Rich_by_the_Bay
Moderator Emeritus
I've spent a big chunk of my career in the decision analysis part of the health care world. The discussions here on SWR often remind me of how people can make tough medical decisions. I'd like to know how this admittedly technical approach works for you:
This approach might make it easier to understand the 4% rule in your own personal context. Others have made this point more clearly than I could, but here is a way to do it with numbers. Depending on your circumstances, maybe a 5% rule is OK; for others, maybe 3.5%, and for still others, maybe you had better reduce your cost of living more than you initially thought, but go with 5% instead of 4%. There is no right or wrong (as far as the impact number), just whatever reflects your values.
Just a tool, but it can have a powerful effect on how you approach your decision for some people. A typical first reaction we hear is, "you can't put a number on something like...." but give it a try if you find it interesting, remembering that it is not the absolute number that counts, but rather its consistency across different scenarios you might be comparing.
- There are two sides to each decision parameter, a "frequency" component (e.g. likelihood of maintaining your income til you die, a la Monte Carlo analysis), and an "impact" component - the subjective, personal, values-driven impact of having to live on a lot less income if things fail. You can assign each component a score between 0 and 1 (works better than % due to the arithmetic).
- The easy part: for a given SWR, estimate the likelihood of success using Firecalc or a similar calculator. This is basically a statistical probability based on evidence, not subjective at all. So, if at 4% WR your probability of maintaining your adjusted income forever is 99%, the score is 0.99, 95% might be 0.95, etc.
- Now the hard part: assume your best case scenario for retirement quality of life gets a perfect score of "1." Estimate your quality of life compared to the best case scanario if you had to take a serious cut in income half way through your anticipated retirement. A score of 1 means no affect on your quality of life at all: plenty of padding, just a number in your monthly statement, living well below your means to begin with. A low score (destitute, bad lifestyle, bills, whatever) might get a 0.2, and a tough but acceptable impact might get a 0.5. You be the judge, just use the same number when comparing different scenarios to one another.
- Assigning a number to this doesn't make it any less subjective in nature, but it forces you to come up with some type of reasonably consistent and useable number so you can compare your options.
- Finally: multiply the two, e.g. 0.9 (firecalc success rate) x 0.5 (hypothetical quality of life given a serious income reduction if you fail) for a score of 0.45.
Compare this to an alternate scenario of a 5% withdrawal rate, given a Firecalc success rate of .87 but where you are more comfortable handling an income reduction half-way out, say for an impact score of .75. The score here is 0.65 (maybe you chose to live well beneath your means, or could easily down size from a nice but way-too-expensive house, location, etc.). This strategy would be the winner for that example.
This approach might make it easier to understand the 4% rule in your own personal context. Others have made this point more clearly than I could, but here is a way to do it with numbers. Depending on your circumstances, maybe a 5% rule is OK; for others, maybe 3.5%, and for still others, maybe you had better reduce your cost of living more than you initially thought, but go with 5% instead of 4%. There is no right or wrong (as far as the impact number), just whatever reflects your values.
Just a tool, but it can have a powerful effect on how you approach your decision for some people. A typical first reaction we hear is, "you can't put a number on something like...." but give it a try if you find it interesting, remembering that it is not the absolute number that counts, but rather its consistency across different scenarios you might be comparing.