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Old 11-16-2016, 01:47 PM   #81
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Yes, that's the difference. If Person A has built up a surplus of cash outside the portfolio, that cash is sheltered from market fluctuations. If that is a large amount, say 10% of portfolio, then if the market drops by 1/2, she has saved herself 5% of portfolio, which is not insignificant.
Yep

In the short run this can really help.

In the long run, the portfolio will not end up as large, but a large ending portfolio value may not be the primary goal.
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Old 11-16-2016, 01:51 PM   #82
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On the other hand, if the market does not slump as bad as that, the 10% in cash will underperform relative to Person B who invests it all.

Basically, one buys more safety margin by being willing to underperform if things are not so dire. It's always a trade-off.

I have always kept a lot of cash in portfolio, so do not see the need to have another pile of cash. My cash underperforms bonds due to lower yields, but I do take a bit higher risk with my stocks. It's a barbell strategy, if you will. So far, it works about the same, even though I initially hoped to do better.
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Old 11-16-2016, 01:55 PM   #83
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It is the same, but at the same time it is not. Both cases may survive a 30-year retirement (the same part), but one likely with a lot of surplus, the other barely scraping by at the end (the different part). ....
If the new retiree retires and the existing retiree ratchets at the same time, which is the case being discussed. they have to be the same as the market prospectively for both will be identical... so if they have identical portfolio sizes, WR and time horizons then their success rates will be identical. It doesn't matter a bit how they got to their identical nesteggs or time horizons.

If I reset with a $1.1m portfolio, a 4% WR and a 30 year time horizon and Joe who has no retirement savings inherits $1.1 million and invests it and retires with a 4% WR and a 30 year time horizon then our chances of success and failure are identical... as will be our annual balances along the way.
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Old 11-16-2016, 02:01 PM   #84
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... if the new retiree retires and the existing retiree ratchets at the same time.. they have to be the same as the market prospectively for both will be identical... so if they have identical portfolio sizes, WR and time horizons then their success rates will be identical...
Yes, their success rate will be identical. Same money, same withdrawal.

And as they use 4% of an overvalued portfolio at the top of the market, their future trajectory will be identical: it will be one of those that FIRECalc shows skimming the zero line after 30 years. They succeed, but will die nearly broke. And if the market sets a new precedent that FIRECalc has not encountered, they will be hurting together big times.

If the existing retiree does not ratchet, his original 4%WR is now 2 or 3% of present portfolio (he retired at bottom of the market). He spends less than the new retiree, so his trajectory will be among the soaring ones that FIRECalc shows.
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Old 11-16-2016, 02:02 PM   #85
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If one withdraws a fixed percentage of the current portfolio value, she will never run out of money. The only problem is that in lean years, one can be very hungry.

From real-life data I mentioned in an earlier post,

So, a retiree drawing 4% of current portfolio started out with $40K in 2007, she would have to make do with $17K in 2009.

I have fluff in my expenses, but I do not know if I can cut down to less than 1/2 of what I normally spend.
I think this is where Bob Clyatt's "95% rule" can help out. Yes, you calculate the 4% based on year-end value, but never reduce the "take" more than 5% from the previous year. A 5% annual decrement is something people can figure out how to accommodate, and since most of these these downturns are of relatively limited duration, the portfolio bounces back before the 50% cut (from withdrawals at peak value) ever arrives.
If a person has started with a 4%+ inflation WR and just adds inflation every year, will they really feel comfortable taking that same dollar amount out when their portfolio has dropped 50% (so, an 8% withdrawal rate when their portfolio is in the toilet and everyone is full of fear about the future and "it's different this time" talk)? Not me. And since I know I'll be tightening my belt under those circumstances anyway, the "% of year end value" approach just suits me better.
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Old 11-16-2016, 02:05 PM   #86
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.... If the existing retiree does not ratchet, his original 4%WR is now 2 or 3% of present portfolio. He spends less than the new retiree, so his trajectory will be among the soaring ones that FIRECalc shows.
and that soaring trajectory is what I am trying to avoid.
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Old 11-16-2016, 02:10 PM   #87
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What confuses people is that they look only at the success rate that FIRECalc spits out. And success simply means that one dies with more than 1c in his pocket.

FIRECalc also shows a range of outcome. Success may mean dying with 1c, but it also means dying with $10M. By ratcheting up, you increase the chance towards dying with 1c. This may not be fine at all, if the market dips lower than FIRECalc has seen in history.
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Old 11-16-2016, 02:14 PM   #88
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and that soaring trajectory is what I am trying to avoid.
Which is fine, as I kept saying.

The real problem is overdoing it, and turning your potential trajectory downwards too badly, such that later in life you find yourself with one of those FIRECalc trajectories skimming the zero line, like an Exocet or a Harpoon cruise missile skimming the ocean surface.
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Old 11-16-2016, 02:18 PM   #89
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... since I know I'll be tightening my belt under those circumstances anyway, the "% of year end value" approach just suits me better.
Even when the market drops more than 1/2, as it has done twice in the recent past (2003, and 2009)?

I cannot live on 1/2 of my usual expenses. On the other hand, I would cut back way more than the 95% rule of Bob Clyatt.
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Old 11-16-2016, 02:37 PM   #90
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Even when the market drops more than 1/2, as it has done twice in the recent past (2003, and 2009)?

I cannot live on 1/2 of my usual expenses. On the other hand, I would cut back way more than the 95% rule of Bob Clyatt.
I meant I would not keep spending the same absolute dollar amount as before if my portfolio was down 50%. I'll adjust downward if my portfolio goes down. I would never be confident that we wouldn't be seeing a "new worst case" in the data set. Like you, I'd adjust withdrawals downward (in real dollars), and probably even more than required by the 95% rule. But it's comforting to know that the historical data sets indicate the "95% rule" only had a tiny impact on the ability of portfolios to maintain their same real value over time (compared to strict "end of year %" method with no smoothing).
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Old 11-16-2016, 03:56 PM   #91
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It may not have to be a "new worst case". Before I elaborate, let me go back a bit. And I can explain the paradox of the 4% WR and the "ratcheting" effect in another way.

As my earlier example shows, a $1M worth of stock in 2007 turned out to be worth only $430K 18 months later. Conceptually, people understand that drawing 4% of a portfolio during the peak of a boom period is nowhere as good as drawing 4% of a portfolio that has been pummeled. The first has no place to go but down, and the second one has nowhere to go but up.

Right now in 2016, if we know if the market will certainly go up or go down, new retirees can allow for it. The problem is that no one knows. And so, the 4% rule and FIRECalc do not presume to know the state of the market. Just draw 4% and, as the past showed, you would be OK. Note that it is the past that FIRECalc talks about.

If this current condition turns out to be a market top, you will barely make it, if the past is of any guide. If this current condition turns out to be a market bottom, you will die rich, if you do not ratchet up your withdrawal.

By sidestepping the sticky evaluation of the current market, the 4% rule gives one a safe withdrawal guideline. Chances are that you can draw more later, if the market keeps on rising from here.

Suppose you retired during a market bottom, and your portfolio outgrows your withdrawal. If you ratchet up your dollar amount of withdrawal if your portfolio goes up, but do not decrease it when your portfolio goes down, eventually you ride it up to the top, and turn yourself into one of those who happened to retire at a market top. Your portfolio no way to go from there but down with that 4% WR. You may still make it, but are more likely to be barely making it. Your retirement is still "successful", but you decrease your safety margin if the market makes a new precedent, or if you live longer than expected.

Now, back to the "new worst case". People said that if the 4% WR survived the Great Depression, and also the stagflation period of 1960-1980, then it would take something worse than these two periods for it to fail.

But how about the initial market condition? What if the future is not worse than the past, but our current condition is better, or as good as any ebullient period in the past? It is the delta, or the change that causes the stock price to shrink. If we start from a high point, the further we have to fall to reach the bottom, even though that bottom is not lower than the past?

How do we value the current market condition? Shiller has been talking about PE10, but that is still debatable, and some people do not believe it. Nobody including Shiller knows what to use it for, other than saying one must be careful and not so optimistic.
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Old 11-16-2016, 04:41 PM   #92
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How do we value the current market condition? Shiller has been talking about PE10, but that is still debatable, and some people do not believe it. Nobody including Shiller knows what to use it for, other than saying one must be careful and not so optimistic.
- I wouldn't say nobody knows how to use it. It looks fairly powerful as long as one is willing to be wrong for a long time (something professional fund managers usually can't afford to do). There has been work on on how using PE10 to adjust asset allocation could allow an investor to improve their performance with the no increase in risk. More here and here. I think it makes sense from an intuitive level and there's data that supports it.

Regarding adjusting withdrawal rates for valuations, I thought the method offered by Gone4Good in this post was very useful. See that thread for good subsequent discussion and details, but 9 months ago he wrote:

Quote:
My approach is to discount current markets back to a level that represents the median valuation of the data set used to originally calculate your SWR. If you're using FIRECalc and PE-10, that would mean discounting the current equity market down to a valuation of about 16x from it's current 24x (a 33% haircut).

I'd also do the same thing with the bond market. 10-year treasuries are yielding 1.74% versus a median of 3.89%. Using an average bond market duration of about 6 years, that 200bp lower current yield results in a price discount of about 12%.

So assuming a 1MM portfolio and a 50/50 asset allocation, I'd mark the $500,000 in stocks down by 33% to $333,000 and the bond allocation down by 12% to $440,000.

My resulting $773,000 portfolio puts me right in the middle of the valuations used in our historic data set. Applying a 4% SWR, I get a withdrawal of about $31,000.

That means my undiscounted portfolio can support a withdrawal rate of 3.1%. Said another way, a 3.1% withdrawal today is equivalent to a 4% withdrawal at median valuations.
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Old 11-16-2016, 05:12 PM   #93
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The difference is that the remaining portfolio is smaller in the A case.

Person B has a slightly larger portfolio exposed to the market.

That is a real difference, whether or not Person A or B change their withdrawal rates or strategies in the future.
Yes, that's the difference. If Person A has built up a surplus of cash outside the portfolio, that cash is sheltered from market fluctuations. If that is a large amount, say 10% of portfolio, then if the market drops by 1/2, she has saved herself 5% of portfolio, which is not insignificant. ...
To me, this is really an AA adjustment. Taking it 'off the books' just confuses things, in my view.

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It may not have to be a "new worst case". ...

But how about the initial market condition? What if the future is not worse than the past, but our current condition is better, or as good as any ebullient period in the past? It is the delta, or the change that causes the stock price to shrink. If we start from a high point, the further we have to fall to reach the bottom, even though that bottom is not lower than the past? ...
But the FIRECalc runs include that initial market conditions. That's part of what makes them failures. It's all taken into account.

As you pointed out earlier,
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By sidestepping the sticky evaluation of the current market, the 4% rule gives one a safe withdrawal guideline. Chances are that you can draw more later, if the market keeps on rising from here.
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Old 11-16-2016, 05:30 PM   #94
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- I wouldn't say nobody knows how to use it. It looks fairly powerful as long as one is willing to be wrong for a long time (something professional fund managers usually can't afford to do). There has been work on on how using PE10 to adjust asset allocation could allow an investor to improve their performance with the no increase in risk. More here and here. I think it makes sense from an intuitive level and there's data that supports it.
The problem with "being wrong for a long time" is that you will be underperforming the market for that long time. Can you be wrong for a large portion of your retirement period, and vindicated when you are so old you no longer care, while your exuberant peers enjoy the good life and keep "ratcheting" it up, and enjoying caviar and Dom Perignon?

I will read the links. Thanks.

Quote:
Regarding adjusting withdrawal rates for valuations, I thought the method offered by Gone4Good in this post was very useful. See that thread for good subsequent discussion and details, but 9 months ago he wrote:
This discounting of the present portfolio value makes sense. In a way, many posters have expressed concerns that we are at an overvalue period of both stocks (high P/E), and of bonds (low interest rate). Hence, many live on just dividends - this would be best - or use a lower WR such as 3 to 3.5%. People usually know to use heuristic adjustments for conditions that they sense are not normal.


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To me, this is really an AA adjustment. Taking it 'off the books' just confuses things, in my view.
I can see that moving some "surplus" to a cash bucket outside the portfolio is a mechanical method that has some advantages. It takes emotions out of the procedure, compared to doing Tactical AA which I do in a more personal ad-hoc manner by seat of the pants.

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But the FIRECalc runs include that initial market conditions. That's part of what makes them failures. It's all taken into account.
-ERD50
Is it? I have to look closer to see if the Great Depression and the stagflation decades of 1960-1980 were preceded by high P/E periods similar to what we have now. What I was saying is that in the future we may go through the same good and bad as before, but in a different sequence or order.
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Old 11-16-2016, 05:33 PM   #95
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- I wouldn't say nobody knows how to use it. It looks fairly powerful as long as one is willing to be wrong for a long time (something professional fund managers usually can't afford to do). There has been work on on how using PE10 to adjust asset allocation could allow an investor to improve their performance with the no increase in risk. More here and here. I think it makes sense from an intuitive level and there's data that supports it.

Regarding adjusting withdrawal rates for valuations, I thought the method offered by Gone4Good in this post was very useful. See that thread for good subsequent discussion and details, but 9 months ago he wrote:
That seems like a good way to model things. But at the same time, since 4% is supposed to work for (most of) the bad sequences of market returns, it seems too conservative to use for median market valuation cases. Seems like you could use a higher withdrawal percent in those cases - like 5% or higher.
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Old 11-16-2016, 05:39 PM   #96
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To me, this is really an AA adjustment. Taking it 'off the books' just confuses things, in my view.

-ERD50
I disagree. I am using the same AA in my portfolio so it's not an AA adjustment of the portfolio. What happens outside the portfolio has no bearing, as the portfolio is the only chunk I am withdrawing from using SWR type rules. So the rules apply to it alone, not anything else.

None of the models require you to return unspent funds to your portfolio or to include all investible assets in a portfolio an apply SWR rules. All they model is that for a given portfolio, asset allocation, withdrawal rate, and time period, what the probabilities are that the portfolio will survive that time period.
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Old 11-16-2016, 06:04 PM   #97
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If one withdraws a fixed percentage of the current portfolio value, she will never run out of money. The only problem is that in lean years, one can be very hungry.
That worries me. Because of this, I also calculate my WR as a percentage of my lowest portfolio value during the 2008-2009 crash, on 3/9/2009 (see right hand column of table below).

Here is a table showing my withdrawal for the seven years of my retirement so far.

YearSWR (annual increase by CPI) WR (based on 12/31 portfolio)WR (based on 3/9/2009 portfolio)
20102.61%2.61%3.45%
20112.13%1.98%2.82%
20122.22%2.12%3.03%
20132.64%2.40%3.68%
20142.00%1.70%2.82%
20151.98%1.72%2.84%
2015 HOUSE! 8.00%6.92%11.48%
2016 (estimated)2.56%2.28%3.67%

Honestly I think the elephant in the room is not surviving through a crash, so much as the big impact of my dream house purchase in 2015, which I also included in my table. I don't see how you all can manage with a 4% withdrawal every year and still have enough for a big expenditure that could happen every decade or two.

If I had withdrawn 4% every year and then saved the excess money in a savings account with 0% interest from 2010-2015, that would more than cover the net purchase price of the house plus moving, renovations, and all other house transaction/move/fixup related expenses that are included in the "2015 HOUSE! " entry in the table.

But is that valid? I wonder. What about the value of money in the bank, versus money in my portfolio? In reality the house money was invested for all those years. Luckily my portfolio has grown steadily so I am pretty sure I am OK. But really, I think this could be a huge issue in a declining market. I probably should have segregated that excess money during those years, by moving it from Vanguard to, say, Fido or Schwab and investing it there. But until I found the right dream house, I didn't know for sure that I definitely would be buying a house.
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Agree. But in my case after 10 years, it's starting to look like I should increase my spending a bit. These would be discretionary items and would not bump the base spending requirement up. Obviously if things turn drastically down I would revert to just dividends.
That's true, too. I don't want to deprive myself of a better lifestyle if I can afford it. I think there are enough other obstacles in life to overcome, without creating imaginary obstacles for ourselves. And as you point out, it is easier to cut back on discretionary items than on one's base spending requirement, should the need for that arise.
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Old 11-16-2016, 06:19 PM   #98
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...None of the models require you to return unspent funds to your portfolio or to include all investible assets in a portfolio an apply SWR rules. All they model is that for a given portfolio, asset allocation, withdrawal rate, and time period, what the probabilities are that the portfolio will survive that time period.
Future returns do not have to follow any formal model either. Models are based on the past, and the past does not have to repeat (we simply hope that it rhymes, as Mark Twain is refuted to say).

Whatever we do, it's just a way to build a bit of safety margin. As long as we are not too exuberant and spend all that we think that we can, it's OK. I don't think we can prove one way is better than the other.

And then, the diagnosis of a terrible illness will cause all that to be thrown out in an instant. Man proposes, God disposes.
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Old 11-16-2016, 06:28 PM   #99
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... If I had withdrawn 4% every year and then saved the excess money in a savings account with 0% interest from 2010-2015, that would more than cover the net purchase price of the house plus moving, renovations, and all other house transaction/move/fixup related expenses that are included in the "2015 HOUSE! " entry in the table.

But is that valid? I wonder. What about the value of money in the bank, versus money in my portfolio? In reality the house money was invested for all those years. Luckily my portfolio has grown steadily so I am pretty sure I am OK. But really, I think this could be a huge issue in a declining market...
It works out OK, so that's a job well done for keeping the surplus invested instead of keeping it in cash.

Now, had the market tanked, then what would happen? You would not even think or look for the dream house, and would have a different set of questions to ask yourself, and not the above question.

What I am saying is if I go back and ask the question of "what if", I would never stop, and would never really know anyway. It's more constructive to take it from here, and see what to do at this point.
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Old 11-16-2016, 06:33 PM   #100
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This may have been mentioned before, but I really, really like Mr. Money Mustache's view on the 4% rule. As usual he is very pragmatic but the bottom line is that you can always adjust as you move forward. Yes, there is a non-zero risk that you might run out of money using 4%, but there is a non-zero risk just about any time you travel in a car, plane, etc. Just be prepared to adjust for reality - need to shrink down the withdrawal rate for a few years? Shouldn't be a problem if you aren't spending every nickel of the 4% every year.
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