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?
Hi Zorba,
It is a combination of factors.
It is the likely return from each asset class and how the mix of different assets work together. If they all move down together and you have to sell 4% when they have all lost 80%, then your capital is in trouble. If all the assets sit 80% underwater from where you retired at, you'll eat through the remainder of your capital in no time. To use actual numbers, if you needed $4 to live each year, you started with $100 capital and it fell to $20, you would still need to sell $4 each year (plus inflation) to live and you would eat thru your remaining capital in less than five years.
There are some mitigating factors.
Your portfolio has a cash dividend yield. Depending on your mix of assets, this reduces the impact on capital in bad years because you have to sell less. So if your portfolio had $2 a year in cash dividends, you lived off $4, you need only sell $2. In the above example, this would double how long your money could last. So considerably better.
What some investors have done in the past is add between 40-60% on standard treasury bonds to provide a cash income stream of 4%-7%. The real returns pre-tax on the bonds varied enormously but were around 2%-3% in the US. Bonds didn't make a great investment for returns but they provided a yield which reduced the damage when stocks fell. You could partially live off the dividends and sell some bonds instead of selling your stocks. Adding 20% in bonds rather than holding 100% in stocks quite often offered better survival rates and higher withdrawal rates even though you're adding a lower returning asset class (bonds). Kinda of counterintuitive. The reason was partly the income which avoid selling stocks when they were underwater and partly because sometimes bonds rose when stocks fell.
Today, investors thankfully have more options than merely stocks and bonds. Global REITs now provide the ability to link capital returns to inflation and provide higher yields than bonds too. These are becoming increasingly attractive as a real alternative.
Timber provides cash from the timber harvests each year 4%-5% and inflation increases in the value of standing timber (plum creek & rayonier are US REITs).
TIPS & I-Bonds provide direct linkage to inflation which beats the old form of treasury bonds that lost out with inflation. They don't provide much in the way of yields unless you plan to spend the capital down over 40 years in which case the returns are around 3.4% for TIPS today. Over 40 years you sell 2.5% of capital and use part of your interest. This may be suitable to someone risk averse for a small part of their portfolio. A 60-year old retiree who has a max life expectancy of 100 might find this appealing. Your other assets are not structured to spend the capital down leaving you with plenty if you do get past 100.
Besides these, the ability to balance a stock allocation with small cap, value stocks, int'l and emerging market stocks provides additional diversification within the global equities asset class itself. As the last five years showed, US small cap did well, US large cap did not. Emerging did well, Asia large cap did not. And so on.
Taken together, these assets can be used to reduce the overall portfolio volatility, increase the cash dividends (depending on how much you put into high cash yielding investments) and greatly smooth out results. This in turn reduces the loss on returns caused by needing to live every year regardless of whether the stock market did well that year. Hopefully you can tell from this run-thru that investing in higher returning asset classes is only half the battle when living off investments. The other half is getting the mix of assets right, balancing the goal of higher long-run returns (assets like ScV) with other assets that pay higher dividends and give more assurance of having enough to live off. Going for broke can actually make you broke, whereas some caution serves you better. The goal is different from the accumulation phase where you want do build assets not provide income, year-to-year consistent returns or any of that. Different lifecycle, different needs.
Let me know if that is helpful for you or if you have any questions. Happy to help.
Petey
