SWR - Keep it simple

[Cut-Throat]

I have seen some formulas and calculations for SWR's in these type of forums that rival anything I had in College in Physics and Calculus. - As much as we'd like to think that these formulas will give us some piece of mind, it just is not so. No one can predict the future, and no matter how complex the formula it is no better predictor than simple ones.

I think the FIRECALC program is a great tool. It provides a look at what past history has done to give us some confindence of the future.

If times get tough, we all pull in our horns. These are the times that we may only pull 2% of our portfolio to survive. If times are better 6% is not out of the question. Applying a complex formula to determine that we can pull 3.34567% of the portfolio will not make the risk go away. Re-evaluating your portfolio on a regular basis, combined with a varying rate of withdrawal probably makes the most sense.

The best thing you can do is stay the course, stick to the basics and a sound plan. I would not get hung up on anything more complex than FIRECalc

 

[dory36]

Excellent point. Getting much more intricate amounts to measuring with a micrometer and cutting with an axe!

Dory36

 

[Telly]

Cutting some discretionary expenses in a down market is one thing.  But doing a 50% cut (say from a 4% Withdrawal Rate down to a 2% Withdrawal Rate) in total annual expenses I think will be tough if not impossible for many people.  Myself included.

Skip paying the property taxes?  Utility bills?  Health insurance premiums?  House and car insurance premiums?  Just postpone a doctor visit till better times?  Do without that water heater that sprung a leak?  Catch and roast small animals? On and on.  

But if someone's annual "Income Requirement" included something like 50% for traveling through Europe every year, I could see a big cutback working out.  In other words, that a large part of their annual income requirement was truly discretionary in nature.

I am certainly a proponent of FireCalc.  However, I DO wonder about uniqueness of situations.  Just as the financial sales and marketing community blabs away about the long term returns of the stock market being, what, 10.5% annualized, and then never correcting it for inflation.  I am interested in some of the work going on elsewhere about valuation of the market, and its impact on the SWR situation.  If anything will be figured out in time for many of us to use it, I don't know.  But it is hard for me to dismiss it out of hand as a vector into a real SWR calculation.

Unless the market since 1871 has gone through all of that, and it has indeed been covered.

My thoughts, anyway :-/

 

[Mr._johngalt]

HI Telly! The past may be prologue, but ERs should
not count on it.

 

[baanista]

One of the big names in this had an article a couple of years ago to the effect that after about the 98% confidence level, you are entering the realm where the unmodeled possibilities are as likely as what you have accounted for. In other words, unless you are able to predict the future, you can't be 100% certain. So keep an eye on things.

 

[Ted]

I think that the wisest way to make projections of future asset returns is to consider historical asset returns (including the variability in them, as FIRECalc does), but then to (1) apply economic logic to estimate how these returns are apt to differ in the future, and (2) be prepared (at least psychologically) to monitor investment performance (at least annually) and make lifestyle changes if things don't work out according to plans.

One specific assumption that I make is that the compounded real (inflation-adjusted) rate of return on stocks will be less than the 7% to 8% experienced over the past century or so. My guess is that it will be more like 5% (for large cap stocks) to 6% (for small cap stocks), with annual variability that is statistically similar to that in the past. As FIRECalc is presently configured, this assumption can be crudely modelled by entering an upwardly-adjusted value for the annual expense ratio. (In other words, if the actual estimated expense ratio is 0.5%, enter 2.5%). I agree that attempting to "fine tune" a plan that may need to cover 30 years or more is futile, but assuming that future stock returns will be 2% per year lower is more than "fine tuning"! (In this regard, it would be useful if Dory36 would get around to upgrading FIRECalc to allow different expense ratios to be input for each asset class.)

The one factor that can increase the reliability of future financial projections is the availability of long-term TIPs that will provide a government-guaranteed real rate of return. Even with these, however, there is the probability that the returns will be taxed more heavily in the future, especially for people who have higher incomes (including social security/pension income).

The absolute best way of insuring against future financial difficulties is to retain a willingness and ability to go back to work (at least part-time, and/or at a job that is enjoyable but not high-paying).

From the standpoint of individual freedom, it is good that people have the right to quit work any time they choose. But looking at the overall economy, the reality is that a higher percentage of people will need to continue working longer in order to sustain the economy's real output per capita -- which is what fundamentally determines the standard of living.

 

[Cut-Throat]

Cutting some discretionary expenses in a down market is one thing.  But doing a 50% cut (say from a 4% Withdrawal Rate down to a 2% Withdrawal Rate) in total annual expenses I think will be tough if not impossible for many people.  Myself included.

Skip paying the property taxes?  Utility bills?  Health insurance premiums?  House and car insurance premiums?  Just postpone a doctor visit till better times?  Do without that water heater that sprung a leak?  Catch and roast small animals?  On and on.  

Telly,

I do have a lot of discretionary slop in my budget. Travel,  New Car etc. and could pare it down to 2% if need be.

That was not all I was talking about however.
What I was suggesting was not necessarily cutting expenses but how much you withdraw from your stock portfoilo. In other words in a year when the market did really well and gained 15%, moving 15% out of stocks into a cash portfoilo. Then when the market did poorly and lost you would not have to spend cheapend stocks, but could withdraw from your cash.

 

[Ted]

What I was suggesting was not necessarily cutting expenses but how much you withdraw from your stock portfoilo. In other words in a year when the market did really well and gained 15%, moving 15% out of stocks into a cash portfoilo. Then when the market did poorly and lost you would not have to spend cheapend stocks, but could withdraw from your cash.

This reasoning is a bit misleading (I assume unintentionally).

By definition, a person's "portfolio" is the total of their assets (or, at least their financial assets). Thus, a person may have a "stock" portion of their portfolio, and a "cash" portion, but they don't really have two separate portfolios.

The practical implication is this. You may be able to vary the rate of withdrawal from the stock portion of your portfolio between 4% and 2% (or even zero). In fact, you should vary the withdrawal rate in order to keep your overall asset allocation in balance. But it is a mathematical fact that your rate of withdrawal from your total portfolio is not varying by nearly as much in percentage terms, if at all.

For example, if 60% of your portfolio is in stocks and 40% is in cash (or other assets) then withdrawing 4% of the value of the stocks represents a withdrawal rate of 2.4% based on your total portfolio.

The whole point of FIRECalc is to estimate what overall rate of withdrawal is sustainable, assuming annual rebalancing of the total portfolio. This inherently requires that a person withdraw more from whichever of their assets have performed the best during the previous year.

 

[ronbyrd]

I like Telly's idea -- take a chunk of money out in a very strong market for a rainy year (or other one time uses).
Once you've done it you just re-evaluation the new portfolio as to its safe withdrawal rate, etc.
Through happenstance I found myself in such a situation. We have $150,000 from a second house sell of 4 years ago. I've kept it separate from our portfolio and have used it to supplement my portfolio withdrawals of 4% during a couple of high expense times. It's worked well.

 

[Telly]

um, no, ronbyrd, that wasn't my idea, that was Cut-Throat's.

I agree with Ted's analysis of it, that followed it.

BTW, I'd be happy with a 3% REAL (inflation adjusted) annual return across my portfolio. Anything beyond that is all gravy

But if worst comes to worst, I can handle a REAL annual return < 3% without resorting to "washing off tinfoil and saran wrap"

 

[Mr._johngalt]

We have some "slop" too obviously. However, if I had
been required to go "bare bones" ER right from day one,
I would still have done it. I can't imagine any sort of
subsistence lifestyle which would have kept me from
taking the plunge. That's how motivated I was.

 

[Ted]

This is a case where all of us have a point.

In planning a "safe withdrawal rate," a person should establish what they regard as a "safe" sustainable rate from their total portfolio. FIRECalc is a useful tool for doing this.

In the real world, however, it would require a ridiculous amount of juggling of expenditures to maintain a perfectly constant, inflation-adjusted rate of withdrawal year after year. There are too many "lumpy" expenses, such as the purchase of a new car, or a major vacation, or an illness involving high drug costs. Thus, the SWR provided by FIRECalc should be regarded as a "guideline," and not a value to be followed rigidly every year, much less every month!

From the standpoint of economic theory, it is interesting that people adjust their spending according to the value of their assets in a way that is rational for them individually, but hurts us collectively by exacerbating the business cycle. In other words, if the value of people's stocks declines, they act rationally and delay discretionary expenditures such as the purchase of a new car. But when everyone does this at once, it causes a contraction in the economy that depresses stock prices still more.

The most fundamental corrective mechanism for this phenomenon is for producers of cars and other goods and services to drop their prices in order to sustain the quantities of their products sold. Since they tend not to do this fast enough (particularly, organized labor) the "artificial" substitute is for the Federal Reserve to create more money (which is actually what it is doing when it lowers the Federal Funds target rate). If the Federal Reserve had not understood this, the recent recession would have been a lot worse.

 

[Ted]

But if worst comes to worst, I can handle a REAL annual return < 3% without resorting to "washing off tinfoil and saran wrap"  

Telly, your prayers are answered. Long-term TIPs are now paying close to 3% over actual inflation. Their current market value has been dropping as interest rates have risen, and may (and I think will) continue to do so. However, if a person owns TIPs directly and holds them to maturity, the inflation-adjusted yield to maturity is guaranteed.