# Question on the 95% rule

##### Recycles dryer sheets
My first posting. I'm 49 and only a couple of years from FIRE. I just got me a copy of Work Less, Live More - great book! Kudos to Bob Clyatt.

I have two questions around the 95% rule in bad years:

1 - The rule is supposed to be "following a bad year" - what constitutes a bad year? A loss? Or something else?
2 - The rule is "you can withdraw at least 95% of the amount you took the previous year". The book doesn't address successive bad years. Does this mean that in bad year #2, you stick to the original 95% value? Or do you take 95% of 95% (which would be 90.25%)?

As I understand it:

1. Bad year = your portfolio is lower than it was a year ago.

2. Yup, 95% of 95% of 95% of... in a succession of bad years. You'd have to be prepared to cut a lot of spending or gin up some income in this scenario.

Maybe ESRBob himself will comment, as I think I am a little shaky on #1.

#1 - You'll know it when you see it.

Welcome to the board, SurfDaddy. I'm not Bob but I've saved one of his PMs that digs into the numbers for my hypothetical series of market returns. I've edited this for brevity & clarity but I've left the numbers alone. So heeeere's Bob:

"If a string of bad years ensues, you would be ratcheting dollars withdrawn down by 5% each year in nominal terms, and therefore also eating inflation (having to make do without inflation adjustments).

The 95% rule historically has rarely kicked in more than a couple years in a row, so while the long multi-year grinding down would be painful, it has rarely happened.

First off, forget inflation in your calculations. My approach just goes with the SWR and the portfolio value.

Start with \$1 million. Withdraw 4%, \$40k, at the beginning of the year. The market is up 5% that year so \$960k grows at 5% to \$1,008,000.

2nd year, withdraw 4% of \$1,008,000 = \$40,320 leaving \$967,680. The market grows at 2% through the year to \$987,033.

3rd year, withdraw 4% of \$987,033 = \$39,481, leaving \$947,552. The market gets whacked at -5% leaving you with \$900,174 at the end of the year.

This is where the 95% rule would kick in for this year: A straight 4% of the \$900,174 would be \$36,006. Using the 'whichever is greater' approach, calculate that 95% of my last year's withdrawal of \$39,481 is greater: it is \$37,506. So withdraw that greater amount giving yourself a bit of a break. This guy is busy trying to earn \$5k this year, to supplement his gap from \$40k, as well as to compensate for four years of inflation that is starting to bite him. But he doesn't mind -- the \$5k isn't much and he knows by doing this he is preserving his portfolio's survival rate much more assuredly than if he were gobbling away at his principal in order to provide himself a perfect inflation-adjusted annual spending rate while ruining his long run chances of financial survival.

To finish off that year, he takes \$37,506 from \$900,174 leaving him with \$862,667. The market is up 6% so the portfolio grows to \$914,427.

The next year, he takes 4% of \$914,427, which is \$36,577. This is greater than 95% of \$37,506 (\$35,630) so he goes with that and keeps his part time job for another year and hopes for one of those nice revert-to-mean years which will bring his portfolio back over the inflation-adjusted \$1 million and get him back on track."

Nords here again: The 95% rule executed twice in a row becomes 90.25%, which is a pretty substantial whack, but by the second year it's entirely possible that you've put off the second Caribbean vacation and cut back on other expenses. (And note that the 95% rule might actually give you MORE money than your portfolio's straight 4% withdrawal rate.) Under Bob's system, with two bad years in a row, you might even have gotten a j-j-j-j-job to tide you over. (Sorry, I have a hard time saying that word without stuttering.) The idea is to not ER with such a thinly-capitalized portfolio that you have no room in the budget to cut back (or chase a paycheck) occasionally. Even the most anal retentive analytical of us engineers would add a fudge factor into our ER budget to account for surprises, so that 5-10% budget slack would hopefully ease the pain of having to implement the 95% rule two years in a row.

Now to the important question: Regarding your username, where do you surf?

Nords said:
Even the most anal retentive analytical of us engineers would add a fudge factor into our ER budget to account for surprises, so that 5-10% budget slack would hopefully ease the pain of having to implement the 95% rule two years in a row.

Heheh, I think the actuaries have a better name for it than "fudge factor," which sounds like it has scat implications, now that I think of it. They call it a Provision for Adverse Development, or PAD. So, yes, they PAD their estimates.

Thank you for posting that Nords. I thought that's how it worked.

brewer12345 said:
Heheh, I think the actuaries have a better name for it than "fudge factor," which sounds like it has scat implications, now that I think of it.  They call it a Provision for Adverse Development, or PAD.  So, yes, they PAD their estimates.
Good one!

"Anal retentive"? "Fudge factor?" I thought that was pretty subtle, but it's nice to have one's work appreciated...

Now to the important question: Regarding your username, where do you surf

Actually, I surf the net! Never surfed *in the ocean* a day in my life!

I did body surf a few times.

Live or dead body you surfed on?

Nords,
Thanks for chiming in as I missed this post with my note to you. You guys can PM me if I seem to be missing one of these questions as I get an email from the PM which jolts me to attention when I'm off doing other ER-ish things besides posting here. (Its been a few good days for sculpture, and also, regrettably, for dealing with the silly condo I bought in Toronto where the tenant bailed on me after 5 months and the property manager appears to be comatose by all reliably estimates).

The 95% Rule ain't perfect but its better than having to drop your spending by 20% in a really bad year. A slow squeeze on the belt notches seems better suited to human nature than a major year-on-year jolt, and the data shows it has little negative 'cost' over the long run.

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