Wade Pfau looks at 4% WR, finds it unsafe

[audreyh1]

I'm still trying to get my mind around the 0.3% real return on intermediate bonds. I guess it's because they are using govt bonds rather than a broader bond portfolio. And of course we know that Monte Carlo analysis gives the worst case.

Anyway - sure makes one want to pull in and reduce withdrawal away rates, doesn't it? I hadn't considered trying to drop down to 2.5% or something. I guess I'll keep with my 3.33% until we go to hell in a hand basket, then I'll be out bartering with everyone else....

This is all just getting way too sobering!

[jebmke]

Quote:

Originally Posted by audreyh1 I'm still trying to get my mind around the 0.3% real return on intermediate bonds. I guess it's because they are using govt bonds rather than a broader bond portfolio. And of course we know that Monte Carlo analysis gives the worst case. Anyway - sure makes one want to pull in and reduce withdrawal away rates, doesn't it? I hadn't considered trying to drop down to 2.5% or something. I guess I'll keep with my 3.33% until we go to hell in a hand basket, then I'll be out bartering with everyone else.... This is all just getting way too sobering!

I think intermediate gov bonds have negative real yield. The .3% for a broad portfolio doesn't seem off the mark to me.

[audreyh1]

Quote:

Originally Posted by jebmke I think intermediate gov bonds have negative real yield. The .3% for a broad portfolio doesn't seem off the mark to me.

My point is - given that scenario, don't exclusively use government bonds! Use a diversified intermediate bond portfolio instead.

[ronin]

Using my actual returns for the past 120 months, my portfolio 70/30 portfolio earned 9.4% with a SD of 12.9%. Plugging that into my MC sim using a 30 yr withdrawal at 4%, I get a 93% success rate. At 35 yrs it drops to 90%, there'd be only a 10% probability of one of the 2 of us surviving, so the failure rate is now actually more like 1%.

Now who's crystal ball is better? Seems like it's pretty useful for entertainment value at best.

[Chuckanut]

It's not all doom and gloom. As I read the graph in Michael's post, the 3% withdrawal rate still offers a success rate in excess of 80%. Given the uncertainties of the future, that is not bad.

[Lsbcal]

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Originally Posted by jebmke I think intermediate gov bonds have negative real yield. The .3% for a broad portfolio doesn't seem off the mark to me.

Below is the 5 year TIPS rates. The historical average real rates for 5 year nominal Treasuries is about 2.3% (as per Swedroe) and TIPS will be below this by about the inflation rate plus a premium for taking inflation risk. We see that the last 10 years have seen a decline in the real rates and quite a dramatic decline over the last 3 years.

What could happen (among an infinite set of possibilities) is that we get back up to normal real rates in 3 to 5 years. Then we could even overshoot and go to fairly high real rates. The 1983-2000 period was a time of high real rates and we had a fairly good economy in those years. So there is a precedent.

None of us knows what the future will bring. Much of the SWR calculations (including Pfau's I think) assume a constant withdrawal rate. Many of us will adjust withdrawals to mitigate declining portfolios and as others have pointed out, that is not generally in those SWR models.

[Lsbcal]

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Originally Posted by marko I'm not even close to being a statistician (or mathematician) but can anyone comment on how Pfau's chart jibes with Firecalc's results?

I think Pfau is choosing selected stock/bond returns and then seeing how that plays out. FIRECalc is taking rolling periods with the actual historical results. Quite different methods.

Quote:

At the same time, the bottom two curves flatten out around a 50% SA, suggesting a needless risk/reward. Counterintuitive?

Interesting question. I think one does not really know over a 20 or 30 year period exactly what their withdrawal rate (particular curve) will be. It might start out at 3% early on and then it could go up quite a bit (or down) depending on investment returns and life events. So you do not necessarily have to worry about being on those flat portions of one particular curve.

[Animorph]

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Originally Posted by Nords About your 50% U.S. equities asset allocation: how many of those equities are shares of large multinational corporations with substantial earnings & assets from overseas business? I wonder what percentage of the S&P500 annual earnings comes from outside of the U.S.

And how many of my 50% foreign equities have substantial earnings and assets from U.S. business? It's pretty much just a convenient way to divide them up. However, they do behave differently and give me rebalancing opprtunities.

[audreyh1]

I'm anticipating, given the sluggish global economy and debt overhang, that interest rates don't normalize for quite a while - maybe not for another 10 years or more. It's in this environment that I wonder about portfolio survival. Currently, US companies are doing well, mortgages and REITs pay decent yields, so I'm not too worried.

[Lsbcal]

Quote:

Originally Posted by audreyh1 I'm anticipating, given the sluggish global economy and debt overhang, that interest rates don't normalize for quite a while - maybe not for another 10 years or more. It's in this environment that I wonder about portfolio survival. Currently, US companies are doing well, mortgages and REITs pay decent yields, so I'm not too worried.

I try to keep upbeat. Yes it's possible that real rates will stay low for many years. Hopefully the equity (US and international) returns will balance this out. That's why I've maintained a fairly high equity percentage in the AA.

We've noticed on a recent vacation how US workers, young and old, seem to be extremely well motivated to do a good job -- one of the upside benefits of a tight economy. One thing I think we can count on, the work world will continue to be an extremely competitive place. I'm hoping this translates into good equity returns.

[MichaelB]

He acknowledged this thread in his comments update. Hopefully he keeps reading. Wade, please feel free to join us and share your thoughts as your time permits.

I notice he lowers the expected return but keeps the same level of volatility for equities. Peter Bernstein said that lower annualized returns are the result of higher volatility, not lower annual returns. If that is the case (and I suspect it is, at least in part) the failure rate he shows for a 50/50 portfolio may be somewhat overstated. In other words, if disciplined rebalancers, allocation funds and mixed funds (Wellesley, Wellington) rebalance rigorously, those portfolios will survive longer.

[EvrClrx311]

The numbers in his assumption table appear inaccurate...

Stocks from 1926-2010
Arithmetic Mean: 8.70%
Geometric Mean: 6.62%

He then removes about 3.5% more off of those to account for inflation.

However, the numbers he started with (8.70%/6.62%) seem to already include inflation, since Compustat dataset of S&P500 from 1928-2003 lists:
Arithmetic Mean: 11.67%
Geometric Mean: 9.70%

missing 2004-2010 doesn't change things "that much"... it should be in the neighborhood of 11.3% and 9.5%

My guess is that Dr. Pfau counted inflation twice. There is no way to explain how a 3% withdrawal rate on a 90-10 (bond-stock) would fail over 30% of the time over a 30 year period using the median returns of the market over the last 80 years. Inadvertently setting inflation to double what it actually is... would accomplish that.

Another supporting factor is that his table shows a higher failure rate with bonds taking over the majority of holdings. That kind of strong trend would only happen if bonds significantly trailed the inflation used...

Only other explanation is that he may be excluding dividends being reinvested for the stock portion... which historically have accounted for a return in the neighborhood of inflation over time.

[EvrClrx311]

Found it... the annualized return of the S&P500 from 1926-2010 was 9.87%

Even if you cherry picked the absolute bottom of the market in March 2009 (when it fell 50%)... essentially the worst 83 year return we'll ever see for the next 50+ years, the annualized market return from 1926-March 2009 was still 6.98%

So I'm not sure where he got the 6.62% geometric mean number from... it must be missing something (either dividends or inflation) already.

[unclemick]

Agile, mobile and hostile. After 18 years, I can't even spell engineer any more so I avoid taking numbers real serious. My unified theory of chickenheartedness requires that I continue to charge into the future with one finger in my belly button and one eye on the rear view mirror. Having roared past 55 and 62 in ER - I now have a floor, SS and non-cola pension, aka 100 to 30% of expenses depending on my navel quiver from last years portfolio. 4% centerpoint, actual takeout 2 to 6% range based on last years performance.

Old habits mean I run FireCalc, ORP several times during the year and avidly read threads like this one.

However I take to heart Dory33's original admonition - to be careful when measuring with a micrometer and cutting with an axe.

Handgrenade and horseshoe wise I run calculators and look at studies to feel warm and smarmy about being in the ballpark.

heh heh heh - put me in the floor and agressively varying expenses year to year school - cause I've given up (many decades ago) trying to outsmart Mr Market with portfolio shifts.

[Lsbcal]

Quote:

Originally Posted by EvrClrx311 Found it... the annualized return of the S&P500 from 1926-2010 was 9.87% Even if you cherry picked the absolute bottom of the market in March 2009 (when it fell 50%)... essentially the worst 83 year return we'll ever see for the next 50+ years, the annualized market return from 1926-March 2009 was still 6.98% So I'm not sure where he got the 6.62% geometric mean number from... it must be missing something (either dividends or inflation) already.

Interesting observation.

My data for the SP500 with dividends from 1951 to present is CAGR = 10.5%. For this period the inflation rate was 3.6% so roughly the real SP500 + dividends return was CAGR = 6.9%.

[Lsbcal]

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Originally Posted by unclemick ...(snip)... Old habits mean I run FireCalc, ORP several times during the year and avidly read threads like this one. However I take to heart Dory33's original admonition - to be careful when measuring with a micrometer and cutting with an axe. Handgrenade and horseshoe wise I run calculators and look at studies to feel warm and smarmy about being in the ballpark. heh heh heh - put me in the floor and agressively varying expenses year to year school - cause I've given up (many decades ago) trying to outsmart Mr Market with portfolio shifts.

Wise comments. I like the Dory33 quote too. Perhaps you should write a blog on this stuff but that might be work .

[REWahoo]

Hey guys, I know it's been a while since Dory36 moved on to find greener pastures, but please don't use that axe on his username.

[Nords]

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Originally Posted by Lsbcal Much of the SWR calculations (including Pfau's I think) assume a constant withdrawal rate.

Yep.

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Originally Posted by audreyh1 I'm anticipating, given the sluggish global economy and debt overhang, that interest rates don't normalize for quite a while - maybe not for another 10 years or more.

I think an analogy is after WWII when the govt did everything they could to keep interest rates as low as possible for as long as possible in order to get rid of all the War Bond debt.

The federal govt has plenty of incentive to keep rates low, even if inflation kicks up to 4%. I bet they've been debating this scenario since March 2009...

[Gumby]

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Originally Posted by Nords Yep. I think an analogy is after WWII when the govt did everything they could to keep interest rates as low as possible for as long as possible in order to get rid of all the War Bond debt. The federal govt has plenty of incentive to keep rates low, even if inflation kicks up to 4%. I bet they've been debating this scenario since March 2009...

An interesting paper on this very topic from the National Bureau of Economic Research.

http://www.imf.org/external/np/semin...2/pdf/crbs.pdf

[Lsbcal]

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Originally Posted by Gumby An interesting paper on this very topic from the National Bureau of Economic Research. http://www.imf.org/external/np/semin...2/pdf/crbs.pdf

Reading the abstract from that paper, they mention "financial repression". This is a term the Pimco (Gross, et. al.) has used a lot recently in regard to the current bond scenario.

If this continues for some years there are going to be a lot of unhappy fixed income investors. So far many of those have benefited somewhat from the falling rate environment but that appears to have played out.

From my SWR models, a particular trying period for a stock/bond portfolio was 1946 to 1949 -- just after WW2. This was true whether your portfolio was 60/40 or 40/60.