Are Even 3% Withdrawal Rates Excessive for Retirees Today?

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Are Even 3% Withdrawal Rates Excessive for Retirees Today?

Postby Simplegift » Mon Nov 12, 2012 7:24 pm

Many of us are now familiar with the lower expected returns currently being forecast for the two major asset classes over the coming decades — about 5% real annual return for stocks and 0% real return for bonds. Here's an example by Wade Pfau, summarizing expected real returns in his May 2012 article, Reality Check on Retirement Planning Assumptions:

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What's interesting is that Wade then goes on to run Monte Carlo simulations using these expected returns to project 30-year failure rates for various stock/bond portfolios at selected withdrawal rates (chart below). Accepting that "safe withdrawal rates" are no longer the latest word in retirement planning (e.g., see Milevsky or Bernstein on "guaranteed floor/upside potential"), it's still rather shocking to see that, given today's low expected returns, a 50% stock/50% bond portfolio with a 4% withdrawal rate is forecast to fail 47% of the time. This same portfolio with a 3% withdrawal rate has a 17% chance of failure. Yikes. Any thoughts?

Image
Source: Wade Pfau
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Re: Are Even 3% Withdrawal Rates Excessive for Retirees Toda

Postby CyberBob » Mon Nov 12, 2012 7:39 pm

There is an interesting Scott Burns article out recently that looks at the issue from a totally different angle; 30-year planning horizons bump up against the reality that you may expire long before your portfolio does.

Scott Burns wrote:The bottom line, however, is that death reduces the risk of running out of money more than does portfolio management.


Life, Death and How Long Your Money Will Last.

Bob
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Re: Are Even 3% Withdrawal Rates Excessive for Retirees Toda

Postby 555 » Mon Nov 12, 2012 7:42 pm

A portfolio with 0% real return with a 3.33% inflation indexed withdrawal rate has a 0% chance of failing in 30 years.
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Re: Are Even 3% Withdrawal Rates Excessive for Retirees Toda

Postby richard » Mon Nov 12, 2012 7:48 pm

555 wrote:A portfolio with 0% real return with a 3.33% inflation indexed withdrawal rate has a 0% chance of failing in 30 years.

If you want a totally safe inflation indexed portfolio, and have more than a nominal amount invested, you're going to need TIPS. TIPS have negative real yields for almost all of the yield curve.

You'll also have a problem under this approach if you live for 31 years.
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Re: Are Even 3% Withdrawal Rates Excessive for Retirees Toda

Postby nisiprius » Mon Nov 12, 2012 8:15 pm

In 1998, the Wall Street Journal Guide To Planning Your Financial Future: The Easy-To-Read Guide to Planning for Retirement said to use these as planning numbers.

Image

In 2012, Wade Pfau says to use these as planning numbers.

Image
Yikes. Any thoughts?
Sure. My thoughts are that if future returns are generous, you can safely withdraw generous amounts, and if future returns are stingy, you can safely withdraw stingy amounts. Duh.

I truly don't see the point of conducting precision simulations based on wildly speculative guesses about future returns of asset classes. How does it get you any farther than saying "if we have good luck as to when we reach retirement age, we'll do well, if we have bad luck, we'll do poorly?"

If we had some ham, we could have ham and eggs--if we had some eggs. But we don't have the eggs, i.e. foreknowledge of future asset returns.

In Safe Withdrawal Rates? Simplicity versus Complexity, Taylor Larimore wrote:
We simply withdrew what we needed and kept an eye on our portfolio balance. Most years our balance went up and we spent the money on vacations, luxuries and charity. When our balance went down we tightened our belt and economized.

This is what most people do and it works.
We spend our whole pre-retirement life adjusting our expenses to an unpredictable income. Why should retirement be all that different? We need to live within our means, and we have much more control--not perfect, but more--over the expense side of the equation than the investment income side. I certainly can't control the year in which I was born.

We don't need fancier numbers and trickier simulations. We don't need more accurate projections of how much ham we could have if we had 1.86 eggs. We can be pretty sure that the right number is somewhere around 4%. We can be pretty sure it's not the 7% that Peter Lynch said it was. Sure, it might be 3%, that's "somewhere around 4%."

What we need are soft-science human-element sociological studies of the nuts and bolts of managing retirement living, how to adapt our expenses to our means, and how the task in retirement differs from our previous life experience.
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Re: Are Even 3% Withdrawal Rates Excessive for Retirees Toda

Postby AndroAsc » Mon Nov 12, 2012 8:28 pm

Not surprising at all. The 4% rule study was extremely US-centric and specific to a time where the US economy was booming (post WW2).

An updated study published a few years back on 10+ countries indicated that the 4% rule only worked in the minority of countries based on historical performance. The average sustainable rate was 3%, and some countries were as low as 2%.
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Re: Are Even 3% Withdrawal Rates Excessive for Retirees Toda

Postby Cut-Throat » Mon Nov 12, 2012 9:31 pm

Like Nisi says no one knows....So in Light of this....Take a 3-4% of remaining portfolio balance and you should be good to go. In good times you'll get to spend more, in bad times less......But it probably won't leave you starving and homeless.
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Re: Are Even 3% Withdrawal Rates Excessive for Retirees Toda

Postby Simplegift » Mon Nov 12, 2012 9:37 pm

nisiprius wrote:We spend our whole pre-retirement life adjusting our expenses to an unpredictable income. Why should retirement be all that different? We need to live within our means, and we have much more control--not perfect, but more--over the expense side of the equation than the investment income side. I certainly can't control the year in which I was born.

Nisi, your point is a good one (retirees will need to adjust spending for unpredictable asset returns) — but your example of Mr. Larimore is a stretch. When he retired in 1982, bond yields were over 14% and stocks were about to embark on a 20-year bull market run. Today's retirees won't have that bond tailwind or anything near the spending flexibility that he experienced.

More instructive for today might be to hear from a 1950 retiree, rather than a 1982 retiree. :wink:

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Source: Business Insider
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Re: Are Even 3% Withdrawal Rates Excessive for Retirees Toda

Postby KyleAAA » Mon Nov 12, 2012 9:41 pm

I don't think these studies are particularly useful for many reasons. One of which is that it assumes continually increasing withdrawals when empirical observation suggests that isn't realistic. It also assumes you'll live 30 years and never adjust your withdrawals depending on market/life conditions. It's all too abstract and theoretical to be particularly useful. You're probably better off just picking a reasonable initial rate, almost any reasonable initial rate will do (anywhere from 2% to 5% or whatever), and adjust as you go. Those with substantial financial assets can afford to withdraw less if need be and those without couldn't afford it even if they wanted to, so what's the difference?
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Re: Are Even 3% Withdrawal Rates Excessive for Retirees Toda

Postby mptfan » Mon Nov 12, 2012 9:46 pm

Nisi, in your post, you compared nominal returns to real returns. That's not really fair.
I eat risk for breakfast. :)
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Re: Are Even 3% Withdrawal Rates Excessive for Retirees Toda

Postby Leesbro63 » Mon Nov 12, 2012 10:12 pm

KyleAAA wrote:I don't think these studies are particularly useful for many reasons. One of which is that it assumes continually increasing withdrawals when empirical observation suggests that isn't realistic. It also assumes you'll live 30 years and never adjust your withdrawals depending on market/life conditions. It's all too abstract and theoretical to be particularly useful. You're probably better off just picking a reasonable initial rate, almost any reasonable initial rate will do (anywhere from 2% to 5% or whatever), and adjust as you go. Those with substantial financial assets can afford to withdraw less if need be and those without couldn't afford it even if they wanted to, so what's the difference?


I disagree. 5% seriously risks disaster. And the "assume you spend less as you age" argument ignores the odds that out of pocket healthcare costs, as you age and require more, will continue to increase faster than inflation and investment returns.
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Re: Are Even 3% Withdrawal Rates Excessive for Retirees Toda

Postby KyleAAA » Mon Nov 12, 2012 10:20 pm

Leesbro63 wrote:
KyleAAA wrote:I don't think these studies are particularly useful for many reasons. One of which is that it assumes continually increasing withdrawals when empirical observation suggests that isn't realistic. It also assumes you'll live 30 years and never adjust your withdrawals depending on market/life conditions. It's all too abstract and theoretical to be particularly useful. You're probably better off just picking a reasonable initial rate, almost any reasonable initial rate will do (anywhere from 2% to 5% or whatever), and adjust as you go. Those with substantial financial assets can afford to withdraw less if need be and those without couldn't afford it even if they wanted to, so what's the difference?


I disagree. 5% seriously risks disaster. And the "assume you spend less as you age" argument ignores the odds that out of pocket healthcare costs, as you age and require more, will continue to increase faster than inflation and investment returns.


No it doesn't, it takes that into account. People literally in absolute terms tend to spend less as they age, on average. There are exceptions, of course. I do not agree that 5% risks disaster. Why would it? If you have a string of good years in the market you're golden. If you have a bad year or two, you cut back. If you can't afford to cut back, well, you probably couldn't have afforded to take out less than 5% to begin with, anyway. If you need to take out 6% of your portfolio to survive, you're going to do it and figure out what to do in the future later. You're not going to starve just because you heard you shouldn't take out more than 4%. If you can afford to be more conservative, great, but if that's the case you could still probably afford to start out with a higher withdrawal rate and cut back later if you had to. It's just not that important to find the "optimal" withdrawal rate ahead of time.
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Re: Are Even 3% Withdrawal Rates Excessive for Retirees Toda

Postby nisiprius » Mon Nov 12, 2012 10:28 pm

mptfan wrote:Nisi, in your post, you compared nominal returns to real returns. That's not really fair.
:oops:

I do see, however (yes, I still have the book) that on page 94, it says that "the standard pension fund mix of 60% invested in stocks, 30% in bonds, and 10% invested in cash has consistently earned four percentage points more than the inflation rate." Consistently! Isn't that nice? Anyone know how long pensions have been investing in that mix? I have a vague impression, maybe wrong, that pension funds didn't begin investing in stocks at all until the 1940s or 1950s, meaning that the book would be taking about "consistent" performance over a period of only about forty years.
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Re: Are Even 3% Withdrawal Rates Excessive for Retirees Toda

Postby nisiprius » Mon Nov 12, 2012 10:43 pm

KyleAAA wrote:No it doesn't, it takes that into account. People literally in absolute terms tend to spend less as they age, on average.
This seems to be a meme on the rise, but I flatly do not believe it... unless long-term-care and other healthcare costs are excluded, which would seem to be excluding the single biggest source of uncertainty there is in retirement costs.

Can you point me to the source that says people in retirement spend less as they age?
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Re: Are Even 3% Withdrawal Rates Excessive for Retirees Toda

Postby cherijoh » Mon Nov 12, 2012 10:44 pm

I don't think the standard safe withdrawal rate scheme is very practical for actual behavior after retirement, but it does serve the purpose of giving you a ballpark of how much money you need to have saved (or conversely how much you can spend) to identify any gaps. In that respect, moving from assuming a 4% SWR to a % SWR is a pretty big deal!

Of course, I suspect that the majority of non-Bogleheads have no idea how much they need to have saved and are have no way of accomplishing it by the time they finally start to think of planning for retirement.

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Re: Are Even 3% Withdrawal Rates Excessive for Retirees Toda

Postby KyleAAA » Mon Nov 12, 2012 10:46 pm

nisiprius wrote:
KyleAAA wrote:No it doesn't, it takes that into account. People literally in absolute terms tend to spend less as they age, on average.
This seems to be a meme on the rise, but I flatly do not believe it... unless long-term-care and other healthcare costs are excluded, which would seem to be excluding the single biggest source of uncertainty there is in retirement costs.

Can you point me to the source that says people in retirement spend less as they age?


There are ample sources cited on the wiki
http://www.bogleheads.org/wiki/Models_o ... e-fisher-2
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Re: Are Even 3% Withdrawal Rates Excessive for Retirees Toda

Postby Angst » Mon Nov 12, 2012 10:52 pm

KyleAAA wrote:There are ample sources cited on the wiki
http://www.bogleheads.org/wiki/Models_o ... e-fisher-2


Which footnotes are you referring to? Surely not every one of them.
What numbers?
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Re: Are Even 3% Withdrawal Rates Excessive for Retirees Toda

Postby rmark1 » Mon Nov 12, 2012 11:18 pm

In this paper, I survey the recent literature on the behavior of consumption as households
transition to retirement. A large literature has emerged showing a “retirement consumption
puzzle”- a sharp decline in expenditures as households transition into retirement. However, after
aggregating the results of the literature, I show that the “retirement consumption puzzle” is a
misnomer. The only categories where consumption, on average, is consistently found to decline
upon retirement are work related expenses and food. Moreover, recent research shows that the
decline in food expenditures at the time of retirement is no puzzle at all given that actual food intake
remains constant through retirement. The falling food expenditure is due to the additional
allocation of time towards home production of food among retirees. Lastly, there is evidence
that there is a tremendous amount of heterogeneity in expenditure declines up retirement within
the population with households in the lowest pre-retirement wealth quartile experiencing the
largest expenditure declines. Some of this heterogeneity, however, can be explained by
households involuntarily retiring (often due to health shocks). But, there is also evidence that
some households do not accumulate enough resources during their working years to maintain
their marginal utility of consumption through retirement. In summary, I conclude that, for most
households, the “retirement consumption puzzle” is dead. Standard models of lifecycle
consumption augmented with home production and uncertain health shocks can explain the
consumption patterns of most households as they transition into retirement

From the Hurst paper in the Wiki
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Re: Are Even 3% Withdrawal Rates Excessive for Retirees Toda

Postby baw703916 » Mon Nov 12, 2012 11:23 pm

The best strategy is to start retirement with a huge pile of money.
Most of my posts assume no behavioral errors.
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Re: Are Even 3% Withdrawal Rates Excessive for Retirees Toda

Postby bmelikia » Mon Nov 12, 2012 11:55 pm

CyberBob wrote:There is an interesting Scott Burns article out recently that looks at the issue from a totally different angle; 30-year planning horizons bump up against the reality that you may expire long before your portfolio does.

Scott Burns wrote:The bottom line, however, is that death reduces the risk of running out of money more than does portfolio management.


Life, Death and How Long Your Money Will Last.

Bob


Wow! I have never thought about it like that before. Quite a refreshing dose of reality. . .Hopefully those of us concerned with our financial portfolios are equally concerned about our "health portfolio". I hope that both of them perform well. . . .
"I would rather die with money, than live without it...." - Bogleheads member Ron | | "The greatest enemy of a good plan, is the dream of a perfect plan." | -Bogle
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Re: Are Even 3% Withdrawal Rates Excessive for Retirees Toda

Postby HomerJ » Tue Nov 13, 2012 12:28 am

Simplegift wrote:lower expected returns currently being forecast for the two major asset classes over the coming decades


<Yawn>

The only thing I know for sure is not to trust anything that is being forecast over the coming DECADES.

We've had long periods of bad returns in the past, and the 4% rule of thumb was generated including those bad years....

If 4% could handle the worst possible periods from the last 80 years, I'd be very surprised if even 3% can't handle the worst possible periods going forward.
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Re: Are Even 3% Withdrawal Rates Excessive for Retirees Toda

Postby Simplegift » Tue Nov 13, 2012 1:49 am

HomerJ wrote:The only thing I know for sure is not to trust anything that is being forecast over the coming DECADES.

Homer, in the comments section of Wade's article above, he makes the point that his return assumptions do NOT have to apply to the entire 30-year retirement period. For someone retiring today, if the low returns only occur during the first 15 years or so of one's retirement period, it can easily create a portfolio depletion hole from which it's difficult to subsequently recover. Cheers.

Wade Pfau wrote:For a quick starter, do note that the assumptions here don't necessarily have to define the entire 30 year retirement period. With sequence of returns risk what happens in the early part of retirement matters a great deal more than what happens later on. Even if conditions "normalize" to the historical averages in 15 or 20 years, that will provide only a quite small amount of help to those retiring today. Wealth depletion in the mean time will be hard to overcome. It is like the worst-case scenario retiree from history: the 1966 retiree. The last half of this 30-year retirement was the 1980s and 1990s bull market, but by then it was too late, too much wealth was depleted to enjoy the recovery.
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Re: Are Even 3% Withdrawal Rates Excessive for Retirees Toda

Postby Clive » Tue Nov 13, 2012 4:14 am

richard wrote:
555 wrote:A portfolio with 0% real return with a 3.33% inflation indexed withdrawal rate has a 0% chance of failing in 30 years.

If you want a totally safe inflation indexed portfolio, and have more than a nominal amount invested, you're going to need TIPS. TIPS have negative real yields for almost all of the yield curve.

You'll also have a problem under this approach if you live for 31 years.

And don't forget tax risk! If you're paying 43% tax on 3.33% nominal gains = 1.9% net

There's also volatility risk. Even if over 30 years inflation averaged perhaps 3.3%, the route it took to get to that figure matters.

There's also personal inflation rate risk (your shopping basket differs from the national average basket from which inflation figures are calculated).
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Re: Are Even 3% Withdrawal Rates Excessive for Retirees Toda

Postby Mitchell777 » Tue Nov 13, 2012 8:26 am

CyberBob wrote:There is an interesting Scott Burns article out recently that looks at the issue from a totally different angle; 30-year planning horizons bump up against the reality that you may expire long before your portfolio does.

Scott Burns wrote:The bottom line, however, is that death reduces the risk of running out of money more than does portfolio management.


Life, Death and How Long Your Money Will Last.

Bob

Interesting. I have often thought about this in my planning. I think I can live with being 95% sure my money will last 40 years. But then when I add to that the chance of my actually living 40 more years, and combine the two, the odds of my running out of money before I die goes to a fraction of 1%. Of course, you still could run out of money
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Re: Are Even 3% Withdrawal Rates Excessive for Retirees Toda

Postby nisiprius » Tue Nov 13, 2012 8:51 am

Simplegift wrote:...if the low returns only occur during the first 15 years or so of one's retirement period, it can easily create a portfolio depletion hole from which it's difficult to subsequently recover.
And one will notice this as it is occurring.

That's the central issue that needs to be solved: what should you do, at what time, if you retire into a bear market and see your portfolio shrinking?

The commonsense approaches all involve short-term regulation. The whole point of SWR studies is to remove the need for short-term regulation and substitute a steady "sustainable" withdrawal rate. But such an approach is basically an encouragement to take on tail risk; when the plan works, it is much more comfortable than short-term adjustments, but when it doesn't, the failures are more serious because the need for adjustment has been stalled.

The commonsense approaches:
  • Taylor Larimore says "We simply withdrew what we needed and kept an eye on our portfolio balance," i.e. adjusted spending to portfolio performance on a fairly short-term basis. He uses the phrase "most years," suggesting year-by-year seat-of-the-pants adjustments.
  • The original Trinity study said: "The word planning is emphasized because of the great uncertainties in the stock and bond markets. Mid-course corrections likely will be required, with the actual dollar amounts withdrawn adjusted downward or upward relative to the plan. The investor needs to keep in mind that selection of a withdrawal rate is not a matter of contract but rather a matter of planning." It's not clear how frequent "course corrections" are assumed to be necessary.
  • And of course, the very old strategy, the only one possible before mutual funds made "total return" and arbitrary withdrawals feasible, was to live on the actual annual income generated by the investments, having tuned the portfolio to include investments with an appropriate balance of growth and income.
All of these involve living with and adjusting to substantial uncertainty, on a short-term year-to-year basis.

Now come along studies that ask "What happens if we do not want to do short-term seat-of-the-pants adjustments to uncertainty? Let's say we treat our portfolio as if it were an annuity and insist on drawing a stable, predetermined amount regardless of market performance. How big can that amount be?"

And, lo and behold, the results are: a) if you had a good statistical characterization of future performance, then you could produce a statistical characterization of outcomes. Interestingly enough, even on their own terms these studies are still recommending what is literally a crapshoot, in the sense that the probabilities of "portfolio exhaustion" displayed in most studies are higher than the probability of rolling snake-eyes.

b) If you proceed on the basis of what you think is the statistical characterization of future performance, and it turns out to be significantly lower than your assumptions, but you go ahead anyway--and the bear market lasts longer than the "average bear market," etc.--you're in serious trouble, because you've waited so long to make any adjustments.

Of course if the retiree retires into a bull market, anything will work. But, if someone retires into a bear market, what is the likely effect of being aware of SWR studies? Without the studies, the retiree is likely to get a little panicky and make some sharp and perhaps difficult adjustments promptly

Knowing a SWR study, or being advised by someone who knows one, the retiree is likely to rely on the study as justification for maintaining spending. Statistically the average bear market didn't last long enough to torpedo a constant-real-withdrawal; statistically the market usually comes roaring back in enough time to rescue you from what naïvely looks like short-term overspending, yadda yadda.

Except, of course, when it doesn't.

In short, the tendency of an SWR study, if taken seriously, would seem to be encourage risk-taking and to dawdle in making painful adjustments to bear markets.
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Re: Are Even 3% Withdrawal Rates Excessive for Retirees Toda

Postby Levett » Tue Nov 13, 2012 9:03 am

simplegift,

First, thank you for your many informative posts (and great graphics). You have a talent for cutting to the chase. :happy

"I have much admiration for Taylor Larimore, but your point about the date of his retirement is an indispensable piece of information--e.g.,
Nisi, your point is a good one (retirees will need to adjust spending for unpredictable asset returns) — but your example of Mr. Larimore is a stretch. When he retired in 1982, bond yields were over 14% and stocks were about to embark on a 20-year bull market run. Today's retirees won't have that bond tailwind or anything near the spending flexibility that he experienced."


The year 1982 and the beginning of the great wave of rising equity returns + falling interest rates coincided with my highest earning years and made my retirement 18 years later both possible and considerably earlier than I planned.

But, having retired in 2000, new challenges awaited me (as they always do), and like most folks I lowered my expectations and adjusted to the "flow."

Nothing I've said is deep, but Wade and you are right to identify the importance of "when" in all discussions of successfully executing a retirement plan.

Again, thanks for your excellent posts.

Lev
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Re: Are Even 3% Withdrawal Rates Excessive for Retirees Toda

Postby Leesbro63 » Tue Nov 13, 2012 9:07 am

I believe that I asked Rick Ferri, on here a while back, what HE does with his clients. And his answer, I think, was that he tries to have them "withdraw" or live on the income of their portfolio...interest and dividends. Which, as mentioned on this thread, was the "old school" way of doing things before we had enough computer power to play with and figure out "SWR". Currently if you do that with any sort of somewhat balanced portfolio you'd get a 2ish to 3ish percent income rate. And if you look at current concerns that 4% may be too high in the current environment, this "spend only the income" method sounds to me to be a reasonable common-sense way to plan for retirement spending. Plus it doesn't require knowing when to sell and is fairly automatic...garner the income then spend it!
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Re: Are Even 3% Withdrawal Rates Excessive for Retirees Toda

Postby HomerJ » Tue Nov 13, 2012 10:33 am

Simplegift wrote:
HomerJ wrote:The only thing I know for sure is not to trust anything that is being forecast over the coming DECADES.

Homer, in the comments section of Wade's article above, he makes the point that his return assumptions do NOT have to apply to the entire 30-year retirement period. For someone retiring today, if the low returns only occur during the first 15 years or so of one's retirement period, it can easily create a portfolio depletion hole from which it's difficult to subsequently recover. Cheers.

Wade Pfau wrote:For a quick starter, do note that the assumptions here don't necessarily have to define the entire 30 year retirement period. With sequence of returns risk what happens in the early part of retirement matters a great deal more than what happens later on. Even if conditions "normalize" to the historical averages in 15 or 20 years, that will provide only a quite small amount of help to those retiring today. Wealth depletion in the mean time will be hard to overcome. It is like the worst-case scenario retiree from history: the 1966 retiree. The last half of this 30-year retirement was the 1980s and 1990s bull market, but by then it was too late, too much wealth was depleted to enjoy the recovery.


But that worst case scenario guy from 1966 didn't run out of money over 30 years even with a 4% withdrawal rate...

So why should we go below 4% (or 3%!) now?

The reason the rule of thumb number is 4% and not 5% is because the 1966-1996 numbers are in there.... 4% already covers the exact scenario Wade Pfau is describing...

I say it's all recency basis... "Things have been kind of bad for 10 years, I bet things will continue to be bad for another 15-20 years!"
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Re: Are Even 3% Withdrawal Rates Excessive for Retirees Toda

Postby HomerJ » Tue Nov 13, 2012 10:35 am

nisiprius wrote:In short, the tendency of an SWR study, if taken seriously, would seem to be encourage risk-taking and to dawdle in making painful adjustments to bear markets.


Good point. SWR is just a rule of thumb... If you retire into a bear market, cut back spending a little. It's not rocket science.
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Re: Are Even 3% Withdrawal Rates Excessive for Retirees Toda

Postby Dandy » Tue Nov 13, 2012 10:53 am

With bond and money market rates so low it probably means that "safe" withdrawal rates are a bit less "safe". These rates may return to "normal" but there will be some dips in bond values for a few years. As always, can't use a rule of thumb as more than a guide. It is always wise to trim back targeted withdrawal rates a bit early than to follow the rule.

I'm not the type to wait for the governer's call to evacuate my home on a barrier island - I'm gassed up and on my way well in advance. Of course I would not own a home on a barrier island. Same for the 4% - I would ease off my 4% withdrawals if possible early until a better investment climate arrived. That doesn't mean get out of the market and go all in on CDs. Stay the course. Just trim your expenses a bit or delay or scale down large purchases/debt.
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Re: Are Even 3% Withdrawal Rates Excessive for Retirees Toda

Postby Leesbro63 » Tue Nov 13, 2012 10:55 am

HomerJ wrote:
But that worst case scenario guy from 1966 didn't run out of money over 30 years even with a 4% withdrawal rate...

So why should we go below 4% (or 3%!) now?

The reason the rule of thumb number is 4% and not 5% is because the 1966-1996 numbers are in there.... 4% already covers the exact scenario Wade Pfau is describing...

I say it's all recency basis... "Things have been kind of bad for 10 years, I bet things will continue to be bad for another 15-20 years!"


Homer, you make a good point. I think for many of us, the REAL goal isn't just SWR, but SWR without a declining balance! Surviving 30 years is no fun if your nest egg keeps dwindling. I'm not sure that it's realistic to expect a 2-3% withdrawal rate AND an increasing balance, but that's what I hope for! :wink:
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Re: Are Even 3% Withdrawal Rates Excessive for Retirees Toda

Postby Cut-Throat » Tue Nov 13, 2012 11:00 am

Leesbro63 wrote:Homer, you make a good point. I think for many of us, the REAL goal isn't just SWR, but SWR without a declining balance! Surviving 30 years is no fun if your nest egg keeps dwindling. I'm not sure that it's realistic to expect a 2-3% withdrawal rate AND an increasing balance, but that's what I hope for! :wink:


Not me!.....Ideally, I'd like the check to the undertaker to bounce. I don't really want to leave anything on the table.
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Re: Are Even 3% Withdrawal Rates Excessive for Retirees Toda

Postby dbr » Tue Nov 13, 2012 11:28 am

HomerJ wrote:But that worst case scenario guy from 1966 didn't run out of money over 30 years even with a 4% withdrawal rate...

So why should we go below 4% (or 3%!) now?

The reason the rule of thumb number is 4% and not 5% is because the 1966-1996 numbers are in there.... 4% already covers the exact scenario Wade Pfau is describing...

I say it's all recency basis... "Things have been kind of bad for 10 years, I bet things will continue to be bad for another 15-20 years!"


Not really. There isn't enough data in historical SWR studies to know what the worst case scenario is given the conditional probability that we already know we are retiring into an expectation of poor returns in initial years. Already such studies only consider four or five really bad times to retire out of only a hundred or so total scenarios, making estimates of probabilities very uncertain.

A missing component in all these calculations is that there are no published measures of uncertainty around the results.

Wade, have you considered plotting your charts with error bars around the predicted values of failure rate? I meant to add that what really needs to be known is the sensitivity to withdrawal rate relative to the error. A different statistic that might be more revealing is how much uncertainty is there in the withdrawal rate required to achieve less than x failure rate for y years. It is inherent in the method that 0% failure rate is not a meaningful computation.
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Re: Are Even 3% Withdrawal Rates Excessive for Retirees Toda

Postby K-Bogle » Tue Nov 13, 2012 11:28 am

Leesbro63 wrote:Homer, you make a good point. I think for many of us, the REAL goal isn't just SWR, but SWR without a declining balance! Surviving 30 years is no fun if your nest egg keeps dwindling. I'm not sure that it's realistic to expect a 2-3% withdrawal rate AND an increasing balance, but that's what I hope for! :wink:


Interesting. I guess old habits die hard particularly the older you get. Strikes me this can lead to a lot of undue stress in my later years. I wonder if those living paycheck to paycheck and on credit cards, assuming they are still contributing to a retirement account, won't find it as painful to watch their balance decrease as they make withdrawals later in life.
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Re: Are Even 3% Withdrawal Rates Excessive for Retirees Toda

Postby Leesbro63 » Tue Nov 13, 2012 11:42 am

The paycheck to paycheck people have a much smaller drop off distance than us financial responsibility guys, thus a softer fall :oops:
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Re: Are Even 3% Withdrawal Rates Excessive for Retirees Toda

Postby dkturner » Tue Nov 13, 2012 12:13 pm

Simplegift wrote:
More instructive for today might be to hear from a 1950 retiree, rather than a 1982 retiree. :wink:

Image
Source: Business Insider


This peeked my curiosity, so I tried your suggestion out. A worker who retired 12/31/1950, with a portfolio invested 50/50 S&P 500 / long-term treasuries would have experienced a 5.7% nominal (1.3% real) annualized return over the ensuing 30 years. If long-term corporates are substituted for treasuries the annualized return increases to 7.1% nominal (2.7% real).

Grandpa said he wished he had been born 30 years later. :wink:
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Re: Are Even 3% Withdrawal Rates Excessive for Retirees Toda

Postby richard » Tue Nov 13, 2012 12:20 pm

There are essentially two possible outcomes:

1) You don't spend as much as you could, leaving something on the table

2) You run out of money (or have to severely curtail spending)

In analyzing how hard you want to push withdrawal rates, consider which would be the worse outcome for you. There is no good way to tell in advance what a truly safe rate will be.
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Re: Are Even 3% Withdrawal Rates Excessive for Retirees Toda

Postby nisiprius » Tue Nov 13, 2012 12:29 pm

dbr wrote:Wade, have you considered plotting your charts with error bars around the predicted values of failure rate? I meant to add that what really needs to be known is the sensitivity to withdrawal rate relative to the error. A different statistic that might be more revealing is how much uncertainty is there in the withdrawal rate required to achieve less than x failure rate for y years. It is inherent in the method that 0% failure rate is not a meaningful computation.
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Re: Are Even 3% Withdrawal Rates Excessive for Retirees Toda

Postby BigFoot48 » Tue Nov 13, 2012 12:30 pm

Leesbro63 wrote:Homer, you make a good point. I think for many of us, the REAL goal isn't just SWR, but SWR without a declining balance! Surviving 30 years is no fun if your nest egg keeps dwindling. I'm not sure that it's realistic to expect a 2-3% withdrawal rate AND an increasing balance, but that's what I hope for! :wink:

I have a graph of my withdrawal rates over the past 10 years, and added a line showing the IRA balance. So far I'm up despite the withdrawals, which I'm a bit amazed at! (Balance is on second Y axis on right with amounts omitted. WR dropped when SS started two years ago.)
Image
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Re: Are Even 3% Withdrawal Rates Excessive for Retirees Toda

Postby Jerry_lee » Tue Nov 13, 2012 12:31 pm

nisiprius wrote:In 1998, the Wall Street Journal Guide To Planning Your Financial Future: The Easy-To-Read Guide to Planning for Retirement said to use these as planning numbers.

Image

In 2012, Wade Pfau says to use these as planning numbers.

Image


Without having read this entire thread, I take the above post to imply that those results were wildly optimistic going forward. But I took a look at a diversified global equity asset class index allocation starting in 1999 (20% S&P 500, 20% US large value, 30% US small value, 10% Int'l value, 10% Int'l small value, and 10% EM value) and find the returns through September 2012 were +9.1% per year. 5YR T-Notes were +5.6% per year. An annually rebalanced 60/40 mix of the above earned +8.7%, or about $8,700/year on a $100,000 investment (obviously returns varied per year), very close to what the first table forecasted.

As to Table 3, I don't really know what to say about that. You might want to use that as a quasi worst case scenario, or something you need to be able to adapt to in the remote chance it comes true. But to use that as your baseline is excessively pessimistic. Looking at just US stocks (TSM or S&P 500), a 4-5% real return is much more realistic (6% to 7% nominal assuming 2% inflation), and short/intermediate bonds of relatively high quality should benefit from rising rates eventually and see 1-2% real returns over our lifetime (3% to 4%). Further, it is reasonable to add about 1.5% for large value and small market, and another 1.5% for small value (8.5%/8.5%/10% respectively). Normally, we'd assume the same returns from non-US developed markets, but they are extremely depressed with much lower earnings multiples. So I'd add another 1% for EAFE, 2% for Int'l Value and Int'l Small, and 2% more for Int'l Small Value (8%, 10%, 10%, and 12%). And EM probably deserves a 2% premium above US stocks, with a 3% addition for market-wide value companies and 2% for EM small stocks.

Looking at the period above (1999-2012), there was a 1% per year "diversification return" on the 60/40 portfolio (that measures the difference in return between the weighted average of the asset class components and the actual portfolio return), so if we cut that in half to be conservative, we have to add another 0.5% to a balanced portfolio's expected return.

In doing so, I get a geometric expected return of about 7.5%. If we feed that into a Monte Carlo simulator using historical volatility (1928-2011) of 15.0 (we have to use arithmetic returns in MC simulations, so I'll add 1% to the 7.5%), we find that a 3% withdrawal over 30 years lasts 96% of the time. Even at 4%, the portfolio lasts 90% of the time. And, of course, MC assumes you take $ from stocks and bonds every year mechanically, whether they are up or down. If you instead take $ from the side of the portfolio that is doing best recently ("rebalancing with cash-flows"), you come out a bit further ahead by not locking in equity declines during painful but often temporary declines.

So while everyone's estimates are just that: estimates, it doesn't appear as though the "old rules" of retirement planning are materially different today. A bit lower expected returns (assuming no P/E expansion), a bit lower expected inflation. Stay the course, stick with your plan, keep it simple, and be flexible, but don't be too quick to make wholesale adjustments based on the new-era thinking of the day -- you'll experience a half-dozen of these paradigm shifts over the course of an investment lifetime, and you probably won't need to act on any of them.
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Re: Are Even 3% Withdrawal Rates Excessive for Retirees Toda

Postby ResNullius » Tue Nov 13, 2012 12:52 pm

What has happened to using some common sense? Continuing to strive for the perfect and absolutely certain withdrawal rate is a waste of time. The only things in life that are certain are death and taxes. If you want to start with 3% and adjust as needed, then do it. If you want to start with 4%, then do it, same for 5%. Just use some common sense. The lower the withdrawal rate, the safer you are in terms of longevity of portfolio life. Living a decent lifestyle is important, so just do it until the numbers say you should adjust upward or downward. You really can't go wrong with 4%, same for 3%, same for 2%, same for 1%. Things could get risky as you move up to 5% or 6%, but a lot depends on how much you start with, how much you need, and whether you care about leaving an inheritance. Endlessly debating the unknown seems like such a waste of time.
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Re: Are Even 3% Withdrawal Rates Excessive for Retirees Toda

Postby Jerry_lee » Tue Nov 13, 2012 1:05 pm

ResNullius wrote:What has happened to using some common sense? Continuing to strive for the perfect and absolutely certain withdrawal rate is a waste of time. The only things in life that are certain are death and taxes. If you want to start with 3% and adjust as needed, then do it. If you want to start with 4%, then do it, same for 5%. Just use some common sense. The lower the withdrawal rate, the safer you are in terms of longevity of portfolio life. Living a decent lifestyle is important, so just do it until the numbers say you should adjust upward or downward. You really can't go wrong with 4%, same for 3%, same for 2%, same for 1%. Things could get risky as you move up to 5% or 6%, but a lot depends on how much you start with, how much you need, and whether you care about leaving an inheritance. Endlessly debating the unknown seems like such a waste of time.


:sharebeer

I should have just said that and saved myself the effort of my previous post!
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Re: Are Even 3% Withdrawal Rates Excessive for Retirees Toda

Postby pc95 » Tue Nov 13, 2012 2:12 pm

While you can't control return rates on stocks, bonds, interest etc, you can always try to goto (or back to) part-time or (gasp) full-time work again.
I'm a long ways from retirement, but get the general feeling that there's no such thing as saving too much. Dying with a large balance to give to others sounds a bunch better than scrambling to replenish the coffers or worse yet broke and ill/unable to.
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Re: Are Even 3% Withdrawal Rates Excessive for Retirees Toda

Postby dbr » Tue Nov 13, 2012 2:17 pm

BigFoot48 wrote:
Leesbro63 wrote:Homer, you make a good point. I think for many of us, the REAL goal isn't just SWR, but SWR without a declining balance! Surviving 30 years is no fun if your nest egg keeps dwindling. I'm not sure that it's realistic to expect a 2-3% withdrawal rate AND an increasing balance, but that's what I hope for! :wink:

I have a graph of my withdrawal rates over the past 10 years, and added a line showing the IRA balance. So far I'm up despite the withdrawals, which I'm a bit amazed at! (Balance is on second Y axis on right with amounts omitted. WR dropped when SS started two years ago.)
Image


Don't forget that a withdrawal rate based on high success in the worst case guarantees that almost all actual cases result in significant end point wealth, indeed even fabulous end-point wealth. Your actual experience above is just an example from somewhere out of the middle of the possibilities. In some scenarios you could have seen a doubling your IRA balance in ten years after withdrawals. That is why a standard criticism in the finance community is that funding retirement from stock and bond portfolios is a very inefficient use of resources.
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Re: Are Even 3% Withdrawal Rates Excessive for Retirees Toda

Postby mptfan » Tue Nov 13, 2012 2:38 pm

Angst wrote:
KyleAAA wrote:There are ample sources cited on the wiki
http://www.bogleheads.org/wiki/Models_o ... e-fisher-2


Which footnotes are you referring to? Surely not every one of them.
What numbers?

Try this...

"Retirement spending trends observed for the average U.S. retiree include the following:
Spending drops modestly (14%) immediately after retirement, partly due to the cessation of work-related expenses (e.g. special clothing and transportation) and changes in food expenditures.
Inflation-adjusted spending continues dropping slowly afterwards as retirees age into their late 70's.
Housing + Related is by far the largest spending category for all age groups.
Health Care expenses rise with age, but remain substantially lower than housing expenses.
Increases in health care spending are not sufficient to change the downward trend in total inflation-adjusted spending, at least not until late in retirement.
Studies of retirement spending patterns across racial and income level subgroups reveal measurable heterogeneity in U.S. retirement spending. Since housing is the largest retirement expense, it is not surprising that such differences are clearly seen in this category. The size of the typical spending drop upon retirement is inversely related to household wealth (poorer hourseholds exhibiting on average a much larger spending drop). However not all retirees exhibit a spending drop: about 53% of households exhibit a drop in spending at retirement, another 35% report a negligible change in spending at retirement, while 12% reported an increase in spending at retirement."

http://www.bogleheads.org/wiki/Surveys_ ... t_spending

It's a free country, you can believe whatever you want, even if the data does not support it. :D
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Re: Are Even 3% Withdrawal Rates Excessive for Retirees Toda

Postby 1210sda » Tue Nov 13, 2012 3:07 pm

Nothing wrong with trying to maintain the same nest egg. However, in 30 yrs (at 3.1% inflation) the value will be worth only 40% of what it's worth today.
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Re: Are Even 3% Withdrawal Rates Excessive for Retirees Toda

Postby wade » Tue Nov 13, 2012 10:26 pm

dbr wrote:Wade, have you considered plotting your charts with error bars around the predicted values of failure rate? I meant to add that what really needs to be known is the sensitivity to withdrawal rate relative to the error. A different statistic that might be more revealing is how much uncertainty is there in the withdrawal rate required to achieve less than x failure rate for y years. It is inherent in the method that 0% failure rate is not a meaningful computation.


Interesting discussion. Simplegift, thanks for starting it.

Nisiprius, I totally agree that the inflexibility of the constant inflation-adjusted spending strategy renders it useless. Playing the game of chicken until wealth is depleted is about the worst income strategy possible, as I've tried testing with a variety of outcome measures. I merely provided the figure about failure rates as a sort of benchmark for comparison, since people are familiar with that criterion.

The whole safe withdrawal rate as an income strategy seems to be a historical accident. It originally started with Bill Bengen just demonstrating that due to sequence of returns risk, the sustainable spending rate from a volatile portfolio is quite a bit lower than the average return on that portfolio. Then the Trinity study came a long as defined "success rates" and "failure rates" with this sort of strategy, and it entered the public consciousness that this is how retirement works, and failure is bad, and here is the probability of failure for your strategy based on a historical average, rather than the market conditions of today.

dbr, I'm not sure I'm following your request: are you asking for error bands around the curves showing failure rates? I'm not sure how that would work out in practical terms, as there isn't really an error band if you just increase the sample size further. The way to introduce an error band would be to have a distribution for your asset returns assumption distributions, but that still requires assumptions and may not help matters. Would an acceptable alternative be to just show the distribution of remaining wealth in order to give a better idea about how far away from failure the strategy may put you, or the magnitude of failure if you do run out. I have considered this sort of approach.
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Re: Are Even 3% Withdrawal Rates Excessive for Retirees Toda

Postby bornloser » Tue Nov 13, 2012 10:59 pm

CyberBob wrote:There is an interesting Scott Burns article out recently that looks at the issue from a totally different angle; 30-year planning horizons bump up against the reality that you may expire long before your portfolio does.

Scott Burns wrote:The bottom line, however, is that death reduces the risk of running out of money more than does portfolio management.


Life, Death and How Long Your Money Will Last.

+1. I think two very important variables are best guess at the age you are going to check out (an educated estimate based on family, lifestyle, etc) and if you want to leave an estate. Got one colleague in a casket for viewing tonight (age 72), one colleague in the ICU (age 69) and a partner that passed last February at 66. All the hoopla about planning to have enough retirement for age 95 is really overkill, IMHO. And if you do not plan to leave an estate, I will remind you that the poor do pretty well in this nation. If I make it to age 90, will I really care if I have to ask for a government handout?
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Re: Are Even 3% Withdrawal Rates Excessive for Retirees Toda

Postby archbish99 » Wed Nov 14, 2012 3:51 am

nisiprius wrote:That's the central issue that needs to be solved: what should you do, at what time, if you retire into a bear market and see your portfolio shrinking?

The commonsense approaches all involve short-term regulation. The whole point of SWR studies is to remove the need for short-term regulation and substitute a steady "sustainable" withdrawal rate. But such an approach is basically an encouragement to take on tail risk; when the plan works, it is much more comfortable than short-term adjustments, but when it doesn't, the failures are more serious because the need for adjustment has been stalled.


I know we've had this conversation before, but that's what I like about Guyton's papers. His portfolio management ideas are (to be gentle) obtuse and unclear, but he proposes rules by which you can do short-term regulation more systematically, along with Monte Carlo simulations demonstrating a much higher initial withdrawal rate (5-6%) can be supported if you're willing to do that regulation.

In short, you start with a target withdrawal percentage, let's say 5%, and tentatively plan to inflation-adjust that annually. If, at year-end, you find that the inflation adjusted amount for the next year is more than 6% (initial percentage + 20%), cut the inflation-adjusted amount by 10% as a belt-tightening step. If instead it's less than 4% (initial percentage - 20%), increase it by 10% to enjoy your bounty. He has some nuances about tossing or relaxing the upper limit as your life expectancy decreases, but it's essentially a set of guard rails around the target SWR.
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Re: Are Even 3% Withdrawal Rates Excessive for Retirees Toda

Postby wade » Wed Nov 14, 2012 7:42 am

bornloser wrote:
CyberBob wrote:There is an interesting Scott Burns article out recently that looks at the issue from a totally different angle; 30-year planning horizons bump up against the reality that you may expire long before your portfolio does.

Scott Burns wrote:The bottom line, however, is that death reduces the risk of running out of money more than does portfolio management.


Life, Death and How Long Your Money Will Last.

+1. I think two very important variables are best guess at the age you are going to check out (an educated estimate based on family, lifestyle, etc) and if you want to leave an estate. Got one colleague in a casket for viewing tonight (age 72), one colleague in the ICU (age 69) and a partner that passed last February at 66. All the hoopla about planning to have enough retirement for age 95 is really overkill, IMHO. And if you do not plan to leave an estate, I will remind you that the poor do pretty well in this nation. If I make it to age 90, will I really care if I have to ask for a government handout?


The point Scott Burns makes is important. Because survival probabilities decline with age, it is rational to plan for spending declines. It doesn't make sense to plan for spending the same amount at 100 as at 65. As such, this means you can spend at a higher rate at the start of retirement than if you assume constant inflation-adjusted spending throughout retirement.

Nonetheless, people will have different feelings about how big the reduction should be. It depends on what Moshe Milevsky calls longevity risk aversion, and what some co-authors and I call spending flexibility.

Here is an example in the case of an assumed 0% real return:

Image
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