Alternative to the 4% rule

[Dtail]

Good summary, big-papa. I find it an interesting topic as well.

Funny thing, if I had to guess, the way I hear people talk here, I'd think most people are using that SWR method you quote. But I'm not sure I've ever seen a thread around the end of the year discussing inflation rate and what number they'll adjust by for the next year. I see topics on how individual investment returns, and how people spent according to budget, but not the inflation rate specific to WR increases. Either the number is so obvious and widely accepted it doesn't have to be discussed (seems doubtful), or people really aren't increasing their spending by inflation.

Okay responding to Big Papa and Running Bum.
I am also intrigued by all the WR methodologies, so really appreciate all the responses.
I actually would be surprised if the majority of the users here would use the original Bengen 4% SWR methodology with inflation increases.
It appears at least to me that many first of all use some number below 4% and don't use the inflation increases in a strict methodical way.
Many posts indicate that one has to be flexible and cut when things are bad. Thus how many would use the 4% scenario when the markets are tanking, which effectively hasn't happened for 10 years.

One could state well would I continue to use the Clyatt methodology when things are tanking? My response is to start with the 3% instead of 4% and thus a 50% 2008 meltdown for just put me back to roughly using an effective 4% WR which would work for me.
If there are a few back to back bad years but less than 50% total, it would also work.
I believe only a Japanese 1989 scenario moving forward to current times there would cause issues.
Hey what do I know......

 

[big-papa]

Okay responding to Big Papa and Running Bum.
I am also intrigued by all the WR methodologies, so really appreciate all the responses.
I actually would be surprised if the majority of the users here would use the original Bengen 4% SWR methodology with inflation increases.
It appears at least to me that many first of all use some number below 4% and don't use the inflation increases in a strict methodical way.
Many posts indicate that one has to be flexible and cut when things are bad. Thus how many would use the 4% scenario when the markets are tanking, which effectively hasn't happened for 10 years.

One could state well would I continue to use the Clyatt methodology when things are tanking? My response is to start with the 3% instead of 4% and thus a 50% 2008 meltdown for just put me back to roughly using an effective 4% WR which would work for me.
If there are a few back to back bad years but less than 50% total, it would also work.
I believe only a Japanese 1989 scenario moving forward to current times there would cause issues.
Hey what do I know......

Yep, this is closer to Taylor's more or less ad-hoc method over on bogleheads. Stay flexible. The variable withdrawal methods described in this thread are an attempt to try and do something algorithmically.

 

[big-papa]

4. Keep a cash bucket. Stick to a realistic budget that meets your needs. All expenses/taxes/etc come out of the cash bucket. Refill the cash bucket each year as needed.

Ignore the SWR, however, put this in a spreadsheet so you can predict if you can do the above for 40 years or whatever.

1-3 was to answer the question of how people use SWR around here. There are literally dozens of other methods, including more ad-hoc ones. But no matter what you use, you first need to understand what your spending needs are and how flexible you can be with them. And most of the methods assume some sort of return on the investments at the end of the day, unless you're one of the lucky ones who everything covered from other income streams such as a pension, rental property, etc...

 

[scrabbler1]

I like to plan conservative. I'm going with a 2% withdrawal rate. Maybe 3, but I think I can get by with 2. My expenses are low -- single, no kids, frugal/simple. I'll be ER in a couple years.

I'm a lot like you (single, no kids, frugal/simple), but have been retired for the last 10 years.

My SWR has been around 2%, some years in the 2.3%-2.6% range, other years 1.8%. Two things have been the main drivers of the variation: (1) medical expenses, sometimes rising insurance premiums, and (2) the quickly rising value of my portfolio since 2009 which has put downward pressure on the SWR.

I have created an income flow from the taxable part of my overall portfolio, the only part I can freely access until the first of my "reinforcements" arrives, unfettered access to my tIRA in about 4 years. After that, I will have SS and my frozen company pension waiting for me. Once those reinforcements arrive, my financial picture only gets better. Getting to age ~60 has always been the main priority, and having gotten from age 45 (when I first retired) to age 55 (my age now) intact has been great.

 

[big-papa]

Here's a series of articles some of you might find interesting. The first 3 are written by a friend of mine over at bogleheads, siamond. "Revisiting risk and reward".
https://finpage.blog/2018/06/17/revisiting-risk-and-reward/

Many who use SWR, choose a withdrawal rate based on the worst SWR that has happened in history for a standard stock/bond portfolio. That would be somewhere around 4% based on a retirement start date in the late 1960's. Or as this thread shows, some might go even lower than that.

A takeaway of this set of articles is that a good variable withdrawal plan will approximate the SWR for your start date, as if you already knew ahead of time what the SWR would be. At least for an apples-to-apples comparison of variable methods that are designed to deplete the portfolio after N number of years, since by definition perfect knowledge of what the SWR would be for your starting year also would deplete the portfolio after the same N number of years. It's more problematic to compare withdrawal methods that are designed to last in perpetuity with withdrawal methods designed to deplete a portfolio, at least with some sort of metric.

 

[pb4uski]

We don't have any particular withdrawal approach.

When I first retired 6 1/2 years ago, we were living solely off investments. I set up an automatic monthly transfer from our retirement portfolio to our local bank account that, at the time, was 3% annual WR. However, we have some lumpy expenses in November (insurances and property taxes) so I would do some occasional special transfers so our overall WR was probably more like 4%. That monthly transfer is the same today as it was in 2012.

5 years later I started my pension, which increased our monthly cash inflows by 23%. Between adding the pension and our investments doing very well we loosened the purse strings a bit and spend more freely now that we did when we first retired.

Our portfolio today is 125% of what it was when I retired, and that is after buyng a winter condo for cash, building a 2-car garage for cash, etc.

We have sufficient redundancy and our WR is now is a little higher then when we first retired because we are spending more but it is low enough that I don't fret about withdrawals at all... I just monitor our WR.

 

[Independent]

Good summary, big-papa. I find it an interesting topic as well.

Funny thing, if I had to guess, the way I hear people talk here, I'd think most people are using that SWR method you quote. But I'm not sure I've ever seen a thread around the end of the year discussing inflation rate and what number they'll adjust by for the next year. I see topics on how individual investment returns, and how people spent according to budget, but not the inflation rate specific to WR increases. Either the number is so obvious and widely accepted it doesn't have to be discussed (seems doubtful), or people really aren't increasing their spending by inflation.

I agree with the bold.

I think that SWR is used to answer two questions
Can I afford to retire today?
How much can I afford to spend in the first year?

It is not used to mechanically determine how much to spend in the second, third, .... years.

It seems that almost everyone who posts here intends to be very conservative. They are spending less than they think they could. Or, they can point to stuff they could easily eliminate if they it looks like the cushion is shrinking.

 

[big-papa]

I agree with the bold.

I think that SWR is used to answer two questions
Can I afford to retire today?
How much can I afford to spend in the first year?

It is not used to mechanically determine how much to spend in the second, third, .... years.

It seems that almost everyone who posts here intends to be very conservative. They are spending less than they think they could. Or, they can point to stuff they could easily eliminate if they it looks like the cushion is shrinking.

Based on the responses, I think you're correct. They'll use an SWR calculation mainly as a guide to see if they are financially ready for retirement. I know many people flip it upside down to determine if they are ready for retirement. For example: 4% means 25X spending. At least over on bogleheads, you'll see people talking about how many times spending they currently have to support retirement. You'll see anywhere from 20X (meaning they cover much with pensions, SS or some other source of income) to as high as 50X in some of the discussions.

Another way to see if you're amassed enough for retirement is to use a technique known as the "Funding Ratio". This is simply the ratio of your assets divided by your liabilities. The math is usually done by taking the ratio of the present value of your assets and future spending. Anything greater than 1.0 and you're covered.

It's described over on Bogleheads in this thread or you can google to get other explanations: https://www.bogleheads.org/forum/viewtopic.php?f=2&t=205824
There are some spreadsheets flying around to help you, but the math is basically:
1. Calculate the present value of your retirement income goal
2. Calculate the present value of your SS benefits
3. Sum the present value of your savings and SS benefits
4. Divide #3 above by #1 above and you have your Funding ratio.

Like all estimates, this is just an estimate and more is certainly better. You have to have a reasonable understanding of what your spending will be and you need to have a reasonable guess of future long term returns. Usually the math is done in "real", not "nominal" terms which helps since the PV of SS is best done in real terms, since there is an inflation adjustment.

Cheers - big-papa

 

[corn18]

I like the way you think big-papa. I use all of the various withdrawal schemes to see what retirement might look like today, next year and 5 years from now. I am close enough now that this works well.

Retire today (age 52):

$72,000 - 3% SWR
$95,870 - VPW
$111,973 - Get me to SS @ age 70 and then live off of SS and COLA pension only ($95k/yr)

Retire @ 55:

$93,683 - 3% SWR
$122,008 - VPW
$178,557 - Get me to SS @ age 70 and then live off of SS and COLA pension only ($95k/yr)

That's quite a range, but I can see what range I have to work with. At this point, it's all about how much risk I am willing to accept. I like my work, so I can hold out until 55. Then I hit the OMY years.

I assume 0% real growth in these calculations. If the market tanks, then I work longer. If it booms, maybe I can retire earlier. Base expenses are $95k.

 

[Dtail]

Here's a series of articles some of you might find interesting. The first 3 are written by a friend of mine over at bogleheads, siamond. "Revisiting risk and reward".
https://finpage.blog/2018/06/17/revisiting-risk-and-reward/

Many who use SWR, choose a withdrawal rate based on the worst SWR that has happened in history for a standard stock/bond portfolio. That would be somewhere around 4% based on a retirement start date in the late 1960's. Or as this thread shows, some might go even lower than that.

A takeaway of this set of articles is that a good variable withdrawal plan will approximate the SWR for your start date, as if you already knew ahead of time what the SWR would be. At least for an apples-to-apples comparison of variable methods that are designed to deplete the portfolio after N number of years, since by definition perfect knowledge of what the SWR would be for your starting year also would deplete the portfolio after the same N number of years. It's more problematic to compare withdrawal methods that are designed to last in perpetuity with withdrawal methods designed to deplete a portfolio, at least with some sort of metric.

Just read the articles including the Cape ratio article. Interesting read. Thanks.

 

[big-papa]

I like the way you think big-papa. I use all of the various withdrawal schemes to see what retirement might look like today, next year and 5 years from now. I am close enough now that this works well.

Retire today (age 52):

$72,000 - 3% SWR
$95,870 - VPW
$111,973 - Get me to SS @ age 70 and then live off of SS and COLA pension only ($95k/yr)

Retire @ 55:

$93,683 - 3% SWR
$122,008 - VPW
$178,557 - Get me to SS @ age 70 and then live off of SS and COLA pension only ($95k/yr)

That's quite a range, but I can see what range I have to work with. At this point, it's all about how much risk I am willing to accept. I like my work, so I can hold out until 55. Then I hit the OMY years.

I assume 0% real growth in these calculations. If the market tanks, then I work longer. If it booms, maybe I can retire earlier. Base expenses are $95k.

Very cool - your numbers look extremely similar to mine! I'm in my late 50's now and the only thing left for me to pull the plug is to see what extra costs college for my daughter are likely to be, beyond what we've already taken care of. That's about a year or so from now. So the plug pulls anywhere between a year and a half from now or 4 years after that, depending.

I personally use the SWR calculation and have begun using the "funding ratio" to determine readiness. On the withdrawal side, I'm convinced of the value of a variable withdrawal method. Being an engineer, I like something a little more deterministic. So a PMT based method is where my head currently is. The calculations are pretty easy and I can teach my wife how to do it (she's also an engineer, but has less interest in this stuff).

I also monitor what my first year's withdrawal would be if this was the actual first year. Like you I have several numbers I monitor assuming around a 40 year retirement
1. PMT method using the long term worldwide stock/bond returns that the VPW author uses.
2. PMT method using forward looking returns. This results in a number a bit lower than #1 - it makes intuitive sense to me since stock valuations are high and interest rates have been low.
3. PMT method using historic returns of my actual portfolio since 1927 based on Simba's spreadsheet over on bogleheads.
4. SWR based on my own particular asset allocation, calculated using Simba's spreadsheet over on bogleheads.

As noted before, I like the idea of a variable withdrawal method, but I want it to be smooth without risking early depletion. #2 above accomplishes that based on my own backtesting. But even then, there is likely to be a step-up in my total amount available to spend once SS kicks in. There are several ways to deal with this.
1. Over on bogleheads, one frequent poster advocates creating a TIPs ladder to bridge the gap between retirement and SS starting. This certainly works, but if the number of years for the gap is very long, this is going to be a pretty expensive way to get there, given interest rates.
2. If whatever method you use gives you enough money each year to cover your expenses, you can always treat SS as a bonus - more to spend later! But some folks want to wait until they're older before doing this meaning they might miss out on things they could have done when they were younger.
3. Another approach is to treat all of your sources of funds as one big pool. The simple example is whatever you have in savings + your future SS stream. The more complex math is again to do a present value calculation of all of this and treat that as your total assets to withdraw from. This also allows you to do things on the spending side like paying off your house at some point in the future, reducing your overall spending. Ignoring a change in future spending, the equivalent is to first do the calculation for your withdrawal amount. Now, on top of that withdrawal amount, you can also withdraw the equivalent of your future SS benefit. On the year that you actually start your SS benefit, you then eliminate the additional withdrawal. What this does is increase your spending in the early years. You no longer get the big step up once SS starts. Now, this does put additional strain on your portfolio during the bridge period and I probably wouldn't do this if the bridge was 15 years or so, but for a shorter bridge it's something to consider. Plus, once the bridge period is over, the strain is then reduced on your portfolio.

Cheers
Big-Papa

 

[Dtail]

3. Another approach is to treat all of your sources of funds as one big pool. The simple example is whatever you have in savings + your future SS stream. The more complex math is again to do a present value calculation of all of this and treat that as your total assets to withdraw from. This also allows you to do things on the spending side like paying off your house at some point in the future, reducing your overall spending. Ignoring a change in future spending, the equivalent is to first do the calculation for your withdrawal amount. Now, on top of that withdrawal amount, you can also withdraw the equivalent of your future SS benefit. On the year that you actually start your SS benefit, you then eliminate the additional withdrawal. What this does is increase your spending in the early years. You no longer get the big step up once SS starts. Now, this does put additional strain on your portfolio during the bridge period and I probably wouldn't do this if the bridge was 15 years or so, but for a shorter bridge it's something to consider. Plus, once the bridge period is over, the strain is then reduced on your portfolio.

Cheers
Big-Papa

The above approach is also a consideration for me. If I delay SS to 70 and substitute spending down the portfolio, I wonder about the sustainability.
I am 12 years from 70 and have 84% of our combined portfolios in TIRA/401k which could be another plus for spend down.
This concept is also combined with the viability of Roth conversion decisions of which I can't really do until 65 due to ACA income management, although DGF can to some extent.
All fascinating and lots more homework to do before hitting 62.

 

[HI Bill]

I have a table running out to 110y old for DM, and myself too. Chances for her being the next Jeanne Calment is next to nil, yet it allows us to at least have the discussion and determine the level of comfort.

Yes, but at what cost? You are giving up your earlier years (with presumably your best health) to have extra safety in the remote event that you live to 110? I don't know how many working years extra that will take you, but in my case, I'd have to work to ~60, instead of retiring at 53. The thought of giving up ages 53-60 and miss out on diving and travel while my health is still relatively good scares me far more than outliving my assets at age 100.

 

[RunningBum]

3. Another approach is to treat all of your sources of funds as one big pool. The simple example is whatever you have in savings + your future SS stream. The more complex math is again to do a present value calculation of all of this and treat that as your total assets to withdraw from. This also allows you to do things on the spending side like paying off your house at some point in the future, reducing your overall spending. Ignoring a change in future spending, the equivalent is to first do the calculation for your withdrawal amount. Now, on top of that withdrawal amount, you can also withdraw the equivalent of your future SS benefit. On the year that you actually start your SS benefit, you then eliminate the additional withdrawal. What this does is increase your spending in the early years. You no longer get the big step up once SS starts. Now, this does put additional strain on your portfolio during the bridge period and I probably wouldn't do this if the bridge was 15 years or so, but for a shorter bridge it's something to consider. Plus, once the bridge period is over, the strain is then reduced on your portfolio.

Cheers
Big-Papa

I do #3. Retired at 49, so I'm bridging 13-21 before collecting SS, and 16 years to a small pension. I use 75% of the PV of SS in case of future cutbacks. It's the easiest way I could figure out withdrawals for the rest of my life given various points at which income streams would be coming in.

I don't see it as a strain on my portfolio since I consider my pension and SS as part of my portfolio. It's just like how I'm pulling money out of my taxable account now since I can't access my IRAs yet. (Yeah, I know there are ways to access them, I'm just not.) It's one big pot of money, and the only question is figuring out the efficiency of which account to tap when. I won't come near emptying my taxable account before 70 so there's no worry about not having enough for an unexpected large expense, as someone living solely on SS+pension might.

If I get 100% of my expected SS benefit, that last 25% will be a bonus.

 

[RunningBum]

Yes, but at what cost? You are giving up your earlier years (with presumably your best health) to have extra safety in the remote event that you live to 110? I don't know how many working years extra that will take you, but in my case, I'd have to work to ~60, instead of retiring at 53. The thought of giving up ages 53-60 and miss out on diving and travel while my health is still relatively good scares me far more than outliving my assets at age 100.

To each their own. Plan your "longest case" life span to whatever you can sleep at night with. I find that a pretty ridiculously long estimate also gives me some buffer. It bothers some people to pretty much plan to leave money behind, but it does not bother me. I know I worked a couple years too long, and have had a nice run in the stock market in my early retirement years. I'm living well now, but I'm not going to over-indulge. I honestly can't tell you what I'd do if I was retired with very little buffer, wrt to living well vs. saving for just in case I live long. I suspect I'd be conservative.

 

[Out of Steam]

To each their own. Plan your "longest case" life span to whatever you can sleep at night with. I find that a pretty ridiculously long estimate also gives me some buffer.

The margin between dying rich and dying broke is really quite small. Using tomhole's "Dead vs. Broke" table and a stock allocation near 50% (which I've never ventured far from), a 4% draw doesn't have a significant chance of failure until after 25 years.

At 3%, there's little chance of dying broke at 50 years of retirement.

This seems to have been known for a while:

Annual income twenty pounds, annual expenditure nineteen six, result happiness. Annual income twenty pounds, annual expenditure twenty pound ought and six, result misery.

Charles Dickens, David Copperfield, 1849
English novelist (1812 - 1870)

 

[Totoro]

Yes, but at what cost? You are giving up your earlier years (with presumably your best health) to have extra safety in the remote event that you live to 110?

I may have not been complete here: Point is we use it in conversation, not as a final decision metric. DM retired before she was 60.

I'm in fact pushing her to spend more, knowing full well there is a risk there. Mostly in not leaving stuff to her kids, mind you.

For myself the same approach, even at 38.

 

[audreyh1]

I'm always interested in discussions regarding withdrawals methods. If there was one perfect method, I'm sure we'd all be using it. But we all have different needs, abilities and willingness to take risk, and other sources of income when we try and figure out what we want to do. Across this forum and other forums I see:

SWR: withdraw a % and adjust amount withdrawn by inflation each year. I see some folks sticking with 4% and I see others going lower due to risk aversion, especially when considering current stock valuations and recent interest rates for bonds vs the past. Many people using this method really want to see steady income and desire or need to be able to plan their spending accordingly. They may use variants such at Guyton-Klinger or Kitce's ratcheting mechanism to modify the withdrawals to either allow more spending in good times or to limit withdrawals when things go south in order to have a higher probability that their portfolios will last as long as they live.

Variable methods that result in your portfolio lasting forever: withdraw a fixed % of your portfolio each year. Here you're depending on your portfolio returns to beat inflation in the long run. People using these methods are able to live with year on year variations, though there are methods like Clyatt's that can limit the variatons somewhat. They are willing or able to trade off variation and guarantee that there will be money left over after they die with the certainty that there will always be something available to withdraw each year.

Those that use actuarial methods with PMT such as VPW, ARVA or customized methods often want to be able to squeeze every drop out of their portfolio for spending, with the tradeoff being that their withdrawals are going to very year on year. They are also relying on portfolio returns to keep up with inflation in the long run. And they may still have money left over if they die before the date planned or if they choose to create the calculation to guarantee a legacy.

And finally there are ad-hoc methods such as Taylor's over on BH. Choose a percentage to withdraw year 1. Increase it in good years and tighten your belt in bad years.

Within all of these methodologies are countless variants, smoothing methods, and the like. The possibilities are endless. One thing that's always in the back of my mind is the ability for my wife to manage the portfolio and the withdrawal method should I pre-decease her.

I thought I had made some notes last time you discussed your modifications to VPW, but I cannot find them. What was the metric you were using to figure expected future returns? I thought it was somehow simple how you were modifying the VPW spreadsheet, but can't seem to reconstruct what I thought I had learned!

 

[big-papa]

I thought I had made some notes last time you discussed your modifications to VPW, but I cannot find them. What was the metric you were using to figure expected future returns? I thought it was somehow simple how you were modifying the VPW spreadsheet, but can't seem to reconstruct what I thought I had learned!

I actually created my own VPW spreadsheet and I did it for several reasons.
1. The original spreadsheet only comprehended a total stock market and total bond market portfolio in the backtesting section. That's not my portfolio.
2. The original spreadsheet uses a fixed expected real return for stocks and bonds based on a Credit Suisse paper from a couple of years ago. It's based on long term (mid 1800's) worldwide returns.
3. I want to be able to treat all future cash flows as my "portfolio". In simple terms when I retire, I will have my savings and some point after I retire, I will have SS. Others may have a pension, etc. Anyway, rather than just withdrawing from my portfolio the percentage dictated, I would withdraw that percentage + the equivalent amount of SS I will eventually get once I do start taking SS. Once I start taking SS, I stop the additional withdrawal.
4. The author of VPW basically reinvented the PMT function already available in excel. The calculations are a lot simpler if you just use PMT.

OK, your actual question was what do I use for estimated future returns. The answer is varied. And some may use an average of any of the answers below.

First, remember that the estimated future returns that you plug into must be real future returns, not nominal future returns. And on whatever day you decide to take your withdrawal, find the data below and use that in the calculation.

Choices for the stock portion of your portfolio
1. 1/CAPE (aka 1/PE10). Not perfect but it is decent. You can always find this at: Shiller PE Ratio or on Professor Shiller's website. For example, today CAPE sits at 32.45 So 1/CAPE=3.08% Note, CAPE is derived by professor Shiller for the S&P 500 index. Probably pretty close if you use a total stock market fund. But if you deviate much from those two, you may need to adjust this number upwards or downwards. Or you can just use it and if your choice of stock fund has higher returns, than that, then the dollar amount withdrawn will automatically reflect it, eventually. This is probably the easiest metric to use as it's always kept up to date.

2. After that, there are a number of websites that make their predictions for the future. Just be aware that they differ in whether they give future returns in nominal terms or real terms. If they give it in nominal terms, you'll need a future inflation guess to go along with it. If you do that, then make sure you do the calculation as a geometric, not arithmetic product. For example. If future nominal returns are 5% and your inflation guess is 2%, then future real is (1+5%)*(1-2%)-1 = 2.9%

List of websites with predictions (there are more if you google)
1. Robeco: https://www.robeco.com/en/themes/expected-returns/
2. Blackrock: https://www.blackrock.com/institutions/en-us/insights/portfolio-design/capital-market-assumptions
3. Research Affiliates: https://interactive.researchaffilia...currency=USD&model=ER&scale=LINEAR&terms=REAL

There are many others. Generally, they are all in reasonable agreement with each other for the most part. I know at least one person who averages 1/CAPE with the data from Research affiliates for example.

What about bonds?
1. The same websites above sometimes also give future bond returns.
2. You can also get a good idea by going to Morningstar and pull up your bond fund. The SEC yield is a decent predictor of nominal future returns for your bond fund. For example, the 30 day SEC yield for VBTLX is currently 3.12% according to Morningstar.

But you still need to take this number and convert it to a real return. So, you need a future inflation predictor to convert the nominal predicted return to a real predicted return. Again, some of the websites above provide an answer. Some alternatives to that:
1. University of Michigan has a survey with consumer expected inflation rates. It's available here: https://fred.stlouisfed.org/series/MICH In May of 2018, the data shows 2.8%
2. You can also look at the difference in yields between nominal bonds and TIPs of the same duration. In the ideal world that difference would be the expected inflation rate. Fortunately FRED has already done the calculation for you and its available here for 10 year expected inflation https://fred.stlouisfed.org/series/T10YIE As of July 6th, it's 2.12% Or you can look at the 5 year numbers which aren't much different and can be found here: https://fred.stlouisfed.org/series/T5YIFR

Now just weight the stock and bond expected returns as your AA. For example, if you're 60/40 then 0.6* stock expected + 0.4 * bond expected and plug that into the PMT equation each year to calculate your %withdrawal.


That's about it. Don't get too hung up on absolute accuracy here. VPW/PMT is somewhat adaptable. If your future actual returns are higher than your expected returns, then the dollar amount in your portfolio will be higher. If the dollar amount is higher, then the withdrawal will also be higher. And vice versa.

In my own backtesting, I have found that this smoothing works a little better for a stock-heavy portfolio than for portfolios with a higher percentage of bonds. This makes intuitive sense because a higher dosage of bonds will already reduce your return variability by itself.

You can also add what's called "short term smoothing" to the withdrawals in order to limit how much you want to allow the withdrawal to change year to year. This is only limited by your imagination, but note that if you oversmooth, then you may deplete your portfolio faster resulting in lower withdrawals later on.

Hope this helps...

 

[audreyh1]

Wow thanks! I do remember you mentioning 1/CAPE10. Thanks for adding the bond and inflation stuff. Total stock market and total bond market are good enough for me. I’m just trying to get a ballpark.

Income smoothing - I’m already doing that after withdrawals (% remaining portfolio method) as I naturally bank the unspent income when the portfolio is high. I prefer to take as much as is allowed when the portfolio is running up, always figuring it might go back down fast soon.

 

[big-papa]

Wow thanks! I do remember you mentioning 1/CAPE10. Thanks for adding the bond and inflation stuff. Total stock market and total bond market are good enough for me. I’m just trying to get a ballpark.

Income smoothing - I’m already doing that after withdrawals (% remaining portfolio method) as I naturally bank the unspent income when the portfolio is high. I prefer to take as much as is allowed when the portfolio is running up, always figuring it might go back down fast soon.

No problem! Yep, there's nothing that says you actually have to spend what you withdraw, so the sort of buffering you describe will work. Plus it also helps with those "unplanned expenses".
Cheers!

 

[joeea]

That's worth a serious eyeroll.

According to Social Security tables, there's only a 5% possibility of getting to 95 for a man, or 98 for a woman.

To be fair those tables are at best a guess about today. They don't attempt to guess what lifespans might look like in 30-50 years or so.

I'm of the age where I start to focus on realistic expectations of personal lifespan. My grandfathers both died at 72. My dad is still around and healthy at 86. For planning purposes, I won't model anything less than 95.

But if I were in my 20s or even 30s, I would likely think of a longer life.

 

[haha]

I'm always interested in discussions regarding withdrawals methods. If there was one perfect method, I'm sure we'd all be using it. But we all have different needs, abilities and willingness to take risk, and other sources of income when we try and figure out what we want to do. Across this forum and other forums I see:

SWR: withdraw a % and adjust amount withdrawn by inflation each year. I see some folks sticking with 4% and I see others going lower due to risk aversion, especially when considering current stock valuations and recent interest rates for bonds vs the past. Many people using this method really want to see steady income and desire or need to be able to plan their spending accordingly. They may use variants such at Guyton-Klinger or Kitce's ratcheting mechanism to modify the withdrawals to either allow more spending in good times or to limit withdrawals when things go south in order to have a higher probability that their portfolios will last as long as they live.

Variable methods that result in your portfolio lasting forever: withdraw a fixed % of your portfolio each year. Here you're depending on your portfolio returns to beat inflation in the long run. People using these methods are able to live with year on year variations, though there are methods like Clyatt's that can limit the variatons somewhat. They are willing or able to trade off variation and guarantee that there will be money left over after they die with the certainty that there will always be something available to withdraw each year.

Those that use actuarial methods with PMT such as VPW, ARVA or customized methods often want to be able to squeeze every drop out of their portfolio for spending, with the tradeoff being that their withdrawals are going to very year on year. They are also relying on portfolio returns to keep up with inflation in the long run. And they may still have money left over if they die before the date planned or if they choose to create the calculation to guarantee a legacy.

And finally there are ad-hoc methods such as Taylor's over on BH. Choose a percentage to withdraw year 1. Increase it in good years and tighten your belt in bad years.

Within all of these methodologies are countless variants, smoothing methods, and the like. The possibilities are endless. One thing that's always in the back of my mind is the ability for my wife to manage the portfolio and the withdrawal method should I pre-decease her.

This is an excellent summary. IMO, there are no magic withdrawal methods. By far the safest is to have way too much money, but life being what it is even this is not bullet proof.

My own method is to pay close attention to my recurring costs, because much of this can be somewhat controlled. Another part of my method is to try to have an enjoyable base camp-ie., my day to day existence. Thus I really don't need "getaways" or "breaks".

But Lady Luck is always a big part of anything, including ER.

Ha

 

[audreyh1]

No problem! Yep, there's nothing that says you actually have to spend what you withdraw, so the sort of buffering you describe will work. Plus it also helps with those "unplanned expenses".
Cheers!

Thanks again. I will probably be back when I create my spreadsheet.

I am going to do like a few do here and create multiple withdrawal rate numbers from various methods to compare and update each year.

 

[bmcgonig]

I actually created my own VPW spreadsheet and I did it for several reasons.
1. The original spreadsheet only comprehended a total stock market and total bond market portfolio in the backtesting section. That's not my portfolio.
2. The original spreadsheet uses a fixed expected real return for stocks and bonds based on a Credit Suisse paper from a couple of years ago. It's based on long term (mid 1800's) worldwide returns.
3. I want to be able to treat all future cash flows as my "portfolio". In simple terms when I retire, I will have my savings and some point after I retire, I will have SS. Others may have a pension, etc. Anyway, rather than just withdrawing from my portfolio the percentage dictated, I would withdraw that percentage + the equivalent amount of SS I will eventually get once I do start taking SS. Once I start taking SS, I stop the additional withdrawal.
4. The author of VPW basically reinvented the PMT function already available in excel. The calculations are a lot simpler if you just use PMT.

OK, your actual question was what do I use for estimated future returns. The answer is varied. And some may use an average of any of the answers below.

First, remember that the estimated future returns that you plug into must be real future returns, not nominal future returns. And on whatever day you decide to take your withdrawal, find the data below and use that in the calculation.

Choices for the stock portion of your portfolio
1. 1/CAPE (aka 1/PE10). Not perfect but it is decent. You can always find this at: Shiller PE Ratio or on Professor Shiller's website. For example, today CAPE sits at 32.45 So 1/CAPE=3.08% Note, CAPE is derived by professor Shiller for the S&P 500 index. Probably pretty close if you use a total stock market fund. But if you deviate much from those two, you may need to adjust this number upwards or downwards. Or you can just use it and if your choice of stock fund has higher returns, than that, then the dollar amount withdrawn will automatically reflect it, eventually. This is probably the easiest metric to use as it's always kept up to date.

2. After that, there are a number of websites that make their predictions for the future. Just be aware that they differ in whether they give future returns in nominal terms or real terms. If they give it in nominal terms, you'll need a future inflation guess to go along with it. If you do that, then make sure you do the calculation as a geometric, not arithmetic product. For example. If future nominal returns are 5% and your inflation guess is 2%, then future real is (1+5%)*(1-2%)-1 = 2.9%

List of websites with predictions (there are more if you google)
1. Robeco: https://www.robeco.com/en/themes/expected-returns/
2. Blackrock: https://www.blackrock.com/institutions/en-us/insights/portfolio-design/capital-market-assumptions
3. Research Affiliates: https://interactive.researchaffilia...currency=USD&model=ER&scale=LINEAR&terms=REAL

There are many others. Generally, they are all in reasonable agreement with each other for the most part. I know at least one person who averages 1/CAPE with the data from Research affiliates for example.

What about bonds?
1. The same websites above sometimes also give future bond returns.
2. You can also get a good idea by going to Morningstar and pull up your bond fund. The SEC yield is a decent predictor of nominal future returns for your bond fund. For example, the 30 day SEC yield for VBTLX is currently 3.12% according to Morningstar.

But you still need to take this number and convert it to a real return. So, you need a future inflation predictor to convert the nominal predicted return to a real predicted return. Again, some of the websites above provide an answer. Some alternatives to that:
1. University of Michigan has a survey with consumer expected inflation rates. It's available here: https://fred.stlouisfed.org/series/MICH In May of 2018, the data shows 2.8%
2. You can also look at the difference in yields between nominal bonds and TIPs of the same duration. In the ideal world that difference would be the expected inflation rate. Fortunately FRED has already done the calculation for you and its available here for 10 year expected inflation https://fred.stlouisfed.org/series/T10YIE As of July 6th, it's 2.12% Or you can look at the 5 year numbers which aren't much different and can be found here: https://fred.stlouisfed.org/series/T5YIFR

Now just weight the stock and bond expected returns as your AA. For example, if you're 60/40 then 0.6* stock expected + 0.4 * bond expected and plug that into the PMT equation each year to calculate your %withdrawal.


That's about it. Don't get too hung up on absolute accuracy here. VPW/PMT is somewhat adaptable. If your future actual returns are higher than your expected returns, then the dollar amount in your portfolio will be higher. If the dollar amount is higher, then the withdrawal will also be higher. And vice versa.

In my own backtesting, I have found that this smoothing works a little better for a stock-heavy portfolio than for portfolios with a higher percentage of bonds. This makes intuitive sense because a higher dosage of bonds will already reduce your return variability by itself.

You can also add what's called "short term smoothing" to the withdrawals in order to limit how much you want to allow the withdrawal to change year to year. This is only limited by your imagination, but note that if you oversmooth, then you may deplete your portfolio faster resulting in lower withdrawals later on.

Hope this helps...

Great post. Thanks.