Achieving a Higher Safe Withdrawal Rate with the Target Percentage Adjustment

[walkinwood]

This is a variable withdrawal methodology that is simpler than Guyton's decision rules. It reduces the inflation adjustment if the withdrawal as a percentage of portfolio value exceeds a glide path that is calculated at the start of retirement. The glide path uses a fixed return that guarantees that the portfolio will survive the withdrawal time frame.

The methodology is simple, but only adjusts downwards. There is no catch up if the markets perform better than expected. Guyton's decision rules account for this.

Nonetheless, it is an interesting concept that is worth knowing.

How to Achieve a Higher Safe Withdrawal Rate With the Target Percentage Adjustment

(download if you think it is worth keeping. It will not be free on the site past this month)

 

[MichaelB]

Interesting. Thanks for the link.

 

[donheff]

Interesting. When we switch to chained CPI and people start using that as the basis for calculating the standard model all the SWR success rates will get a bump up.

 

[marko]

My eyes glazed over after a while. Isn't this similar as the old rule of skipping a year or two of inflation adjustments every few years?

 

[Meadbh]

My eyes glazed over after a while. Isn't this similar as the old rule of skipping a year or two of inflation adjustments every few years?

Thanks to the OP for posting this. My eyes glazed over too. It does seem complicated, but that was the math he had to do to prove the point. It is an academic journal. A decision tool such as a spreadsheet would be helpful.

 

[donheff]

I think you are misreading the approach. It is very simple, although I would not choose to use it. Instead of starting at a number and blindly raising it by CPI, you select a percentage less than CPI (e.g. -1, -2, or -3%) and you blindly raise by that figure (e.g. CPI less 1%) except in bad years when you skip the raise. You never adjust downward (except when CPI is negative, i.e, deflation). So in a bad market downturn you keep spending at the previous year's level.

This lets you start higher than 4% and still stay in the 95% survival range under historical precedents but decreases real spending as you age .

 

[Live And Learn]

Great link. It gives me a little more confidence in taking a bit more risk than most others in this forum would like. My WR will be 3.8% and I'm wanting my portfolio to last 40 years. I currently have a 10% chance of running dry at age 80, and 20% at age 90. After that I'd have to figure out how to live on SS alone.

The reason I haven't pulled the plug yet is that I KNOW that I'll spend alot of time worrying about my finances even tho in all my calcs I have 400k set aside (200k for one time expenses, 100k for bucket-list travel, 100k for elder assistance / long term care), am using only 90% of my portfolio in my calcs and am assuming that pay full silver level premiums for Obamacare plus another 7500 / year for copays.

This at least gives me some hope that I have so many contingencies built in that the 3.8% rate will work.

 

[audreyh1]

I prefer to stay with the fixed % of portfolio each year, unadjusted for inflation approach. And stick with the lower withdrawal %.

If my portfolio keeps up with inflation on average, so will my income. If not - well, I'll be glad I wasn't increasing my withdrawals by some inflation adjustment factor.

If my portfolio beats inflation, I'll get to enjoy the bonus sooner rather than later.

The year-to-year income variability is simply not an issue for me, as I tend to have some left over from the previous year. In addition, income taxes tend to have a "smoothing" effect on my after tax income anyway - i.e., after a good year I may have a bump in income, but taxes tend to be higher; after a bad year, I may have a drop in income, but the taxes also tend to be lower, sometimes even resulting in a higher after-tax income compared to the prior year.

Funny how that works.

 

[youbet]

Bottom line, the author is saying that you can begin retirement with a higher withdrawal rate if you agree to allow the real withdrawal amount to erode due to inflation over time.

Makes sense to me........ And is simply another take on the "spend more early by spending less later" outlook. You just have to be comfortable that a real shrinking retirement budget will work out for you. In my case, I don't think that assumption is necessarily true.

This is the beginning of our 7th calendar year of RE. (DW RE'd at 55 and I RE'd at 58. We're both 65 now) Each year, we build a bottom up budget and compare it to the withdrawal rate required to support it. Given the prior year's portfolio performance, my guesstimate and concerns about anticipated current year performance and special considerations, we adjust the budget up or down until we're comfortable. (Special considerations might be something like a special trip we want to take this year with the understanding we might then have to cut back next year, etc.)

We also do bottom up budgets for the next 4 years in declining levels of detail.

I like FireCalc and seem to be constantly building FireCalc models. But we're finding that our spending is quite variable from year to year and we're more comfortable with annual budgets than with constant, or nearly constant, withdrawal rates that might be significantly too big or too small for our plans for the year.

 

[youbet]

If my portfolio keeps up with inflation on average, so will my income. .

Am I interpreting this as meaning your portfolio must grow by Year #1 inflation plus year #1 withdrawal for year #2 withdrawal to be equal to year #1 withdrawal in real terms?

For example, you have a million buck portfolio. You withdraw 3% = $3K in year #1. Inflation is 3% = $3k in year #1. To have year #2 withdrawal = year #1 withdrawal in real terms, your portfolio must grow approximately $6k to $1,000,003.00 ($997,000 + $3k to replace the withdrawal + $3k to keep the portfolio value constant in real terms.)

Your portfolio growth must replace the prior year's withdrawal and keep up with inflation. Is that it?

How would you handle a year where your portfolio fails to keep up with inflation?

 

[Focus]

This is excellent stuff. Thank you for posting the link.

I know the intent of the report is to see how high the SWR can be, but looking at those charts makes me feel even more comfortable about aiming for 3% -- but no less, with inflation adjustments only when needed -- for 40 years. It's a highly conservative choice that appears to succeed even under the most pessimistic (just short of worldwide economic collapse) scenarios.

And yet I know there are those who would still consider this not conservative enough!

 

[audreyh1]

Am I interpreting this as meaning your portfolio must grow by Year #1 inflation plus year #1 withdrawal for year #2 withdrawal to be equal to year #1 withdrawal in real terms?

For example, you have a million buck portfolio. You withdraw 3% = $3K in year #1. Inflation is 3% = $3k in year #1. To have year #2 withdrawal = year #1 withdrawal in real terms, your portfolio must grow approximately $6k to $1,000,003.00 ($997,000 + $3k to replace the withdrawal + $3k to keep the portfolio value constant in real terms.)

Your portfolio growth must replace the prior year's withdrawal and keep up with inflation. Is that it?

It only has to keep up with the initial portfolio value in real terms, not necessarily each year.

I know that with a 50%+ equity exposure, over a long period of time, I can reasonably expect the portfolio to do better than inflation in real terms, even after my withdrawals. No rocket science here.

How would you handle a year where your portfolio fails to keep up with inflation?

I wouldn't be doing anything different. I would be withdrawing less in real terms compared to the prior year, just like I would after any bad market year. I might end up dropping to a real spending level from several years prior. No problem, I figure it will eventually catch back up.

And if worst comes to worst, and it doesn't keep up with inflation, I'll be gradually drawing down the portfolio, but less and less each year, so I don't risk depleting it very quickly at all (theoretically never). And under this unhappy scenario I should also be grateful that I didn't adjust my withdrawal by inflation each year, as I would have just depleted the portfolio faster.

 

[obgyn65]

Same here. This article is too complex for non financial people like me.

Thanks to the OP for posting this. My eyes glazed over too. It does seem complicated, but that was the math he had to do to prove the point. It is an academic journal. A decision tool such as a spreadsheet would be helpful.

 

[youbet]

Thanks Audrey. Makes sense and sounds like a very reasonable approach.

 

[marko]

It only has to keep up with the initial portfolio value in real terms, not necessarily each year.

I know that with a 50%+ equity exposure, over a long period of time, I can reasonably expect the portfolio to do better than inflation in real terms, even after my withdrawals. No rocket science here.


I wouldn't be doing anything different. I would be withdrawing less in real terms compared to the prior year, just like I would after any bad market year. I might end up dropping to a real spending level from several years prior. No problem, I figure it will eventually catch back up.

And if worst comes to worst, and it doesn't keep up with inflation, I'll be gradually drawing down the portfolio, but less and less each year, so I don't risk depleting it very quickly at all (theoretically never). And under this unhappy scenario I should also be grateful that I didn't adjust my withdrawal by inflation each year, as I would have just depleted the portfolio faster.

Forgive me, but are you saying that if your portfolio delivered (example) 12% performance/increase one year and inflation was 2%, you feel that you could withdraw up to 10% (12 minus 2) and feel that you've remained whole?

If not, how have you determined your SWR?

 

[audreyh1]

Forgive me, but are you saying that if your portfolio delivered (example) 12% performance/increase one year and inflation was 2%, you feel that you could withdraw up to 10% (12 minus 2) and feel that you've remained whole?

If not, how have you determined your SWR?

No, I withdraw a fixed percent of the end of year portfolio value each year and totally ignore inflation.

 

[Focus]

I believe this is audreyh1's strategy, as described on Bogleheads.

 

[walkinwood]

We use the same strategy as Audrey. We use it because we have, hopefully, a lot more than 30 years to go. It does lead to wild swings in annual expenses. In 2009, for example, we had to really reduce our spending. However, like Audrey, we now need less than 4% of our portfolio value, so the fluctuations do not really bother us. That is, till the next big downturn in the market.

The methodology in the paper is a bit more complex than just keeping your annual increase less than CPI. You only do that in years when your withdrawal as a percentage of your portfolio is less than the glide path (I can't think of a better term for this) percentage for that particular year (see table 3 in the article). The glide path is determined by an SWR assumption (4%), an inflation assumption 3% and a time duration (45 years )