Why won't a 4% SWR last forever?

[gindie]

I know I have read many articles over the years in Money and Kiplingers that have made the claim that a 4% withdrawal rate, adjusted yearly for inflation, should last you 'for a XX year period'.

My question is, as long as your annual rate of return on your investment is greater than the rate of inflation, shouldn't your account value continue growing? (I realize I'm not accounting for market dips, but I don't think they do either in their articles).

For example, assume a $1,000,000 nest egg on December 31 of my final year of work. I take out $40,000 (4%) on the first day of my retirement year. And further assume a 3% inflation rate and 7% investment rate of return in retirement.

Then, after year 1 of retirement, my account would be:

1,000,000 - 40,000 = 960,000 * (1.07) = 1,027,200

Year 2 would then be:

1,027,200 - 41,200 (the original amount * 1.03) = 986,000 * (1.07) = 1,055,020, and so on.

Am I missing something here?

 

[razztazz]

Volitility

 

[Nords]

Am I missing something here?

Razz's terse answer notwithstanding, volatility makes it easier for the portfolio to crash over longer periods of time. ALthough you'd usually beat inflation over the long term, in some years the rate of inflation would exceed the portfolio's returns and push it closer to failure.

The reason that FIRECalc doesn't show that so well is its reduction in data runs for longer periods. It throws out partial periods and so doesn't have as many runs for longer series.

Maybe a Monte Carlo simulator would show the effects of accumulating crashes over longer periods of time.

 

[scrubradio]

Wouldn't a well balanced portfolio help to reduce the effects of volitility?

 

[mathjak107]

Even a well balanced portfolio can have wild swings. The long term average may be 7% but even so you can have years up 30% and years down 14-15% . The problem with average returns is they only exist after very long time periods short term they are liking trying to say " if i put my feet in the oven and my head in the freezer overall i should be quite comfortable.

The farther you go out in years the smoother things get, i was hard pressed to randomly pull out any 14 year period since the 60's and run the various indexes for the different asset classes for those years and not have it come up to almost the exact same average return amount. It was mind blowing to actually try a monte carlo simulation yourself and see the return come out the same no matter what the block was.

Even 10 year blocks of time come close but there was slightly more variation.

 

[scrubradio]

Gotcha.

So if I decided to FIRE and miscalculated, I could end up watching my
portfolio deteriorate and find myself back out in the workforce in a hurry.

 

[mathjak107]

See our discussion on ray lucia's thoughts.

 

[dory36]

As others have said, it's volatility. See the graph and discussion at the top of http://firecalc.com/intro.php for a longer discussion.

Chances are, your plan would work, although historically, you'd have about 1 chance in 6 of running out of money within 50 years.

Everyone has their own sense of what is an acceptable risk, and 1 in 6 may be fine for some, while others may be unwilling to take that risk.

The ~4% idea is to reduce that 1 in 6 chance to a safer ratio.

 

[2B]

So if I decided to FIRE and miscalculated, I could end up watching my
portfolio deteriorate and find myself back out in the workforce in a hurry.

The most dangerous time to begin living off your assets is right before a major market downturn. If you look at FIRECalc's graph, you can see that the "failed" years are right at major market downturns.

The answer if you are one of the unlucky ones is to either rejoin the workforce (if anyone is hiring) or cut spending. There are various spending adjustments out there you can use. ESRBob had one in his book (and on FIRECalc) and there's the Goyton (spelling?) method which lets you start at up to a 6.2% withdrawl rate.

Also, don't forget the Bernicke approach that says you'll stop spending as much as you age.

 

[mathjak107]

Thats why quite a few of us like ray"s bucket system. Its simple ,it gives you 14 years of money in case of a prolonged market downturn so odds are you will never liquidate when down. You trade maximizing gains for safety and steady inflation income draw.

Im big on plans and structure so for me im very comfortable doing this way.

 

[LOL!]

The most dangerous time to begin living off your assets is right before a major market downturn. If you look at FIRECalc's graph, you can see that the "failed" years are right at major market downturns.

The answer if you are one of the unlucky ones is to either rejoin the workforce (if anyone is hiring) or cut spending. There are various spending ....

I'm curious about that observation/anecdote. Does that mean that folks that are close to, but not quite at, their number could actually retire and see what happens the first few years of retirement? If their investment results are good in those few early years, they have made it. If their investment results are poor, then unretire for a little while and try again later.

But if you are already retired for 10 to 15 years when your investments start doing poorly, does that mean it is no big deal because you are over the hump?

Or live miserly those first few years, and then kick up expenditures after wards?

 

[2B]

Thats why quite a few of us like ray"s bucket system. Its simple ,it gives you 14 years of money in case of a prolonged market downturn so odds are you will never liquidate when down. You trade maximizing gains for safety and steady inflation income draw.

Im big on plans and structure so for me im very comfortable doing this way.

There is not any difference between the "buckets of money" and a portfolio with a high % of laddered bonds. Ray likes "privately traded, low leveraged" REITS which he likes to sell clients to give them "safe" income with a high overall return (Bucket 2). I'm sure he also gets a nice commission. You could also put in Canadian Oil Trusts and get even income.

There are various ways to play with the buckets. I agree it sounds good conceptually but I don't see where it really changes anything.

 

[dory36]

I'm curious about that observation/anecdote. Does that mean that folks that are close to, but not quite at, their number could actually retire and see what happens the first few years of retirement? If their investment results are good in those few early years, they have made it. If their investment results are poor, then unretire for a little while and try again later.

But if you are already retired for 10 to 15 years when your investments start doing poorly, does that mean it is no big deal because you are over the hump?

Or live miserly those first few years, and then kick up expenditures after wards?

Exactly.

 

[2B]

I'm curious about that observation/anecdote. Does that mean that folks that are close to, but not quite at, their number could actually retire and see what happens the first few years of retirement? If their investment results are good in those few early years, they have made it. If their investment results are poor, then unretire for a little while and try again later.

But if you are already retired for 10 to 15 years when your investments start doing poorly, does that mean it is no big deal because you are over the hump?

Or live miserly those first few years, and then kick up expenditures after wards?

It's all in the math, dear grasshopper.

If you retired in 1982 with a 4% SWR, the impact of 2000 - 2003 was irrelevant if you maintained a balanced portfolio. By starting in 1982, your portfolio grew far faster than inflation so you had a fortune by the time 2000 came around. If you retired in 1973 at the same 4% SWR you saw your portfolio fall and you probably wouldn't be retired in 1982 on the same inflation adjusted income.

I knew a guy who retired in 1999 based on the 20+% he had been making in tech stocks. He had $500,000 and felt he could get by on $75,000/yr. He thought that would be no problem even if his returns dropped a little. He went back to work in 2003 effectively broke. He tried to go back to work sooner but no one was hiring IT types in 2002.

Now if you retired in 2000 you are probably still concerned or have trimmed your spending. Will you make it? I don't know.

 

[Rich_by_the_Bay]

Actually, I have run the numbers as did a few others from a previous thread. It turns out that as you approach and exceed a "25-30 x expenses" nest egg the length of time it lasts based on historic data begins to get closer and closer to forever. It is asymptotic.

So while no formula would guarantee forever in the absence of midcourse corrections, you can get very high odds at those levels of savings.

 

[2B]

Actually, I have run the numbers as did a few others from a previous thread. It turns out that as you approach and exceed a "25-30 x expenses" nest egg the length of time it lasts based on historic data begins to get closer and closer to forever. It is asymptotic.

So while no formula would guarantee forever in the absence of midcourse corrections, you can get very high odds at those levels of savings.

I agree if you withdraw below 4% you approach "forever" but the real big market free falls make even the 25X expenses look risky. An even bigger factor would be the mental stress of watching your $1MM drop to $500K in 2 years while still pulling out your $40K per year plus inflation. I find it hard to believe anyone would sit back and smile "knowing" that in the long run it will all work out 98% of the time.

 

[retire@40]

I agree if you withdraw below 4% you approach "forever" but the real big market free falls make even the 25X expenses look risky. An even bigger factor would be the mental stress of watching your $1MM drop to $500K in 2 years while still pulling out your $40K per year plus inflation. I find it hard to believe anyone would sit back and smile "knowing" that in the long run it will all work out 98% of the time.

Yup. That's why people should have 2 budgets:

1. A comfort budget.
2. A bare bones budget which should be no more than 1/2 to 2/3 of your comfort budget.

If you can live on a 4% SWR comfort budget, then even in a major downturn, if you can temporarily revert to your bare bones budget, you should at least feel better about your potential outcome.

 

[Rich_by_the_Bay]

I agree if you withdraw below 4% you approach "forever" but the real big market free falls make even the 25X expenses look risky. An even bigger factor would be the mental stress of watching your $1MM drop to $500K in 2 years while still pulling out your $40K per year plus inflation. I find it hard to believe anyone would sit back and smile "knowing" that in the long run it will all work out 98% of the time.

Poin well taken.

If you really want "forever" you should take 4% of your annual balance, period. That may result in highly variable annual income, but you're good to go. Might use Clyatt's 95% rule to smooth things out, but that voids the warranty other than for historic circumstances.

 

[mathjak107]

There is not any difference between the "buckets of money" and a portfolio with a high % of laddered bonds. Ray likes "privately traded, low leveraged" REITS which he likes to sell clients to give them "safe" income with a high overall return (Bucket 2). I'm sure he also gets a nice commission. You could also put in Canadian Oil Trusts and get even income.

There are various ways to play with the buckets. I agree it sounds good conceptually but I don't see where it really changes anything.

IT changes nothing overall from what everyone kind of tries to do with a hodge podge of stuff and seat of the pants calculations as to how much to keep in cash in terms of income years ,and how much in bonds and what duration.

The numbers he generates give you some concrete well thought out numbers you can use as well as the time frames for the various buckets are carefully arrived at so there is noooooo chance of selling at a loss or not maintaining the average long term returns on your investments.

One other thing it did for me is it allowed me to invest more aggressively in my stock bucket then i might have done if i was just putting together a standard 50/50 or 60/40 mix. I may have gone more growth and income funds instead of high alpha growth funds.

 

[2B]

One other thing it did for me is it allowed me to invest more aggressively in my stock bucket then i might have done if i was just putting together a standard 50/50 or 60/40 mix. I may have gone more growth and income funds instead of high alpha growth funds.

That may not be to your advantage. In 2000 all of the "high alpha growth funds" were in tech. How long will it take for the Janus fund (can't remember the name) that was the great high flyer pre-bubble burst to get back? I think 15 years is very optimistic if the fund is even still around.

I continue to fall back on the basic concept of diversification among asset classes. I have some growth (small cap growth) but it's relatively small -- about 10%.

 

[youbet]

For example, assume a $1,000,000 nest egg on December 31 of my final year of work. I take out $40,000 (4%) on the first day of my retirement year. And further assume a 3% inflation rate and 7% investment rate of return in retirement.

Then, after year 1 of retirement, my account would be:

1,000,000 - 40,000 = 960,000 * (1.07) = 1,027,200

Year 2 would then be:

1,027,200 - 41,200 (the original amount * 1.03) = 986,000 * (1.07) = 1,055,020, and so on.

Using averages for your calculations is extremely risky. If you check the numbers, there is hardly ever a year with a 7% return and 3% inflation. You may get those numbers as averages over time, but the actual data will fluctuate widely around those means.

Instead of using the averages as you did, build a simple spead sheet and start with huge portfolio loses the first few years coupled with high inflation. The loses will dramatically reduce your portfolio and the high inflation will drive your required withdrawals way up. Then start plugging in market gains and low inflation numbers until the average is about 7% and 3% respectively. You'll see the difference!

Just remember that a 7% average return is not a typical return for any year.

 

[mathjak107]

That may not be to your advantage. In 2000 all of the "high alpha growth funds" were in tech. How long will it take for the Janus fund (can't remember the name) that was the great high flyer pre-bubble burst to get back? I think 15 years is very optimistic if the fund is even still around.

I continue to fall back on the basic concept of diversification among asset classes. I have some growth (small cap growth) but it's relatively small -- about 10%.

Not true, i had quite a few high alpha funds that out performed the market in 2001 2002 and 2003 . they were well diversified and not tech heavy.

Actually we wished they were tech heavy when those sectors were soaring but were soooooooo glad they werent afterwards

 

[youbet]

There is not any difference between the "buckets of money" and a portfolio with a high % of laddered bonds.

Oh no...... Ray's system is "magic." Your cash and bond ladders will all yield more if you call them "bucket 1." Your fixed income funds and reits will sail with more favorable winds if you call them "bucket 2." And your aggressive equity positions will make you a fortune if you call them "bucket 3."

OK, sorry about the sarcasm.

2B, I've been busy trying to understand what Ray Lucia is really doing and I think I'm getting close. His system is a combination of asset allocation phased with a rebalancing and withdrawal plan. Other than sometimes carrying a very high cash allocation, I don't see a particular problem with what he's doing. (And, hey, sometimes a high cash allocation is the way to go!) I'm just not comfortable classifying assets into "buckets" simply because I'm more comfortable with a "one portfolio" approach. Although, I might wind up doing the same thing someone using Ray's methodology might do, I just don't vision my assets being in "buckets."

Ray is obviously a charismatic speaker/writer and lots of folks have grabbed onto his jargon with a religious-like zeal. And so be it. You can certainly execute an allocation/rebalancing/withdrawal plan with all the advantages/disadvantages of Ray's without his "buckets" terminology, but if using it gives folks a level of confidence they need, great.

To Ray's credit, he does give an appropriate emphasis to withdrawal strategies, something most of the "gurus" don't do, instead focusing almost exclusively on the accumulation period.

 

[2B]

The airwaves and book aisles are full of people wanting you to let them manage your money. There are a few "pure" authors about financial matters but most are looking for that "hook" that will bring in the customers/clients. Ray is a financial planner that has found it and I don't have anything negative to say about it. I've read his book and I've evaluated "bucketizing" for my plan. It's an overall conservative approach. He is encouraging people to become clients of his firm.

On the other side of the spectrum, I heard a financial planner on a Houston radio station yesterday morning say that all of the people buying no load mutual funds are ruining the American economy. If we pay a load, we know that the mutual fund is working "for us." If we buy a no load, that money is used to buy influence with CEOs. The no load fund will buy/prop up his company's stock price but the CEO will have to give the firm investment banking fees for acquisitions and mergers. Thereby, the companies are forced to do bad deals or their stock prices will plunge. Before that I didn't know how much investment banking Vanguard and Fidelity must do. People like this should be off the air and have their CFP (if they have one) revoked.

 

[scrubradio]

Poin well taken.

If you really want "forever" you should take 4% of your annual balance, period. That may result in highly variable annual income, but you're good to go. Might use Clyatt's 95% rule to smooth things out, but that voids the warranty other than for historic circumstances.

IRA SEPP payments can't be set up to draw at a variable rate based on
4% can they?