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The Safe Water Reservoir: (SWR): An analogy?
Old 03-29-2005, 05:04 AM   #1
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The Safe Water Reservoir: (SWR): An analogy?

A mining town on the edge of the desert has built a dam to hold the
water it needs to survive. Each year the rains come. In some years
the rainfall is enough to replenish the reservoir, but in other
years evaporation depletes the water level. How much water can
the town draw from the reservoir each year to be reasonably certain
of not running it dry?

Analogies can be useful. They help us identify the essential elements
in any problem. Would the SWR experts here have a look at this toy
model and tell me what what is common and what is missing?

Zorba

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Re: The Safe Water Reservoir: (SWR): An analogy?
Old 03-29-2005, 06:22 AM   #2
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Re: The Safe Water Reservoir: (SWR): An analogy?

Quote:
Hmmm...
I smell a troll. zorba ~ hocoloco?
No. Not even close. I appreciate that everyone is on red alert these days
but you have just found the fastest way to chase away new contributors to
this board! I'm interested and I'm a newbie so please be gentle

I am trying to get some intuitive understanding of what the main factors
are in a SWR. Backtesting (with historical data) or simulation (via
Monte Carlo modeling) don't do it for me.
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Re: The Safe Water Reservoir: (SWR): An analogy?
Old 03-29-2005, 06:27 AM   #3
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Re: The Safe Water Reservoir: (SWR): An analogy?

What if a bunch of people urinated in the reservoir?
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Re: The Safe Water Reservoir: (SWR): An analogy?
Old 03-29-2005, 06:37 AM   #4
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Re: The Safe Water Reservoir: (SWR): An analogy?

Zorba:

I will give you the benefit of the doubt re: the troll issue.

FWIW, I think that the analogy you proposed is reasonable. The chief holes in it are:

- Every year the mining town's population grows by about 3%. If the reservoir isn't periodically expanded, eventually the annual rains won't come close to replenishing the water supply. I am referencing inflation risk here.

- The population of the town has the ability to attempt to influence rainfall amounts. If the town's attempts to boost rainfall are successful, ithe reservoir could receive much more than average annual rainfall. If they fail, the town could receive much less rainfall than required. I am referring to how much portfolio risk one can afford to take.

- The town can follow water use reduction strategies to use less water in times of extended drought (no watering the lawn, etc.). I am referring to cutting one's expenses/withdrawals in extended bad times.

Anyone else?
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Re: The Safe Water Reservoir: (SWR): An analogy?
Old 03-29-2005, 06:50 AM   #5
 
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Re: The Safe Water Reservoir: (SWR): An analogy?

Quote:
No. Not even close. *I appreciate that everyone is on red alert these days
but you have *just found the fastest way to chase away new contributors to
this board! I'm interested and I'm a newbie so please be gentle *

I am trying to get some intuitive understanding of what the main factors
are in a SWR. *Backtesting (with historical data) or simulation (via
Monte Carlo modeling) don't do it for me.
Not sure what your objective is? - If the tools that you mention don't do it for you, and you are looking for a truly 'safe' WR - There isn't any. I don't care whether you take only 1% a year, I can concoct a scenerario where you'll be broke in 5 years.

Bottom line is that there is no way to predict the future. FireCalc is a good enough guideline. Anything else is just mental masturbation.
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Re: The Safe Water Reservoir: (SWR): An analogy?
Old 03-29-2005, 06:54 AM   #6
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Re: The Safe Water Reservoir: (SWR): An analogy?

One point I can see where the analogy breaks with the portfolio and SWR system is that the amount of water in the reservoir doesn't affect how much falls from the sky. In the portfolio how much is there affects how much you gain. To keep to the analogy the portfolio would have to gain some specific set amount of dollars in a year rather than as a percentage of dollars in the portfolio. Just about all analogies break at some point - it's important to realize where.
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Re: The Safe Water Reservoir: (SWR): An analogy?
Old 03-29-2005, 06:58 AM   #7
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Re: The Safe Water Reservoir: (SWR): An analogy?

Zorba:
Brewer beat me to the punch.
An interesting analogy.
So what's the answer? (We're busy retiring here, haven't got all day!)







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Re: The Safe Water Reservoir: (SWR): An analogy?
Old 03-29-2005, 06:59 AM   #8
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Re: The Safe Water Reservoir: (SWR): An analogy?

Quote:
Not sure what your objective is?
I can see the need for something like this. The financial concepts behind portfolio returns, withdrawals, inflation, etc. can be difficult for some to understand and even for those that understand it some can have difficulty "visualizing" it. When I was a physics undergrad I would always try to build a mental picture of how various systems worked - it gave me a better "intuitive" understanding beyond the equations.
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Re: The Safe Water Reservoir: (SWR): An analogy?
Old 03-29-2005, 07:26 AM   #9
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Re: The Safe Water Reservoir: (SWR): An analogy?

Thanks Hyperborea. As a newbie I am trying to reduce this problem down
to its main elements so that I can intuitively understand what all of you
are talking about. In other words, what are the dominant factors that
influence the SWR?

To first order I thought we could discount inflation in my analogy
since both the annual returns (rainfall) and SWR (withdrawal) are
inflation adjusted. However, Inflation does introduce a correlation
that does not exist in my analogy. The other problem I see is that a
real SWR must depend somewhat on the age of the person. The limiting
case of large time is like an endowment.

The annual returns (aka rainfall) cannot be influenced. They are a
stochastic variable and cannot be predicted in advance. You might know
the distribution function from past events but it doesn't help you.
Rainfall like stock market returns have some mean reversion but that
doesn't help you much either.

What about the variance of the returns (uh, rainfall)? Whats better
for a SWR: a modest return with low variance, or a high return with
high variance?
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Re: The Safe Water Reservoir: (SWR): An analogy?
Old 03-29-2005, 09:17 AM   #10
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Re: The Safe Water Reservoir: (SWR): An analogy?

Quote:
What about the variance of the returns (uh, rainfall)? Whats better
for a SWR: a modest return with low variance, or a high return with high variance?
I would want the modest return with low variance. Predictability may not be accurate, but it would be more accurate with low variance. Now the question is, what would the modest return be? I think a 7% long-term total return with a 4% real return is the target.

Anything under that, you may drown. Anything over that, you will walk on water. I would be happy coasting for 40 years or more.
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Re: The Safe Water Reservoir: (SWR): An analogy?
Old 03-29-2005, 09:17 AM   #11
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Re: The Safe Water Reservoir: (SWR): An analogy?

Quote:
Analogies can be useful.
So can strawmen. But that doesn't make them relevant to solving the problem-- only to distracting everyone's attention from the real question by trying to build a good simulator.

Quote:
In other words, what are the dominant factors that
influence the SWR?
I think the most dominant factor is "spending no more money than the portfolio can replace." I'd say that other dominant factors include (1) anything that survives history with greater than 80% or (2) anything that survives Monte Carlo with greater than 80% or (3) predicting the future.

I think that the problem here is that you're over-analyzing the SWR. (Hence the ***** accusation.) Build a portfolio that's 25x your projected expenses, withdraw 4% of the initial amount and adjust that annually for inflation, and get on with your life.

Or try Bud Hebeler's feedback loop in "J.K. Lasser's Your Winning Retirement", and then you won't have to worry about history or methodology or predicting the future or whether a 4.00001% SWR is less survivable than 3.99999%.

Quote:
Whats better for a SWR: a modest return with low variance, or a high return with high variance?
The one that survives more historical or Monte-Carlo situations, right? These are just a couple of factors in an extremely complex system whose behavior is not easily predicted (if it even can be). But returns can't be "too modest" and variance can't be "too high"-- it all has to be "about right." At which point the over-analysis tendencies kick in again...



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Re: The Safe Water Reservoir: (SWR): An analogy?
Old 03-29-2005, 09:21 AM   #12
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Re: The Safe Water Reservoir: (SWR): An analogy?

I'm trying to be really open minded on new users. I did notice that most of the suspected 'hoco loco' variants stopped posting within a day or so of his banning.

There is a progression for most new users though...a "Hi I am..." post, a few questions, etc. I'm automatically suspicious of anyone who has a first post on the ever ridiculous 'safe withdrawal rates' or assailing firecalc. I'm even more suspicious of someone who doesnt ask "who is 'hoco-loco'".

That having been said, I have a solution to this question. The town stops drinking water and drinks beer instead. Its safer. Water is a terrible substance. Fish do unspeakable things in it.
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Re: The Safe Water Reservoir: (SWR): An analogy?
Old 03-29-2005, 11:12 AM   #13
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Re: The Safe Water Reservoir: (SWR): An analogy?

What if it rains so much, that the reservoir overflows? And then you lose all that extra water cause it seeps into the ground? *Or what if it floods the town, and the inhabitants flee or drown? *Then who gets claim on the water? *What if global changes in climate cause all the water in the reservoir to freeze? *I don't get this analogy.

Can you kayak in it?
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Re: The Safe Water Reservoir: (SWR): An analogy?
Old 03-29-2005, 11:47 AM   #14
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Re: The Safe Water Reservoir: (SWR): An analogy?

Well, I suppose I deserved an ass whopping for posting a *****-like
thread. Just for the record, I'm male, mid-40's, married, two kids,
living in the southwest. I have a net worth of $1.5M+. Still
working... Christ, it does sounds alot like *****, doesn't it.

FIRECalc is a great tool. I've used it a lot but it has left me with
some questions that I am trying to answer. Over-analysis? To each
their own I guess. Some people like to just push the buttons on the
outside of the black box, while other people like to rip 'em apart to
see whats inside.

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Re: The Safe Water Reservoir: (SWR): An analogy?
Old 03-29-2005, 11:52 AM   #15
 
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Re: The Safe Water Reservoir: (SWR): An analogy?

Quote:
FIRECalc is a great tool. I've used it a lot but it has left me with
some questions that I am trying to answer.
Why don't you ask the specific questions? You'll probably get very specific answers.

Damn - And I was just about to build a tail water trout fishery just below the dam!
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Re: The Safe Water Reservoir: (SWR): An analogy?
Old 03-29-2005, 12:19 PM   #16
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Re: The Safe Water Reservoir: (SWR): An analogy?

Q1: How important is the variance of the real return (inflation
adjusted) to the value of the SWR? (This is the rms variation in
rainfall in my lame analogy.)

Q2: If variance is important to SWR are there accepted strategies to
reduce the variance? I suspect you'll just tell me to go read
Bernstein but when people talk about asset allocation they rarely talk
about what their mix does in terms of return *and* risk.

Q3: How important is the age of the person to the SWR? Instead of a
fixed portfolio lifetime, FIRECalc could use mortality tables to give
some confidence interval. Doesn't someone in their mid-40's have a
different SWR than someone in their mid-60's?

Thanks.
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Re: The Safe Water Reservoir: (SWR): An analogy?
Old 03-29-2005, 12:26 PM   #17
 
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Re: The Safe Water Reservoir: (SWR): An analogy?

Quote:
Q3: How important is the age of the person to the SWR? Instead of a
fixed portfolio lifetime, FIRECalc could use mortality tables to give
some confidence interval. Doesn't someone in their mid-40's have a
different SWR than someone in their mid-60's?
Well, I'll try and deal with this one - Age is very important to SWR. When FireCalc asks you to input the Life of the Portfolio, this is essentially where you decide how long you are going to live. If you are 60 you might input 40 or 45 years. If you are only 40, you might input 60 or 65.

So, yes different aged folks have different SWR's.
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Re: The Safe Water Reservoir: (SWR): An analogy?
Old 03-29-2005, 12:35 PM   #18
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Re: The Safe Water Reservoir: (SWR): An analogy?

Quote:
Q1: How important is the variance of the real return (inflation
adjusted) to the value of the SWR? (This is the rms variation in
rainfall in my lame analogy.)

Q2: If variance is important to SWR are there accepted strategies to
reduce the variance? I suspect you'll just tell me to go read
Bernstein but when people talk about asset allocation they rarely talk
about what their mix does in terms of return *and* risk.

Q3: How important is the age of the person to the SWR? Instead of a
fixed portfolio lifetime, FIRECalc could use mortality tables to give
some confidence interval. Doesn't someone in their mid-40's have a
different SWR than someone in their mid-60's?

Thanks.
A1. It's pretty important. If you take a look around for 10 minutes on http://www.retireearlyhomepage.com/ you can find discussions of how the portfolio structure affects the SWR, examples of different portfolio structures and their associated SWR's, etc. For the record, I believe the canonical 4% assumes a roughly 75% S&P 500 / 25% commercial paper mix.

A2. Actually what you want to look at is the variance or portfolio makeup plotted against the SWR and pick the portfolio makeup / SWR local maximum. Again, there are graphs of this stuff over at the website mentioned in A1.

A3. Actually it depends on the person's life expectancy, which does in turn depend on one's age (and health, and family history...). The crude answer is to pick a payout period that roughly matches your life expectancy. Another approach is outlined at http://www.retireearlyhomepage.com/swrlife.html.

malakito
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Re: The Safe Water Reservoir: (SWR): An analogy?
Old 03-29-2005, 12:46 PM   #19
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Re: The Safe Water Reservoir: (SWR): An analogy?

I used to live next to a reservoir. No worries about water...I have a pump and a hose. I did in fact kayak in it extensively.

What used to make me chuckle was that when we had heavy early rains, they'd start 'preemptively' letting water out just in case we had more heavy rains they didnt want to have to let it out later. Or some such other dumb reason. Inevitably, after one of these substantial water dumpings, we'd get no water for the rest of the rainy season. Reservoir looked llike a big bomb went off and left a crater, in which a small amount of muddy rain water had collected.

I would refer to that state as the "Safe Water Reservoir After Use Of Hoco Magic Tool", which would make a dumb and fairly useless acronym of SWRAUOHMT. But feel free to use it anyhow.
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Re: The Safe Water Reservoir: (SWR): An analogy?
Old 03-29-2005, 12:53 PM   #20
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Re: The Safe Water Reservoir: (SWR): An analogy?

Quote:
No. Not even close. *I appreciate that everyone is on red alert these days
but you have *just found the fastest way to chase away new contributors to
this board! I'm interested and I'm a newbie so please be gentle *

I am trying to get some intuitive understanding of what the main factors are in a SWR. *Backtesting (with historical data) or simulation (via Monte Carlo modeling) don't do it for me.
To understand SWR you need at least a passing aquaintance with arithmetic. If you can't fathom a simple historical backtest of the data, the best thing to do is just sit back and dream about retirement -- that may be as close as you'll get to it.

intercst
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