The "Father" of 4% SWR doesn't recommend it...

Wow, good article. Based on his findings, since the current overall P/E ratio is 28 right now, a 4% SWR is about right on for someone retiring this year, since the P/E ratio is still in the overvalued range, though it is nowhere near how bad it was at the peak in 2000. Someone trying to retire in 2000 probably would have only had a SWR of 2.5-3%.

It seems higher SWR's would be possible if the P/E ratio were to go down further, he states about 4.5% if it were to go down to 20 and 5.0% if it were to go down to 12.
 
One of the assumptions that seems to be in all of the models is using a constant equities/fixed income ratio. Reality says that when the market tanks people are hesitant to move "safe" fixed income dollars into the declining stock market. In minor, short term drops this is probably a mistake. However, in the few "retirement killer" periods keeping cash is probably the best way to prolong the portfolio's life.

1929 starts a big drop. Rebalancing annually moves cash into the market which continues to be slaughtered for several more years. 1970 is another period of collapse where annual rebalancing costs equity dearly and cash disappears from the faithful reallocation.

I'm curious what the real survival numbers are if the rebalancing was only one way. As the market goes up, assets are shifted to keep the fixed income portion from falling too low.

I haven't tried to recreate Dory's numbers but I've made some simple "what ifs" if the market falls but I keep my cash intact. My cash, pension and interest income can pretty much carry me for over a decade. Assuming the stock market doesn't go to zero, I'd be able to rebalance to keep the cash up but it's highly likely that within a decade the equities would recover.

Any thoughts?
 
Yep. If the stock market goes to zero or anywhere near zero, your cash and pensions probably wont be worth anything either. ;)
 
2B said:
One of the assumptions that seems to be in all of the models is using a constant equities/fixed income ratio. Reality says that when the market tanks people are hesitant to move "safe" fixed income dollars into the declining stock market. In minor, short term drops this is probably a mistake. However, in the few "retirement killer" periods keeping cash is probably the best way to prolong the portfolio's life.

1929 starts a big drop. Rebalancing annually moves cash into the market which continues to be slaughtered for several more years. 1970 is another period of collapse where annual rebalancing costs equity dearly and cash disappears from the faithful reallocation.

I'm curious what the real survival numbers are if the rebalancing was only one way. As the market goes up, assets are shifted to keep the fixed income portion from falling too low.

I haven't tried to recreate Dory's numbers but I've made some simple "what ifs" if the market falls but I keep my cash intact. My cash, pension and interest income can pretty much carry me for over a decade. Assuming the stock market doesn't go to zero, I'd be able to rebalance to keep the cash up but it's highly likely that within a decade the equities would recover.

Any thoughts?
Click to expand...

I, too, have built up enough cash to draw on for up to 10 years while re-balancing my portfolio to maintain 40% equities. If the market does not recover within a decade then I'm sure I would be re-thinking the strategy. Staying the course is a good mantra, but at some point you need to start looking for a lifeboat rather than go down with the ship.
 
2B said:
I'm curious what the real survival numbers are if the rebalancing was only one way. As the market goes up, assets are shifted to keep the fixed income portion from falling too low.

Any thoughts?
Click to expand...
While not exactly following what you are suggesting, there was an article in the Journal of Financial Planning in June 2007 - Is Rebalancing a Portfolio During Retirement Necessary.

From the article:
"The study uses two analysis methods: bootstrap and historical inflationadjusted rates of return in their true temporal order. Both methods find that rebalancing provides no significant protection on portfolio longevity, and this holds for all withdrawal periods. In fact, in some cases, rebalancing increases the number of shortfalls.

Withdrawing bonds first, over stocks, performs the best of all the methods, though the resulting stock-heavy portfolio may make some investors uneasy, This method also is most apt to leave a larger remaining balance at the end of 30 years, while rebalancing leaves the smallest amount."

I plan to rebalance to my set asset allocation. It was easy during the accumulation phase, but only time will tell how consistently I do it in the future.
 
Funny how neither the BusinessWeek article nor any posts on this thread so far mentioned age. But life expectancy is really the primary factor that will determine what a safe withdrawal rate is, assuming the typical definition of "safe" (not broke before death).

Futzing about whether it's 4% or 4.1% or 4.5% with a low P/E or whatever - it matters much more whether the subject is a 70 year old single man or a 60 year old couple FIREing. The former could probably safely take 8%, with less than 2% chance of being broke before death.

Too bad none of the retirement calculators online - or even ESPlanner - incorporate actuarial information. A plot to get us to oversave, or perhaps just a symptom of our collective psychological aversion to being realistic about our mortality?
 
Here is a page from the Retire Early website where there is a LOT of information on SWR and especially as it relates to age at retirement (years in retirement) and the Safe Withdraw Rate for your asset mix and life exceptancy.

Combining Safe Withdrawal Rates and Life Expectancy


For those of us who are already retired and too lazy to follow the link here is the text.

"With all the worry that the current bear market means they'll run out of cash, most folks have forgotten that there are many things that will actually improve your safe withdrawal rate -- and some of them are easily to calculate with a tremendous degree of accuracy.
For example, there is a large body of data on average life expectancy and how many people will likely live to be 100. If you choose a long pay out period, there is only a small chance you'll actually live long enough to be in a position to run out of money.
The table below is based on a 40-year pay out period and 79% stock, 21% fixed income. The "99% safe" withdrawal rate is 4.10%, "95% safe" rate is 4.23%, and "90% safe" rate is 4.57%.
Using the IRS 2003 Mortality Table we get the following:
A 65-year-old has a 1% chance (99th percentile) of living another 40 years to age 105.
A 60-year-old has a 5% chance (95th percentile) of living another 40 years to age 100.
A 57-year old has a 10% chance (90th percentile) of living another 40 years to age 91.
Combining the probabilities of the portfolio running dry and the odds that our retiree will actually live long enough to see his portfolio run dry yields the following table (see Note (1) below):
Joint Probability
Portfolio Survivability & Life Expectancy
0.20% expense ratio, inflation indexed to CPI-U, January start date, $1,000 initial balance,
Stock allocation in S&P500, remainder of the portfolio in 3-6 month commercial paper
based on Shiller's 1871-2001 database..
----40-Year Pay Out Period-----Odds of Living 40 Years
Beyond Current Age3.90% (99% safe)4.13% (95% safe)4.26% (90% safe)65-year-old (1% odds)99.96%99.76%99.47%60-year-old (5% odds)99.8%99.2%98.6%57-year-old (10% odds)98.3%96.6%95.3%Note (1): The combined probabilities were calculated by examining each of the 92 forty-year pay out periods from 1871-2002 with a January starting date and determining the chance that portfolio would run dry in that year and multiplying that probability by the chance that the retiree would still be alive in the year the portfolio ran dry. The sum of these joint probabilities calculated for each of the 40-year pay out periods examined is the figure reported in the table above. Pretty amazing, huh? A 5% chance that your portfolio runs dry in 40 years, combined with a 5% chance you'll die in less than 40 years, still keeps your overall financial picture solvent more than 99% of the time."


Or, this one on a Bear market and SWR where the starting year for the SWR was 1929...can't get much worse than that for a 30 year retirement period. The SWR for the period was 3.9%. There was still money in the account at the end of the 30 year period.
Retiring at the Worst of Times.

A SWR of around 4% "should" last you at least 30 years unless the market is ever worse than the period after 1929, 1973 or 2002.

Who invented it is less important than the fact that it works for most folks with appropriate adjustments for years in retirement and asset mix. Fees and rebalancing are also very important to keep this SWR near 4%. The data suggests that a SWR of 3.7-4.?% should be adequate for even the worse market years.
 
freebeer said:
Funny how neither the BusinessWeek article nor any posts on this thread so far mentioned age. But life expectancy is really the primary factor that will determine what a safe withdrawal rate is, assuming the typical definition of "safe" (not broke before death).
Click to expand...

Longevity and the age at which one retires can make a difference. I think the white paper mentioned a portfolio lasting 30 years... for the analysis?? Most of these studies have a defined period of time.

If you intend to draw down for 40 or 45 years... I think the (max) starting amount (%) is reduced.

However, for many people... 40 years would mean that people are ER. Most will have a reduction in the amount they need pull from their portfolio due to SS kicking in (at least).

For us... If I ER at 55. I need to cover 7 years from the portfolio. I will have a small pension that will cover some of our needs... But let's say we need 5 or 6% per year in that 7 years. At 62, DW begins SS... the amount pulled from the portfolio drops by 1.5%. At 66 I begin my SS... the amount pulled from the portfolio drops by another 1.5%. The numbers cited are not absolutely correct... but it makes the point.

Plus, as we age, we will likely spend less money. For example we will probably spend less at 85 than at 65. The wild card here is inflation on things like medical and/or having expensive medical problems.

The other contingency that needs to be considered is the early death of one spouse. In retirement, losing one of the SS payments (and perhaps reducing the amount of a private pension) due to a death would reduce those income streams and could require more to be drawn from the portfolio.

There are a number of what-if scenarios to consider. Identifying those situations and a contingency plan is pretty important.
 
chinaco said:
other contingency that needs to be considered is the early death of one spouse. In retirement, losing one of the SS payments (and perhaps reducing the amount of a private pension) due to a death would reduce those income streams and could require more to be drawn from the portfolio.

There are a number of what-if scenarios to consider. Identifying those situations and a contingency plan is pretty important.
Click to expand...


I think it is virtually impossible to identify all the things that could befall you that would affect your finances . The best you can do is just hope you have a solid plan and retire.
 
I believe for most of us without a secure 100% COLA pension, measure, compute, plan, execute, review, adjust, repeat..is about all we can do once we know our "number".

Measure your current living expenses...everything not just the big stuff, over at least 5 years. Add up all your fixed expenses and then add the discrepancy expenses plus a conservative inflation factor.

Compute your best guess at what you will spend once retired. Compute all your income sources and then see what you need to have in assets to pay the difference annually over your expected lifespan.

Plan how you are going to get the needed assets or how you are going to liquidate or otherwise create an income stream from them that will last as long as you will plus a fudge factor in case you were wrong and outlived your estimate or inflation was worse than you guessed etc.

Execute your plan.

Review your assets, income and your plan as often as you feel necessary.

Review annually and adjust SWR, spending, and asset allocation.

Your SWR is unique to you. All the studies and data available only tell you what "might" work for a stated portfolio based on the history of the financial markets over the past 100+ years. If you want or need to spend more than account for it in your "number". If you spend less then you won't need as much of a nest egg and can retire earlier.

It is really pretty simple but you need to do your homework. Once you know how you want to live in retirement the rest is not all that complex.

Haggling over an actual percent SWR is a waste of time unless you are very very close to having enough to retire. If a person is that close then perhaps waiting a bit might be prudent.

Once you pull the trigger and retire you still have options to change your lifestyle so again an exact percent SWR is really meaningless in the bigger picture but periodically reviewing and adjusting your spending and/or income is a really good idea.
 
SteveR said:
Here is a page from the Retire Early website where there is a LOT of information on SWR and especially as it relates to age at retirement (years in retirement) and the Safe Withdraw Rate for your asset mix and life exceptancy.

Combining Safe Withdrawal Rates and Life Expectancy


For those of us who are already retired and too lazy to follow the link here is the text.

"With all the worry that the current bear market means they'll run out of cash, most folks have forgotten that there are many things that will actually improve your safe withdrawal rate -- and some of them are easily to calculate with a tremendous degree of accuracy.
For example, there is a large body of data on average life expectancy and how many people will likely live to be 100. If you choose a long pay out period, there is only a small chance you'll actually live long enough to be in a position to run out of money.
The table below is based on a 40-year pay out period and 79% stock, 21% fixed income. The "99% safe" withdrawal rate is 4.10%, "95% safe" rate is 4.23%, and "90% safe" rate is 4.57%.
Using the IRS 2003 Mortality Table we get the following:
A 65-year-old has a 1% chance (99th percentile) of living another 40 years to age 105.
A 60-year-old has a 5% chance (95th percentile) of living another 40 years to age 100.
A 57-year old has a 10% chance (90th percentile) of living another 40 years to age 91.
Combining the probabilities of the portfolio running dry and the odds that our retiree will actually live long enough to see his portfolio run dry yields the following table (see Note (1) below):
Joint Probability
Portfolio Survivability & Life Expectancy
0.20% expense ratio, inflation indexed to CPI-U, January start date, $1,000 initial balance,
Stock allocation in S&P500, remainder of the portfolio in 3-6 month commercial paper
based on Shiller's 1871-2001 database..
----40-Year Pay Out Period-----Odds of Living 40 Years
Beyond Current Age3.90% (99% safe)4.13% (95% safe)4.26% (90% safe)65-year-old (1% odds)99.96%99.76%99.47%60-year-old (5% odds)99.8%99.2%98.6%57-year-old (10% odds)98.3%96.6%95.3%Note (1): The combined probabilities were calculated by examining each of the 92 forty-year pay out periods from 1871-2002 with a January starting date and determining the chance that portfolio would run dry in that year and multiplying that probability by the chance that the retiree would still be alive in the year the portfolio ran dry. The sum of these joint probabilities calculated for each of the 40-year pay out periods examined is the figure reported in the table above. Pretty amazing, huh? A 5% chance that your portfolio runs dry in 40 years, combined with a 5% chance you'll die in less than 40 years, still keeps your overall financial picture solvent more than 99% of the time."


Or, this one on a Bear market and SWR where the starting year for the SWR was 1929...can't get much worse than that for a 30 year retirement period. The SWR for the period was 3.9%. There was still money in the account at the end of the 30 year period.
Retiring at the Worst of Times.

A SWR of around 4% "should" last you at least 30 years unless the market is ever worse than the period after 1929, 1973 or 2002.

Who invented it is less important than the fact that it works for most folks with appropriate adjustments for years in retirement and asset mix. Fees and rebalancing are also very important to keep this SWR near 4%. The data suggests that a SWR of 3.7-4.?% should be adequate for even the worse market years.
Click to expand...

Thanks for the post. It always amazes me that people who are smart enough to figure out that they shouldn't do retirement planning with a single interest rate turn around and plan with a single date of death.

The "better" way to handle mortality is by multiplying the probabilities as you've shown.
 
Independent said:
Thanks for the post. It always amazes me that people who are smart enough to figure out that they shouldn't do retirement planning with a single interest rate turn around and plan with a single date of death.

The "better" way to handle mortality is by multiplying the probabilities as you've shown.
Click to expand...


Yes... and it sure shows the importance of systems like SS. If it didn't exist, many/most would probably wind up in the streets.... because the vast majority do not know how to do that type of money management or planning.
 
The intricacies involved in this discussion of the 4% solution are enough to make my head spin - and it's not even CH. I'm still so glad I learned about the 4% solution several years ago. Even if it's flawed, it gives a starting point and is sufficiently conservative to prevent most of us from going broke in early retirement.

In reality, I still don't feel comfortable in following the plan exactly. I plan to limit my WDR to 4% or less each year. I'll not adjust for inflation, but rather start fresh each year and calculate 4%. When I see how that works for a while (NW going up or down) I may reevaluate and increase or decrease spending. During "bad" years, I'll definitely decrease WDR.

The point is, I now have high confidence that I can survive early retirement as long as I stick close to the 4% WDR and stay flexible. It's very liberating! Whoo hooo!
 
Koolau said:
The intricacies involved in this discussion of the 4% solution are enough to make my head spin - and it's not even CH. I'm still so glad I learned about the 4% solution several years ago. Even if it's flawed, it gives a starting point and is sufficiently conservative to prevent most of us from going broke in early retirement.

In reality, I still don't feel comfortable in following the plan exactly. I plan to limit my WDR to 4% or less each year. I'll not adjust for inflation, but rather start fresh each year and calculate 4%. When I see how that works for a while (NW going up or down) I may reevaluate and increase or decrease spending. During "bad" years, I'll definitely decrease WDR.

The point is, I now have high confidence that I can survive early retirement as long as I stick close to the 4% WDR and stay flexible. It's very liberating! Whoo hooo!
Click to expand...

During bad years, however, not only does your portfolio go down, say 15%, but you want to decrease your SWR from 4 to 3.5% or whatever? That is a 25.6% decrease in amount of money taken out. Not saying it is impossible, because it is possible to change spending, just that with inflation it may be harder to accomplish this than it looks.
 
Most people use the 4% SWR as the starting position and do not reset it each year. That way the good years can build up a buffer for the bad years, preventing the need to adjust up and down every year.

Make sure to use a liberal assumption for inflation and do not accept government figures on faith.
 
chinaco said:
Did anyone take a look at Kitces report?

He suggests that the 4% to 4.5% range (to mark the starting WD amount) is too conservative for some. Especially of the market is down when the WD amount is established.

He suggests that PE ratio might be a good indicator to help people establish the beginning WD Rate to establish the initial WD amount.


http://www.kitces.com/assets/pdfs/Kitces_Report_May_2008.pdf
Click to expand...
Finally got around to reading this today, thought it was very interesting, thanks for pointing it out...
 
kcowan said:
Most people use the 4% SWR as the starting position and do not reset it each year. That way the good years can build up a buffer for the bad years, preventing the need to adjust up and down every year.

Make sure to use a liberal assumption for inflation and do not accept government figures on faith.
Click to expand...

They are playing with this over at Bogleheads forum. What really really ticks me off - where's the real money?? - aka Psst Wellesley dividends and interest!! rant rant rant :rant: :rant:;).

Why not live forever like Anthony Quinn planting the tree in the movie I forgot the name of.

The Norwegian widow gets no respect! Spreadsheets/sims/calc's. and all that produce all kinds of fun numbers but dividends and interest are almost as good as real money (Yogi Berra, famous guru).

"Do or do not - there is no try." Yoda.

heh heh heh - at 65, after 15 yrs of ER practicing, I get back to ya when I get it figured out. Meanawhile I play with FireCalc, ORP and do what I think is ok. :cool:
 
unclemick said:
They are playing with this over at Bogleheads forum. What really really ticks me off - where's the real money?? - aka Psst Wellesley dividends and interest!! rant rant rant :rant: :rant:.
Click to expand...

You're absolutely right Uncle Mick.

The theory says, accumulate, accumulate, then when you're ready to drawdown, take no more than 4% of your nest egg as a starting amount. And adjust for inflation and/or bad market results every year thereafter. If you don't take more than 4% you won't outlive your money.

What everyone forgets is that earnings (that Psst-thingy you always talk about), plus results from annual rebalancing can result in an initial (or subsequent) drawdown of of less than 4% of the original nest egg.

What's missing from this discussion is the overall cash management policy that each retiree needs to define so they know how to manage their money. The SWR is a part of that policy -- but not the total cash management policy.

-- Rita
 
Gotadimple said:
You're absolutely right Uncle Mick.
What everyone forgets is that earnings (that Psst-thingy you always talk about), plus results from annual rebalancing can result in an initial (or subsequent) drawdown of of less than 4% of the original nest egg.
Click to expand...

I thought that the SWR studies assumed that withdrawals are taken first from dividends, interest and distributions, and if any remains, it is reinvested. What am I missing?

Gotadimple said:
What's missing from this discussion is the overall cash management policy that each retiree needs to define so they know how to manage their money. The SWR is a part of that policy -- but not the total cash management policy.

-- Rita
Click to expand...
I'm interested in hearing more about the "Cash management policy". Do you mean the order of withdrawals from different accounts, the way dividends, interest and distribution are used?

Being in my first year of ER, I'm still trying to figure the mechanics of the withdrawls, so all info in appreciated.
 
walkinwood said:
I'm interested in hearing more about the "Cash management policy". Do you mean the order of withdrawals from different accounts, the way dividends, interest and distribution are used?

Being in my first year of ER, I'm still trying to figure the mechanics of the withdrawls, so all info in appreciated.
Click to expand...

I'm far from an expert on this and like things to be simple but here are my plans.

I'm due to retire early 2010 and I expect to need $30K in my first year. (pension will be $60k/year).

My after tax savings are currently paying ~$20K in dividends which I will be paying into my cash bucket. That cash bucket will have 5 years of expenses already in it by then ($150K). Each year I'll re-balance so that my nest egg maintains its allocation of stocks and bonds.

If/when I start to run out of funds in the cash bucket I'll have to start thinking about selling MF shares to pay for my expenses, but 7 years after ER we'll both be eligible for SS so that's another income stream coming in.
 
walkinwood said:
I thought that the SWR studies assumed that withdrawals are taken first from dividends, interest and distributions, and if any remains, it is reinvested. What am I missing?


I'm interested in hearing more about the "Cash management policy". Do you mean the order of withdrawals from different accounts, the way dividends, interest and distribution are used?

Being in my first year of ER, I'm still trying to figure the mechanics of the withdrawls, so all info in appreciated.
Click to expand...

WnW,
The SWR is simply a percentage of the retiree's starting portfolio -- how one does the Withdrawal is up to them. The theory then is that the beginning Withdrawal amount is adjusted for inflation. AND, if you are following the 95% rule, in a down year, your withdrawal will be no more than 95% of the prior year's amount.

I've been struggling with the concept as well, as it is my first year in retirement.

My comment to Uncle Mick about a cash management policy re: an overly long discussion about whether 4% or 6% or some other % is 'safe.' That discussion totally ignores the intent of the safe withdrawal rate, which is only the beginning number. As he's proven for the last 15 years, his withdrawal rate is sometimes less than 4%, sometimes more than 6% AND there is still plenty of funds available after 15 years.

I've read those discussion ad infinitum, and there are many excuses why one can draw 5% and someone can draw 4%, but no where does anyone incorporate the SWR into an overall cash management policy (and investment policy as well). For newbies, these two policies are the first decision points to be made -- then deciding what the SWR amount will be for the first year is the next decision.

My cash management policy outlines which accounts will be tapped in order, how I determined my emergency reserve and where the funds are located, and how the withdrawals will be run through my bank to cover expenses. My investment policy is simply my asset allocation and when I plan on rebalancing.

-- Rita
 
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