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withdraw rates graph
Old 12-14-2009, 09:12 AM   #1
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withdraw rates graph

There is a lot of data available on simple withdraw rates, but I thought some of you might be interested in the below.

Flipping through a new book, "Your Nest Egg Game Plan", I found a nice bar graph showing the maximum safe initial withdraw rates by starting year for a 60/40 US stock-bond portfolio. (The graph is copyrighted by The Kite Report, a monthly financial newsletter, but I didn't see it on the associated web site.) I liked the graph since it gave sort of birds-eye view of FireCalc results for a vanilla 60/40 portfolio. Unfortunately, the data in the book's graph was wrong, showing around a 50% success rate for 6% withdraws and around a 95% success rate for 5% (if it was only true!).

Wanting to see what the correct data looked like and with more variations, I used the same idea to do the calculations using Professor Shiller's online data for S&P stocks and long interest rates. Shown in the attached graph is the highest constant inflation-adjusted withdraw rate that is successful for any given year. For example, a person retiring in 1940 could have successfully withdrawn up to 2.6 percent for a 100% bond portfolio, 4.2% for a 40/60 stock bond ratio, 5% for 60/40, and 6.3% for a 100% stock portfolio.

A few related thoughts.....
-- When it comes to withdraw rates, I was surprised the late 1960's appeared to be worse than the Depression for stock holders.
-- The safest stock-bond ratio depends on the withdraw rate (i.e. higher withdraws rates do better with a higher stock ratio).
-- A better diversified portfolio should do better than just S&P stocks, but equivalent historical data is not available.

withdraw-rates-30.pdf
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Old 12-14-2009, 01:14 PM   #2
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There is a diversification premium for sure.

Are you also not accounting for the effects of withdrawals? If not, it is essentially impossible to tell if you can implement a 100% stock portfolio during the withdrawal stage (from other graphs I have seen, you can't, it destroys your portfolio). While stocks may only dip heavily for a couple of years, per the graph, during that time, the portfolio takes a significant hit if you are withdrawing from the stocks, resulting in a significantly weakened upswing when stocks recover. This occurs again the next time there is a downswing, because you are in the decumulation phase, not the accumulation phase. If you at least have a reserve of 10% fixed assets (4-5 years of CD ladders), or 20% bonds, you can have something to draw on that will not be devastated by withdrawals when until a correction finally occurs. This of course does not address the diversification premium, I think this would also significantly change the numbers as well.
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Old 12-14-2009, 03:19 PM   #3
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plex,
-- The calculations assume withdraws begin on the starting date, so everything you see displayed is in the withdrawal phase. CPI is used for inflation adjustments to the withdraw amount. I did not do extensive testing (so mistake are always possible) but I did make a few comparisons with Firecalc to check my results.
-- The "All Stocks" case does include the negatives you mention. 1929 and the latter half of the 1960's could be examples of what you describe (i.e. all-stocks causing fast depletion during severe bears), but bonds do not provide nearly as much protection as one would hope for.
-- I agree better diversification should change the numbers for the better, but I can only speculate on the details (this is someone I hope to understand better).

As a side note, a few months ago I ran some tests to see how much a bond buffer/bucket would improve my success rate for a specific withdraw rate (again using Shiller's US data from 1871 to present). My plan was simple -- if there is a big enough surplus of bonds, based on allocation percentage, then withdraw each year only from bonds until the target allocation is reached/rebalanced (of course dividends come off the top). The aim was that after a sharp stock decline withdraws would come only from bonds for a few years, which they did. The problem was my success rate did not improve (actually it seemed to consistently drop a percent or two). My conclusion was I needed a smarter bond-buffer strategy to compete with the advantages of rebalancing (i.e. buying stocks when cheaper) if I was going to see an improvement. I plan to search for academic results in this area and try again (or try to roll my own if necessary). I only mention this here because simple bond-bucket strategies may not work as well as our intuition would expect (there is always the chance I made a mistake too ).

To put my original posting in context, I founds the graph an interesting addition to my personal knowledge base on withdraw rates, but standing alone I would not base any strategy on it.
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Old 12-14-2009, 04:31 PM   #4
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A few related thoughts.....
-- When it comes to withdraw rates, I was surprised the late 1960's appeared to be worse than the Depression for stock holders

Attachment 7854
If your portfolio can survive retiring in 1966 it should survive anything we have yet seen.
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Old 12-14-2009, 05:41 PM   #5
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A few related thoughts.....
-- When it comes to withdraw rates, I was surprised the late 1960's appeared to be worse than the Depression for stock holders.
Inflation was a killer...in 1965 Johnson signed Medicare/Medicaid, we were increasing our war effort in Vietnam, sound familiar?
TJ
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Old 12-14-2009, 08:07 PM   #6
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All-stock portfolios only have to survive a few initial years without a significant downturn. If returns are good for the first few years, they will build up a buffer. At the end you may be a billionaire still withdrawing your 4% plus inflation. A downturn near the end of the retirement period may be no threat at all. So they do OK in FIRECalc.
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Old 12-15-2009, 12:02 AM   #7
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Agreed Animorph, I saw a data graph earlier which showed what happens if you get hit by a recession right after retiring, rather than retiring right after a recession, and the differences are massive. This may have been in the thread that was talking about needing a bump your SWR considerations below 4% if the market has been doing well for a long stretch, and increase it above, or even well above 4% if you are in the middle of or exiting a recession.

As for whether bonds provide worthwhile diversification on their own, the answer from 2008 is no, but it may be standing out only because it is recent. From what I read, 2008 was bad for all forms of diversification except for CD's (Penfed's 6.5 or 6% 3-year CD!) or short term treasuries. So, I would not say bonds are not worthwhile to have in a portfolio, just from this. Similar to how I would not say REITs are bad either (which tanked in 2008).
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Old 12-15-2009, 12:26 PM   #8
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Three techy questions:
Did you rebalance to maintain your initial stock/bond split?

How did you recognize market value losses on bonds?

Did you compare your results to Firecalc?
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Old 12-15-2009, 05:19 PM   #9
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To MMCC

I'm the co-author of "Your Nest Egg Game Plan," and while I appreciate that you mentioned the book you are incorrect in your assertion that the data presented in the Kitces graph re withdrawal rates is inaccurate. This graph is based on actual returns and take into account the sequence of returns. As you read the accompanying text, you'll see we are not suggesting a 5% withdrawal rate. We too were surprised that a 5% rate did indeed prove successful for 95% of the starting dates, and we believe that is too aggressive an approach for most retirees. The point is that luck plays a huge role in the success of one's retirement. People who retired in the late 70's just as the huge bull market was about to begin were very lucky; those who retired in 2000 were not so lucky -- and anyone who retired in 2007 had exceptionally bad luck.

Again, thanks for mentioning the book -- but please take a closer look before stating that the information is inaccurate.

Phil Fragasso
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Old 12-15-2009, 05:54 PM   #10
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If your portfolio can survive retiring in 1966 it should survive anything we have yet seen.
Mine survived starting investing in 1966.



Speaking as an ex with emphasis on ex engineer - I apply the caution to my retirement the late S.I. Hayakawa applied to language - 'the word is not the thing' or the spreadsheet does not make it so. Pay attention here it comes - pssst dividends. Has anyone else noticed that for the bulk of the periods covered by these studies - 4% dividend yield was 'speaking handgrenade wise' in the ballpark? Bogle used to paraphrase Keynes as to looking at history one needed to examine why it was what it was - to look behind the green curtain to verify you weren't in Kansas anymore.

The studies are a useful benchmark - but after 16 years of retirement I apply belt and suspenders - watch my SEC portfolio yield like a hawk versus what budget expenditures would have to go in 'hard times'.

Also an up to date American Passport and an Alabama linebacker's agile, mobile and hostile attitude.

heh heh heh - post Katrina I also live on a hill - 1000 miles inland above, way above the wide Missouri. 1/4 mile from the local tornado siren - so some risk is always there speaking 60/40 wise. . Hopefully I know the difference between panic and flexible ala pssst Wellesley.
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Old 12-15-2009, 06:19 PM   #11
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Three techy questions:
Did you rebalance to maintain your initial stock/bond split?

How did you recognize market value losses on bonds?

Did you compare your results to Firecalc?
I used the January data of each year to calculate return and rebalance to target levels.

Shiller provides the long interest rate GS10. The bond allocation rose or drop annually as the rate when up or down.

A few months I wrote the core withdraw-rate code to run various tests. At that time I used Firecalc as my reference of correctness and did close comparisons (Firecalc provides good hooks to do this). This round I enhanced the core code and only did a rough comparisons based on overall success rates. I'd say I did reasonable testing, but certainly not extensive testing (experience says there are probably some bugs floating around in my code, but probably/hopefully nothing visible in the results to the naked eye).
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Old 12-15-2009, 06:45 PM   #12
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mmcc,
That's a very interesting graphic. I'm glad you explained it in your post, as it's a little unusual in concept/layout. Observations:
- Something we talk about sometimes here: When we do a typical FIRECALC run and see a 95% or 98% success rate for a particular withdrawal rate, it is useful to do one more step: Imagine you are retired and actually riding one of the "OH NO!" lines down toward the X axis. Without the benefit of seeing the future--that the line rises back up-that's one darn scary trip into Alpo-land. Terrifying. In all likelihood, most retirees would seriously curtail withdrawals if at all possible if their portfolio value heads south. "Hey, this mix has always worked in the past" would be little comfort in real life. Every single line on your graph represents the "max performance" withdrawal rate for the 30 years following that retirement year using that asset mix. Put another way, if that withdrawal rate and asset mix was used, then at some point within the next 30 years the portfolio value will just nick the zero balance line (right? For each line, if I'd taken a withdrawal of even .1% additional each year, the series would have gone below the $0 line somewhere within the 30 year window). So, if I've got that right, this graph is the bleeding edge, and any retiree who happened to choose that WR and that asset mix ended up broke at the end or experienced "virtually broke" somewhere along the line. It's useful for a reader to understand that when looking at the chart.
- The 100% stock portfolio does better than I would have guessed. Despite everything (esp. the chance for the 100% stock portfolio to be devastated by withdrawals and price dips), there were relatively few (15%?) starting years when the investor could have had a higher max withdrawal rate with one of the more conservative portfolios. And yet, I believe Wm Bernstein noted that an 80% equity portfolio had nearly the same overall historical return with much less volatility. I really thought the ability of bonds or bonds/cash to prevent disaster would have shown up more often in your depiction as providing a better max rate than 100% equities.
- I'm planning to use the "take a fixed % of each year's ending balance" approach. Obviously it is tough to hit a zero balance with this method, but one can slowly sink into reduced real spending power if the withdrawal rate is too high. Your graphic allows one to get a feel for the withdrawal rates that would have avoided this in the past.

Now, if the future would just cooperate and repeat past performance . . .
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Old 12-15-2009, 07:13 PM   #13
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Shiller provides the long interest rate GS10. The bond allocation rose or drop annually as the rate when up or down.
Actually, that's not a very good answer. (I knew I should have quit when my 7 year-old climbed up in my lap ). I'll look at the code tomorrow.
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Old 12-16-2009, 10:58 AM   #14
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Three techy questions:
...
How did you recognize market value losses on bonds?
Independent,
There are no losses on bonds in these calculations. The long interest rate (GS10, 10-Year Treasury Constant Maturity Rate)is used to calculate the interested earned each year on the fixed-income allocation. So this is an approximation assuming all bonds are held til maturity. FireCalc calculates the fixed income part the same way (assuming "Long Interest Rate" is selected under Fixed Income on the Portfolio tab).

BTW, while checking on the above, I did some retesting given it has been a few months since I wrote the core code. I reconfirmed my results match FireCalc results in detail for the 1960 cycle. I also reconfirmed my success rate matches FireCalc's for a dozen or so random cases.

One last detail -- for the withdraw rates shown on the graph, expense rates are not considered (FireCalc defaults to a .18% expense rate).
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Old 12-16-2009, 12:54 PM   #15
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samclem, good observations.

Quote:
Originally Posted by samclem View Post
- Something we talk about sometimes here: When we do a typical FIRECALC run and see a 95% or 98% success rate for a particular withdrawal rate, it is useful to do one more step: Imagine you are retired and actually riding one of the "OH NO!" lines down toward the X axis. Without the benefit of seeing the future--that the line rises back up-that's one darn scary trip into Alpo-land. Terrifying. In all likelihood, most retirees would seriously curtail withdrawals if at all possible if their portfolio value heads south. "Hey, this mix has always worked in the past" would be little comfort in real life. Every single line on your graph represents the "max performance" withdrawal rate for the 30 years following that retirement year using that asset mix. Put another way, if that withdrawal rate and asset mix was used, then at some point within the next 30 years the portfolio value will just nick the zero balance line (right? For each line, if I'd taken a withdrawal of even .1% additional each year, the series would have gone below the $0 line somewhere within the 30 year window). So, if I've got that right, this graph is the bleeding edge, and any retiree who happened to choose that WR and that asset mix ended up broke at the end or experienced "virtually broke" somewhere along the line. It's useful for a reader to understand that when looking at the chart.
You are correct the graph shows the bleeding edge for each allocation. The max success rate is actually the demarcation line between success and failure -- withdraw less and the portfolio survives but withdraw .1% more as you said and the portfolio fails.

Quote:
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- The 100% stock portfolio does better than I would have guessed. Despite everything (esp. the chance for the 100% stock portfolio to be devastated by withdrawals and price dips), there were relatively few (15%?) starting years when the investor could have had a higher max withdrawal rate with one of the more conservative portfolios. And yet, I believe Wm Bernstein noted that an 80% equity portfolio had nearly the same overall historical return with much less volatility. I really thought the ability of bonds or bonds/cash to prevent disaster would have shown up more often in your depiction as providing a better max rate than 100% equities.
The 100% stock portfolio does better than (or matches) the other allocations 90% of the time (it's hard to see this precisely without looking at the numbers). Although not shown, the 80/20 portfolio line fits consistently between the 60/40 and 100 stock lines.

During the withdraw phase, I believe the value of bonds heavily depends on how the income is harvested from the portfolio. The graph I created strictly uses annual rebalancing to target allocations, which I doubt is optimal. The bucket strategics try to improve on rebalancing but I'm still looking for clear evidence on how well these perform (the Bogleheads site delves into performance some, perhaps here too, but I have not seen conclusively evidence). There is a solid study showing an all-bonds-first withdraw approach has the best performance (compared to stocks first, "best-performing" first, or "worse-performing" first) but this behaves as a one-shot bucket leaving the portfolio with 100% stocks for the duration, so I think some refinement is due there. When/if I understand a better approach to harvesting (well enough to turn it into code), I'd like to incorporate it and regenerate the graph using it. Then perhaps the value of bonds, beyond providing a comfort level below our "risk tolerance", will be more evident. Of course if a person can live off a very small withdraw rate, then bonds are excellent for safe withdraws (or risk-free if they are inflation-protected).

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- I'm planning to use the "take a fixed % of each year's ending balance" approach. Obviously it is tough to hit a zero balance with this method, but one can slowly sink into reduced real spending power if the withdrawal rate is too high. Your graphic allows one to get a feel for the withdrawal rates that would have avoided this in the past.
I'm partial to variable-amount withdraw schemes too, but I haven't narrowed in on one yet.
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Old 12-16-2009, 01:41 PM   #16
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Portfolio SEC yield when I'm nervous about the future and 5% variable when ready for bon temps rolliere.

heh heh heh - with a nod to 4% SWR benchmark when it's ho hum time. . Math/market wise an asute person can conjure some interesting shifts of the above benchmarks/rules.

And after 16 yrs if I really get in trouble in my old age there is always psssst Wellesley.
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Old 12-16-2009, 02:12 PM   #17
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During the withdraw phase, I believe the value of bonds heavily depends on how the income is harvested from the portfolio.
My gut tells me you are right, but I've got no proof.
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When/if I understand a better approach to harvesting (well enough to turn it into code), I'd like to incorporate it and regenerate the graph using it.
I alsio wonder if an allocation to cash (MM rate) would impact things.
I think a lot of folks would do something similar to my (probably simplistic) plan:
- If stocks are up, withdraw for next year's spending and then rebalance to target allocation.
- If stocks lost during previous year:
-- Take next year's spending from the cash bucket.
--- If bond "bucket" is up, sell enough to replenish cash bucket.
--- If bond bucket value (interest payments and bond value) decreased, leave it alone.
-- If insufficient funds in cash bucket to fund next year's withdrawal, then sell bonds to meet expenses
-- If insufficient funds in both cash bucket and bond bucket to fund next year's withdrawal, sell stocks. (Hopefully, the preceding prioritization will reduce the number of times stocks have to be sold at a loss.

Of course, there are endless permutations (size of "buckets, should we really take from the stock bucket if the prices are up for the previous year--maybe stocks are still in the hole and way off their high or even below the price paid, etc).

Anyway, thanks again for the graphs, please post more when you make 'em.
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Old 12-16-2009, 02:12 PM   #18
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Independent,
There are no losses on bonds in these calculations. The long interest rate (GS10, 10-Year Treasury Constant Maturity Rate)is used to calculate the interested earned each year on the fixed-income allocation. So this is an approximation assuming all bonds are held til maturity. FireCalc calculates the fixed income part the same way (assuming "Long Interest Rate" is selected under Fixed Income on the Portfolio tab).

BTW, while checking on the above, I did some retesting given it has been a few months since I wrote the core code. I reconfirmed my results match FireCalc results in detail for the 1960 cycle. I also reconfirmed my success rate matches FireCalc's for a dozen or so random cases.

One last detail -- for the withdraw rates shown on the graph, expense rates are not considered (FireCalc defaults to a .18% expense rate).
I think I understand what you are saying. If Shiller's10 year bond rate is 6% this year and 7% next year, you will credit 6% to your bond fund this year and 7% next year. The math is exactly what you would use if you were investing in one-year bonds. Is this correct? I believe that's what FireCalc does.

My question relates to the notion that I'm probably holding my bonds in a mutual fund. When I sell shares to fund my spending, I'll take a market value hit if interest rates are up. My rebalancing will also be impacted by market value changes. "over the long run" interest rates will go up and down so this may all cancel out. But withdrawal issues are impacted by the short run effects, especially when we're looking for 95% survivals.

Any thoughts?
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Old 12-16-2009, 03:13 PM   #19
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I think I understand what you are saying. If Shiller's10 year bond rate is 6% this year and 7% next year, you will credit 6% to your bond fund this year and 7% next year. The math is exactly what you would use if you were investing in one-year bonds. Is this correct? I believe that's what FireCalc does.
Right.

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My question relates to the notion that I'm probably holding my bonds in a mutual fund. When I sell shares to fund my spending, I'll take a market value hit if interest rates are up. My rebalancing will also be impacted by market value changes. "over the long run" interest rates will go up and down so this may all cancel out. But withdrawal issues are impacted by the short run effects, especially when we're looking for 95% survivals.

Any thoughts?
Valid question but I don't know the answer. I would guess most if not all retirement calculators do not include market risks (or default risks) into their bond-return calculations, using a fixed rate of return from individual bonds held till maturity. An individual has to choose between bonds and bond funds (BTW, there are quite a few good write-ups on the web about the trade offs), but when it comes to retirement tools you may be stuck treating bond funds as bonds. I'd be interested too if others have more illuminating thoughts on this.
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Old 12-16-2009, 09:00 PM   #20
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Thanks for the reply. I had guessed that FireCalc handled it this way but was never sure. I think your results verify that.

This prompted me to try a calculation. I took the Shiller data and assumed I started with a ladder of 10 year bonds (no stocks), all with the new money interest rate (for simplicity). I then ran a typical fixed purchasing power withdrawal pattern, using all the interest and any required portion of the maturing bond to cover the withdrawals. I always replaced maturing bonds with a new 10 year bond at the new money rate for the appropriate year. I compared this to the "simple interest" approach of applying the new money rate as interest on the whole portfolio.

As you'd expect, time periods with high rates of inflation and rising interest rates showed that the bond ladder was worse than the simple interest approach. For example, when I started in 1966 I could afford a withdrawal rate of 4.38% under the simple interest rule, but only 3.98% with the bond ladder. I'm not sure if that's a "big" or "small" deal.

I haven't tried to build a mutual fund for comparisons. One of the problems there is that I'd need the whole yield curve for every year instead of just the 10 year rates.


On a completely separate issue, you're talking about "percent of current fund" withdrawal strategies. I've always thought that the standard 4% of initial fund is too conservative for someone who is willing to reduce spending if the market tanks. (Though I appreciate Sam's observation that even scenarios where the 4% lasts the 30 years are often "too scary" to be considered really successful.)

I've tried a rule of: maximum [ 3% of the inflated original portfolio; 6% of the current portfolio]. It seemed to have about the same survival rates in my calculations. It puts a floor under your decreased spending, but seems to give noticeably more dollars in most cases.
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