Why won't a 4% SWR last forever?

[youbet]

Quote:

Originally Posted by gindie For example, assume a $1,000,000 nest egg on December 31 of my final year of work. I take out $40,000 (4%) on the first day of my retirement year. And further assume a 3% inflation rate and 7% investment rate of return in retirement. Then, after year 1 of retirement, my account would be: 1,000,000 - 40,000 = 960,000 * (1.07) = 1,027,200 Year 2 would then be: 1,027,200 - 41,200 (the original amount * 1.03) = 986,000 * (1.07) = 1,055,020, and so on.

Using averages for your calculations is extremely risky. If you check the numbers, there is hardly ever a year with a 7% return and 3% inflation. You may get those numbers as averages over time, but the actual data will fluctuate widely around those means.

Instead of using the averages as you did, build a simple spead sheet and start with huge portfolio loses the first few years coupled with high inflation. The loses will dramatically reduce your portfolio and the high inflation will drive your required withdrawals way up. Then start plugging in market gains and low inflation numbers until the average is about 7% and 3% respectively. You'll see the difference!

Just remember that a 7% average return is not a typical return for any year.

[mathjak107]

Quote:

Originally Posted by 2B That may not be to your advantage. In 2000 all of the "high alpha growth funds" were in tech. How long will it take for the Janus fund (can't remember the name) that was the great high flyer pre-bubble burst to get back? I think 15 years is very optimistic if the fund is even still around. I continue to fall back on the basic concept of diversification among asset classes. I have some growth (small cap growth) but it's relatively small -- about 10%.

Not true, i had quite a few high alpha funds that out performed the market in 2001 2002 and 2003 . they were well diversified and not tech heavy.

Actually we wished they were tech heavy when those sectors were soaring but were soooooooo glad they werent afterwards

[youbet]

Quote:

Originally Posted by 2B There is not any difference between the "buckets of money" and a portfolio with a high % of laddered bonds.

Oh no...... Ray's system is "magic." Your cash and bond ladders will all yield more if you call them "bucket 1." Your fixed income funds and reits will sail with more favorable winds if you call them "bucket 2." And your aggressive equity positions will make you a fortune if you call them "bucket 3."

OK, sorry about the sarcasm.

2B, I've been busy trying to understand what Ray Lucia is really doing and I think I'm getting close. His system is a combination of asset allocation phased with a rebalancing and withdrawal plan. Other than sometimes carrying a very high cash allocation, I don't see a particular problem with what he's doing. (And, hey, sometimes a high cash allocation is the way to go!) I'm just not comfortable classifying assets into "buckets" simply because I'm more comfortable with a "one portfolio" approach. Although, I might wind up doing the same thing someone using Ray's methodology might do, I just don't vision my assets being in "buckets."

Ray is obviously a charismatic speaker/writer and lots of folks have grabbed onto his jargon with a religious-like zeal. And so be it. You can certainly execute an allocation/rebalancing/withdrawal plan with all the advantages/disadvantages of Ray's without his "buckets" terminology, but if using it gives folks a level of confidence they need, great.

To Ray's credit, he does give an appropriate emphasis to withdrawal strategies, something most of the "gurus" don't do, instead focusing almost exclusively on the accumulation period.

[2B]

The airwaves and book aisles are full of people wanting you to let them manage your money. There are a few "pure" authors about financial matters but most are looking for that "hook" that will bring in the customers/clients. Ray is a financial planner that has found it and I don't have anything negative to say about it. I've read his book and I've evaluated "bucketizing" for my plan. It's an overall conservative approach. He is encouraging people to become clients of his firm.

On the other side of the spectrum, I heard a financial planner on a Houston radio station yesterday morning say that all of the people buying no load mutual funds are ruining the American economy. If we pay a load, we know that the mutual fund is working "for us." If we buy a no load, that money is used to buy influence with CEOs. The no load fund will buy/prop up his company's stock price but the CEO will have to give the firm investment banking fees for acquisitions and mergers. Thereby, the companies are forced to do bad deals or their stock prices will plunge. Before that I didn't know how much investment banking Vanguard and Fidelity must do. People like this should be off the air and have their CFP (if they have one) revoked.

[scrubradio]

Quote:

Originally Posted by Rich_in_Tampa Poin well taken. If you really want "forever" you should take 4% of your annual balance, period. That may result in highly variable annual income, but you're good to go. Might use Clyatt's 95% rule to smooth things out, but that voids the warranty other than for historic circumstances.

IRA SEPP payments can't be set up to draw at a variable rate based on
4% can they?

[Rich_by_the_Bay]

Quote:

Originally Posted by scrubradio IRA SEPP payments can't be set up to draw at a variable rate based on 4% can they?

Depends on your fund, but I don't see why not.

If not, just estimate a fixed amount a little lower than the estimated amount and take it that way, with an occasional additional withdrawal to set it right.

[scrubradio]

Quote:

Originally Posted by Rich_in_Tampa Depends on your fund, but I don't see why not. If not, just estimate a fixed amount a little lower than the estimated amount and take it that way, with an occasional additional withdrawal to set it right.

If in fact it could then it would make sense to set it up to do exactly that.
Take 4% each year and in good years where you don't need the full 4%
dump the un-needed ammount in a different stable investment you have
full access to during the not so good years.

I'm just throwing ideas out to get feedback to help me formulate a plan.

[razztazz]

Quote:

If in fact it could then it would make sense to set it up to do exactly that. Take 4% each year and in good years where you don't need the full 4% dump the un-needed ammount in a different stable investment you have full access to during the not so good years. I'm just throwing ideas out to get feedback to help me formulate a plan.

A long time ago someone else method mentioned this as a way to make a single payment immediate annuity keep up with inflation. Since you can already get a higher payout from an annuity (well, usually) than you can in'regular" fixed income" stashes, you just take the diffrence bwtween your expences and the annuity payout and put it in a sinking fund to grow so that when inflation starts eating into your annuity check you can "top it off" with that reserved money

[dory36]

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Originally Posted by retire@40 Yup. That's why people should have 2 budgets: 1. A comfort budget. 2. A bare bones budget which should be no more than 1/2 to 2/3 of your comfort budget. If you can live on a 4% SWR comfort budget, then even in a major downturn, if you can temporarily revert to your bare bones budget, you should at least feel better about your potential outcome.

I divided it into 3 buckets a few years back...

Quote:

Originally Posted by dory36 ...Mentally I divide my portfolio into 3 buckets. Bucket one is what I feel I need to maintain my lifestyle until social security kicks in. I withdraw at the nearly 100% safe rate from this now, nut the time frame is only until SS kicks in. Bucket two is the part I'll need to add to SS to maintain that lifestyle. No withdrawals now; nearly 100% safe rate starting when I start withdrawals, with a time frame to outlast me. Bucket three is "play" money, and I feel comfortable withdrawing at a more risky rate, like 85%. Taking this approach, rather than trying to make a single decision on what I needed, has helped me a lot -- and speeded up my early retirement by about 2 years.

[OAG]

Isn't this just what an annuity is? I have two annuities, both of which are COLA'd. So what you are saying is that take the income from these that exceed annual expenses and put it someplace and let it grow. I think that pretty well describes the system. My annuities are SS and MIL Retired Pay, both act just like an annuity and have a survivors aspect to them (SS in the higher rate being transfered to a spouse) and the Military Retired Pay has a benefit program attached (even at 10% it will provide about a 17% of gross lifetime annuity to the spouse). Since the combination of these "annuities" exceed the expenses the question then becomes where to you stick the excess where it will grow, more or less, to offset any shortfall in the spouses living expenses when I check out. Personally, for me CD's provide a safe and pretty solid return (in excess of 5.5% in a laddered set of CD's in three institurions) with maturities over the next 8 years (through 2014).

Since the "annuites" are backed by the "full faith" of the US Govt there is no reason they will go south anytime soon. Even the CD's can provide, if necessary, current income if need be by just taking the interest part as income (without penalty of any kind; other than reducing current growth). Home new and paid for, 2005 SUV paid for and no other debt.

With this type of situation I only have to be "careful crossing streets". I guess it helps being old enough to be getting SS (which I started at 62), having employer medical care provided, and kind of a lower need for living expenses.

I guess if I could get the 7% rate of return everyone ascribes to the Stock Market it would be better. But, having $1M in cash a tad quicker in time would be nice but for the effort that seems to be needed I will settle for the 5.5+ rate (year in and year out) and not worry about the other 1.5%.

I have also toyed with a bit of a modification of the SWR (although I do see the wisdom of 4%). In my modification I gear withdrawals at the combined RMD rates for Traditional IRA's since both DW and I have IRA's which will require RMD's starting in the next couple of years. Using those rates (IRS PUB 915) and sticking with them the money does not exhaust itself until the one reaches approximately 114 years old. I guess if you start at 70 years of age that means the money will last approximately 40 years. (to answer the question in "Why won't a 4% SWR last forever" it sure will, at least, in my case); and, if the principal is protected, I would think it would for most.

[Nords]

Quote:

Originally Posted by scrubradio Wouldn't a well balanced portfolio help to reduce the effects of volitility?

Well, yeah, but volatility won't go to zero unless your income is a fixed pension or an annuity. Even CDs & bonds mature and have to be reinvested at different rates.

The best way to handle volatility is to render it irrelevant by not having to sell your assets in a down market.

Quote:

Originally Posted by scrubradio Gotcha. So if I decided to FIRE and miscalculated, I could end up watching my portfolio deteriorate and find myself back out in the workforce in a hurry.

Yup, but if you have sufficient cash (or some other asset) on the sidelines to draw from while the bear market lurches onward, then you'll probably survive. That's the basis of diversification, look at Old Army Guy's system below, and it's also why everyone seems to be spouting buckets this month.

Quote:

Originally Posted by 2B I knew a guy who retired in 1999 based on the 20+% he had been making in tech stocks. He had $500,000 and felt he could get by on $75,000/yr. He thought that would be no problem even if his returns dropped a little. He went back to work in 2003 effectively broke. He tried to go back to work sooner but no one was hiring IT types in 2002.

I have an uncle-in-law who retired in the 1980s on the strength of the bull market and was doing just fine until he started shorting the ridiculously overvalued NASDAQ.

In 1996.

A few dozen margin calls later he was back in the work force, teaching math & science in East LA, but he's retired again on a pension.

Quote:

Originally Posted by Old Army Guy Isn't this just what an annuity is? I have two annuities, both of which are COLA'd. So what you are saying is that take the income from these that exceed annual expenses and put it someplace and let it grow. I think that pretty well describes the system. My annuities are SS and MIL Retired Pay, both act just like an annuity and have a survivors aspect to them (SS in the higher rate being transfered to a spouse) and the Military Retired Pay has a benefit program attached (even at 10% it will provide about a 17% of gross lifetime annuity to the spouse). Since the combination of these "annuities" exceed the expenses the question then becomes where to you stick the excess where it will grow, more or less, to offset any shortfall in the spouses living expenses when I check out. Personally, for me CD's provide a safe and pretty solid return (in excess of 5.5% in a laddered set of CD's in three institurions) with maturities over the next 8 years (through 2014).

Whoa, careful, wild talk like that will convince you to put the rest of your portfolio in equities!

[donheff]

By the way, back to the original question, in most scenarios it will last forever - just not all.

[unclemick]

Yawn! So 4% SWR is Norwegian for 60/40, 4% benchmark with SEC portfolio yield(ballpark 3%) in hard times and 5% variable when it's bon temps rolliere using the Saint's win/loss, and my belly button as highly personal technical indicators - with pssst Wellesley yield as a confirming indicator.

16 yrs and still practicing - I'll get this ER thing down yet - you'll see. Plus a small pension(non cola 1998) and early SS(2005) now count for 40% in good times - functioning as faux annuities.

25 times expenses and 4% have been great guideposts since 1993 with the knowledge that I can vary expenses more than convince Mr Market to do my bidding.

heh heh heh - yes Gertrude I think I'm a Boglehead - now that it doesn't cost 5 bucks to sign up anymore. Balanced index, 60/40, slide asset mix as you age - go team go. Oh and Geaux Saint's!

[tuixiu]

Flexibility is a huge factor in all this. If you're willing to go back to work even for part time low wage if the market isn't cooperating it can make a huge difference in the percent you're withdrawing. Same with being able to go lay low in Thailand/Panama/etc. for a couple year, etc.

[Gone4Good]

Quote:

Originally Posted by gindie Am I missing something here?

Not only does volatility hurt you, as others have said, but even if you assume away volatility your example doesn't last in perpetuity. Although your withdrawals grow 3% every year, your ending principal balance only grows 2.7% to start with and shrinks from there. Eventually (in this case, year 72) you run out of money.

[traineeinvestor]

As others have said, its the volatility that kills a portfolio which relies on an average return being acheived every year. It would actually be unusual for a portfolio to produce the average return in any year. If you get below average returns in the early years the probability of failure (i.e. running out of money) goes up a lot because the reduced remaining principal has to produce ever higher returns to get things back on track.

To use an overly simplified example:

Start with $1000, and plan on an average return of 7% and a constant SWR of 4% of the original capital ($40) each year (i.e. no inflation adjustment).

If you get the expected average return of 7% each year, you will be left with $1030 at the end of year one ($1,000 +7% - $40) and $1062.10 at the end of year 2 ($1,030 + 7% - $40).

But if the markets have a bad year and you actually lose 10% in year one you are left with $860 ($1,000 - 10% - $40). In order to get to the same end position the year two return would need to be about 28.1%. This is possible but unlikely. Given that you will be spending principal each year, it is more likely that the hole will just keep getting bigger and the portfolio will fail.

Playing around with a spreadsheet will show that missing the average return by even a small amount a year for a couple of years will kill the portfolio.

Of course, the reverse is also true. A few above average years at the start of the portfolio's life will extend the duration of the portfolio significantly if you can resist the urge not to inflate your lifestyle.

There is a very good explanation here: The Flaw of Averages

We're also facing a potentially very long period of retirement (40-50 years) and have decided that there is no such thing as a SWR for that length of time. We're also planning on me working for 1-2 years more after we hit the number to provide a buffer against the problem of below average returns in the early years.

[charlie]

I have been around the block a few times and have come to the conclusion that I started with over 20 years ago when I FIRED.

Just put your money in Wellesley Income and live off of the distributions.

There is a good chance your income will keep up with inflation and a
better than good chance your money will out last you.

Even when the dreaded RMD eventually rears its ugly head it is likely
that you will not have to invade pricipal for several years. And when you do start spending principal there is a great chance that you will be so far out of it that you won't be aware or even care!

In the meantime, enjoy life and your family and don't fixate on money.
You don't need to beat Mr. Market to be a winner in life.

If your harmones cause you a problem, invest time in your grandkid's
sports and root for your favorite teams.

Go Mavs!

Cheers,

charlie

[cashflo2u2]

I was reading something by Otar where he states that one may need an annuity to offset the "luck" factor in retirement. He calculates the minimum value of the annuity as

MA= 100X (RWR -SWR) /(AR-SWR)

where RWR=required withdrawal rate; SWR = safe withdrawal rate; AR = payout rate on immediate annuity

If the answer is less than zero you don't need one. If MA is between 0 and 100 you should have enough to retire (mathmatically) but not enought to offet the luck factor. So you take the answer, e.g., 35 and multiply that times your retirement portfolio and that is the amount of annuity (SPIA) to purchase. If the MA is larger than 100, keep on working for da' man.

Note- this is for portolios in the distribution mode only.

[figner]

Quote:

Originally Posted by cashflo2u2 I was reading something by Otar where he states that one may need an annuity to offset the "luck" factor in retirement. He calculates the minimum value of the annuity as MA= 100X (RWR -SWR) /(AR-SWR) where RWR=required withdrawal rate; SWR = safe withdrawal rate; AR = payout rate on immediate annuity

What are the definitions of Required Withdrawal Rate and Safe Withdrawal Rate as used in the formula? If I had to guess, RWR == actual projected annual necessary expenses, and SWR == annual amount that some retirement calculator says you can withdraw without running out of money in your lifetime?

[cashflo2u2]

RWR (required withdrawal rate) is defined as the amount you need annually from your portfolio, i.e., your initial withdrawal rate in first year of retirement indexed to inflation thereafter.
I misnamed the SWR as the safe withdrawal rate. He calls it the sustainable withdrawal rate, or the maximum amount one can periodically withdraw from a distribution portfolio with no possibility of failure during your lifetime. He gives examples, and I think comes down on 3.7%.