Ratchet Up

[big-papa]

That looks straightforward enough. Simple enough for me anyway.

I just need ballpark.

Yep pretty straightforward. Main key is updating it into the PMT equation each year. Of course guessing inflation is always fun. For backtesting, I've tried using the previous year's inflation or an average of the last 2-5 years and that seems OK. These days one can look at the breakeven rate of TIPs to get an idea of future inflation. Like I said, many choices.

 

[audreyh1]

Here is a spreadsheet showing how the %remaining portfolio behaves with a 50/50 Total Stock Market and 5 year Treasury and various withdrawal rates over a 30 year period.

%remaining portfolio means you withdraw the same % of the portfolio value each year. So income goes up and down with portfolio performance. As the portfolio grows you get higher income right away, but if the portfolio drops, your income from the portfolio also drops. A burning question is always - how much of an income drop might someone have to deal with using this withdrawal method?

All numbers are real. So an ending portfolio of $1M means you have what you started with in real spending power even after 30 years of withdrawals and inflation. This comes from some work samclem and I did a while back trying to figure out where the %remaining portfolio tipped from growing to shrinking on average. 4.35% was the magic number for this allocation. For this scenario the average ending portfolio matches the starting one.

This spreadsheet looks at various withdrawal rates on $1M portfolio. It shows the worst historical case for each and the lowest income someone would have experienced during the 30 years. It also shows the lowest ending portfolio (which historically does not correspond to the lowest intermediate income sequence) and the average ending portfolio.

% withdrawal remaining portfolio	$1M starting portfolio income	lowest portfolio	lowest income	worst income drop from start in %	average ending portfolio	income from average ending portfolio	lowest ending portfolio	income from lowest ending portfolio
6.00%	$60,000	$270,798	$16,248	73%	$593,418	$35,605	$298,371	$17,902
5.00%	$50,000	$345,873	$17,294	65%	$815,142	$40,757	$409,854	$20,493
4.50%	$45,000	$388,214	$17,470	61%	$954,171	$42,938	$479,758	$21,589
4.35%	$43,500	$401,853	$17,481	60%	$1,000,171	$43,507	$512,306	$22,285
4.25%	$42,500	$411,198	$17,476	59%	$1,032,020	$43,861	$518,901	$22,053
4.00%	$40,000	$435,476	$17,419	56%	$1,115,994	$44,640	$561,123	$22,445
3.50%	$35,000	$474,093	$16,593	53%	$1,304,200	$45,647	$655,754	$22,951
3.33%	$33,300	$486,776	$16,210	51%	$1,374,917	$45,785	$691,310	$23,021
3.25%	$32,500	$492,854	$16,018	51%	$1,409,464	$45,808	$708,681	$23,032
3.00%	$30,000	$512,306	$15,369	49%	$1,522,919	$45,688	$765,726	$22,972

I think it's important to point out that historically, even with higher withdrawal rates, the lowest income was still above the income for lower withdrawal rates until you exceeded 4.35%. So the drops in income were more drastic, but in spending terms you were able to withdraw far more income before hitting that low number. You do have a higher terminal portfolio value with lower withdrawal rates. So perhaps a good way to choose a withdrawal rate is to look at the average and lowest ending portfolio and decide what is OK, and then look at how much of a drop in income you might have to stomach. If you start with much higher income supposedly you can build a cushion or that steeper drop.

In exploring the historical data with Firecalc it turned out that 1906, 1899 and 1892 were worse starting years than 1966. In fact there were several more - maybe 10 worse starting years before 1966, and these were mostly before 1916. It took quite a bit of reviewing the data to tease out the lowest income years. In general, the 1966 worst case income drop was ~5% less than these cases.

Here is another spreadsheet that shows the worst case starting year, the lowest income year, and the number of years it took to drop to that lowest income. As you can see they all occurred over a very long period of time, at least 15 years. So you have a combination of stock market losses, inflation, and withdrawals, grinding away at the portfolio over many years before a turnaround finally occurs and things improve. Interestingly all of the worst case historical periods ended with a higher terminal portfolio value than the historically lowest ending portfolio. 1920 was the lowest income year in all cases.

% withdrawal remaining portfolio	starting year for worst case run	Lowest income year	Years to lowest portfolio value
6.00%	1892	1920	29
5.00%	1899	1920	22
4.50%	1899	1920	22
4.35%	1899	1920	22
4.25%	1899	1920	22
4.00%	1899	1920	22
3.50%	1906	1920	15
3.33%	1906	1920	15
3.25%	1906	1920	15
3.00%	1906	1920	15

In the 1966 case it took 16 years to get to the lowest income, so similar time period - long slow grind down.

 

[Chuckanut]

Personally I prefer to take the full chunk out after a big up year figuring that it could go poof the next, so I might as well pull out the entire amount, accepting the raise the market gave me. I stockpile my excess income instead.

+1

Where do you put it? I was in ST Bond funds but now that interest rates are going up, maybe MM funds again?

And, do you think it should count when figuring one's the AA? I feel like it is no longer investment funds, but just money sitting around waiting to be spent.

 

[audreyh1]

+1

Where do you put it? I was in ST Bond funds but now that interest rates are going up, maybe MM funds again?

And, do you think it should count when figuring one's the AA? I feel like it is no longer investment funds, but just money sitting around waiting to be spent.

Currently I have a combination of short-term CDs and high yield savings accounts, although I do still have some funds from a while back in short-term bond funds and some 3% 5 year CDs.

I don’t figure it as part of my AA because the funds have already been withdrawn from the portfolio.

What is the purpose of an AA? - it’s to let you know what/when to rebalance and to decide what percent you can reasonably withdraw. I only apply those rules to my retirement portfolio. Once the funds are removed I can do whatever I want without it affecting the retirement portfolio.

 

[Chuckanut]

Thanks.

 

[RenoJay]

To the OP: I wish I had it at my fingertips, but I recently read an interview with the guy who created the 4% rule in which he pretty much validated your thesis that if you have a great market for a few years after retirement, go ahead and “pretend”’that your retirement started later with a 4% withdrawal on the new higher balance.

 

[REWahoo]

... I recently read an interview with the guy who created the 4% rule ...

Cooley, Hubbard or Walz?

http://afcpe.org/assets/pdf/vol1014.pdf

 

[Independent]

To the OP: I wish I had it at my fingertips, but I recently read an interview with the guy who created the 4% rule in which he pretty much validated your thesis that if you have a great market for a few years after retirement, go ahead and “pretend”’that your retirement started later with a 4% withdrawal on the new higher balance.

I'm the OP. I did not intend to say that you should automatically ratchet up as soon as you have a good year.

I back tested that strategy with FireCalc's returns and found that it introduced additional failure years.

I did not test "a few years". I would expect that waiting longer before ratcheting would work out in back testing. But, I haven't tried to put a number on "longer".

(IF 4% were 100% successful in back testing, I would have gotten a different answer. But, 4% is only 95% successful in FireCalc. And, then we get into the limits on back testing.)