could have pulled an excess for many years and set it aside, but never got excited about any big purchase, so it just sits there. Then let's say the market melts down and your 'compartmentalized portfolio' fails, but then you 'refill' from your off-the-books stash.

Did your portfolio (the whole nut) actually fail? I'd say no, but I think you would say yes. This is why I say it is confusing. A big picture view has no such uncertainty in terms.

-ERD50

 

[NW-Bound]

On the thread about portfolio return YTD, there are posters who say "this account of mine has wonderful return of so and so". Well, owning individual stocks, I can always point to some stocks where I double my money, while neglecting the ones where I lost my shirt.

I have that big pile of cash, and it is included in Quicken. Even the cash in my checking account is included (used to be in the mid 5 figures). And my total return always includes the effect of the meager yield of all that cash.