Work Less, Live More - 2 Questions

[DouglasRThompson]

After reading Byb Clyatt's book, Work Less, Live More, there were two questions that I have about his Rational Investing Portfolio, and withdrawing a maximum of 4% of the portfolio's worth each year:

1. He states that during a "bad" year, you should only withdraw 95% of what you withdrew the previous year. What is a "bad" year? A certain percentage less than the 9.5% average expected return? No profit? Lost profits?

2. What if you have 2 bad years in a row; 3 bad years in a row; etc. Do you keep reducing the amount you withdrew by 5% in each successive bad year?

If you are already following this strategy, how is it going for you? (Okay, okay, I know--that was 3 questions).

Thanks for your opinions.

Be @ Peace,
Douglas

 

[Alan]

I think for me a bad year would be one with any return less than inflation, and for successive bad years I would try to avoid withdrawing 5% less every year, but it is all going to depend on how much below inflation the portfolio is performing and how well my expenditure is within my budget. I may be having good years with expenses while the returns on my 'egg' are poor or the perfect storm may occur and at the same time I am having other issues with major unexpected costs the market is going down.

I think this is all going to be very subjective.

 

[Nords]

Welcome to the board, Douglas. Bob drops by every week or so but when a big sculpture show is coming up he's pretty scarce. You may want to e-mail him directly, but in the meantime:

1. He states that during a "bad" year, you should only withdraw 95% of what you withdrew the previous year. What is a "bad" year? A certain percentage less than the 9.5% average expected return? No profit? Lost profits?

A "bad" year is one where the portfolio goes down in value. The idea is that a 4% withdrawal of a smaller portfolio might really be a big step drop in your spending ability, so 95% of the year before is an option for a smaller reduction even though it may be more than 4% of the current portfolio value.

You may withdraw $44K from your $1.1M portfolio in 2007 when you begin ER, but if its 2008 value starts at only $1M then $40K might be too big a whack. Taking $41.8K (95% of $44K) can soften the blow. You could still opt to defer expenses and drop your spending down to $40K. Or even less.

2. What if you have 2 bad years in a row; 3 bad years in a row; etc. Do you keep reducing the amount you withdrew by 5% in each successive bad year?

Then you start saying "Ouch" and doing as you've asked... $41.8K in 2008, $39.7K in 2009, and so on.

Keep in mind that this is "semi"-retirement, so when your portfolio is dropping you can either cut your spending or go back to work. The 4%/95% is an attempt to institute a variable-withdrawal scheme without making it too difficult to follow. The vast majority of financial calculators don't expect ERs to change their withdrawals during ER, but in real life at the first sign of adversity most people slam shut their wallets and defer that vacation or major home improvement for another year. This system provides a quick check on whether your portfolio is likely to survive the downturn or whether you want to start ramping up your working hours.

If you are already following this strategy, how is it going for you?

Five years, no complaints!

The problem is that your question is coming after five years of huge market gains, so we've never been forced to cut spending. You may want to run your ER portfolio through a number of FIRECalc runs and see how it would have survived the worst that most of the 20th century had to offer.

 

[mickeyd]

What is a "bad" year?

It is all very vague, as is "What is a good year?"

If you understand the math involved in the 4% W/D scheme you will know that you should pull back on the reins when returns are down. How much? Don't know for sure, but I would know that this is what must be done in order to make my plan work. There have been many times in my life when I had to reduce spending (even @ Christmastime) so I just did it and when times got better (and they always will) went back to normal.

 

[DouglasRThompson]

Reply from Bob Clyatt

Re: A Yoga Teacher's question about the Rational Investment Portfolio‏From:Bob Clyatt Sent:Sun 11/25/07 11:40 PMTo: Douglas Thompson

Douglas,
Hi and thanks for your note. Good question and one that could use more definition (look for one in 3rd edition!) I hope this answer will help:

A 'bad year' simply means a year where the value of your portfolio supports a safe withdrawal less than 95% of what you had the previous year.

Most people would want a safe withdrawal that rose roughly in line with inflation. If the value of your portfolio fell, your withdrawal would also fall. Even if your portfolio remained flat, your real withdrawal would have fallen. These are all in the range of 'belt-tightening' or annual micro-adjustments which make your long-run portfolio success more likely. Take a little less spending cash out in these lean years -- a real drop in income from the portfolio -- in order to leave more cash invested and bounce back when good markets return.

But we wouldn't want to ratchet down spending by a full 20% in a year when your portfolio fell 20%. The 95% Rule provides a backstop, a floor -- if the value of the portfolio at the end of the year is less than 95% of what it was a the beginning of the year, you can just still take a withdrawal 95% as big as last year's, even though your portfolio wouldn't strictly speaking support it. (In other words, you can withdraw at a percentage higher than the normal 'safe' withdrawal rates for those few years.)

And yes, the historical data all support taking this approach for as many years in a row as you need -- that this bit of smoothing out the trough won't impact long run portfolio survival in any meaningful sense. It is worth noting that even through the worst times historically, you only needed to 'over=withdraw' 5 or 6 times in a 40 year period, and only 2 or 3 years in a row.

Hope this helps, and good luck with the yoga studio! I study at both a studio and at the itinerant teacher-in-church-assembly-room types of classes, and find both great.

Bob

ps: if there was a thread on this, would you mind posting my answer here as it might help clear up some confusion for others. (I might not find the right thread just by searching on my own) Thanks!