New Withdrawal Rate Study

[cyclone6]

http://www.fpanet.org/journal/articles/2006_Issues/jfp0306-art6.cfm

Interesting reading. Now that I'm going ER within the next 3 months I guess its time to pick a strategy and stick to it.

Do most of you just stick with the 4%, or modify things as they go as suggested in the above article?

 

[REWahoo]

Do most of you just stick with the 4%, or modify things as they go as suggested in the above article?

I try not to exceed my 95% number from FIRECalc. So far I'm batting 1000.

 

[Nords]

Do most of you just stick with the 4%, or modify things as they go as suggested in the above article?

I may be a retired nuclear engineer, but it's a lot easier to stick with 4% than it would be to explain Guyton to my spouse. I can't even imagine explaining it to the average co-worker or skeptical relative.

Do a keyword search here (or on many ER boards) for "Guyton" and some of the following issues crop up:
- Monte Carlo analysis is more "conservative" than FIRECalc, or just about any other retirement planner for that matter, because it doesn't realize that returns from one year to the next are somewhat correlated. I'd hesitate to declare that MC is the "best" calculator for ER and not check other systems.
- The study's data lacks enough history for perspective. Heck, it barely avoids being called "data mining".
- A high-equity portfolio is considered essential to overcome inflation, but investor psychology has a tough time living with high volatility.
- Guyton's "rules" don't allow for much catch-up to inflation. You set a higher initial withdrawal rate because you have to live with that for a very long time while inflation eats away at it.
- Guyton is not an ER. I have a tough time reading this type of "research" from those who have no idea how to handle the daily routine or the emotional effects of ER. If we made Guyton live with his system for five or 10 years I bet he'd "research" a few new "conclusions"...

 

[samclem]

The number of rules, their precedence, and the criteria for applying them make me suspect data mining. I anticipate the third article in the series will find that annual withdrawals can be doubled on even-numbered years not coincident with a presidential election, or some other means to devine the max wihdrawal rates given the 1973-2004 data pile (which won't likely match the next 40 years anyway).

 

[d]

in any such study it is inevitable that the more complicated the "rules" the higher the return/swr

 

[obryanjf]

Guyton is not too complicated and offers high withdrawl rates. What he does not offer is low volutility nor a floor on the withdrawls so his model risks a serious degradation of purchasing power. However, Guyton got me thinking about different models and comparing them.

I offer once again that there are other models other then the fixed inflation adjusted (original FIRECALC) model that I think offer higher withdrawls, some purchasing power risk (with a floor) and inflation adjustments and an oppurtunity to reap some of the market returns.

I personally like the Hybrib model (2.5% fixed + 2.5% variable) (yields 5% at 40 years with low volutility) but ESRBob's (yields 5.5% at 40 years) is not bad either but volitile. Most of you guys might think I'm full of BS or selling something that way I harp on this, but my only motivation was and is, is to understand the math behind the/a SWR and what make a good withdrawl model. All the above is with NO extras nor Ty's old age reduction scenerios. Adding Extras and/or Ty improves the SWr further.

I hope to ER in 3 to 5 to 10 years (depends on mkt) and will soon pick my model for the next couple of years at least.

From Nords, not picking a fight but i disagree with your statement (read Guyton many times).
- Guyton's "rules" don't allow for much catch-up to inflation. You set a higher initial withdrawal rate because you have to live with that for a very long time while inflation eats away at it.
Guyton throttles the withdrawls (up and down) based on the withdrawl percentage from the previous year. It keeps up with inflation well and also the portfolio growth. He starts with a higher withdrawl rate because he can throttle up/down the withdrawls based on the limits he imposes on the upper and lower bands of that rate.

I won't bore everyone with another graph.

job

 

[d]

Guyton is not too complicated

perhaps not ... i'm just not too sharp ... i've read the article several times and it's still not entirely clear to me, but as I said, I'm not too sharp.
ps: I like the charts

 

[modlair]

How do those withdrawl models perform vs monte carlo where

1) the MC pseudo random number generator is Gaussian

2) the MC pseudo random number generator is Uniform

3) the pseudo random number generator has been modified to look in some way more real world than pure noise. Some attempts have been done at this but there is no settled upon approach.

 

[larry]

Was listening to Dave Ramsey on the long drive home today and someone asked how much is enough for retirement, his reply was in effect an 8% SWR, claiming 12% in mutual fund returns and 4% inflation.

I know, I know, it's entertainment radio.

 

[obryanjf]

Guyton explained without all the BS;

first seperate the rules to determine the actual withdrawl and then the rules to get the money from which account.

Calc withdrawl:
At its heart it is the FIRECALC method, a fixed inflation adjusted method.  Withdrawls grow with inflation .. unless the portfolio has pretty bad results in which case the withdrawl is what it was last year (frozen).

Now if the portfolio does real good or real bad then of course the withdrawl rate will go down or up.  If the withdrawl rate goes outside some bounds (+/-20%) from the initial withdrawl rate, the withdrawl gets adjusted (-/+ 10)%.

Example 1: port = $100 and withdrawls = $4 => so withdrawl rate = 4%, ..
but just had  a bad year/s and port = $75, so the withdrawl rate is 4/75=5.3%.  5.3% is over then 20% threshold from the 4% withdrawl rate so CPR kicks in and the withdrawl is reduced 10% to $3.6.

Example 2: port = $100 and withdrawls = $4 => so withdrawl rate = 4%, ..
but just had  a good year/s and port = $135, so the withdrawl rate is 4/135=2.9%.  2.9% is over the 20% threshold from the 4% withdrawl rate so PR kicks in and the withdrawl is increased 10% to $4.4.

In each case the 4% initial withdrawl rate is the 'anchor' which your portfolio and withdrawls are measured against.  When the withdrawl rate gets to high (because of low portfolio value) then the withdrawls get reduced and when the withdrawl rate gets too low(due to a much larger portfolio), the withdrawls get increased.

I actually like the approach, but it gets too complicated to keep track of all this, not to mention the which bucket to take the withdrawl out of issue.   Thats another day.  The other thing he glosses over is the lost purchasing power could be extreme in some cases.   Being able to explain it is his biggest problem.   However that fact will likely mean he will be able to sell more seminars and books.

job

 

[donheff]

Guyton explained without all the BS;

Nicely described, if it is accurate . I like models that adjust up and down a bit to deal with market changes (particularly down market changes). Since my 4% SWR leaves plenty of padding, I would keep any "extras" from high withdrawal years in a mad money fund to prop up the lower withdrawal in the bad years.

 

[Cut-Throat]

Was listening to Dave Ramsey on the long drive home today and someone asked how much is enough for retirement, his reply was in effect an 8% SWR, claiming 12% in mutual fund returns and 4% inflation.

I know, I know, it's entertainment radio.

Ol Dave has been telling folks about the 12% return for the last 5 years now. His listeners never call him on it, because they are all in debt!

 

[youbet]

Guyton is not too complicated and offers high withdrawl rates. 

Maybe it would help me if you could give an example. 

The minimum I'd need in retirement is $40K/yr. Absolutely can't go below that, so a variable withdrawal plan must have this amount as a fixed minimum, anything less would be a problem. 

With the traditional 4% guideline, I'd need a $1,000,000 portfolio before retiring and I'd take $40K/yr inflation adjusted.  (Of course, as the years go by, I'd reevaluate my situation based on actual results.  But, I'd feel confident I could continue the 4% based on the fact that, historically, 4% has always survived.)

What portfolio value would I need to retire with the system you're suggesting to support a minimum $40K/yr withdrawal?

 

[samclem]

Daddy O,
- I understood your explanation of Guyton--thanks.
- It appears that his withdrawal rules, while based on "fixed plus inflation" foundation, might actually produce more year-to-year variability in withdrawal amounts than a strategy based solely on year-end portfolio value without the special "if-then" rules.

- It seems to me that any strategy that bases annual withdrawal amounts on the inflation rate will increase the long-term risk of running out of $$ or maintain purchasing power year to year. If the assets within the portfolio aren't keeping up with inflation, then basing withdrawals on inflation is not a rational strategy--you'll run out of money or lose purchasing power, and the excessive withdrawals will severely reduce the ability to catch up if/when assets revert to the mean. If the portfolio is growing faster than inflation over the long term, then basing your withdrawals on inflation is not an optimum strategy: it deprives you of cash you could safely take while you are younger/more healthy. Since nearly every one of these inflation-indexed withdrawal methods ends up doing periodic "recalibrations" to the portfolio's true value, or they include an annual linkage to the scenario's value (as does your hybrid method and Guyton's method), I'm just not seeing the advantage of these approaches compared to just simply pegging the annual withdrawal to a % of the year-end value. If the year-to-year volatility of that approach is too uncomfortable, then use of ESRBob's "95% of last year's withdrawal" floor probably makes sense.

samclem

PS: I also like your charts.

 

[audreyh1]

It seems to me that any strategy that bases annual withdrawal amounts on the inflation rate will increase the long-term risk of running out of $$ or maintain purchasing power year to year. 

- If the assets within the portfolio aren't keeping up with inflation, then basing withdrawals on inflation is not a rational strategy--you'll run out of money or lose purchasing power, and the excessive withdrawals will severely reduce the ability to catch up if/when assets revert to the mean. 

- If the portfolio is growing faster than inflation over the long term, then basing your withdrawals on inflation is not an optimum strategy:  it deprives you of cash you could safely take while you are younger/more healthy. 

I'm just not seeing the advantage of these approaches compared to just simply pegging the annual withdrawal to a % of the year-end value.  

I'm with you on this samclem. Just use a fixed % withdrawal strategy (which is so simple to implement!!!) and live with the annual variability. You'll probably feel better then way anyway - as you know you're being more frugal after a bad year, but you also get to take advantage of good years.

It's easy to "smooth out" annual usage after the fact - you don't have to spend all your withdrawals after a good year, and can set aside monies for that inevitable "bad year".

These withdrawal schemes were originally designed to mimic a regular annual salary with yearly inflation adjustments. People get used to fixed salaries. But that is not the "real world". It's better to get used to variability.

Audrey

 

[youbet]

It's better to get used to variability.

Audrey

But what withdrawal number do you use to calculate how much $$$ minimum you want in your portfolio before you kick the work plug out of the wall and retire? 

 

[audreyh1]

Well I personally still use 4%, which is probably too conservative under these (non-inflation indexed) circumstances, but I also need 50+ year portfolio survival.

Audrey

 

[d]

Guyton is not too complicated

but it gets too complicated to keep track of all this

 

[youbet]

Well I personally still use 4%, which is probably too conservative under these (non-inflation indexed) circumstances, but I also need 50+ year portfolio survival.

Audrey

Me too.  I find that when I use a more aggressive SWR number, I wind up "padding" the budget, assuming I can cut back in hard times, assuming the amount above 4% is variable or other gimicks which, when backed out, wind up still giving me approximately the 4% rate.   

Regardless of the twists and spins you put on the calculation, you still need to formulate a retirement budget and balance that budget against sources of retirement income.  To calculate the amount you want in your retirement portfolio at RE, you must assume some withdrawal rate that must be supported over the years.

IMHO, calling the budget and the SWR "variable" just dodges the question "how much do I need?"

 

[obryanjf]

Sorry for the confusion d. My point is that I think I understand it after reading it 5 to 10 times, but to explain it to someone (the masses) might not be easy.

job

 

[SteveR]

Each of us has a unique set of variables that we need to balance.  I don't see any one number or any one system that will work for everyone.  My numbers are very different from many that I see reported here.  My needs are unique to me and my income plan is also unique to my desires and my nest egg.

For example.

My first 8 years of retirement will include:
Pensions
After tax withdrawls from a variety of accounts to make up the difference which will be 5-6% of my nest egg.  

Year 9 income is adjusted for loss of an income stream and begining SS.  
Expenses are adjusted down to reflect no more mortgage payments and several other items we will no longer have to fund.
Nest egg withdraws are decreased by 1-2% as expenses decrease.

Year 12 expenses are adjusted down by a 15-20% and income needs will also be adjusted downward by further reductions in nest egg withdraws.  SEPP payments will be reduced since we will have "spent down" the bulk of the funding IRA.

Year 16 begins RMDs from all 4 IRAs.  Excess income goes into Aftertax accounts.  Or gets spent on who knows what?

After year 16 it the great unknown...we plan on a level to slowly declining level of expenses.  Our income will continue to rise with RMDs alone so the excess (above inflation) will continue to be floated off to after-tax accounts and ....maybe charities...educational scholarships etc......or maybe just fun money for Vegas trips to play the slots all daywith our oxygen tanks in tow.    

In our case, life events change over time and we have a plan to adjust expenses and income as these changes occur.  A flat rate for withdraws does not work for us due to the variable nature of our expenses...at least in the early years of retirement.  In the later years, income will be determined by IRS IRA RMD rules.  Because we don't want or need a huge income (and income tax problem) in our Golden Years...we plan on chewing into the largest IRA long before that to reduce it to a more palatable level before RMDs hit.  The trick is to balance it so we can continue to cover income needs plus inflation by still spend it down to avoid excess RMDs and taxes.  But, it is a problem I can live with.  

 

[bosco]

Each of us has a unique set of variables that we need to balance. I don't see any one number or any one system that will work for everyone.

Amen

I have pathological variables. I haven't found any spreadsheet or program that can possibly deal with it accurately. I have written one, but I don't have a monte carlo engine to deal with the expected investment returns.

a small example:

I will have a pension coming. It attains full value at age 55. If I take it earlier, it is reducet 0.5% per month before age 55. Up until age 60 it is not inflation proofed. Age 60-65 it is 50% protected (versus CPI). After 65, 75% indexed.

If that's not weird enough, I can also take the "level income option." That involves a larger pension until social security eligibility (at age 66 for me), thereafter substantially reduced. This is to combat the "windfall elimination provision." so in theory I can prevent some of my SS from being eaten up. Since I got my 40 quarters in before becoming a state employee (Alaska opted out of SS in 1987), I will in theory get some SS, but it is subject to being reduced due to the pension.

combine that with 2 pensions of my wife (both small, one indexed to cpi, one like mine), IRAs and RRSPs with minimum distribution requirements at age 70, after-tax investments etc., and it can get pretty overwhelming.

All of this is complicated by the US-Canada tax treaty, differing tax rates and policies etc.

If anyone knows of a spreadsheet with the flexibility to handle all this (and more) let me know.

When I try to deal with these issues, I program the Canadian tax rates into the program (in other words I make the assumption they will stay higher than the US rates). I also have to make assumptions about currency exchange values. How much do I devalue the US dollar in 20 years?

loads of fun....

 

[d]

I think I understand it after reading it 5 to 10 times

job: that's pretty much my point as well.  after more than several readings i think i understand it, but even then it's not too clear.

 

[youbet]

So, SteveR and bosco, how are you estimating the amount of $$$ you want in your portfolio at the time you RE? 

My planning involves many budgeting and income issues as you describe for yourselves in your posts.   Still, I estimated the portfolio withdrawal I'd need to make each year and bumped it against the 4% inflation corrected guideline as a "rule of thumb" to give myself some confidence that I wouldn't be depleting the portfolio while I was still young enough to care. 

BTW, I never use the 4% as a "must withdraw and spend" number, but only as a guideline for a sustainable real withdrawal rate over the long haul. I also assume that if I happen to get lucky and retire in boom times in the market, I'll reevaluate and up my spending when I notice I'm now tied with Bill Gates for richest person in the world!    If I retire into bust market times, my plan allows me to stay within the 4% guideline, so I should OK as long as the future market performance is no worse than the past.

I fully realize that years down the road, I may need to make changes.  But I also needed some guideline to allow me to estimate the required retirement portfolio so I'd know when to kick the work plug out of the wall, which I'm doing four weeks from tomorrow.

Anyway, I'm curious, what rules of thumb or guidelines are you using to estimate the size of retirement portfolio you'll need in order to RE given your other sources of retirement income? Do those rules of thumb include an SWR assumption such as 4% or another number?
 

 

[bosco]

So, SteveR and bosco, how are you estimating the amount of $$$ you want in your portfolio at the time you RE?

since I am an engineer, I am used to dealing with uncertain quantities. I also quickly (because I'm a lazy engineer) know when the level of analysis is unwarranted given the degree of unknowns.

there are 2 very big unknowns in my planning and a bunch of smaller unknowns. The big 2 are equity performance over the next X years, and the US/CD exchange rate (majority of pensions and investments are US dollar-denominated). In the face of these uncertainties, too much analysis is pointless.

What I have done is run a spreadsheet and tried to bracket the biggies, and make reasonable assumptions on the small uncertainties. Ultimately, I am going to have to remain flexible and change my strategies based on what happens.

Fortunately, DB pensions will likely suffice for the first 10-12 years with minimial help from the portfolio. This puts DW and I in a strong position in terms of being able to let the nest egg grow. There will be some repositioning that needs to occur. And the RMDs loom very large when we reach age 70. For that reason, it will probably make sense to tap the IRAs and RRSPs before we need the money and redeploy it in after-tax accounts. Since we will be living in Canada, Roth conversions are not an option.

Does anyone know where there is useful information about currency hedging? A google search I undertook mostly ended up with info only suitable to institutions. I am currently overweighted in international and resources due to US dollar concerns.

The fact is that we are basically FI now--since I don't money from investments now. Assuming modest (3% or so real) growth in our portfolio, it will easily be able to inflation-proof the pensions once they are ground down.

I plan to work until Oct 07 and then pull the plug. That way I will have the mortgage paid off--psychologically worth it to me. Plus I will have 4 or 5 months off next winter. The difference of the last 12 or 13 months of work is the difference between a healthy travel budget and the difference between drinking fine Belgian beers or having to settle for Buttwiper Budweiser.