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-   -   Does the 4% "rule" apply if you spend less than you make? (http://www.early-retirement.org/forums/f28/does-the-4-rule-apply-if-you-spend-less-than-you-make-76951.html)

45th Birthday 04-22-2015 09:09 AM

Does the 4% "rule" apply if you spend less than you make?
 
My question is whether one should even be concerned about the "withdrawal" rate if one earns more than one spends.

In my case, if I look at planned spending in 2015, it is 4.3% of my 12/31 investment portfolio (does not include personal real estate). However, the spending is only 63% of what I will earn this year from dividends, interest, and options trading. In other words, all other things being equal, my investable assets will increase by 37% of my gross income this year. Put another way, my net cash income (gross income less all spending including taxes) will be 2.6% of my beginning investable assets.

Does the 4% "rule" apply here? Would your answer change if all my income was from w*rking?

38Chevy454 04-22-2015 09:18 AM

If income from working then withdrawal does not apply. In your case, you are assuming a higher return on investments than what might be the actual result.

What about years when your investment returns are less than 4.3%? The withdrawal rate is whatever you are comfortable with, and combined with investment return (total including dividends, interest, value increase, etc) and the length of time is what works for you. The 4% or other percentage/strategy is just a guideline.

gauss 04-22-2015 09:40 AM

Quote:

Originally Posted by 45th Birthday (Post 1584709)
In my case, if I look at planned spending in 2015, it is 4.3% of my 12/31 investment portfolio (does not include personal real estate). However, the spending is only 63% of what I will earn this year from dividends, interest, and options trading. In other words, all other things being equal, my investable assets will increase by 37% of my gross income this year. Put another way, my net cash income (gross income less all spending including taxes) will be 2.6% of my beginning investable assets.

Does the 4% "rule" apply here? Would your answer change if all my income was from w*rking?

It sound like you are getting returns from actively managing your accounts. Will the returns you are getting now be sustainable (ie will the market change)? Will you change and be unable to continue?

I believe that the 4% SWR rule is based on a passively invested portfolio with perhaps yearly balancing or so.

I think we are comparing apples and oranges

-gauss

ArkTinkerer 04-22-2015 09:48 AM

I think the 4% rule has two other aspects--

1. It is based upon historical returns. If this was a very good year for you, then your net worth will increase but other years may be a net decrease.
2. The 4% rule also is suppose to allow for some inflation. If you don't increase your net worth, then the 4% will mean less and less purchasing power every year.

Ronstar 04-22-2015 09:56 AM

IMO, an SWR applies whether or not your investments earn more than you spend. For example, say one has 1m in their portfolio. If their spending is 40k, then their WR would be 4%. Say through the course of the year, the person earns 100k on their investments. Just add the returns into the portfolio. So at the end of the year they would have 1,060,000. The next year they could keep their spending at 40k resulting in a 3.77% WR, or up their spending.
I just lump my dividends, etc back into my portfolio - I don't consider it income. I even did this while working part time. I put my paycheck in checking that was part of my portfolio. My WR was extremely low including the paycheck, but I also calculated my WR without my paycheck income as a check that I could meet my targeted WR when I quit work.

Dwhit 04-22-2015 10:27 AM

Quote:

Originally Posted by 45th Birthday (Post 1584709)
My question is whether one should even be concerned about the "withdrawal" rate if one earns more than one spends?

No it doesn't matter. If you always earn more than you spend you will not run out of money. But if your earnings go down, then you must spend less. And if you earnings go negative, you have to make it back up in other years. Then you have to decide how much spending to cut to try to make it up over how many years.

The 4% rate tries to give you some spending stability, but really it is no guarantee. If you spend more than you earn, then eventually your money will run out.

Davis65 04-22-2015 03:19 PM

It's important to remember that this is a rule-of-thumb, not a rule. It is a short cut to give you a quick way of getting an answer. Your mileage may vary. For example, 4% may be too high for someone who is invested in a bunch of high-fee, low performance mutual funds, and too conservative for somone with a higher-performing portfolio of income-generating investments.

I am getting 5.67% yield from a portfolio of conservative dividend-generating stocks and REITs. So if I draw down only 4%, my portfolio will grow quickly, instead of being drawn down. I won't live forever, and have no reason for my investments to do so.

Even if you compare similar gross returns on portfolio, the person who is managing their investments themselves should be able to draw down more than someone whose investment manager is drawing 1.5 to 2% from the portfolio in fees every year.

Independent 04-22-2015 03:25 PM

It might be best to show your income separately, dividends, interest, and options trading.

I'll guess that you can't live off dividends and interest and have your portfolio grow with inflation, so you're relying on your option income.

Then look at the risks you're taking with your options, and see whether you can convince yourself that those risks will never turn into reality.

(The answer to your direct question is that the work on the "4% rule" looks at total return, and doesn't care about sources. And, it also assumes that you will have plenty of years when your portfolio grows even after withdrawals and inflation. The 4% focuses on the expectation there will be some bad years.)

45th Birthday 04-22-2015 04:12 PM

I realize 4% isn't a hard and fast rule, just using it (in quotes) as a discussion point.

I do track my income by type. I could live off the dividends and interest, but would have to cut expenses if no option income. However, the option income, even during the bad market years, has been significant. Children will stop being a drain soon, which will save a bunch. Also, when we downsize our third house (originally our main residence) in a few years, that will also save.

I evaluate the option risk daily, but disagree that I need to convince myself the risks will never turn into reality. That's not how it works.

Independent 04-22-2015 05:32 PM

Okay.

The "4% rule" applies to people who want a stable income, increasing with inflation. Kind of like a nice, stable paycheck. The "rule" is that IF you want that type of income*, THEN you shouldn't spend more than 4% of your original portfolio.

But, you are okay with an income that flexes down in poor years, so you don't meet the "IF" part of the rule.


* and, if a list of other assumptions holds

rodi 04-22-2015 05:55 PM

I thought the 4% rule, as described in the trinity study, was to start with a withdrawal of 4% of your *initial* portfolio value. The following year the withdrawal would be the same as the initial year, but adjusted for inflation. So in non-deflationary times, your withdrawal goes up with inflation. Your portfolio is going up and down with the market - but you still get a withdrawal every year even in down markets. The up market years make up for the down years.

It should be noted that even at the time of the initial 4% withdrawal conclusions - that only gave a 95% success on a 30 year retirement. If your retirement is longer, or if there is an extended downturn, you'd be taking a bigger risk of running out of money before you died.

It should also be noted that Bengen, Pfau and others have since lowered the "safe" 4% rule to a lower percentage.

What the OP is suggesting is more of a variable withdrawal rate (rather than the fixed 4%). When the market is up, take more, when the market is down, take less. As long as you are prepared to take LESS when the market is down, it's fine to spend more when it's up. The problem is that folks don't always like to cut back on spending.

Davis65 04-22-2015 06:14 PM

AN interesting article on the 4% rule-of-thumb from SeekingAlpha today:
Summary
  • The 4% Retirement Rule is frequently cited as a financial planning guide for retirees. But I believe the theory is flawed.
  • To me, investing in high-yield dividend stocks seems to be a better solution. There are many stocks yielding more than 4%, that even raise their dividends over time.
  • And, while the 4% Retirement Rule calls for a nest egg to eventually go to zero, retirees will not have to drain their savings by investing in dividend stocks.
  • As a result, investors could use dividend stocks as an even better retirement income strategy.

FreqFlyer 04-22-2015 06:16 PM

If your option income falls dramatically for some reason AND you're willing to reduce your spending (flexibility) I personally would have no problem spending 4.3% of my portfolio in a year.

I'd be very uncomfortable establishing a certain rigid lifestyle cost structure spending 4.3% of my portfolio with the assumption that the high option income will continue in perpetuity.

This is obviously just my opinion, YMMV. My plan is to have a baseline spend of 3% (average, I can easily do 2.5 to 2.8% if needed for a few years). If the market performs well I might splurge on certain things (hey how about a month in London!). I'm 43 so my time horizon is perhaps 45 years vs 30 from the trinity study.

pb4uski 04-22-2015 06:52 PM

For many of us who retire early, it isn't at all unusual for the WR to be higher before pensions and SS come online so while your WR may be 4.3% for some years, once any pensions or SS come online and offset living expenses, your withdrawals are typically lower.

My current WR is about 4% but plummets once my pension and SS come online... meaning that I probably worked longer then I had to and can splurge some in retirement.

lemming 04-22-2015 08:07 PM

I think this might be a time for a cookie jar fund. Funds that you withdraw from your portfolio and keep aside for the bad years. Has the pain of 2008/09 faded so fast. ?

I'm one who has been doing the SWR wrong. I think Firecalc takes the original withdrawal dollars you pick and then increases that by the inflation rate you picked and compares that to the historic markets. Run firecalc with your spending assumptions and see if you are happy with the results

45th Birthday 04-23-2015 08:25 AM

Quote:

Originally Posted by FreqFlyer (Post 1584937)
If your option income falls dramatically for some reason AND you're willing to reduce your spending (flexibility) I personally would have no problem spending 4.3% of my portfolio in a year.

I'd be very uncomfortable establishing a certain rigid lifestyle cost structure spending 4.3% of my portfolio with the assumption that the high option income will continue in perpetuity.

This is obviously just my opinion, YMMV. My plan is to have a baseline spend of 3% (average, I can easily do 2.5 to 2.8% if needed for a few years). If the market performs well I might splurge on certain things (hey how about a month in London!). I'm 43 so my time horizon is perhaps 45 years vs 30 from the trinity study.

Without kids on the payroll (last one graduates next year), the withdrawal rate drops to 3%.

Independent 04-24-2015 08:28 AM

Quote:

Originally Posted by Davis65 (Post 1584934)
AN interesting article on the 4% rule-of-thumb from SeekingAlpha today:
Summary
  • The 4% Retirement Rule is frequently cited as a financial planning guide for retirees. But I believe the theory is flawed.
  • To me, investing in high-yield dividend stocks seems to be a better solution. There are many stocks yielding more than 4%, that even raise their dividends over time.
  • And, while the 4% Retirement Rule calls for a nest egg to eventually go to zero, retirees will not have to drain their savings by investing in dividend stocks.
  • As a result, investors could use dividend stocks as an even better retirement income strategy.

The bold is wrong.
Calculations using the 4% rule show that in most cases retirees end up with more money than they had when they started.

Reading the article, he makes this mistake consistently.

He could provide some backtesting for his strategy. Let's look at companies that would have satisfied this requirement at some time in the past:

"These companies are all large, established leaders in their respective industries. I chose them because they have strong brands and long histories of paying dividends and raising those dividends over time."

And show how they performed over the next 30 years. For example, did GM and Sears fit this description?

Davis65 04-24-2015 10:20 AM

Quote:

Originally Posted by Independent (Post 1585474)
The bold is wrong.
Calculations using the 4% rule show that in most cases retirees end up with more money than they had when they started.

Reading the article, he makes this mistake consistently.

Interesting - I didn't know that. I am amazed at how many people on this forum, e.g., here, are really proud of having a WR below 4% and of having their assets grow. That, to me, is very conservative, but then I have no heirs to be concerned about. I am happily planning a WR > 4%.

RunningBum 04-24-2015 11:34 AM

Quote:

Originally Posted by Davis65 (Post 1585529)
Interesting - I didn't know that. I am amazed at how many people on this forum, e.g., here, are really proud of having a WR below 4% and of having their assets grow. That, to me, is very conservative, but then I have no heirs to be concerned about. I am happily planning a WR > 4%.

In some of the worst cases, 4% DOES drop fail or drop near 0. >4% is going to have more of those cases. Your choice whether to take that risk. If you've got some fat in your budget you could live without, it's probably fine since chances are it's not needed. If you're bare bones, it's more of a risk.

ulrichw 04-24-2015 02:50 PM

Quote:

Originally Posted by 45th Birthday (Post 1584709)
My question is whether one should even be concerned about the "withdrawal" rate if one earns more than one spends.

I'll take a fresh tack at answering the original question.

At face value, the answer to your question is "yes". The safe withdrawal rate is meant to be a rate that is safe through good years and bad years. So the fact that you're in a good year doesn't mean (under this strategy) that you should spend any more. You should be saving the excess for the bad years.

Quote:

Originally Posted by 45th Birthday (Post 1584709)
In my case, if I look at planned spending in 2015, it is 4.3% of my 12/31 investment portfolio (does not include personal real estate). However, the spending is only 63% of what I will earn this year from dividends, interest, and options trading. In other words, all other things being equal, my investable assets will increase by 37% of my gross income this year. Put another way, my net cash income (gross income less all spending including taxes) will be 2.6% of my beginning investable assets.

Does the 4% "rule" apply here? Would your answer change if all my income was from w*rking?

Ok, so you're actually asking a different question.

You're asking - "If I can outperform the market consistently, does the 4% rule apply to me?"

The answer changes in this case - if you can consistently outperform the market, then absolutely, you can spend more than the 4%.

The 4% number was computed using a set of return assumptions that match average historical bond and stock market returns.

What it comes down to is whether you have a strategy that consistently beats the markets or not. It seems that you believe you have such a strategy, therefore (assuming you're correct, of course) you should be able to exceed 4%.

You would probably want to run some Monte Carlo Analysis using return assumptions to figure out how much you could exceed that by.


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