Thoughts on risk and the 4% guidance

[Surfdaddy]

As we are approaching our retirement "number", a number of thoughts come to mind, mainly related to "is that still really enough?".

Seems to me that there are a number of risks:

1 - What will our expenses be? (we still have kids in college, don't know whether they'll find jobs, etc.)
2 - What if there's an economic disaster, US debt bites us, etc. Not sure there is any way to protect against this, so probably shouldn't even worry about it.
3 - And the point of this post, a possible flaw in the 4% rule:

We all know that if you retire and the the market drops rapidly right after that, then it can be bad and this situation is what would lead to potential failures per Firecalc. But take the last 5 years as an example. Say you were at 90% of your retirement target in 2007. Then the market plunged and you dropped to perhaps 50% of your target. So now after 5 or so years you reach your target number.

It seems that statistically, anybody is most likely to be at their target at the end of a run-up in the market. This also implies that the risk of a market drop is higher at the times when people are more likely to have met their financial goals. Whereas something like Firecalc calculates the odds of retirement success randomly for each year in a set of scenarios, the reality is that you are *more likely* to reach your goals and retire in the years after good market runups, which means you might be more likely to experience failures of the market right after retirement. This implies that a target should be higher than the 4% (or whatever other percentage target you set) for this reason.

Has anybody else thought of this problem? Any thoughts?

 

[dtbach]

"Has anybody else thought of this problem?"

Trust me, many have thought about this problem. It's as old as modern retirement. I say modern as this is a fairly new innovation.

At some point you have to pull the handle. Maybe just take 3% the first year. Things go OK, then maybe 3.5% the second year. Looks good.

The fact is nobody knows. But decades of accumulated information give the 4% rule a high probability of success. You could do worse.

 

[REWahoo]

Whereas something like Firecalc calculates the odds of retirement success randomly for each year in a set of scenarios, the reality is that you are *more likely* to reach your goals and retire in the years after good market runups, which means you might be more likely to experience failures of the market right after retirement. This implies that a target should be higher than the 4% (or whatever other percentage target you set) for this reason.

FIRECalc doesn't do random runs, it does sequential runs, beginning with retiring in 1871 and then retiring beginning with each consecutive year for whatever time period you choose (30 years, etc.). The failure rates FIRECalc returns include how you would have fared had you retired the year before the worst market drops and at the end of the highest market runups since 1871. Therefore, IF you are getting a 100% success rate and IF the future is no worse than the past, and IF you don't withdraw more than your FIRECalc results going forward, your target amount does not need to be higher.

Your thoughts are typical of someone about to pull the plug, having second thoughts and succumbing to the JOMY syndrome. My advice: keep working until you can no longer stand it or your health fails. Those are both guaranteed cures for JOMY.

 

[Midpack]

Yes, it's a commonly discussed topic related to SWR. Just search 'safe withdrawal rates and p/e' and you'll find lots written about the most common methodology I've seen that attempts to quantify how to adjust SWR (initial) considering how the market is performing when you retire. Kitces, Pfau and others have studied this issue - there are some thoughtful articles and as always some garbage. Then you can judge for yourself. It is worth considering but remember FIRECALC already includes events worse than the 2007 meltdown. Ultimately it depends on how good your crystal ball is...

 

[youbet]

Has anybody else thought of this problem? Any thoughts?

Yes, retiring into sustained inflation or sustained poor market performance will likely put you on a track towards low ending portfolio levels. But FireCalc has starting periods that test both of those unfortunate scenarios. If you believe that worse times than the worst experienced in the past lie ahead, then you have cause for concern.

If you're nervous about retiring today, at market all time highs, because you think it's now more likely there will be a near term sustained downtrend, then you need to take that into consideration. You also have to consider, especially if you're not enjoying life as a worker bee, that time goes by and retirement delays are impossible to reverse. Once the sand runs through the hour glass, you're not allowed to tip it back and have another go at it.

The connection you're trying to draw between most folks reaching critical mass at market peaks and therefore are likely retiring into near term down markets is a bit sketchy. Certainly that scenario could happen, but even if it does, if you're following prudent withdrawal rates/strategies as tested by FireCalc and other widely accepted tools, the odds of your portfolio surviving as long as you do are on your side.

 

[growing_older]

IF you are getting a 100% success rate and IF the future is no worse than the past, and IF you don't withdraw more than your FIRECalc results going forward, your target amount does not need to be higher.

However, there is a possibility of strong selection bias. If people tend to retire at the point when a bull market has increased their portfolio just above some target number, then the 100% FireCalc results are accurate for past years, but the reassuring notion that many scenarios have been examined is not completely true. Most of those scenarios do not include the precondition that retirement coincides with a recent market run up. Certainly a few do. But the majority of sequences occur after a neural or down market, so aren't really relevant. If you retire when a market run up just pushes you over a target number, then you are preselecting for a possible worst case scenario, and of the few real life worst case scenarios in FireCalc data, you are okay at 100%. If you get anything less than 100%, then you may in fact be a LOT less successful than the number indicates, because many of the scenarios are not similar to what you have.

 

[REWahoo]

However, there is a possibility of strong selection bias. If people tend to retire at the point when a bull market has increased their portfolio just above some target number, then the 100% FireCalc results are accurate for past years, but the reassuring notion that many scenarios have been examined is not completely true. Most of those scenarios do not include the precondition that retirement coincides with a recent market run up. Certainly a few do. But the majority of sequences occur after a neural or down market, so aren't really relevant. If you retire when a market run up just pushes you over a target number, then you are preselecting for a possible worst case scenario, and of the few real life worst case scenarios in FireCalc data, you are okay at 100%. If you get anything less than 100%, then you may in fact be a LOT less successful than the number indicates, because many of the scenarios are not similar to what you have.

"The only thing we can predict accurately regarding future performance is that our ability to accurately predict future performance is inaccurate."

Does that about sum it up?

 

[NW-Bound]

However, there is a possibility of strong selection bias. If people tend to retire at the point when a bull market has increased their portfolio just above some target number...

Like the condition that we have now after a heck of a bull market...

I surely hope the "Wh***ing" will continue till the end of 2014 and beyond, but I would not bet my life on that.

 

[youbet]

If you get anything less than 100%, then you may in fact be a LOT less successful than the number indicates, because many of the scenarios are not similar to what you have.

If you believe that the actual market returns and inflation rates you encounter will be worse than any of the historical periods tested by FireCalc, this could certainly be true. We all had to make those [-]guesses[/-] predictions for ourselves. And none of us will know the answer for sure until the bell tolls......

I think that is one of the pleasures of retirement. Living primarily off of passive income from financial investments and not knowing how things will go keeps an old fella on his toes! 7.5 years into the adventure, and having retired into the Great Recession, I'm finding it all very interesting.

 

[growing_older]

If you believe that the actual market returns and inflation rates you encounter will be worse than any of the historical periods tested by FireCalc, this could certainly be true.

Actually, I'm trying to make the point that even if future market returns are no worse than any in the FireCalc dataset, the percentages can be misleading. Just to make the numbers easy to work with, lets say the dataset includes 20 examples of years following significant run up, 20 examples of years following significant decline and 60 years of meandering around. If you retire after a significant market run up, with 100% FireCalc success, then all the known historic scenarios are accounted for. Good for you.

But if you retire after a significant run up and get 90% success, what you actually have is 100% success in the 20 years the market was at a low, 100% in the 60 years of sideways markets and 10 of the 20 years when your retirement date coincided with a market run up. Which is to say, in the subset of years you are interested in that have similar starting conditions, you have success in 10 out of 20 years, or only 50% of the samples. Calling this a 90% success can easily give a more optimistic outlook than in reality exists. If knowing that in like historic economic conditions, you have a 50% success rate, that might change your mind about how safe you r plan really is.

No need to rely on conditions outside of past history. Just need to understand the bias in selection if you ONLY retire after the market dramatically pushes you over your target portfolio size.

This is completely different than if you pick a date and retire on that date, because then you are not preselecting for a particular market sequence.

 

[Ed_The_Gypsy]

I surely hope the "Wh***ing" will continue till the end of 2014 and beyond, but I would not bet my life on that.

It looks like I may be in the bad old position of retiring at the beginning of a bear market (towards the end of the current bull market). At least my Roth conversions will be more advantageous.

 

[NW-Bound]

Well, I will not be doing that much better as I am basing my 3.5% WR on a high portfolio value at a possible market top.

One cannot do OMY forever, so has to call it done at some point. But I cannot help noticing there are more new posters looking to retire soon than in the 2009-2012 period. This plus people asking if the 4%WR is too conservative gets me a bit leery. The market always has a way of making fools out of the majority of the people.

 

[Options]

From a discussion on Bogleheads regarding planning, complexity, and flexibility pre/post-retirement:

A plan is one thing. A silly plan is another. First, many posts read as if people actually believe their hyper-precise plans. Some believe the "4% rule" really is a plan (and many tinker like crazy to fine-tune the percentage), rather than a back of the envelope approximation. This occurs over many threads. And in many publications (see the thousand and one threads and published articles on the 4% "rule"). If you actually know better you are ahead of the curve. Go to the head of the class.

But, since one has to keep adjusting their plan it makes no sense to be overly complicated. Many of the plans in this thread, and the OP, are fine illustrations of the problem of people trying to get three significant digit answers out of 1 significant digit of knowledge.

Honestly, do you really think it is sensible to have a plan to that goes from 4.95% one year to 5.17% two years later? Talk about false precision. Other so-called plans are no better.

The OP and many others are making this far too complicated. This is wasted energy at best.

 

[CaliforniaMan]

But if you retire after a significant run up and get 90% success, what you actually have is 100% success in the 20 years the market was at a low, 100% in the 60 years of sideways markets and 10 of the 20 years when your retirement date coincided with a market run up. Which is to say, in the subset of years you are interested in that have similar starting conditions, you have success in 10 out of 20 years, or only 50% of the samples. Calling this a 90% success can easily give a more optimistic outlook than in reality exists. If knowing that in like historic economic conditions, you have a 50% success rate, that might change your mind about how safe you r plan really is.

You make a good point about the selection bias, and no doubt that more people are planning near term retirement now, than were at the bottom of the bear market. I think many of us have thought about this, but in the final analysis, you are in the time you are in. While it was not possible for us to select the time of our birth we can to some extent select the time of our retirement....

And it is likely that people retiring now may have higher WR plans than those retiring in 2009. I know for myself, I planned to retire by the middle of next year some time ago and feel fortunate that I am better off than I thought I might be. On the other hand if we were 40% down this year, would I delay OMY, possibly, or just spend less, I don't know. A lot of it is just that we are in the time we are in, that's it.

When we got our first job, bought our first house, had our first kid, we couldn't change the time. The problem is we don't live forever, and sometimes you just have to pull the trigger. And just like when you got your first job, or your first house, you could adjust as conditions changed (the kids, hmmm more difficult, maybe they just get fewer toys).

For my own insecurities, in my spreadsheet, I assume a market decline before calculating the withdrawal. (I know this probably doesn't make any sense, could just choose a lower withdrawal rate, but it makes me feel better) I haven't started yet, but this is the plan. There are plenty of fallback positions should conditions deteriorate. (I hear it is hard to tell the difference between dog food and pate)

The only fallback position we don't have, is getting more time, more time to spend while we are able and healthy and not dead.

P.S. Anyone know how to do multiple quotes, looks like it didn't work here.

 

[NW-Bound]

... A lot of it is just that we are in the time we are in, that's it.

... There are plenty of fallback positions should conditions deteriorate. (I hear it is hard to tell the difference between dog food and pate)

The only fallback position we don't have, is getting more time, more time to spend while we are able and healthy and not dead.

If you had been here a bit longer, you would know about UncleMick's favorite saying about "staying mobile, agile, and hostile" to cope with bad times, of which he seemed to know plenty. A long-time retiree and poster here, he is doing better financially than ever as he says, after some tough time immediately after early retirement.

After the sudden health problem that I have been through, I have come to a firm conclusion that once one has to seriously face the possibility of his demise, any financial concern is not that big a deal. Of course you do not want to become a beggar or live under a bridge, but most people here are careful enough to avoid these fates I think.

P.S. Anyone know how to do multiple quotes, looks like it didn't work here.

You are missing the right square bracket at

.

 

[Surfdaddy]

But if you retire after a significant run up and get 90% success, what you actually have is 100% success in the 20 years the market was at a low, 100% in the 60 years of sideways markets and 10 of the 20 years when your retirement date coincided with a market run up. Which is to say, in the subset of years you are interested in that have similar starting conditions, you have success in 10 out of 20 years, or only 50% of the samples. Calling this a 90% success can easily give a more optimistic outlook than in reality exists. If knowing that in like historic economic conditions, you have a 50% success rate, that might change your mind about how safe you r plan really is.

Growing_older, you have captured very well what I originally meant when I posted. The likelihood of hitting "your number" is greatest after a large market runup, which would be when the market would typically be more likely to decline in the near term. This could mean that your success percentages are less than otherwise expected. If I have a scenario where Firecalc says, historically, I have a 90% success chance, I might really have a lower chance than that as the market is more highly valued at the time that I reach my target. That suggests to me that I should aim for 3.5% or 3%, all other things being equal.

 

[haha]

Here's the real dope. Amass as much money as you can, and spend as little as you can and still enjoy your life. I believe that reversion to old returns may not come and stay.

To me the return is not what the S &P averages do, although if you can get recent returns and bank them so it is no longer at risk, you have done well. It is the internal return at the firm and economy level. An old man can consume all the supplements he wants, he is still not going to run a ten second 100m. And our economy is not going to grow like it did 60 years ago.

Ha

 

[Katsmeow]

But if you retire after a significant run up and get 90% success, what you actually have is 100% success in the 20 years the market was at a low, 100% in the 60 years of sideways markets and 10 of the 20 years when your retirement date coincided with a market run up. Which is to say, in the subset of years you are interested in that have similar starting conditions, you have success in 10 out of 20 years, or only 50% of the samples. Calling this a 90% success can easily give a more optimistic outlook than in reality exists. If knowing that in like historic economic conditions, you have a 50% success rate, that might change your mind about how safe you r plan really is.

Actually, that isn't true. You are assuming that all the failures happened after a runup in the market. When I do our plan I get 100% in Firecalc. But I wanted to see what failures would look like so I increased spending to the point that I got to a 90% rate. I then looked at the spending in each of the failed years. Some of the failures did involve situations like you are talking about. They typically had a huge drop in the market in the first 3 years after retirement and the portfolio never recovered. But, a surprising number of failures didn't involve that situation at all. In some of them things looked fine in the first several years after retirement and the problems occurred many years later in the 30 year period.

I don't disagree with the general concept that one should be wary in retiring when there is a market run up. I just disagree that failures only happen in that situation.

 

[obgyn65]

+1. This is one of the reasons why I got cold feet this year and did not FIRE. Building up the financial cushion instead.

I don't disagree with the general concept that one should be wary in retiring when there is a market run up. I just disagree that failures only happen in that situation.

 

[growing_older]

Actually, that isn't true. You are assuming that all the failures happened after a runup in the market. When I do our plan I get 100% in Firecalc. But I wanted to see what failures would look like so I increased spending to the point that I got to a 90% rate. I then looked at the spending in each of the failed years. Some of the failures did involve situations like you are talking about. They typically had a huge drop in the market in the first 3 years after retirement and the portfolio never recovered. But, a surprising number of failures didn't involve that situation at all. In some of them things looked fine in the first several years after retirement and the problems occurred many years later in the 30 year period.

Thank you for the more detailed analysis. I meant to be clear that I was just making up numbers to illustrate my point, but trying to make the point that any percentage success rate is only reflection of the starting conditions. If you pre-select for a certain set of starting conditions (just after a big market run up) then you may be misleadingly reassured with projected success rates less than 100%. I would be very interested in your analysis and what common patterns you were able to see.

 

[NW-Bound]

...Some of the failures did involve situations like you are talking about. They typically had a huge drop in the market in the first 3 years after retirement and the portfolio never recovered. But, a surprising number of failures didn't involve that situation at all. In some of them things looked fine in the first several years after retirement and the problems occurred many years later in the 30 year period.

I don't disagree with the general concept that one should be wary in retiring when there is a market run up. I just disagree that failures only happen in that situation.

There were cases that failed immediately, and there were indeed cases that failed after a few years. With the latter cases, what happened was that the market condition caused the portfolio to stay relatively flat, and not be able to build up a surplus to withstand the later onslaught.

For example, had the market stayed flat from 1990 to 2000 or barely eked out enough return for a 4% WR, then someone who retired in 1990 would be in the same shoes as someone who retired in 2000 when the market tanked in 2003. However, in the earlier case, one was able to enjoy a few more years of serene retirement before panic set in. In the end, we all have to take a leap of faith if we do not want to work till we die.

I guess what we can take from this is that after a good year like 2013, we must not be complacent and should bank the gain for possible lean years ahead.

 

[Katsmeow]

There were cases that failed immediately, and there were indeed cases that failed after a few years. With the latter cases, what happened was that the market condition caused the portfolio to stay relatively flat, and not be able to build up a surplus to withstand the later onslaught.

I agree...to a point. However, I think it would be misleading to think that failures only occur when there has been a market run up. It is indeed possible to have a retirement occur when there wasn't been a big run up and for subsequent events to cause a failure.

 

[Ready]

If you are worried about a correction early on in retirement, just model it in Firecalc. Assume a 30% bear market is coming tomorrow, calculate your new net worth, and see what level of expenses you can incur and still have 100% success. If you can live on this number, I'd say you are in pretty good shape for ER.

 

[Live And Learn]

Well, I will not be doing that much better as I am basing my 3.5% WR on a high portfolio value at a possible market top.

One cannot do OMY forever, so has to call it done at some point. But I cannot help noticing there are more new posters looking to retire soon than in the 2009-2012 period. This plus people asking if the 4%WR is too conservative gets me a bit leery. The market always has a way of making fools out of the majority of the people.

Very astute. As you know, I am one of those who has destined to do OMY x 2 (one of which is already over ! so theoretically I now really do only have OMY - well, 14 months but who's counting). The market run-up and the rising confidence levels in our economy and the market make me a bit more leery and have me sticking it out even tho FIRECalc gives me 100% and I have a WR of 3.25%. DH and I are 55 and 51, with no pensions, so I can justify the conservatism to myself. Buffet is right when he says "be greedy when others are scared, and scared when others are greedy". I have to wonder if we're entering "greedy" territory soon (or perhaps are already there).

 

[Ready]

So when the markets are down we practice OMY because our portfolios have lost value and we want to keep working until we make it up.

And when the markets are up, we practice OMY because we fear a correction is coming soon and we won't have the full current value of our portfolio to count on when we begin the draw down.

Makes perfect sense to me.