Dr. Pfau looks at the 4% rule in an interview

[obgyn65]

Understood. However right now I have less than 10% in deferred annuities, so it does not really impact my cash. I also understand that when I do buy annuities when I turn 80 for example, my capital will go down. My model takes this into consideration also.

Oby, you do understand that the payment your receive from an annuity is composed largely of the principal (the amount you paid the insurance company for the annuity)? So by using annuities you are spending your principal.

 

[obgyn65]

Net of inflation, but very, very low. Either I go back to some part time hours or locum tenens or just spend less if inflation goes up. I will adapt as time goes by.

Net of inflation?

 

[REWahoo]

Net of inflation, but very, very low. Either I go back to some part time hours or locum tenens or just spend less if inflation goes up. I will adapt as time goes by.

+1

I think your reluctance to retire now is based on solid financial concerns. Better to work a few more years if you have no investments with a chance of keeping up with inflation and your only options after age 80 are food stamps or returning to work.

 

[audreyh1]

My IRA (retirement) portfolio is in high-dividend stocks and high-yield bonds.
As a whole, the portfolio throws off an 8% annual income stream, which I intend to start withdrawing next year to fund living expenses and "fun spending." I would not have to draw down any principal to cover living expenses until and unless my portfolio income yield deteriorated below 3% per year due to dividend reductions and/or bond defaults.

So, is my current withdrawal rate 8% or is it 0%? I think the latter.

Alex in Virginia

Your withdrawal rate is 8%.

 

[REWahoo]

Your withdrawal rate is 8%.

+1

 

[audreyh1]

Oby, you do understand that the payment your receive from an annuity is composed largely of the principal (the amount you paid the insurance company for the annuity)? So by using annuities you are spending your principal.

Part of what the insurance company is returning to the annuity holder in payments each year is their principal, but the annuity holder doesn't have to worry about the "spending down the principal" part during their lifetime, because the insurance company will cover any shortfall.

 

[REWahoo]

Part of what the insurance company is returning to the annuity holder in payments each year is their principal, but the annuity holder doesn't have to worry about the "spending down the principal" part during their lifetime, because the insurance company will cover any shortfall.

True.

The point I was making is a slug of the money the insurance co pays you when you buy an annuity is the money you paid them - return of principal. So anyone who states they don't plan to spend down their principal in retirement - but will live on dividends, interest and annuity payments - is confused.

 

[obgyn65]

In my case it will be a mix. I will only buy annuities say every 5 or 10 years in retirement up to the age of 90, leaving a cash nest egg I feel happy and safe about.

True.

The point I was making is a slug of the money the insurance co pays you when you buy an annuity is the money you paid them - return of principal. So anyone who states they don't plan to spend down their principal in retirement - but will live on dividends, interest and annuity payments - is confused.

 

[audreyh1]

The Morningstar article today also admits that additional stock will also help, since the problem their talking about is low bond returns. Just sayin'...

They also assume:

• a 40% equity portfolio.
• intermediate-term US Government Bond Index for the bond portion.
• 1% lost annually to fund fees.
• equity returns over the next 30 years to be 2% below the long-term historical US average return.

It's a little difficult to feel that worried about the affect of low government bond yields after a year with a 13% return on a 53eq/47fi diversified portfolio, but of course there are good years, and there are bad years.

These studies tend to use very restricted asset classes, and it is specifically the US government bond index funds that are yielding super low at the moment.

I think someone mentioned there were super low government bond yields in the 1940s, yet those aren't the years that break the Trinity model.

 

[audreyh1]

True.

The point I was making is a slug of the money the insurance co pays you when you buy an annuity is the money you paid them - return of principal. So anyone who states they don't plan to spend down their principal in retirement - but will live on dividends, interest and annuity payments - is confused.

Maybe (about the confusion) - but I give them a pass in this case since they don't have to worry about running out of annuity payments as long as they are alive.

Of course whatever principal they "spend down" by passing it along to the insurance company is principal they won't be carefully preserving for their heirs......

And then we aren't even getting into the annuity payments keeping up with inflation bit....

 

[RonBoyd]

Maybe (about the confusion) - but I give them a pass in this case since they don't have to worry about running out of annuity payments as long as they are alive.

Of course whatever principal they "spend down" by passing it along to the insurance company is principal they won't be carefully preserving for their heirs......

And then we aren't even getting into the annuity payments keeping up with inflation bit....

+1

 

[photoguy]

obgyn65 -- thanks for clarifying your approach.

With 100% fixed assets, I personally would consider it "not spending the principal" if my return > (inflation + WR). At the present, this is would be very difficult to achieve (without substantial pensions/ss/annuities) but things can always change.

 

[Animorph]

My IRA (retirement) portfolio is in high-dividend stocks and high-yield bonds.
As a whole, the portfolio throws off an 8% annual income stream, which I intend to start withdrawing next year to fund living expenses and "fun spending." I would not have to draw down any principal to cover living expenses until and unless my portfolio income yield deteriorated below 3% per year due to dividend reductions and/or bond defaults.

So, is my current withdrawal rate 8% or is it 0%? I think the latter.

Alex in Virginia

FIRECalc and the 4% rule use total returns. Dividends and distributions are reinvested if no withdrawals are taken, dividends and distributions are counted towards the withdrawal percentage if they are not reinvested. For the purpose of these calculations, your WR is 8%. They also make assumptions about your portfolio, so you will have to hope you have something different that works.

 

[samclem]

Figure 2 from the Morningstar paper co-authored by Dr Pfau was interesting. There aren't many outliers or a wide dispersion in this sample: If the current govt bond yield is 1.5%, historically the average annual compounded 10 year govt bond return has been somewhere between 1% and 3%. That's a sample covering 1930 to 2011 and bonds have never done better than that over the following decade when they have the yields we see at present.

Yes, these are intermediate term govt bonds, but this is probably an important thing to consider as we decide how much of our allocation should be in bonds right now. Of course, this time it could be different

 

[clifp]

Figure 2 from the Morningstar paper co-authored by Dr Pfau was interesting. There aren't many outliers or a wide dispersion in this sample: If the current govt bond yield is 1.5%, historically the average annual compounded 10 year govt bond return has been somewhere between 1% and 3%. That's a sample covering 1930 to 2011 and bonds have never done better than that over the following decade when they have the yields we see at present.

Yes, these are intermediate term govt bonds, but this is probably an important thing to consider as we decide how much of our allocation should be in bonds right now. Of course, this time it could be different

Yes it could be different, but money is it will not be. I think this is one of the most important papers in the last year and well worth reading..

Intuitively I think most of us long time members understood that horribly low bond yields made the the 4% SWR far less certain. The key thing that papers identified is putting a pretty precise projection 1.8% for the return of intermediate bonds at today's yields, with a very narrow band.

We can double check this prediction by looking at the yield of 10 year TIPs -.5% look at the average last 3 years of inflation of 2.3% add the two together and we also arrive at 1.8%.

The basis of the 4% SWR working is that bonds/CD yield 5-6% with relatively low volatility and stocks average 9-10% with huge volatility year to year. If inflation is 3% (relatively stable other than 70s early 80s)
Then a 50/50 portfolio get 2.5-3% return from bonds and 4.5-5.0% from equities= 7% to 8% minus inflation of 3% = 4%-5%. Throw in a dallop of small cap and other equities beyond the S&P and the average real return is north of 5% which is why many FIRECALC runs end up leaving a pile of money after 30 years even with a 4% withdrawal rate. Of course the sequence of returns is a huge factor on survival.

Knowing that sequence of returns for the bond portion of your portfolio is very likely to be significantly (~3.7%) below average for the next decade, this lower the SWR from 4% to 2.8% for a 40% equity portfolio and even lower for those with little or no equities. A huge reduction for those in retirement or alternatively it means you need to save 40% more for those in the accumulation phase.

 

[gcgang]

While I understand conceptually how maintaining a constant inflation adjusted withdrawal works, and have run the MC simulations with various AA and spending levels to obtain a high degree of confidence that I will be OK, after 40+ years of saving, I wonder if I will ever be comfortable with depleting principal.

 

[REWahoo]

Knowing that sequence of returns for the bond portion of your portfolio is very likely to be significantly (~3.7%) below average for the next decade, this lower the SWR from 4% to 2.8% for a 40% equity portfolio and even lower for those with little or no equities.

Once again, shouldn't there be an additional qualifier to this statement to include "for those who are paying 1% to investment fees" ?

 

[clifp]

Once again, shouldn't there be an additional qualifier to this statement to include "for those who are paying 1% to investment fees" ?

Yes I guess so. Meaning that those fortunate enough to Ameriprise investment advisers might as well just figure on working until they die so they can fund their advisers retirement.

Oh were suggesting that it might be a little less grime for those of us who have low expense ratios on our investments.

 

[REWahoo]

Yes I guess so. Meaning that those fortunate enough to Ameriprise investment advisers might as well just figure on working until they die so they can fund their advisers retirement.

Oh were suggesting that it might be a little less grime for those of us who have low expense ratios on our investments.

Yes to both the above.

There are so many folks who already think a 4% WR is too optimistic and say they will go with less than 3.5%. I fear the 2.8% number will send them into deep depression so I think it important the 1% fee be highlighted.

 

[mathjak107]

while the effect of fees certainly count the problem is they are not in a vacuum by themselves and there are so many other paramters that count so much more that can make that extra 1% into not such a bad thing .

the best analogy is the person who hondles the lowest possible price on a car, then pounds the salesman into the ground on the lowest finance terms and buys the car knowing he got the lowest deal out there.

then he sells the car back to the dealer at a wholesale price.

in the mean time grandma paid a higher price,higher finance terms but sold the car at a better price and beat the pants off mr lowest price.

the point is getting everything down and dirty does not count much if you sold and left money on the table. they cancel each other out.

i am more interested in how my portfolio is doing overall. are all the parts playing nice? do they work together as a team?

i have had combo's of funds at times which beat the markets working together and did not beat them individually.

case in point i used fidelity export and multi-national fund when the dollar was weak. as it strengthened i moved more to a fund with a manager that weighted for a stronger dollar.

the 2 together beat the s&p 500 but individualy they did not.

while i watch fees and calculate fees in my performance i am not so fixated on them as many bogleheads are.

that 1% advisor fee looks bad in the calculation but it may actually improve things if you are getting something for that money.

the problem is there is no way to calculate that in advance so a 1% advisor fee just drops the success rate but in reality as things play out it may increase it.

i looked at wades figures with the difference expenses added back in but the problem is the indexes used do not reflect any extra alpha gained as it is all based on indexes..

its hard to explain but i think you can follow my logic. the numbers are working off mr lowest price going in but don't consider down the road grandma had alot better results but those results are not in the calculation .

 

[RonBoyd]

that 1% advisor fee looks bad in the calculation but it may actually improve things if you are getting something for that money.

I agree. If you feel that you will not get a >1% greater return (if that's the fee) from a selected advisor, than you are better off than DIY. However, that is a tough call and not everyone can make it -- and, perhaps, not necessary if the "right" advisor is found. (Full disclosure: I do not pay an advisor.) But then again, the same can be said about the whole subject article.

 

[mathjak107]

i i was looking at wades examples and watching the success rate fall as fees were added in. but the more i thought about the variable of one person selling or rebalancing at a greater profit then another was enough to make the expense fees not really accurate in its own way..

there was just no accounting for any better performance in the mix for that fee. of course i understand why as results will be all over the place so you cannot figure any alpha at all.

but in my mind it did kind of does take some of the importance of what fees mean in reality and lighten up the weight they carry.

i look at the entire big picture more heavily then the parameters making it up is what it all boils down to.

kind of like the sum of the parts can be greater then the parts individually.

 

[audreyh1]

In talking about the direness of low-yielding bonds - they're using 10-year government bonds for crying out loud. Does everyone here have all of their bond portfolio in US treasuries or the equivalent index?

The bond index funds hold a lot of them right now, because that's the biggest chunk of the outstanding bond universe at the moment. But many diversified bond funds do not hold a large chunk of US treasuries. I notice quite a few folks in this forum use mostly corporate bond funds at the moment.

The bond portion and equity portion of our portfolio are both far more diverse than these studies. Plus we don't give ourselves an inflation adjusted raise every year. And then there's the lower fees. So I am not so concerned about the "this time it's different" aspect of this paper crying over low-yielding bonds. [Although actually reading the paper, they give the same result with 80% equities, so why are they naming low-yielding bonds as the primary culprit? It reads like spin. I expect that the real issue is the 1% fee assumption and the models with lower average future equity returns.]

When I read some of the tweaks of the assumptions and the models created for this new paper - well, it's annoying. One M* poster pointed out that they come out trumpeting a wildly different result than previous studies when a huge difference is adding a 1% management fee to the mix. They're comparing apples to oranges, yet making it appear that the previous studies are "wrong". Apples to apples would likely have given a 3.8% answer even with the other model tweaks. Lower, yes, but not nearly so drastic.

Another very annoying aspect about the 1% fee, is that if someone is using a pure bond index and pure stock index to make their mix (from which these models are built) - these are available with very low fees. So the 1% fee aspect seems disingenuous. Far better to warn the reader that if they want to achieve the "better case" survival rate, they better be holding index funds that only charge a 0.25% fee or whatever.

 

[samclem]

there was just no accounting for any better performance in the mix for that fee. of course i understand why as results will be all over the place so you cannot figure any alpha at all.

In this respect, the study exactly replicates the real world.

 

[samclem]

Plus we don't give ourselves an inflation adjusted raise every year.

Yes, I think the sustainable WR will be higher with annual re-figuring of the withdrawals. The "4% adjusted for inflation" is an easier model to present in a short paper, probably makes a more dramatic case for their claim, and preserves another topic as grist for another paper later. Another bullet on the performance report!

Far better to warn the reader that if they want to achieve the "better case" survival rate, they better be holding index funds that only charge a 0.25% fee or whatever.

Costs matter, especially if we anticipate low returns (whatever the cause). I guess that doesn't make for a bombshell of a paper.

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