SWR Inflation Adjustment

[astroboy]

My question may have been discussed before (if so, sorry!) but what is the right (or best) way to adjust your initial SWR for inflation in subsequent years? Say you begin with a SWR of 4% of 500,000 portfolio the first year, for $20,000. If inflation is then 3%, do you:
1) take out 4.12% of portfolio balance the second year, which if grows 8%, minus initial 20K leaves 520K for a second yr. w/drawal of $21,420; or,
2) take out 3% more of the initial w/drawal, for $20,600.
Are there other options? Which is the best for long term succcess? Thanks.
Astroboy

 

[charlie]

Take out what you need ..... no more, no less.

Cheers,

Charlie

 

[Michael]

,,,take out 3% more of the initial w/drawal, for $20,600.

That's the way the calculator works.

 

[Hyperborea]

My question may have been discussed before (if so, sorry!) but what is the right (or best) way to adjust your initial SWR for inflation in subsequent years?

2) take out 3% more of the initial w/drawal, for $20,600.

This is the model that FIREcalc uses.

Are there other options?

Yup. Have a look at this site - http://www.gummy-stuff.org/sensible_withdrawals.htm - for one possible other.

Which is the best for long term succcess?

Why, to take out exactly enough so that you run out of money exactly on the moment that you die. However, to do that you will need to accurately predict investment returns, inflation, and "unanticipated" expenses.

 

[ESRBob]

For long run success (portfolio survivability), my inclination/research suggests that the safest way is to take out a maximum of 4% of the nominal portfolio each year.

Obviously that doesn't guarantee you'll keep up with inflation.

But it does help on portfolio survivability, and if markets tank, you'll tighten with confidence in your long run as opposed to giving yourself the full inflation-adjusted withdrawal while losing sleep at night.

A different approach, but one that seems to be easier to keep to over the decades you (might) need to keep with this system.

ESRBob

 

[unclemick]

I use FireCalc runs as a ballpark indicator and then ignore it.

We're in the Chuck-Lyn camp: for the last 11 years - took out what we needed plus a little lagniappe on frivolous occasions.

Three glancing hurricane hits plus losing the roof to a tornado were unplanned events.

Inflation is personal - we either pay up or find a subsitute way to adjust.

 

[Cut-Throat]

Obviously if you took out 4% of your portfoilo every year, you would never run out of money, no matter what happended.

 

[John Galt]

Hi Cut-THroat! At first I said "Huh?", then I "got" it.
That's pretty cute.



JG

 

[Nords]

 Hi Cut-THroat!  At first I said "Huh?", then I "got" it.
That's pretty cute. JG

It works for a 99% withdrawal rate too...

 

[John Galt]

Yep!

JG

 

[Jarhead*]

Obviously if you took out 4% of your portfoilo every year, you would never run out of money, no matter what happended.

Cutthroat: I wouldn't have to self discipline to stick with it forever. I'd probably blow it when it got down to $100.00 left, and go ahead and shoot the works

Not sure if Chuck-Lynn is there yet, and I am about 3 years from the gummint handeling my amount of withdrawals for me. (At least on the IRA side).

 

[charlie]

Yep, I turned 70 this past May 31. OTOH I have
been drawing down my IRA since 1991 and it is
bigger now than when I started. Thank God for
the 90's.

Cheers,

Charlie

 

[ESRBob]

Obviously if you took out 4% of your portfoilo every year, you would never run out of money, no matter what happended.

Ha, Ha, Ha!
I'd have trouble getting by on that last 4 cents, though.
Yeah, inflation is the worry, but interestingly, when you look at the historical studies on this approach, you see that the 'actual dollars withdrawn' is higher this way than if you'd made the withdrawals to keep up steadily with inflation.

The reason seems to be that by leaving more in the portfolio during the lean years (when actual SWR would be > 4% due to inflation adjustments on your initial 4% combined with a shrinking portfolio value) leaves more to rebound and your simple 4% later on is out of a bigger portfolio.

In other words, you do less 'selling low'. Gotta love reversion to the mean. Is it the best thing since sliced bread? I have found very little academic verification that reversion to the mean can be counted on by investors, but I guess any system that helps you try to get there, like annual rebalancing, is better than letting your emotions run wild. I used to 'sell low' just by reading the paper and panicking...

ESRBob

 

[indymom]

For long run success (portfolio survivability), my inclination/research suggests that the safest way is to take out a maximum of 4% of the nominal portfolio each year.
.

ESRBob

What is a "nominal portfolio"? I'm not clear on how adjust for inflation each year...is this how one does that?

 

[JOhn Galt]

"nominal portfolio" is a "Bob Brinkerism" Jibberish.

JG

 

[ESRBob]

What is a "nominal portfolio"?  I'm not clear on how adjust for inflation each year...is this how one does that?

It just means the amount of the portfolio in dollars that year.  You aren't working back to some previous year's inflation-adjusted real value or anything fancy.  Sorry if it is giberish -- nominal just means the actual dollars with no inflation adjustment.

If you ever want to sober yourself up, make a little spreadsheet and put in 20 columns, and see what happens to the real value of your portfolio after 20 years of 3% inflation (which we all agree is nothing, right?)

Let me know if you need help on the formula.

20 years pretty much knocks you in half in real terms. So normally I only care about real values of anything.   Imagine what a 60-year retirement would do to real values!

With my SWR approach, though, the system works by taking 4% of the nominal dollar value and that is what makes it both safer long term for portfolio survivability ( defined as the real value of your portfolio being likely to be maintained, not that the portfolio won't crash to $0.00 -- it never can by definition! )and conversely, leaves you exposed to rising and falling withdrawals based on portfolio performance.  

In other words, you're not giving yourself a COLA'd annuity here; your annual spend is rising and falling with your portfolio performance. So you absorb that adjustment year to year in order to increase the probability of maintaining real living standards over several decades.  A tradeoff that works for me.

 

[indymom]

So it is 4% of whatever the portfolio is worth at the beginning of that year?

 

[ESRBob]

So it is 4% of whatever the portfolio is worth at the beginning of that year?

Indymom,
Yes-- that is how I do it. Seems so simple!

 

[samclem]

I agree with ESRBob, and will be using that method--take out a certain percentage of the balance at the end of the year (probably 3.5% for us). It seems like the best way to avaoid entirely running out of money.

- Adjusting for inflation in your annual payouts greatly increases the risk of running out of $$. If you want to be protected for inflation, the best approach is to buy securities to do that (TIPS, I-Bonds, maybe even gold mining stocks, etc)--then, when you take out your fixed percentage of the balance at the end of the year, the balance will have gone up some amount to cover inflation. But--choosing these investments does forfeit the upside potential of owning other things (value stocks, bonds paying more, etc).

- Of course, everyone has a unique situation. For example, the bulk of our retirement income comes from an inflation-indexed pension, which makes it less painful to take a fixed percentage of our investments each year without adjusting for inflation. But, I'd do the same thing either way.

samclem

 

[Zipper]

Hopefully your portfolio has increased at year end after withdrawals. This gives you some inflation protection.

In my own example, as of yesterday, my investments have been up ~8% for 2004, and I withdrew 5%.

2003 was also positive.

1997 through 2000 were all positive.

2001&2002 however were negative.

I maintain a 60/40 balance, with the 60 consisting of 60% Canadian, 20% American and 20% Global. The 40 is all Canadian fixed income and cash.

 

[indymom]

2003 was also positive.

1997 through 2000 were all positive.

2001&2002 however were negative.

So, how did you decide what to withdraw in 2001 $2002?

 

[Zipper]

.....5%. That's what I've taken every year since 1997.

 

[ESRBob]

Zipper,
Not sure your age and other circumstances, but 5% makes me nervous over the decades. (Of course its been fine for you over the past half-dozen years and the nice thing about this is you can always start today with a clean slate on SWR and just plan forward from here.)

Still all the SWR studies I've seen look a lot happier for a lot longer at 4% and below.

Just my 2 cents...

 

[Cut-Throat]

Zipper,
Not sure your age and other circumstances, but 5% makes me nervous over the decades.  (Of course its been fine for you over the past half-dozen years and the nice thing about this is you can always start today with a clean slate on SWR and just plan forward from here.)

Still all the SWR studies I've seen look a lot happier for a lot longer at 4% and below.

Just my 2 cents...

5% nominal is probably a lot safer than the 4% inflation adjusted.

He'll never run out of money, and if the market ever gets hammered by 50%, his withdrawal will be cut in half also - unlike the 4% inflation adjusted.

I'd say that the 5% without the inflation adjustment is very, very safe. -

 

[Hyperborea]

Just catching up on all the postings you lot have done while I was enjoying the holidays.

ESRBob and Zipper (and anybody else who uses variable withdrawal type system), do you use a fixed income buffer between your yearly spending and the withdrawal amounts?  Do you take that 5% of the current value and essentially average it with a CD ladder?  This would take a lot of the year to year variability out of your budget.  If you don't then why not?