The Current Annuity Factor & Dangers of the 4% "Rule"

[SecondCor521]

The other logical problem with relying on the annuity factor is that it includes a profit for the annuity company. If one keeps that themselves, then there is more meat on the bone, to speak.

If someone's going to annuitize their entire portfolio, then sure, maybe that's a logical reason to use that number. But I wouldn't do that personally and there are very few situations where I think it would make sense to do so.

 

[Navigator]

The Bloomberg article seems geared towards someone who has barely enough assets to make it through retirement and therefore must be very cautious about how they invest and spend there money.

The boglehead piece was more interesting. It had a link to an article by Sharpe that reminded us the 4% rule is not based on solid data. Stock prices have a huge variance and the 4% rule is based on 30 year periods that overlap (for example, someone who retired in 1975 has 29 years in common with someone who retired in 1976). This means that just because the 4% rule worked up until now, there is good reason to believe there will be future 30 year retirement periods when it will not. Sharpe’s solution was to pick a monetary goal and find the least risky way to meet that goal. One thing odd about the article is that he considered accumulating too much money just as bad as not having enough.

 

[ncbill]

4% rule uses 30 year overlapping periods back to the 1920s.

Not since WWII, or since the 1970s.

Based on history, not returns & variances generated by Monte Carlo analyses.

 

[Dtail]

4% rule uses 30 year overlapping periods back to the 1920s.

Not since WWII, or since the 1970s.

Based on history, not returns & variances generated by Monte Carlo analyses.

I'm with you.
There still hasn't been a beginning worse year to retire recently compared to 1966; 55 years ago and counting.

 

[Navigator]

4% rule uses 30 year overlapping periods back to the 1920s.

Not since WWII, or since the 1970s.

Based on history, not returns & variances generated by Monte Carlo analyses.

I think you may misunderstand the points I was trying to make about what Sharpe and his co-authors stated in their paper. Sharpe is a Nobel prize winning economist, so I believe his points are correct, even if my explanation didn’t convey it clearly.

First, there are only three independent 30 year periods since the 1920s. The overlapping periods used in retirement calculations means the same data is churned over and over again in the calculations, which reduces their significance.

Second, even though historical data was used to suggest the 4% rule, it is still a statistical problem. That is because you are taking all portfolio returns from the 1920s until today and saying they are representative of all possible returns. To know if that is true, one must know how much noise there is in portfolio returns ( I.e., variance). In the case of stocks, the point is that the there is a lot of noise in the data, meaning there is reason to believe the 4% rule may not always hold up.

 

[Sunset]

I was a fan of the liability matching poster, Bobcat2, since we FIREd and have followed his advice. ...... My main solution to negative real returns on bonds is to get our personal inflation rate well below the CPI rate by continually optimizing our expenses. ....... DH switched to a hair stylist that is half the price of what he used to pay; and a bunch of other stuff that didn't lower our quality of life but combined shaved over $5K off our annual run rate.

DW & I cut each others hair for years now, saves a trip/wait and random quality at the hair cutter, possibility of pickup lice and of course saves $$.

 

[daylatedollarshort]

I think you may misunderstand the points I was trying to make about what Sharpe and his co-authors stated in their paper. Sharpe is a Nobel prize winning economist, so I believe his points are correct, even if my explanation didn’t convey it clearly.

First, there are only three independent 30 year periods since the 1920s. The overlapping periods used in retirement calculations means the same data is churned over and over again in the calculations, which reduces their significance.

Second, even though historical data was used to suggest the 4% rule, it is still a statistical problem. That is because you are taking all portfolio returns from the 1920s until today and saying they are representative of all possible returns. To know if that is true, one must know how much noise there is in portfolio returns ( I.e., variance). In the case of stocks, the point is that the there is a lot of noise in the data, meaning there is reason to believe the 4% rule may not always hold up.

One of the authors of Triumph of the Optimists, who reviewed stock returns for 16 different countries over the 103 year period 1900-2002, put it this way: "While a country has only one past, there are many possible futures." From Agenda (csinvesting.org)

 

[ncbill]

I think you may misunderstand the points I was trying to make about what Sharpe and his co-authors stated in their paper. Sharpe is a Nobel prize winning economist, so I believe his points are correct, even if my explanation didn’t convey it clearly.

First, there are only three independent 30 year periods since the 1920s. The overlapping periods used in retirement calculations means the same data is churned over and over again in the calculations, which reduces their significance.

Second, even though historical data was used to suggest the 4% rule, it is still a statistical problem. That is because you are taking all portfolio returns from the 1920s until today and saying they are representative of all possible returns. To know if that is true, one must know how much noise there is in portfolio returns ( I.e., variance). In the case of stocks, the point is that the there is a lot of noise in the data, meaning there is reason to believe the 4% rule may not always hold up.

History is what we have.

Implying the 4% rule will not work for the future is saying the future will be worse than historical periods which include the Great Recession, WWII wage & price controls, 1960s Vietnam+Great Society ("guns & butter") inflation, & the stagflation of the 1970s which included two major exogenous "oil shocks."

Given the 4% rule worked for 30 years for those retiring during the above, I remain skeptical that "it's different this time."

 

[aja8888]

I was a fan of the liability matching poster, Bobcat2, since we FIREd and have followed his advice. We loaded up on TIPS early on, though I haven't been buying at the current low rates, which have been below the inflation rate. My main solution to negative real returns on bonds is to get our personal inflation rate well below the CPI rate by continually optimizing our expenses. Like this year we refinanced our mortgage when rates went down; we're shutting down a small business we haven't really worked on that had some lingering overhead costs; we found a free app channel that provides local programming which save $25 a month over the cable fees; DH switched to a hair stylist that is half the price of what he used to pay; and a bunch of other stuff that didn't lower our quality of life but combined shaved over $5K off our annual run rate.

Quite impressive your ability to continually cut expenses. But what are you going to focus on when you get to the point of diminishing returns on cost cutting and seeing your investment scenario seems to be in Tips which have negative yields these days?

Have you thought through a "going forward"strategy?

 

[daylatedollarshort]

Quite impressive your ability to continually cut expenses. But what are you going to focus on when you get to the point of diminishing returns on cost cutting and seeing your investment scenario seems to be in Tips which have negative yields these days?

Have you thought through a "going forward"strategy?

Individual TIPS only have a negative yield if you buy them at current rates, which I am not. Older TIPS are returning inflation + the coupon rate. If inflation goes to 5% and the coupon is at 2%, then the combined return would be 7%. This is why they are so expensive to buy today with investors worried about inflation. When some of the TIPS mature I have been putting the money into short term CDs for now. I have thought about buying I-bonds again and we will move some money to a super reward checking.

Our baseline expenses are below our SS and pension income these days, so any returns on our investments just mean extra savings. We don't have any set rate of return we need to have for retirement expenses. Interestingly, I still have a long list of projects on the expense optimization / increase income (without getting a job) front. I don't think I will ever run out of projects.

 

[Exchme]

Our baseline expenses are below our SS and pension income these days, so any returns on our investments just mean extra savings. We don't have any set rate of return we need to have for retirement expenses. Interestingly, I still have a long list of projects on the expense optimization / increase income (without getting a job) front. I don't think I will ever run out of projects.

It sounds like continually cutting costs has become a point of pride, so you could continue to live that way if you want, but if you have fixed income that more than covers your expenses, you could put the rest into the stock market and try to get some growth.

 

[chassis]

It seems like some of the posts that criticize the planning tools (4% rule, Monte Carlo analyses, etc.) are seeking a guaranteed outcome.

There are no guarantees. Today may be all of our last day on earth.

A planning tool is what it is. It helps outline, forecast or estimate what could, or is likely, to be the case. It’s not a guarantee. Guarantees don’t exist. There are none.

Seeking a guarantee is a chase after the wind.

 

[pb4uski]

.... Using the annuity factor remains too conservative, IMHO...ignores equity returns.

+1 IME most annuity books of business are backed by bonds and/or mortgages and are typically zero equities because the risk-based capital requirements for equities are too high to make using equities to back annuities attractive.

You can see this in IRRs for 5 and 10 year period certain annuities on immediateannuities.com which are 0.03% and 0.11% respectively.... you would be just as well off keeping your money in a FDIC insured savings account and just making monthly withdrawals at those rates rather than tying up money in an annuity certain.

 

[VanWinkle]

History is what we have.

Implying the 4% rule will not work for the future is saying the future will be worse than historical periods which include the Great Recession, WWII wage & price controls, 1960s Vietnam+Great Society ("guns & butter") inflation, & the stagflation of the 1970s which included two major exogenous "oil shocks."

Given the 4% rule worked for 30 years for those retiring during the above, I remain skeptical that "it's different this time."

+1 great example ncbill!!!

 

[daylatedollarshort]

It sounds like continually cutting costs has become a point of pride, so you could continue to live that way if you want, but if you have fixed income that more than covers your expenses, you could put the rest into the stock market and try to get some growth.

We do have some stocks, but our retirement plan relies more on asset matching and preservation of capital rather than growth. If we decide to spend down the portfolio, with even a zero real return in mostly relatively safe investments like TIPS and insured CDs, our SWR is 3.3% (100 / 30 years = 3.33%) which works for us.