The “Safe Withdrawal Rate” May Be Changing

[MasterBlaster]

Alarmism or common sense ?

The “Safe Withdrawal Rate” May Be Changing - Registered Investment Advisor

Another thing to remember is that all these probability studies were done in periods where interest rates and stock dividend yields were considerably higher. For instance, the yield on a 50/50 portfolio of S&P 500 index stocks and 5 year Treasury obligations is under 2 percent today. In 2000 the same portfolio provided a yield of 3.65 percent and in 1990 it provided a yield of 5.99 percent.

 

[Rich_by_the_Bay]

Another thing to remember is that all these probability studies were done in periods where interest rates and stock dividend yields were considerably higher. For instance, the yield on a 50/50 portfolio of S&P 500 index stocks and 5 year Treasury obligations is under 2 percent today. In 2000 the same portfolio provided a yield of 3.65 percent and in 1990 it provided a yield of 5.99 percent.http://assetbuilder.com/blogs/scott...the-safe-withdrawal-rate-may-be-changing.aspx

If you use a flexible withdrawal strategy (% of portfolio balance), wouldn't today's lower returns result in a lower portfolio value, and an "automatic" downward adjustment (compared to the good old days)?

 

[MasterBlaster]

If you use a flexible withdrawal strategy (% of portfolio balance), wouldn't today's lower returns result in a lower portfolio value, and an "automatic" downward adjustment (compared to the good old days)?

yes that's true, but who wants to see a lower payout or a smaller portfolio. The point being that past market total returns (including dividends/interest) may be richer than those we can expect today.

Taking out 4% in the past may be more do-able than taking out 4% today. the likelihood of portfolio failure just may be increased due to the factors pointed out in the article.

I posted the article for discussion. I thought that it would be of general interest to the board. Scott Burns is usually worth paying attention to.

 

[haha]

I can't think how this POV could be anything other than true. With long term nominal interst rates at 4% max, ST rates even less, and cash flow (dividends) available from a stock allocation historically low, where does the money for a 4% real withdrawal rate come from?

A greater fool may be there to sell to, but I wouldn't count on it.

"Another thing to remember is that all these probability studies were done in periods where interest rates and stock dividend yields were considerably higher. For instance, the yield on a 50/50 portfolio of S&P 500 index stocks and 5 year Treasury obligations is under 2 percent today. In 2000 the same portfolio provided a yield of 3.65 percent and in 1990 it provided a yield of 5.99 percent. You can read more about this on my website under "portfolio survival."
The difference in current yield is important because every dime of withdrawal that doesn’t come from current interest and dividend income must come from principal. So in 1990 you could withdraw 6 percent and not touch your principal. If you did that today you'd be taking 4 percent of your principal each year. That's a formula to go broke well before you die.
This is a serious problem, one that I pointed out in an earlier column about "Solvent Seniors" and how low interest rates had chopped their investment income. The current Federal Reserve interest rate policy— which works to hold interest rates down— may encourage home ownership and support home prices, but it also works to devastate the retirement security of older people who have saved and invested. I call it the “Hood Robin” policy, robbing savers to restore big banks and maintain egregious bonuses."

Although Scott Burns is a clever guy, it really wouldn't be any less true if Donald Duck had said it, rather than Scott.

Ha

 

[audreyh1]

Alarmism or common sense ?

The “Safe Withdrawal Rate” May Be Changing - Registered Investment Advisor

Well the CPI has been lower during the recent period as well, so supposedly your withdrawals don't grow as fast as they did during prior periods either.

But we are just in one of the nastier periods, which we have had in the past, where the portfolio probably shrinks for a few years before recovering.

We all just hope to see a recovery period some time in the not to distant future.

Audrey

 

[W2R]

He makes a good point, though we do not know what interest rates and stock dividend rates will be in the future and they might rise. Still, the 4% rule assumes future market conditions that are based on past market conditions. I have always thought (and continue to think) that the basis for such assumptions is too shaky for me due to the relatively short time for which we have historical data, and due to the complexity of the problem and many interacting factors that can affect interest and dividend rates.

On the other hand, if we regard the "4% rule" as not being really a RULE, but simply a jumping-off place for our considerations and calculations, it can be very helpful.

Personally I have never withdrawn 4%, and do not plan to ever withdraw that much in the future. I do plan to be at least somewhat flexible in my withdrawal percentage, depending on market conditions.

 

[jIMOh]

The difference in current yield is important because every dime of withdrawal that doesn’t come from current interest and dividend income must come from principal. So in 1990 you could withdraw 6 percent and not touch your principal. If you did that today you'd be taking 4 percent of your principal each year. That's a formula to go broke well before you die.

scare tactic

should read this

The difference in current yield is important because every dime of withdrawal that doesn’t come from current interest and dividend income must come from principal OR SHARE PRICE APPRECIATION. So in 1990 you could withdraw 6 percent and not touch your principal. If you did that today you'd be taking 4 percent of your principal each year. That's a formula to go broke well before you die.

**to me, its not principal if account had more in it than I started with**

 

[Rustic23]

I thought the article would have made more sense if he had used bond/interest rates minus inflation to compare past performance. It matters little, IMHO, if you get 5% interest on your portfolio if inflation is running at 7%.

 

[FIREd]

The ever shrinking SWR must have a floor. After all, a 4% SWR requires to accumulate 25 x annual living expenses, so even with a long period of real returns at 0%, one's money should last at least 25 years, with no loss of purchasing power. If you are worried about such a long period of low or even negative real returns in the market, why not invest all of your money in a TIPS ladder? TIPS will give you at least a small positive real rate of return and a 3.5% SWR (28.5% x annual expenses) should last at least 30 years.

 

[Moemg]

If you use a flexible withdrawal strategy (% of portfolio balance), wouldn't today's lower returns result in a lower portfolio value, and an "automatic" downward adjustment (compared to the good old days)?

That is what I use . There is no way I would have taken 4% plus inflation after the market dropped like a lead balloon . I write down the 4% amount but I have never gotten close to that and believe me this year I'm trying with all the home improvements .

 

[Gone4Good]

For much of the 1950's 10-yr bond yields were sub-3%. Stock yields were a little north of 3%.

As Audrey pointed out, it is the real yield that matters. Markets are forecasting low inflation going forward, and they are probably right.

 

[MasterBlaster]

For much of the 1950's 10-yr bond yields were sub-3%. Stock yields were a little north of 3%.

As Audrey pointed out, it is the real yield that matters. Markets are forecasting low inflation going forward, and they are probably right.

For much of the 1950's stock market total yields were spectacular. Any mixed portfolio would do just fine under those circumstances.

Perhaps the single best time to retire ever was around 1950.

 

[haha]

The ever shrinking SWR must have a floor. After all, a 4% SWR requires to accumulate 25 x annual living expenses, so even with a long period of real returns at 0%, one's money should last at least 25 years, with no loss of purchasing power.

Could you explain the reasoning behind this? I have every confidence that the positive thinkers here will explain how Scott Burns is wrong, so I can quit being concerned.

Ha

 

[Peter]

Could you explain the reasoning behind this? I have every confidence that the positive thinkers here will explain how Scott Burns is wrong, so I can quit being concerned.

Ha

If real return is zero, this is equivalent to zero inflation with zero returns. Then if you draw out 1/25th of your money every year, it will last 25 years.

Peter

 

[FIREd]

Could you explain the reasoning behind this? I have every confidence that the positive thinkers here will explain how Scott Burns is wrong, so I can quit being concerned.

Ha

I was thinking along those lines:

The long version:
Say you have $1M and you need $40K/year. Divide the $1M into 25, $40K buckets. Keep bucket 1 in cash to pay for living expenses during year 1. Invest bucket 2 in a TIPS maturing in 1 year. Invest bucket 3 in a TIPS maturing in 2 years, etc... you can buy TIPS of various maturities either at auction or on the secondary market. The principal of each bucket will increase with inflation between now and the maturity date when you will cash the TIPS to pay for your living expenses, hence insuring that your purchasing power remains constant over at least the next 25 years. In the meantime, the TIPS throw some real interests your way every year (1-2% currently for TIPS with 8-30 year maturities) which can be used to pay taxes or reinvested to finance your retirement beyond year 25 (how far beyond will depend on the kind of real rate you can lock in when you purchase the TIPS and whether your TIPS are held in a retirement account and/or a taxable account).

The short version:
See Pete's comment above.

Now I think that Scott is right that traditional SWRs for longer retirements might need to be revised downward (I never said he was wrong by the way). Traditionally, a 3% SWR should be good enough for a 40-50 year retirement. But a 3% SWR means that you only have about 33 x annual expenses saved up, so you need strong real returns to stretch your money for 40-50 years. If you don't have strong real returns, then your SWR will have to plunge to 2.5% or even 2% in order to make it work.

 

[haha]

I was thinking along those lines:

The long version:
Say you have $1M and you need $40K/year. Divide the $1M into 25, $40K buckets. Keep bucket 1 in cash to pay for living expenses during year 1. Invest bucket 2 in a TIPS maturing in 1 year. Invest bucket 3 in a TIPS maturing in 2 years, etc... you can buy TIPS of various maturities either at auction or on the secondary market. The principal of each bucket will increase with inflation between now and the maturity date when you will cash the TIPS to pay for your living expenses, hence insuring that your purchasing power remains constant over at least the next 25 years. In the meantime, the TIPS throw some real interests your way every year (1-2% currently for TIPS with 8-30 year maturities) which can be used to pay taxes or reinvested to finance your retirement beyond year 25 (how far beyond will depend on the kind of real rate you can lock in when you purchase the TIPS and whether your TIPS are held in a retirement account and/or a taxable account).

The short version:
See Pete's comment above.

Now I think that Scott is right that traditional SWRs for longer retirements might need to be revised downward (I never said he was wrong by the way). Traditionally, a 3% SWR should be good enough for a 40-50 year retirement. But a 3% SWR means that you only have about 33 x annual expenses saved up, so you need strong real returns to stretch your money for 40-50 years. If you don't have strong real returns, then your SWR will have to plunge to 2.5% or even 2% in order to make it work.

I understand-I missed the word real in your original post.

 

[traineeinvestor]

If (i) the article is correct in pointing out that yields on bonds and equities are both lower today than they have been for much of the recent past and (ii) I accept that there is at least a possibility that yields will return to higher levels (which either requires real growth in asset values or (more likely) declining asset values), then any strategy which relies on spending more than the actual yield (i.e. requires some sell down of assets) to meet living expenses is vulnerable if your time period of retirement is long enough (in my case 40+ years). Accordingly, I will stick with my "live off 80% of the yield in a debt free house" plan.

In theory an all TIPS or equivalent plan addresses this problem, but this assumes that the CPI will be an accurate proxy for my personal rate of cost of living increases. Personal experience and anecdotal evidence suggests that this is a unlikely to be a safe assumption.

 

[donheff]

If you use a flexible withdrawal strategy (% of portfolio balance), wouldn't today's lower returns result in a lower portfolio value, and an "automatic" downward adjustment (compared to the good old days)?

This is my route. If things go consistently poorly I guess you could end up pretty bare bones but what is the alternative - never retiring?

 

[braumeister]

OTOH, some of us are more concerned about things going in the other direction.

At the rate the government is spending our money, I see massive inflation in our future (think of the 1970s), and far higher interest rates than we have today.

No matter which side of this fence you're on, we all need to be on our toes, because TANSTAAFL.

 

[bbbamI]

TANSTAAFL

Telling A Naughty Secret To Allure A Fellow Lumpen?

 

[RonBoyd]

Telling A Naughty Secret To Allure A Fellow Lumpen?

If you paid for lunch, the beer would be cheaper.

 

[jIMOh]

I was thinking along those lines:


Now I think that Scott is right that traditional SWRs for longer retirements might need to be revised downward (I never said he was wrong by the way). Traditionally, a 3% SWR should be good enough for a 40-50 year retirement. But a 3% SWR means that you only have about 33 x annual expenses saved up, so you need strong real returns to stretch your money for 40-50 years. If you don't have strong real returns, then your SWR will have to plunge to 2.5% or even 2% in order to make it work.

It has been documented the "lowest" SWR for any 40-50 year portfolio is 3.1%. This is based on a study linked here a few months back.

Study was detailed enough to even so far as it does not matter what the allocation is (80% equity or 20% equity or 40% or 60%) that the success rates were all the same with 3.1% SWR over 40 year periods (meaning when making portfolio last that long, SWR matters, allocation does not).

My take then is when I see someone suggest a SWR of 2-2.5% that more thought is needed, because other studies have shown lowest SWR needed is 3.1% (regardless of allocation).

 

[FIREd]

It has been documented the "lowest" SWR for any 40-50 year portfolio is 3.1%. This is based on a study linked here a few months back.

Study was detailed enough to even so far as it does not matter what the allocation is (80% equity or 20% equity or 40% or 60%) that the success rates were all the same with 3.1% SWR over 40 year periods (meaning when making portfolio last that long, SWR matters, allocation does not).

My take then is when I see someone suggest a SWR of 2-2.5% that more thought is needed, because other studies have shown lowest SWR needed is 3.1% (regardless of allocation).

You seem to believe that this study can accurately forecast the future when in fact it is based on past market performance. Read again what I wrote:

But a 3% SWR means that you only have about 33 x annual expenses saved up, so you need strong real returns to stretch your money for 40-50 years. If you don't have strong real returns, then your SWR will have to plunge to 2.5% or even 2% in order to make it work.

All the study shows is that, in the past, real returns were strong enough to support a 3.1% SWR for at least 40 years. How can you be so sure that real returns will continue to support such as high SWR in the future? What I said above is that if future real returns are lower than past real returns, then a 3.1% SWR is too optimistic. Can you prove me wrong?

 

[kumquat]

All the study shows is that, in the past, real returns were strong enough to support a 3.1% SWR for at least 40 years. How can you be so sure that real returns will continue to support such as high SWR in the future? What I said above is that if future real returns are lower than past real returns, then a 3.1% SWR is too optimistic. Can you prove me wrong?

My bold.

The world will end next week! Can you prove me wrong today?

 

[MichaelB]

There's a lively discussion over at Bogleheads on this article, for those interested. Bogleheads :: View topic - Safe Withdrawal Rate May be Changing

IMHO The 4% withdrawal rate is more at risk from high volatility than low returns.