What do you use as estimate (guess) regarding future rate of return?

[daylatedollarshort]

We use 0 - 1% real return in a spreadsheet and also look at the Fidelity RIP using very conservative AAs.

As ERD50 posted, a zero real return will let us withdraw up to 2.5% per year for 40 years, though we plan to spend less most years.

 

[photoguy]

First, probably a minor mathematical shorthand on your part, but for clarity, a 4% static real return provides for far more than a 4% WR for 30 years. One can take 3.33% (1/30) with zero static real return.

The 4% is just a made up number for the example. The relevant aspect is that it is lower than the historical data in firecalc. The exact value isn't important.

So now you want to go more pessimistic that any past period. OK fine, so where do you get the data to tell you what to use? You say that 'Historical reports don't consider important factors like valuations for equities or current yields in bond returns.' - well sure they do, they do it on the pessimistic side. The failures are due to jumping in at high valuations. So where do you get your data to make an estimate?

When I say pessimism (or optimism) I'm referring to the accuracy of the probability estimate, not whether there were good or bad sequences in the data.

More specifically, I'm saying that the FIRECALC probability number when used as an estimate of future success can either be too high (optimistic), about right, or too low (pessimistic). Obviously it has to be in one of these buckets as this covers all the possible outcomes.

Expected returns tell me which bucket we are likely to fall into in the future.

I'm not sure where to logically go from here - it all seems so circular. I'm an Occam's Razor kind of guy. I don't know what the future holds so I look at the past, and make a guess about how much buffer I need. You are also making a guess, but you put your guess into an estimate of real return, and then you seem to want to say those resulting calculations have more value than the initial guess - but they are just the result of a guess. Just go with the guess.

The relationship between equity valuations and expected future returns is well known (See Shiller P/E or CAPE). We also know that the higher future returns, the greater withdrawal rate a portfolio will support. The relationship seems pretty clear and if I'm going to make a guess about my probability of future success, it's going to be consistent with that information.

I'm not really sure how to explain this to you differently.

 

[pb4uski]

If don't think that using static returns is very useful or insightful, other than for a reference point.....

I suspect you will not agree with me in this but I'll throw it out there and we can agree to disagree if necessary.

I think deterministic analysis is quite useful for general retirement planning since you are dealing with quite long time horizons. Then it is prudent to supplement any deterministic plan with stochastic analysis to deal with sequence of returns risk. Or put another way, deterministic is easier for people to comprehend and until you have a reasonable deterministic plan that is successful, any stochastic testing is simply a waste of time.

 

[jkern]

I use 4% nominal with a 40/40/20 AA. The only reason I even use this is to give me a guesstimate on what the picture will look like in 5 years when I begin taking Social Security.

 

[ERD50]

First, probably a minor mathematical shorthand on your part, but for clarity, a 4% static real return provides for far more than a 4% WR for 30 years. One can take 3.33% (1/30) with zero static real return.

The 4% is just a made up number for the example. The relevant aspect is that it is lower than the historical data in firecalc. The exact value isn't important.

I think it is important, and maybe why we are having this communication gap. The number is so far from historical data in firecalc, that I it may be distorting the view.


I went back and did the math (well, let a spreadsheet do the math). The 100% historically safe inflation adjusted WR for 30 years is the 3.59% I mentioned earlier. A static real return that that will provide that is a mere 0.52%. And to re-re-hash for reference, a 0.0% real return provides a 3.33% WR (1/30).

The difference between 4% real returns you mention, and 0.52% real returns is too huge to just hand wave. It makes it hard to talk about when we aren't in the same universe.

More specifically, I'm saying that the FIRECALC probability number when used as an estimate of future success can either be too high (optimistic), about right, or too low (pessimistic). Obviously it has to be in one of these buckets as this covers all the possible outcomes.

Now there's some logic that I just have to agree with!

Expected returns tell me which bucket we are likely to fall into in the future.

Well, ummm, OK. I can go along with the idea that if we are at historically high valuations (PE10 or some other measure), we are more likely to be on a path that follows the squiggly lines near the bottom of the distribution on the FIRECalc output graph.

But if the a FIRECalc 100% SWR ends up being too high, it just means the actual future ended up being worse than the worst in the data set. I've said that all along.


Are we more likely to see relatively high stresses on a portfolio when we are at a peak (which we don't know until it passes), or even when we seem to be nearing a peak? Sure, if we continue to see economic cycles similar to the past.

But once again, only if they are worse than the worst in the data set. Past high valuations are already in there. And now we are back to square one - how do you estimate how much worse we might get?

And I don't see where creating some fictitiously low real return number is any different than any other guestimate. But you seem to be implying that some how it is more logical, rigorous, methodological, or something?

-ERD50

 

[Gatordoc50]

I have read a few people on this board who say they use 0-2%. Is that what most of you do, and if not, what do you estimate and why?

My plan is that our portfolio keeps pace with inflation. If I believed that the only risk to my plan involved shallow risks as Bernstein described them, I would probably be invested totally in the market at about 75/25. I do believe, however, there are threats that could cause deep risks ( Bernstein) and a permanent loss of capital. Tax increases or means tested entitlements would be examples. Those don't necessarily hamper market returns but may have a profound effect on ones personal rate or return. So, I try to hold assets like real estate which are harder ( maybe/ hopefully) to means tested but still provide a real return. Only time will tell.

 

[Live And Learn]

If don't think that using static returns is very useful or insightful, other than for a reference point.
...<snip>...
Strikes me as circular - I can't make an estimate of whether I can meet my goals unless I make an estimate of my expected returns? Either way, I'm making an estimate.

I don't use a static return per se, but being a spreadsheet junkie I do have one for that. At a 1.5% real return I am good to go. Since the real world doesn't give static returns I only use this spreadsheet to see if the "needed" annual real return seems reasonable for my 50/40/10 AA.

 

[photoguy]

I think it is important, and maybe why we are having this communication gap. The number is so far from historical data in firecalc, that I it may be distorting the view.

I was trying to give a qualitative example to keep things simple. It's possible to use expectations in a quantitative manner (see my comments at the end).

Well, ummm, OK. I can go along with the idea that if we are at historically high valuations (PE10 or some other measure), we are more likely to be on a path that follows the squiggly lines near the bottom of the distribution on the FIRECalc output graph.

I think we have agreement here. Your statement is

high valuations --> lower lines more likely on firecalc​

I'm just saying it's because of expectations:

high valuations --> lower expected returns --> lower lines more likely on firecalc​

To take this one step further, "lower lines more likely" means that the success probability that comes out of firecalc is too high (when used as a future estimate). Firecalc computes an equal weighted probability but if we agree that some lines are more likely, then they should have greater weight in the calculation

If we have more weight on the lower lines, then we are in the following situation:

(A) if we keep the withdrawal rate constant, the probability of success decreases

(B) if we keep the probability of succcess constant, we have to reduce the withdrawal rate
​

But if the a FIRECalc 100% SWR ends up being too high, it just means the actual future ended up being worse than the worst in the data set. I've said that all along.

I never said that a withdrawal rate of 3.59% (for 100% success in FIRECALC) is too high or too low. I'm saying that probability of future success for a 3.59% w.r. is not 100%. And it's going to be lower when current valuations are higher (expectations are lower).

I'm not sure why it's necessary to draw a distinction with the future being worse than past. The future can easily be worse than the past. Consider that we have only about 4 independent (non-overlapping) 30 year periods in Firecalc. What's the chance that the next (5th) period is going to be worse?

Are we more likely to see relatively high stresses on a portfolio when we are at a peak (which we don't know until it passes), or even when we seem to be nearing a peak? Sure, if we continue to see economic cycles similar to the past.

But once again, only if they are worse than the worst in the data set. Past high valuations are already in there.

The issue is not whether high valuations are in the data used by FIRECALC but whether they receive the right weight (for forward estimates of success). If you agree that "some lines are more likely" then by definition the equal weight calculation FIRECALC uses is not appropriate.

And now we are back to square one - how do you estimate how much worse we might get?

In this thread, I've been trying to stick to a qualitative example to keep things simple. But if you want a quantitative number, you can get this through simulation or monte carlo methods.

(I know you don't like monte carlo and I definitely don't want to rehash their pros and cons here)

Edit: I guess an alternative to using MC methods would be to re-weight the lines in Firecalc according how likely you think each path is based on current valuations.

 

[ERD50]

I don't use a static return per se, but being a spreadsheet junkie I do have one for that. At a 1.5% real return I am good to go. Since the real world doesn't give static returns I only use this spreadsheet to see if the "needed" annual real return seems reasonable for my 50/40/10 AA.

I also have some spreadsheets with static returns. As I said earlier, I think it makes sense to use them for a reference point, keeping in mind their limitations.

I actually use ZERO real returns in those spreadsheets, for two reasons. First, it keeps things simple, I'm far less likely to make an error, as I don't need formulas for inflation adjustments. The only adjustment is that I deflate my non-cola pension, but that's one line and fairly small impact anyhow. The second is that zero real return is a bit worse than the historical worst case that I showed in the previous post, so I get a simple, conservative SS.

I agree with you, I think it is useful as just another data point, to see if things seem within reason when looked at from another angle. I've always found it useful to view things from different angles, as a check (it applies to pretty girls as well! It's a universal constant! ).




photoguy, I'm not going to quote it all, but I think there is just a semantic difference here, a gap that keeps this conversation going back and forth. I think I said this before, but I can't find it off-hand so I'll repeat it here:

A) FIRECalc provides a report. Barring calculation or data errors, and within rounding, it is 100% accurate. There were references to this being 'scientific' - OK, but I don't care to debate the meaning(s) of that word, I don't think it is important. We could say it is deterministic. Different people with the same inputs get the same results.

B) What you do with those results is up to you. Looking to the future, and devising a plan is not deterministic. Different people with the same inputs will offer different approaches.​

And I think you continue to blend the two, and that's where our conversations get twisted and difficult.


I'll try a few excerpts:

... To take this one step further, "lower lines more likely" means that the success probability that comes out of firecalc is too high (when used as a future estimate). ...

Here's where we breakdown (cue Led Zeppelin...) Using 100% HSWR (Historically Safe Withdraw Rates), none of those lines fail. The probability of success is 100%. Period.

(when used as a future estimate) - now you are into 'B'. It's a different conversation. It isn't FIRECalc that reported anything that is 'too high', it just reported the facts. They are what they are.

Firecalc computes an equal weighted probability but if we agree that some lines are more likely, then they should have greater weight in the calculation

If we have more weight on the lower lines, then we are in the following situation:

(A) if we keep the withdrawal rate constant, the probability of success decreases

(B) if we keep the probability of success constant, we have to reduce the withdrawal rate
​

No, the lower lines are the worst case, and with a HSWR, they don't fail. You don't have to make any changes, they don't fail. Period.


bold mine:

I'm saying that probability of future success for a 3.59% w.r. is not 100%.

And I've never disagreed with that. I have no Crystal Ball. But don't confuse/mix that and try to rewrite history. It is 100% for the past. Period. It confuses things when we don't accept that.

And it's going to be lower when current valuations are higher (expectations are lower).

Sure, FIRECalc (and common sense) tells us that it's better to have $1M at the trough of an economic cycle than to have $1M at the peak.

I'm not sure why it's necessary to draw a distinction with the future being worse than past.

Because we run into these endless semantic differences if we don't!

The future can easily be worse than the past. Consider that we have only about 4 independent (non-overlapping) 30 year periods in Firecalc. What's the chance that the next (5th) period is going to be worse?

I don't know, do you? It is certainly a possibility.

My point is, take history for what it is, and then apply your fudge factor, don't mix the two.

Take the case of ten engineers reporting to their boss on the probability of failure of their subsystem. The boss wants to calculate the probability of failure of the overall system. If each of the engineers includes their own fudge factor, the boss is lost when trying to apply some fudge. Better to take the numbers straight, and apply one overall fudge factor. It's cleaner and more transparent.

That's all I'm saying.

One more analogy - what are the odds of rolling a "1" with a single, fair die? Clearly 1 out of 6. No one can correctly dispute that. Do you want to take the bet with a fair payout (6:1)? Do you want to take the bet with $100,000 at stake with a generous payout (say 12:1)? Different people will give different answers, but the 1 out of 6 odds remain the same. They are fact. They don't change based on the decision of taking the bet or not. It's the A/B I posted above. Get it?


-ERD50

 

[ERD50]

photoguy - after my last post, let me try it from a positive angle, where we kind of come together....

I think we would agree that if we took the 10 starting years with the highest valuations, and ran FIRECalc for just those years, the average ending portfolios would very likely be lower than the averages for all years in the data set. Agreed?

But with a HSWR, they still all succeed. The HSWR tells you were the 'edge' of passing/failing has been. Now, go to "B", and decide what to do with that information.


-ERD50

 

[photoguy]

photoguy, I'm not going to quote it all, but I think there is just a semantic difference here, a gap that keeps this conversation going back and forth. I think I said this before, but I can't find it off-hand so I'll repeat it here:

A) FIRECalc provides a report. Barring calculation or data errors, and within rounding, it is 100% accurate. There were references to this being 'scientific' - OK, but I don't care to debate the meaning(s) of that word, I don't think it is important. We could say it is deterministic. Different people with the same inputs get the same results.

B) What you do with those results is up to you. Looking to the future, and devising a plan is not deterministic. Different people with the same inputs will offer different approaches.​

And I think you continue to blend the two, and that's where our conversations get twisted and difficult.

Sorry I thought I was being clear. In this thread I'm exclusively talking about how I start with the firecalc number and modify it for the future (Scenario B) and how I use expectations to do so.

My point is, take history for what it is, and then apply your fudge factor, don't mix the two.

Take the case of ten engineers reporting to their boss on the probability of failure of their subsystem. The boss wants to calculate the probability of failure of the overall system. If each of the engineers includes their own fudge factor, the boss is lost when trying to apply some fudge. Better to take the numbers straight, and apply one overall fudge factor. It's cleaner and more transparent.

I think this is a good analogy.

I'd expect each engineer to adjust their probability of failure based on what they know about the current conditions of their subsystem. For example, they might know the age of their parts and I'd expect them to use a survival curve to estimate the failure probability as opposed to using a historical average failure rate. That's all I'm trying to do with expected returns in a SWR scenario.

I think this is very different from a fudge factor.

 

[Options]

My plan is that our portfolio keeps pace with inflation. If I believed that the only risk to my plan involved shallow risks as Bernstein described them, I would probably be invested totally in the market at about 75/25. I do believe, however, there are threats that could cause deep risks ( Bernstein) and a permanent loss of capital. Tax increases or means tested entitlements would be examples. Those don't necessarily hamper market returns but may have a profound effect on ones personal rate or return. So, I try to hold assets like real estate which are harder ( maybe/ hopefully) to means tested but still provide a real return. Only time will tell. [Emphasis added]

Well put. Tax increases and means tested entitlements are two large looming unknowns. OTOH--and speaking strictly for myself--I'm not sure if I'm willing to put the time, effort, and energy into real estate as a Plan B to offset those unknowns. I don't want to get into any sort of annuity debate, but from everything I've read, annuities post-70 could be a Plan B or even Plan C (and one which I intend to use in a worst case scenario).

IMO, your last statement sums it up well for all of us: "only time will tell."

 

[daylatedollarshort]

This chart has real interest rates across time and countries:

Real interest rate (%) | Data | Table

It is the lending rate, but I think still useful for a long term perspective on planning for those using a real return planning model.

 

[Gatordoc50]

Well put. Tax increases and means tested entitlements are two large looming unknowns. OTOH--and speaking strictly for myself--I'm not sure if I'm willing to put the time, effort, and energy into real estate as a Plan B to offset those unknowns. I don't want to get into any sort of annuity debate, but from everything I've read, annuities post-70 could be a Plan B or even Plan C (and one which I intend to use in a worst case scenario).

IMO, your last statement sums it up well for all of us: "only time will tell."

I understand the concerns with real estate. It is work, no doubt. I purchased the real estate for various reasons over the past decades. I have considered liquidating it to simplify things but for the reasons mentioned, it has a place in my portfolio. I wouldn't recommend purchasing it in retirement. Too many unknowns.

 

[palomalou]

Firecalc says we are fine. But firecalc uses historical returns, and I'm seeing a number of people saying a significant trough is very possible, which would be less than historical returns.


Sent from my iPad using Early Retirement Forum

 

[Options]

Rick Ferri's 30 year forecast is now out:

Portfolio Solutions® 30-Year Market Forecast for 2015

 

[NW-Bound]

Firecalc says we are fine. But firecalc uses historical returns, and I'm seeing a number of people saying a significant trough is very possible, which would be less than historical returns.

Well, FIRECalc tells me that historically, in 30 years I could be a decamillionaire, or my stash could shrivel to a fraction of its current value. History has always shown such a wide range of outcome.

Looking forward, what many pundits including well-known figures like Shiller and Bogle have said that future returns will be at the low end of the historical range. In other words, it will be below the average return. But I don't think any has said that the future return will set a new precedent low. There's a big difference.

 

[walkinwood]

Like a few above, I don't predict future returns - and didn't do that in the accumulation phase either. I figured that we'd ER when our portfolio got big enough for a conservative SWR to meet our expense requirements with some padding. Now, I use an AA that, based on historical returns, should give me peace of mind. Based on historical returns, this AA & a relatively conservative withdrawal should meet needs over our expected lifespan.

But if you're interested in an opinion, Rick Ferri gives you one:
Portfolio Solutions® 30-Year Market Forecast for 2015

 

[Major Tom]

Like Walkinwood, I don't try to predict future returns now that I am in the withdrawal phase. I have a simple portfolio consisting almost entirely of index funds with an approximately 65/33/2 AA, and a WR of ~2% of current portfolio value (~2.4% of starting value) which lets me sleep at night.

The rather wonderful thing about all of this (to me) is that whether you spend a great deal of time performing portfolio survivability calculations, or simply pick an AA and a reasonably conservative WR, and do little else in the way of analysis, both approaches are equally likely to yield success, due to the one thing we can't predict - the future.

However, if detailed analysis helps you to feel more comfortable, then I say go for it. My "poor man's" version of in-depth analysis consists of plugging the same (or very similar) numbers into Firecalc, clicking the "Submit" button, and becoming oddly surprised when I keep getting the same results - but like a trained monkey, I keep doing it

 

[audreyh1]

Like a few above, I don't predict future returns - and didn't do that in the accumulation phase either. I figured that we'd ER when our portfolio got big enough for a conservative SWR to meet our expense requirements with some padding. Now, I use an AA that, based on historical returns, should give me peace of mind. Based on historical returns, this AA & a relatively conservative withdrawal should meet needs over our expected lifespan.

+2

Although I can see folks using projections to make sure their investments are aggressive enough during accumulation to grow the portfolio faster.

 

[petershk]

Personally I think once you hit a sub 3% withdrawal rate with 95%+ historical success, other factors are far more likely to squash your plan than "the worst economy ever" types of scenarios.

A terrible illness, a local natural disaster, a family or friend that suddenly needs substantial help. Those seem far more likely and equally hard to control or predict.

Sooo... I think once you hit around 3% it's better to enjoy it and focus on making yourself flexible such that those surprises may be more manageable.

The other question is what to do about it. I personally use the worst historic case as my worst case and once that is "safe" I don't try to guess how much worse it could be.

Humans are fairly flexible so if it gets THAT much worse than it has in the past it'll be really bad for people that are already worse off which means that SWR is unlikely to be top of mind for me .

Sent from my HTC One_M8 using Early Retirement Forum mobile app

 

[gcgang]

I use lower than historical returns and higher than normal standard deviations when updating my Monte Carlo simulations.

It's not the bad average return that'll wreck you, it's bad sequencing.

That's why Bernstein recommends at least 7 years cash, and others talk about "glide path" with low initial equity weighting, for those embarking on retirement.


Sent from my iPhone using Early Retirement Forum

 

[audreyh1]

Personally I think once you hit a sub 3% withdrawal rate with 95%+ historical success, other factors are far more likely to squash your plan than "the worst economy ever" types of scenarios.

A terrible illness, a local natural disaster, a family or friend that suddenly needs substantial help. Those seem far more likely and equally hard to control or predict.

Sooo... I think once you hit around 3% it's better to enjoy it and focus on making yourself flexible such that those surprises may be more manageable.

The other question is what to do about it. I personally use the worst historic case as my worst case and once that is "safe" I don't try to guess how much worse it could be.

Humans are fairly flexible so if it gets THAT much worse than it has in the past it'll be really bad for people that are already worse off which means that SWR is unlikely to be top of mind for me .

Sent from my HTC One_M8 using Early Retirement Forum mobile app

I think that's a good, sensible approach. If you can live comfortably off of 3% or lower.

 

[accountingsucks]

For fixed income I assume 3% return being 2.5% interest + 0.5% capital appreciation. For equities I assume 5.25% return being 3% dividends and 2.25% capital appreciation. Nominal

 

[MooreBonds]

I assume 1% real return in my modeling (still in the accumulation stage) to factor in worst-case assumptions, but I realize that it will hopefully be better. Given that I have a large minority % exposure to oil/natural resources, it isn't too far off due to the plummeting we've seen lately in oil.

But if the a FIRECalc 100% SWR ends up being too high, it just means the actual future ended up being worse than the worst in the data set. I've said that all along.


Are we more likely to see relatively high stresses on a portfolio when we are at a peak (which we don't know until it passes), or even when we seem to be nearing a peak? Sure, if we continue to see economic cycles similar to the past.

But once again, only if they are worse than the worst in the data set. Past high valuations are already in there. And now we are back to square one - how do you estimate how much worse we might get?

A few points to bring up, some of which have been pointed out by posters in various threads:

Current bond yields - FireCALC assumes a default, what, 60/40 portfolio mix? If 40% of your portfolio is bonds, and currently have a weighted yield of, what, 2% (maybe less?)...how does that compare with inflation, and what return will be going forward for bonds (both capital losses and microscopic yields)? How would another 5 years with your bond portfolio yielding this microscopic yield affect things? Remember that it's the first few years which can have huge ramifications later on in years 20-40. If 40% of your portfolio has a negative real yield for several years early on, how does that factor in with what your 60% of portfolio must do to compensate? Have rates ever been like this before in FireCALC's data inventory?

Before you answer that, read the other points below (especially the 'stock dividend yield point - which would do wonders to help offset non-existent bond yields)

One-time PE Expansion - If your average equity PE expands from perhaps 10 to more like 15-18 over the course of 60 years, that's a true one-time benefit to the investment returns which would NEVER be repeated....unless average PE expands again from 15-18 up to 25. Do you see this happening? Especially with world stock markets growing and making up a larger share of the equity pie?

Dividend Yields - Average stock dividend yields were ALMOST ALWAYS more than 4% for most of recent history up until perhaps 1980s. After that, zooming equity prices (coupled with economic expansion and PE expansion) dropped those dividend yields down to the S&P average yield of under 2% today. Do you think having 60% of your portfolio in equities yielding 4%-6% would be a significant factor in achieving a 4% SWR, irrespective of whatever the stock price did?

Now imagine what that does when that same 60% of your portfolio suddenly yields just 1.5%-2% instead of 4%-6%. Do you think it might have different results going forward during market gyrations? Yes, there will be capital gains to spend and grow your portfolio...but if you have to rely on eating up more of your portfolio capital gains to live off of, it becomes far more sensitive to the specific timing, compared to having your equities funding almost all of your expenses from dividends alone.

Tax impacts - as recently pointed out in this thread, there is also the specter of possible legislative policies which would have a true black swan impact to your models, completely unrelated to your asset mix, SWR, or any other calculations you previously worked up.

If you wish to take your chances with your models and assume higher real returns, then so be it....but don't act like those who take a more conservative approach for very legitimate, sound reasons are completely unrealistic and not basing their view on anything rational or real.