Variable Percentage Withdrawal (VPW)

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longinvest
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Re: Variable Percentage Withdrawal (VPW)

Post by longinvest » Sun Oct 09, 2016 5:13 pm

LadyGeek wrote:longinvest,

The Answer is inside the SPIA question and I totally missed the intent. Perhaps others have missed this point as well?

Would a user simply reduce the amount of the initial portfolio, or, is a portfolio final value (lower limit, floor) needed?

===============

Suggestion: Copy-n-paste the F.A.Q into the "Instructions" worksheet. This is important information that should be available within the spreadsheet directly.

LadyGeek,

You are right; things are currently disorganized. The FAQ should probably be moved into the wiki, too. Since the time I wrote the FAQ, I've learned quite a few things and my view of retirement planning has evolved.

I'll include the FAQ in the next spreadsheet version.
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Re: Variable Percentage Withdrawal (VPW)

Post by BlueEars » Sun Oct 09, 2016 5:32 pm

longinvest wrote:
LadyGeek wrote:longinvest,

The Answer is inside the SPIA question and I totally missed the intent. Perhaps others have missed this point as well?

Would a user simply reduce the amount of the initial portfolio, or, is a portfolio final value (lower limit, floor) needed?

===============

Suggestion: Copy-n-paste the F.A.Q into the "Instructions" worksheet. This is important information that should be available within the spreadsheet directly.

LadyGeek,

You are right; things are currently disorganized. The FAQ should probably be moved into the wiki, too. Since the time I wrote the FAQ, I've learned quite a few things and my view of retirement planning has evolved.

I'll include the FAQ in the next spreadsheet version.

The sentence in blue caught my eye. I've seen some experts evolve their views quite radically (Bernstein comes to mind). Several "experts" are pretty young and even very well off. This is as opposed to those who are living through the retirement planning process and will be more versed in their particular tradeoffs. I do wonder how expert anyone can be beyond some general tools and directions.

I do want to emphasize that I really appreciate all the views expressed in this thread and the hard work that has gone into VPW.

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Re: Variable Percentage Withdrawal (VPW)

Post by longinvest » Sun Oct 09, 2016 6:34 pm

BlueEars wrote:I've seen some experts evolve their views quite radically (Bernstein comes to mind).

BlueEars,

It's nothing as dramatic as that. I've only learned more, since then, about how to coherently combine VPW, delayed Social Security (with a bridging TIPS ladder), and SPIAs (bought late in life) within a retirement plan; that's all.
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Re: Variable Percentage Withdrawal (VPW)

Post by AlohaJoe » Sun Oct 09, 2016 7:16 pm

longinvest wrote:Somehow, insurance companies know a few things that escape many of us. At age 65, they are able to offer inflation-indexed SPIA payouts, which have no volatility whatsoever, that are more attractive* than a VPW percentage with a Last Withdrawal Age of 120 (which would expose the retiree to volatile portfolio withdrawals).


Reichling & Smetters's 2013 paper from the Congressional Budget Office, "Optimal Annuitization and Stochastic Mortality Probabilities", showed that only about 10% of households should annuitize.

even under conservative assumptions, it is indeed not optimal for most households to annuitize any wealth; many young households should actually short annuities.


Even though I personally am in favor of annuities, I recognise that my circumstances happen to put me in that range of 10% that Reichling & Smetters identify; I don't think it is clear that insurance companies know things that escape others.

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Re: Variable Percentage Withdrawal (VPW)

Post by longinvest » Mon Oct 10, 2016 9:45 am

AlohaJoe wrote:
longinvest wrote:Somehow, insurance companies know a few things that escape many of us. At age 65, they are able to offer inflation-indexed SPIA payouts, which have no volatility whatsoever, that are more attractive* than a VPW percentage with a Last Withdrawal Age of 120 (which would expose the retiree to volatile portfolio withdrawals).


Reichling & Smetters's 2013 paper from the Congressional Budget Office, "Optimal Annuitization and Stochastic Mortality Probabilities", showed that only about 10% of households should annuitize.

even under conservative assumptions, it is indeed not optimal for most households to annuitize any wealth; many young households should actually short annuities.


Even though I personally am in favor of annuities, I recognise that my circumstances happen to put me in that range of 10% that Reichling & Smetters identify; I don't think it is clear that insurance companies know things that escape others.

AlohaJoe,

I read parts of the paper (not all of it, because it is quite complex with lots of advanced mathematics) and I think that this paper actually agrees with common sense:
  • When young, one should buy life insurance (that's what shorting an annuity means).
  • When in late age, one should buy SPIAs with a part of accumulated wealth when Social Security is insufficient.

One of the paper's main objectives was to discredit the conclusion of Yaari (1965) about putting 100% of one's wealth into SPIAs at retirement in absence of bequest motives.

About the impressive 10% of households. See the explanation below Table 5: Fraction of wealth annuitized and fraction of households with any annuities, for the entire population, retirees, and non-retirees at different levels of management fees and bequest motives. It makes sense that the household of a 30-years old couple with children should buy life insurance rather than annuities! In that table, the 10% of all households becomes 27% when considering retired households alone (all retirees, including the many below age 80). This all makes a lot of sense when considering the population's (and retirees) age distribution.

Anyway, I think that it is the task of each person to apply common sense to their own situation. I am of the opinion that longevity risk should be avoided without paying too much for it and without crippling liquidity. Securing a floor of lifelong income by delaying Social Secutity to 70, bridging the gap using a TIPS ladder (or something relatively equivalent), and, when necessary, buying inflation-indexed SPIAs late in life with part of one's wealth (while they are still available, which means when one approaches age 80, after which fewer companies continue to sell SPIAs) accomplishes this. Of course, VPW would guide portfolio withdrawals all along.

It is quite possible that some retirees will get a sufficient income floor just from delayed Social Security (sometimes with an additional work pension). I think that an inflation-indexed SPIA should only be bought late in life when necessary to eliminate longevity risk.
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Re: Variable Percentage Withdrawal (VPW)

Post by jaj2276 » Sun Dec 18, 2016 3:34 pm

I just donated a good sum of money to a Vanguard Donor Advised Fund (seeded by appreciated stock to boot). I want to optimize my yearly distributions given the performance of the investment portfolio and have an idea for how long I expect this amount to last. Wouldn't VPN help me with this? Seems like I would select my current age, the amount I donated, the allocation, and the # of years I expect the money to last and VPN would do the rest. Yes?

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Re: Variable Percentage Withdrawal (VPW)

Post by BlueEars » Sun Jan 22, 2017 4:56 pm

Some time ago we talked about using VPW and accumulating a reserve with the unspent year's money. One would invest this money in some low risk investment such as CD's or short term bonds or even Tbills. For those of us who don't need all the percentage VPW says we can spend, this can be used to even out a possible bad set of down years like what was experienced starting with 1968. Right after 1968 there were two following bad recessions (1969 and 1973/74) and the bad inflation of the 1970's.

I wanted to see what would happen using a slightly modified VPW spreadsheet. So I basically added 2 columns. The reserve that is left unspent at the end of each year, and the accumulated reserve. Thus I assumed the same percentage spending as VPW but some of it was marked as available in future down years. The accumulated reserves were reduced in down years to correct the shortfall in the portfolio income.

Below is an example of this approach with the revised VPW. The couple had a $1M portfolio, drew $34000 from social security, and basically spent at a 3.1% rate from the portfolio. The first year they earmarked 1.4% of the portfolio for reserves. As we personally do, I separated the couple's spending into basics and fun (vacations, discretionary) spending. I am assuming that the reserves do not affect the fixed income returns very much. They will lower FI returns on average by the roughly the term premium for that percentage of FI used. Who knows, in a rising rate environment they might at least keep pace with intermediate bonds.

You can see that the cumulative reserves covered the difficult years up to age 80 for this example. The portfolio was still below the 50% of the start portfolio 15 years into this simulation i.e. the portfolio is still going to suffer overall in a bad sequence of years. Gives me more confidence in this use of VPW for our spending levels.

Image

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Re: Variable Percentage Withdrawal (VPW)

Post by AlohaJoe » Mon Jan 23, 2017 2:58 am

BlueEars wrote:Below is an example of this approach with the revised VPW. The couple had a $1M portfolio, drew $34000 from social security, and basically spent at a 3.1% rate from the portfolio.


I don't quite follow the example. It seems like you're saying "the couple has a fixed need of $65,000 a year. $34,000 comes from Social Security, leaving $31,000 from their portfolio. Instead of withdrawing whatever VPW says, what happens if we just withdraw $31,000 a year?"

That seems equivalent to saying, "Is a 3.1% inflation-adjusted withdrawal rate safe over a certain period of time?" The answer to which is yes, most people think it is safe over most time periods. But withdrawing an inflation-adjusted fixed amount seems to have little to do with VPW.

There is the slight twist of putting (small) amounts of "excess funds" into bonds but I'm not sure it is ever enough to be worth the effort.

I looked at something similar. After all, I agree you that, intuitively "VPW says to withdraw X but I only need 80% of X to be extremely happy" seems to suggest there is some room to do something with the 80%-X portion.

I didn't seriously pursue it but these were the rules I came up with:

- Every year run a PMT calculation. If you are spending more than this, then you need to cut spending.
- If you are spending less than this, then you have Excess Moneys.
- You can do two things with Excess Moneys: convert them to bonds (to de-risk your portfolio) or increase your standard of living. In regular VPW, 100% of the gains go to increasing your standard of living. The theory is that doing in incrementally like this will buffer you from future spending cuts.
- Withdrawals will draw from bonds preferentially if we've used Excess Moneys to buy extra bonds. That is, if we have "extra" bonds, we'll sell those first.

Let's say that whenever there is Excess Moneys you take 25% of it for lifestyle creep and the rest goes into bonds. And let's put a cap saying if we ever get to double our original standard of living we say enough is enough and just shovel everything into bonds. Obviously all of those are subject to lots of discussion.

I called this strategy "PMTPrime" in the following graphs.

For a 1990-2010 retiree things look like this:

As expected, income grew more slowly that raw VPW. We still had some nasty spending shocks, so already the strategy is looking a bit questionable.
Image

The bond percentages went as high as 50%, whereas they stay flat at 40% in VPW.
Image

And we do end up having slightly higher portfolio values at most points in time
Image

But 1990 was a pretty standard year. I just picked it because it was a nice round number. What about some bad years like 1966? Does this strategy help us weather that storm better?

Hmmm....not really.
Image
Image

Mainly because we never have enough good years to build up any kind of cushion

Image

After playing with it a bit, I couldn't really decide what problem it was solving, so I didn't explore it further.

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Re: Variable Percentage Withdrawal (VPW)

Post by BlueEars » Mon Jan 23, 2017 10:30 am

AlohaJoe wrote:
BlueEars wrote:Below is an example of this approach with the revised VPW. The couple had a $1M portfolio, drew $34000 from social security, and basically spent at a 3.1% rate from the portfolio.


I don't quite follow the example. It seems like you're saying "the couple has a fixed need of $65,000 a year. $34,000 comes from Social Security, leaving $31,000 from their portfolio. Instead of withdrawing whatever VPW says, what happens if we just withdraw $31,000 a year?"

That seems equivalent to saying, "Is a 3.1% inflation-adjusted withdrawal rate safe over a certain period of time?" The answer to which is yes, most people think it is safe over most time periods. But withdrawing an inflation-adjusted fixed amount seems to have little to do with VPW.

There is the slight twist of putting (small) amounts of "excess funds" into bonds but I'm not sure it is ever enough to be worth the effort.


As mentioned, I am retired and actually using this stuff. I need to be very explicit about my strategy and not just guess that things would have worked out in the past. If I did this example right, then that gives me more confidence.

What my example use of VPW shows is how to set up a small reserves fund to smooth out and cover spending needs. I'm just trying to explore (1) will having a reserve cover the needs in a bad set of years (2) how much reserve might be a good amount. In the example, the answer to (1) is yes, the left column covers those spending shortfall years shown in the next to the last column (red numbered years). Also regarding (2) the example suggests that since the left column is more then enough to cover the shortfall years, we might bump up the couple's basic spending or the couple might cap their reserve at say $40,000.

Note the "excess funds" are not to be put into just "bonds". This should go into a short term investment that is rolled over so that it can keep up with inflation and be there for spending when needed i.e. the duration should probably be 2 years or shorter. Also we do not have to let this excess grow too large and the VPW simulation can suggest where to cap it.

In simulations for our actual case (not the example), the reserve grew to something like 8% of the portfolio and then declined (starting in 1975 for the 1968 starting sequence) and our spending level was 3.3%. The 3.3% spending is what we have actually been averaging over the last 4 years.

It is just using VPW as a guide to smooth out spending should a very bad sequence emerge. This assumes one doesn't need all that VPW suggests. For those who really need all the VPW withdrawal amounts, this method does not help at all. They will just have to fully cut back spending should a really bad sequence emerge.

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Actual withdrawal

Post by billthecat » Tue Jan 24, 2017 2:54 pm

Why does the spreadsheet ask you to enter your actual withdrawal? It doesn't seem used anywhere. You already enter your starting balance the next year, which seems to be what matters, so it's not clear why it asks for your actual withdrawal.

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Re: Actual withdrawal

Post by BlueEars » Tue Jan 24, 2017 4:21 pm

billthecat wrote:Why does the spreadsheet ask you to enter your actual withdrawal? It doesn't seem used anywhere. You already enter your starting balance the next year, which seems to be what matters, so it's not clear why it asks for your actual withdrawal.

Hi, I notice this is your first post here. Welcome.

Are you asking about my spreadsheet view above from a few days ago? If so, this is just an experimental modification to Longinvest's official VPW. Those yellow boxes are my way of showing an input. They are only used for the column directly below it which is something I added for discussion purposes. They are then used to show the percentage actually spent and the difference is set aside as reserves. Since these columns are inflation adjusted they are basically constants in this example.

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Re: Actual withdrawal

Post by billthecat » Tue Jan 24, 2017 5:00 pm

BlueEars wrote:
billthecat wrote:Why does the spreadsheet ask you to enter your actual withdrawal? It doesn't seem used anywhere. You already enter your starting balance the next year, which seems to be what matters, so it's not clear why it asks for your actual withdrawal.

Hi, I notice this is your first post here. Welcome.

Are you asking about my spreadsheet view above from a few days ago? If so, this is just an experimental modification to Longinvest's official VPW. Those yellow boxes are my way of showing an input. They are only used for the column directly below it which is something I added for discussion purposes. They are then used to show the percentage actually spent and the difference is set aside as reserves. Since these columns are inflation adjusted they are basically constants in this example.


Hi - nope, I was referring to the spreadsheet available through the wiki. I was playing around with it, and didn't see why it asks for the actual withdrawal.

Second post! :happy

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Re: Actual withdrawal

Post by longinvest » Tue Jan 24, 2017 5:17 pm

billthecat wrote:Why does the spreadsheet ask you to enter your actual withdrawal? It doesn't seem used anywhere. You already enter your starting balance the next year, which seems to be what matters, so it's not clear why it asks for your actual withdrawal.


Billthecat,

It serves no other purpose than to keep track of the retiree's withdrawal history. This information would be lost otherwise, if the retiree's portfolio is on a glide path (such as "age in bonds"), because the recommended withdrawal amount changes when the asset allocation is changed.

longinvest
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Re: Variable Percentage Withdrawal (VPW)

Post by hiosilver » Tue Jan 24, 2017 5:19 pm

I believe it to be just for recording history. You're right, it has no bearing on the calculations.

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Re: Variable Percentage Withdrawal (VPW)

Post by billthecat » Tue Jan 24, 2017 6:42 pm

longinvest wrote:
billthecat wrote:Why does the spreadsheet ask you to enter your actual withdrawal? It doesn't seem used anywhere. You already enter your starting balance the next year, which seems to be what matters, so it's not clear why it asks for your actual withdrawal.


Billthecat,

It serves no other purpose than to keep track of the retiree's withdrawal history. This information would be lost otherwise, if the retiree's portfolio is on a glide path (such as "age in bonds"), because the recommended withdrawal amount changes when the asset allocation is changed.

longinvest


hiosilver wrote:I believe it to be just for recording history. You're right, it has no bearing on the calculations.


Thanks

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Re: Variable Percentage Withdrawal (VPW)

Post by sengsational » Mon Feb 13, 2017 6:06 pm

This is an interesting sheet / technique. I had not run into it until I started on a separate project that has the same kind of flavor to it.

Not wanting to hijack this thread, I've started a new one: https://www.bogleheads.org/forum/viewtopic.php?f=10&t=210958#p3237343

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Re: Variable Percentage Withdrawal (VPW)

Post by FrugalInvestor » Mon Feb 13, 2017 6:51 pm

Blueears, I like your concept and the modified spreadsheet (above) supporting it. It sounds like we're in a similar situation...retired and living off our our portfolios and, coincidentally, spending about 3.3% (this is prior to SS for me at this point).

I've been very interested in VPW but haven't implemented it because of uncertainty about what happens in the down years. So I've just been sticking with a rule of thumb 3.3% which seemed more conservative. However, I do try and keep a 'reserve' amounting to about 2 years of spending to prevent me from having to withdraw during a severe downturn. Your modified VPW sheet looks to take a somewhat similar approach in a more structured and programmed manner, which I like.

However, I'd like to stop being so conservative in my withdrawals if it's not necessary for our future security. My wife gets frustrated because she sometimes feels that we're passing up opportunities for (extra) enjoyment while we are still healthy and active. Finding a formula to allow myself to comfortably loosen the reins a bit would be very valuable.

I'll spend a little more time with it but so far I like your concept. I not only need something to guide me and give me financial comfort (especially during down markets) but also to pass along to my wife in the event something happens to me.

Thanks for your ideas.
Last edited by FrugalInvestor on Mon Feb 13, 2017 8:57 pm, edited 1 time in total.
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Re: Variable Percentage Withdrawal (VPW)

Post by siamond » Mon Feb 13, 2017 8:54 pm

sengsational wrote:This is an interesting sheet / technique. I had not run into it until I started on a separate project that has the same kind of flavor to it.

Not wanting to hijack this thread, I've started a new one: https://www.bogleheads.org/forum/viewtopic.php?f=10&t=210958#p3237343

You may want to check a series of posts starting here. One key idea basically combines VPW with a PE-based smoothing technique. I personally settled on something close to that.

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Re: Variable Percentage Withdrawal (VPW)

Post by BlueEars » Sun Feb 19, 2017 4:10 pm

FrugalInvestor wrote:Blueears, I like your concept and the modified spreadsheet (above) supporting it. It sounds like we're in a similar situation...retired and living off our our portfolios and, coincidentally, spending about 3.3% (this is prior to SS for me at this point).

I've been very interested in VPW but haven't implemented it because of uncertainty about what happens in the down years. So I've just been sticking with a rule of thumb 3.3% which seemed more conservative. However, I do try and keep a 'reserve' amounting to about 2 years of spending to prevent me from having to withdraw during a severe downturn. Your modified VPW sheet looks to take a somewhat similar approach in a more structured and programmed manner, which I like.

However, I'd like to stop being so conservative in my withdrawals if it's not necessary for our future security. My wife gets frustrated because she sometimes feels that we're passing up opportunities for (extra) enjoyment while we are still healthy and active. Finding a formula to allow myself to comfortably loosen the reins a bit would be very valuable.

I'll spend a little more time with it but so far I like your concept. I not only need something to guide me and give me financial comfort (especially during down markets) but also to pass along to my wife in the event something happens to me.

Thanks for your ideas.

Just got back from a short vacation. My wife too is into enjoying our later years and is a good counterpoint to my frugality. I think Longinvest's efforts are a great tool for testing out our spending models. It is rare to have such an open tool. What I showed above is not a new idea and was basically suggested by Longinvest. I've just tried to show the sequence of spending explicitly because it helps me to get comfortable with the ideas.

FWIW, for us I'm coming to the conclusion that the VPW withdrawal percentages can be somewhat managed to put aside our excess VPW withdrawals into a short term reserves fund (not subject to stock and intermediate term bond fluctuations). This helps in a sequence such as the one starting in 1966. It still doesn't prevent one from depleting the portfolio to around 50% (or below) of the initial value around 16 years into this 1966 start sequence. I'll just have to get comfortable with the idea that this kind of depletion is possible. That got one to 1982 which coincidentally started up a major bull market run.

One might also want to manage the reserves fund since the next years might be bad but not as bad as the 1966 sequence i.e. managing spending is still required going forward. One doesn't want to leave too much on the table. Might be forced to buy a new car. :wink:

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Re: Variable Percentage Withdrawal

Post by gilgamesh » Fri Jun 16, 2017 8:40 pm

longinvest wrote:Internally, VPW does calculate a long-term, asset-allocation-specific expected return rate, using the last century's real asset returns on US Stocks (5%) and Bonds (2%). This does not need to be precise at all. It just needs to give an approximate very long-term tangent of the graph. I've explained the intuition behind this in http://www.bogleheads.org/forum/viewtop ... 0#p1765039


Could someone please confirm the table in the boglehead VPW table assumes this historic return...that is 5% us stocks and 2% bonds. Thank you!

P.S: I wish it gave this information in the boglehead page here

https://www.bogleheads.org/wiki/Variabl ... withdrawal

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Re: Variable Percentage Withdrawal

Post by AlohaJoe » Fri Jun 16, 2017 9:36 pm

gilgamesh wrote:Could someone please confirm the table in the boglehead VPW table assumes this historic return...that is 5% us stocks and 2% bonds.


Go to the tab "Table" in the spreadsheet and look at that "VPW Parameters" area in the top right. Different versions of the spreadsheet will have slightly different numbers since longinvest would update it every year based on the most recent Credit Suisse report. It isn't based on US data. My version of the spreadsheet says

Based on the global (world) long-term growth of $1 from 1900 to 2015
according to the Credit Suisse Global Investment Returns Yearbook 2016.

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Re: Variable Percentage Withdrawal

Post by longinvest » Fri Jun 16, 2017 10:43 pm

Gilgamesh,

gilgamesh wrote:
longinvest wrote:Internally, VPW does calculate a long-term, asset-allocation-specific expected return rate, using the last century's real asset returns on US Stocks (5%) and Bonds (2%). This does not need to be precise at all. It just needs to give an approximate very long-term tangent of the graph. I've explained the intuition behind this in http://www.bogleheads.org/forum/viewtop ... 0#p1765039


Could someone please confirm the table in the boglehead VPW table assumes this historic return...that is 5% us stocks and 2% bonds. Thank you!


AlohaJoe provided the answer. The tables in the Wiki were calculated using an earlier version of the spreadsheet which had slightly different values. Note that I did not update the wiki's table last year, when I last updated the spreadsheet's internal rates, because precision is not important.

In the grand scheme of things, precision is really not important. Taking a withdrawals of 4.4% or 4.6% instead of 4.5% won't make a difference on the robustness of the withdrawal method. It's not like taking a 15% withdrawal, instead; that would make a difference.

In the spreadsheet, to avoid putting too arbitrary values, I've chosen long-term returns extracted from the Credit Suisse Global Investment Returns Yearbook. Unfortunately, in the 2017 version, the Yearbook doesn't provide the growth of $1 numbers anymore. So, when I'll update the spreadsheet with 2016 return data (didn't publish it yet), I'll probably leave the current values (based on growth from 1900 to 2015) in place.

Let me insist on it: Precision is not important at all here, given the huge uncertainties about future returns, and their annual variability.

gilgamesh wrote:P.S: I wish it gave this information in the boglehead page here

https://www.bogleheads.org/wiki/Variabl ... withdrawal


I wish I could easily summarize in the Wiki everything I've written in the Bogleheads forums about VPW, but this is a huge undertaking. One could easily write an entire booklet about VPW, its design, how to use it, and so on. It is a project of mine to work on making the wiki page more complete, someday. I just don't have the time, these days. For the time being, with the help of LadyGeek, I've tried to put the most important highlights into the Wiki page and provided a pointer to this thread.

This thread contains the main ideas and explanations, as well as a few pointers to posts in other threads. One could also look through my post history (clicking on my username), but I notice that I'm already up to more than 2,300 posts. There's a search feature, though, to filter posts. "VPW" would be a good keyword for that. :wink:

Finally, there's the fully open spreadsheet which provides all the details and formulas to recreate VPW tables from scratch, and which illustrates the use of VPW (along with base income: social security and pension) and how it would have behaved in the past (what is called backtesting).
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Re: Variable Percentage Withdrawal (VPW)

Post by longinvest » Sat Jun 17, 2017 8:31 pm

Gilgamesh,

You're lucky* that I was subscribed to the other thread, so I got notice of your reply.

* If you didn't notice, I am taking a leave from the Bogleheads forums, except for answering questions on some subscribed threads, when I get notice of a post.

In another thread:

viewtopic.php?p=3411924#p3411924
gilgamesh wrote:First of all, thank you for answering my question in the VPW thread, didn't want to thank you there and further clutter the thread.


You're welcome. It would be worse to scatter answers about VPW in other threads. So, I am replying here.

gilgamesh wrote:Isn't building either a TIPS ladder or CD the same as increasing bond exposure of the overall portfolio which you have shown reduces jitteriness on VPW withdrawal? I understand you don't recommend VPW as a stand alone retirement income strategy, and CD/TIPS ladder will be beneficial in that sense, but adding those just to smooth out WR is the same as increasing bond allocation to smooth it out, no?


No, it is not the same. I am proposing to use a non-rolling CD (or TIPS) ladder to build a predictable** income stream over a very specific time frame. While the non-rolling CD ladder carries some inflation risk, over the typical 7 years*** (from age 62 to 69) when it serves to fill the gap in delayed Social Security payments until age 70, the cumulative risk of inflation is low enough. The non-rolling CD ladder is very easy to build (easier than a non-rolling TIPS ladder) and it's often possible to find higher yielding CDs.

The role of the ladder is to deliver specific amounts of money on specific dates during a specific time period. It's effectively a do-it-yourself term-certain SPIA (Single Premium Immediate Annuity); it is not meant as the equivalent of a bond fund in a portfolio.

Like a SPIA, this income stream is not affected by stock or bond market fluctuations. While bond market fluctuations (or yields across the curve, if you prefer) affect the marked-to-market value of the non-rolling ladder, they don't affect the income stream, as there is no reinvestment risk whatsoever.

** The CD ladder allows for a predictable nominal income stream of increasing payments, hopefully matching inflation or beating it. A TIPS ladder would allow for a predictable real income stream.

*** Of course, the money for first year of the 8 missing Social Security payments is not put into the ladder; it is put into a savings account to be spent during the first year.

gilgamesh wrote:How about if the objective is to maximize withdrawal for the first 10 years of of a 40 year retirement. Which is different from the objectives laid out here or with VPW.


Future returns, specially those of each of the next 10 years, are impossible to predict for total-market bond and stock index funds. (See The Futility of Predicting Future Returns for an actual proof of this). Furthermore, VPW cannot guarantee an income floor. All it mathematically guarantees is that it won't prematurely deplete the portfolio, regardless of future returns.

So, trying to tweak VPW's percentages to front-load withdrawals is an exercise in futility. Of course one could easily increase the likelihood of higher initial withdrawals by increasing the internal rate, but this could easily leave the retiree in an undesirable financial position later on.

Also, we just don't know if markets won't decide to crash just after the day we retire. And if they do, we just don't know when they'll recover.

Principle #1 of our Philosophy tells us to Develop a workable plan. We must have a plan which will work even if markets crash at an inopportune time.

So, to guarantee that one will not only have enough, but actually have more during an initial 10-year period, the best way is to buy an income stream which is unaffected by markets for the additional spending in that initial period. This can be done using a non-rolling CD (or TIPS) ladder or a term-certain inflation-indexed SPIA.

Let me take a step back. Here's my workable plan for when I retire (far in the future):
1- I will delay government pensions (OAS and QPP, in Canada, equivalent to U.S. Social Security) until age 70 to maximize this lifelong non-portfolio inflation-indexed income base.
2- I will fill the gap in the above payments between retirement and age 70 using a non-rolling ladder.
3- I will have a sizeable non-indexed pension which will provide additional lifelong but decreasing base income (in real terms) unaffected by markets.
4- I will have a huge pot of money (a balanced portfolio) from which I will safely withdraw using VPW.
5- Around age 80, assuming I'm still alive, I will use enough of the remaining pot of money to insure my wife and myself a sufficient lifelong inflation-indexed income floor (taking into account government pensions). The idea is that even if the portfolio gets down to zero, this floor should be sufficient to live well. Luckily, inflation-indexed SPIAs are cost-efficient at age 80.
6- I will continue depleting the remaining pot of money using VPW, but I might adjust the last withdrawal age, based on our specific circumstances. It's too early to say.

What I was suggesting, earlier, is to add an additional 10-year income stream to such a plan to take care of additional spending during the initial 10-year period. This should be simple enough.

gilgamesh wrote:Kitces had shown the first 10 years of poor market performance as the biggest influence in the success of a SAFEMAX withdrawal and thus the SWR needs to be unnecessarily conservative for this potential to happen, dampening the potential spending, which would have been unnecessary in majority of the cases.


Any study based on using SWR as an actual withdrawal method during retirement is meaningless. I won't waste my time discussing such a study.

Reminder: The goal of the Trinity study was not to to promote 4% SWR as an actual withdrawal method, it was to discredit the 8% and more withdrawal rates that some financial advisers were suggesting at the time based on stocks returning as much. Look for Nisiprius' request for clarification and the author's answer in our Wiki's Safe withdrawal rates page.

gilgamesh wrote:I have to of course keep track of SWR rate by keeping tally of what I would have withdrawn each year adjusted for inflation on a separate sheet (the actual balance via VPW will be different than this theoretical pathway if I decided to follow SAFEMAX from the start).


SWR is a dumb withdrawal method which lets most of its retirees die as the richest people in the graveyard, while bankrupting most of its remaining retirees. I don't understand why anyone would ever consider using such brainless method. By the way, you just don't know what SAFEMAX is, and nobody will know, until the day you die. Not very useful, if you ask me. :wink:

If you want my opinion, it's this: forget about SWR during retirement; it's a rough planning tool to help answer: how much do I approximately need to retire. If you want a stable income stream, just go and buy one. For lifelong income, SPIAs do exist and can be bought, including inflation-indexed ones. For time-limited income, one can easily build a non-rolling CD ladder. Of course, a stable income stream is more expensive than a fluctuating one. With some flexibility, one can afford to complement a base stable income with fluctuating income. A balanced portfolio along with VPW can provide such a complementary income while keeping fluctuations at a manageable level.

OK, it took a long time to write this post; I'm way over my Bogleheads time allocation. I just hope my post will help you design your own workable plan. Just try to stay away from anything that relies on guessing future returns; we just don't know, so it's not workable.

Cheers,

longinvest
Last edited by longinvest on Sun Jun 18, 2017 8:11 am, edited 1 time in total.
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Re: Variable Percentage Withdrawal (VPW)

Post by dbr » Sun Jun 18, 2017 8:04 am

longinvest wrote:
If you want my opinion, it's this: forget about SWR during retirement; it's a rough planning tool to help answer: how much do I approximately need to retire. If you want a stable income stream, just go and buy one. For lifelong income, SPIAs do exist and can be bought, including inflation-indexed ones. For time-limited income, one can easily build a non-rolling CD ladder. Of course, a stable income stream is more expensive than a fluctuating one. With some flexibility, one can afford to complement a base stable income with fluctuating income. A balanced portfolio along with VPW can provide such a complementary income while keeping fluctuations at a manageable level.



The forum should implement a bot that automatically inserts the above in the signature line of any post where the term "SWR" is found!

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Re: Variable Percentage Withdrawal (VPW)

Post by gilgamesh » Sun Jun 18, 2017 8:44 am

Longinvest

Thank you for the detailed reply. My plan is almost identical to yours except the pension part. I just didn't know what method of withdrawal I would implement for my side portfolio. My non-rolling TIPS ladder does account for my desire to have more for the first ten years of retirement.

I was hoping there might be a way to have the side portfolio skew towards having more for the first ten years as well. Thank you for letting me know it's not possible. VPW will be ideal as it based on the past average performance of the market, then corrected annually to my remaining balance (accounts for previous years market performance ) and past history (The future percentage withdrawal). I like that. I was looking for a withdrawal method based on average market performance. VPW does that. I wish there is a way to reduce its sensitivity to previous years market correction/crash (even if it was just the year to quickly rebound,...I know, VPW corrects it immediately after recovery) and smooth it out based on average performance within certain constraints (limits placed in terms of time &/or magnitude), but that of course is not viable (otherwise it would have been done) - it is mostly unnecessary with a floor. This side portfolio of mine only accounts for 20-25% of my desired income, and minor tweaking of that won't matter much in my situation for sure.

I just wanted to clarify there was no way of skewing a withdrawal method to make it top heavy. But, in the process you had validated my overall retirement plan too...cool!, and thanks!

Thank you for developing this VPW, I know it was and still is hard work. IMO your absence will be a great loss to this forum. I'm glad you were available to answer my question, appreciate it very much.

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Re: Variable Percentage Withdrawal (VPW)

Post by AlohaJoe » Sun Jun 18, 2017 9:43 am

gilgamesh wrote:I was hoping there might be a way to have the side portfolio skew towards having more for the first ten years as well. Thank you for letting me know it's not possible.


Of course it is possible. You just introduce some amount of risk. longinvest says it "could easily leave the retiree in an undesirable financial position later on". Everyone agrees that it "could" result in something bad later on. People can and do disagree about the size of that risk.

I wish there is a way to reduce its sensitivity to previous years market correction/crash (even if it was just the year to quickly rebound,...I know, VPW corrects it immediately after recovery) and smooth it out based on average performance within certain constraints (limits placed in terms of time &/or magnitude), but that of course is not viable (otherwise it would have been done)


Of course it can be done. It has been done. Again, it introduces some amount of risk and reasonable people will disagree about what kinds of risk are toleranble in what amounts under what circumstances.

But all of these are topics that have been rehashed ad nauseum -- I doubt parties on either side of the question are interested in talking about it more -- so you're probably better off looking through this thread to see how those previous conversations went.

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Re: Variable Percentage Withdrawal (VPW)

Post by siamond » Sun Jun 18, 2017 10:35 am

AlohaJoe wrote:
gilgamesh wrote:I was hoping there might be a way to have the side portfolio skew towards having more for the first ten years as well. Thank you for letting me know it's not possible.

Of course it is possible. You just introduce some amount of risk. longinvest says it "could easily leave the retiree in an undesirable financial position later on". Everyone agrees that it "could" result in something bad later on. People can and do disagree about the size of that risk.

A few of us modeled those things to death, and AlohaJoe summed it up perfectly. To be more specific, if you want to introduce such a skew, then increase a bit (say by stocks by a point and bonds by half a point, or something like that, don't go crazy!) the parameters in the VPW 'Table' tab, where longinvest conveniently provided an override mechanism.

You can check with the backtesting logic (in the same spreadsheet) how it would have changed past trajectories. Just be mindful about the long-term effects (and this is where the perception of 'risk' can differ greatly - we're all different in this respect), and the fact that stock vagaries are *very* unpredictable and may introduce a *lot* of noise (ups and downs) in any such plan...

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Re: Variable Percentage Withdrawal (VPW)

Post by gilgamesh » Sun Jun 18, 2017 12:27 pm

AlohaJoe wrote:
I wish there is a way to reduce its sensitivity to previous years market correction/crash (even if it was just the year to quickly rebound,...I know, VPW corrects it immediately after recovery) and smooth it out based on average performance within certain constraints (limits placed in terms of time &/or magnitude), but that of course is not viable (otherwise it would have been done)


Of course it can be done. It has been done. Again, it introduces some amount of risk and reasonable people will disagree about what kinds of risk are toleranble in what amounts under what circumstances.

But all of these are topics that have been rehashed ad nauseum -- I doubt parties on either side of the question are interested in talking about it more -- so you're probably better off looking through this thread to see how those previous conversations went.


I read most of this thread, it was hard to weed through some of the clutter and may have missed something. I am sure it said this jitteriness can be reduced by increasing bond exposure. I did not see any other methods of correction.

For instance, I did not see a method, where by, past market downswings including long tail events are compared to the one retiree is experiencing and modulate the following year's correction based on that. If I missed it, please let me know. After all, the whole withdrawal percentage is based on past history, why not a response to a market downswing be based on historical downswings as well?

For instance a market correction of 10% happens frequently, a retiree may not necessarily have to respond to each market correction the following year unless it reaches a point atypical of past history. Even a long tail event like 50% market crash may not require a full correction immediately following it. Why can't it be spread over the next few years. If over the next few years it doesn't match the past, the intensity of correction can be strengthened.

I understand not repeating what's been discussed prior, but can you tell me whether such a thing was contemplated? If so, I missed it and will read through the thread again more carefully.

P.S: My bad..., not just downswings, it has to be deviation either way from a certain range.
Last edited by gilgamesh on Sun Jun 18, 2017 1:00 pm, edited 1 time in total.

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Re: Variable Percentage Withdrawal (VPW)

Post by gilgamesh » Sun Jun 18, 2017 12:33 pm

siamond wrote:
AlohaJoe wrote:
gilgamesh wrote:I was hoping there might be a way to have the side portfolio skew towards having more for the first ten years as well. Thank you for letting me know it's not possible.

Of course it is possible. You just introduce some amount of risk. longinvest says it "could easily leave the retiree in an undesirable financial position later on". Everyone agrees that it "could" result in something bad later on. People can and do disagree about the size of that risk.

A few of us modeled those things to death, and AlohaJoe summed it up perfectly. To be more specific, if you want to introduce such a skew, then increase a bit (say by stocks by a point and bonds by half a point, or something like that, don't go crazy!) the parameters in the VPW 'Table' tab, where longinvest conveniently provided an override mechanism.

You can check with the backtesting logic (in the same spreadsheet) how it would have changed past trajectories. Just be mindful about the long-term effects (and this is where the perception of 'risk' can differ greatly - we're all different in this respect), and the fact that stock vagaries are *very* unpredictable and may introduce a *lot* of noise (ups and downs) in any such plan...


Thank you! ...yes! I could give a more favorable historical performance to skew it to be front heavy. However, I am uncomfortable with it, as it is not built on any foundation. I was hoping, it would be OK to run multiple withdrawal strategies con-concurrently, each based on its own logic with concrete foundation, but pick the best for each of the first ten years, before settling onto VPW after the ten years....anyhow, it really doesn't matter, I am not much interested in this anymore anyways.

I know you were the one to raise the issue with jitteriness of VPW. Was a smoothing based on past performance contemplated (please read my post above, to see what I mean), and if yes, would you know which parts of this thread where you guys discussed this? Or at least tell me whether it was discussed and I'll try to find it.

Thanks!

P.S: I'm sure spreading a market downswing over a few years was discussed, but what I am thinking is to modulate the correction based on historical downswings. Were these corrective measures abandoned to maintain simplicity or because either it's not possible, or of no significance. If it is just for inconvenience only, wouldn't be good to have different version of VPW incorporating these?

P.S2: it's not just market downswing, it's change in either direction beyond a certain threshold so the following years income is neither drastically increased or decreased.

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Re: Variable Percentage Withdrawal (VPW)

Post by siamond » Sun Jun 18, 2017 1:14 pm

gilgamesh wrote:I know you were the one to raise the issue with jitteriness of VPW. Was a smoothing based on past performance contemplated (please read my post above, to see what I mean), and if yes, would you know which parts of this thread where you guys discussed this? Or at least tell me whether it was discussed and I'll try to find it.

Well, I wasn't the only one being concerned, far from it, and longinvest's answer of increasing bonds exposure never satisfied me. Here is the thread where most of the corresponding discussion unraveled, sometimes in a constructive manner, sometimes in a more, er, 'animated' manner. It started by a discussion about Guyton-Klinger decision rules, another variable withdrawal method which puts a lot of emphasis on minimizing year-over-year changes, and then developed in a broader discussion about various ways to improve smoothing for both VPW and Guyton-Klinger.

At the end, longinvest and myself agreed to respectfully disagree, and I elected to follow one of the VPW/PMT variations being discussed in this thread for myself and have been doing it since then. I know a couple of folks followed suit, while others chose to follow longinvest's approach. To each their own! I am very curious to see how the various VPW followers will react to the next stock crisis though, I am sure this will trigger more lively discussion on such smoothing techniques or lack thereof... This is all a live experiment ready to happen! :wink:

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Re: Variable Percentage Withdrawal (VPW)

Post by gilgamesh » Sun Jun 18, 2017 4:49 pm

Thank you for posting that thread. It was very useful. Having read that, I think further discussion on smoothing VPW is not a good idea here. Everything that needs to be said has been said there.

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Re: Variable Percentage Withdrawal (VPW)

Post by longinvest » Sat Aug 05, 2017 1:54 pm

Lately, I've written a few posts related to VPW on other threads. I'm copying some extracts on this thread and adding links back to these threads, as reference.

-----

One frequent complaint, about VPW, is that it apparently delivers "volatile" withdrawals. The fact that VPW had to be backtested on a volatile portfolio, to get to this conclusion, usually remains undisclosed or out of focus in the discussion.
:oops:

So, here's a first post in reply to a member seeking to smooth VPW withdrawals (on an volatile portfolio, of course) using a 5-year moving average:

Re: Using a 5y moving average to smooth withdrawals in VPW?
longinvest wrote:Mortal,
mortal wrote:I'm entirely ok withdrawing lower amounts for a longer time period provided the individual yearly adjustments aren't as severe or volatile.

Using a balanced portfolio (e.g. 50/50 stocks/bonds) will deliver a much smoother ride than a 70/30 or 80/20 portfolio when looking (rightfully) at the nominal withdrawal path. Looking at a CPI-adjusted withdrawal path is a mistake, as CPI is only an indirect measure of inflation, and it is quite volatile (often more so than bonds).

I simply don't remember the last time I checked how my paycheck fluctuates in CPI-adjusted terms. Why would I expect to start doing so after retirement? All I care about is that I have enough money to buy food and pay for shelter, transportation, clothing, and other things. When broccoli costs more, I buy cauliflower (or another vegetable) instead. Long term inflation is a real concern, though. So, we do care about inflation, but not necessarily about short-term CPI fluctuations which significantly affect historical returns.

Let me repeat this: looking at a CPI-adjusted chart without taking into account the volatility and imprecision of CPI to measure short-term personal inflation is a huge mistake.

Here's the backtested nominal VPW withdrawal path of a $1,000,000 50/50 portfolio using a 35-year horizon, starting in 1966, one of the worst ever retirement years:

Image

The following chart shows what happens when we combine VPW with base income, as recommended in our wiki. I added a $20,000 Social Security (SS) inflation-indexed pension to the above backtested VPW withdrawal path. The black line represents total income (VPW + SS):

Image

This is what a retiree would have seen deposited into his bank account, annually. Total income kept increasing (with very minor setbacks in very bad years). Better: the long-term increase actually beat inflation.

This definitely qualifies as good enough for me.


As for smoothing VPW using averaging techniques (or market-timing using metrics such as P/E ratios), while maintaining a high-stock allocation, here's my opinion:

People fail to see how dreadful it was to be fully invested in stocks during 1973-1975. Yes, I know, inflation was high and it was not the best of times for nominal bonds either, but stocks fared much worse than bonds! The nominal dip in the 50/50 portfolio VPW path seen above was entirely due to stocks. Bonds actually had positive nominal returns all along in the 1970s. One would have slept much better with a 50/50 portfolio than with a 100/0 portfolio during this period. Nobody seems to see this, as they usually look at CPI-adjusted charts and often use highly-volatile long Treasuries for bond returns.

It is very easy, mathematically, to average VPW withdrawals (or find a metric that backtests well) to smooth them and hide the 40% drop experienced by a 100% stock portfolio in 1973-1974 while inflation was up 20%, but this means that the retiree would have been taking an unsustainable amount of money out of the portfolio at the worst of times, hurting the portfolio in the process.

Of course, with 20/20 hindsight, we now know that it was "safe" to withdraw a smoothed amount in the mid 1970s, as we know that the portfolio would have been able to recover from the harm done to it by the outsized withdrawals. But, I doubt that any sane retiree would have actually withdrawn such an unsustainable amount at the time, when looking at his portfolio balance during a deep crisis, without knowing for sure what will happen in the future. It would be quite scary to apply a similar smoothing approach in a Japan-like situation where stocks dropped and never recovered within the next almost 30 years.


In summary: It is my opinion that combining lifelong non-portfolio inflation-indexed base income* with VPW applied on a balanced portfolio is a simple yet very robust approach to retirement funding. If too high, the volatility of total income can easily be reduced by (a) increasing the amount of lifelong non-portfolio income or (b) adding more bonds to the portfolio. As for inflation worries, with bonds, there now exist bonds which carry no inflation risk: Treasury Inflation Protected Securities (TIPS).

* Early retirees can use a non-rolling TIPS ladder to safely fill the gap between retirement and the start of pension payments.
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Re: Variable Percentage Withdrawal (VPW)

Post by longinvest » Sat Aug 05, 2017 1:57 pm

Here's another post where I put in focus an often forgotten, but so practical aspect of VPW: it's simplicity.

viewtopic.php?f=10&t=222480&p=3433932#p3433972
longinvest wrote:The simplicity of VPW is very important. I cannot imagine explaining to my wife how to go and lookup CPI numbers and calculate complex ratios (or use a spreadsheet) after my death. But, I would have no trouble explaining to her how to use the following table which would be easy to include in my will:

50/50 portfolio allocation

Year Age Withdrawal Percentage
2016 65 4.8%
2017 66 4.9%
2018 67 4.9%
2019 68 5.0%
2020 69 5.1%
2021 70 5.2%
2022 71 5.3%
2023 72 5.4%
2024 73 5.5%
2025 74 5.7%
2026 75 5.8%
2027 76 6.0%
2028 77 6.1%
2029 78 6.3%
2030 79 6.5%
2031 80 6.8% *** Buy as much inflation-indexed SPIA as necessary (but no more) to insure a sufficient lifelong income floor (including Social Security and other pensions) and, thus, eliminate longevity risk ***
2032 81 7.0%
2033 82 7.3%
2034 83 7.6%
2035 84 7.9%
2036 85 8.3%
2037 86 8.8%
2038 87 9.3%
2039 88 10.0%
2040 89 10.7%
2041 90 11.6%
2042 91 12.7%
2043 92 14.0%
2044 93 15.8%
2045 94 18.1%
2046 95 21.4% *** Possibly limit this and future portfolio withdrawals to 20%, so as to never fully deplete the portfolio ***
2047 96 26.3%
2048 97 34.5%
2049 98 50.8%
2050 99 100.0%

DIsclaimer: My wife and I are younger than the above example table indicates. I'm still in my 40's. I'm not retired.

Acronyms:
CPI: Consumer Price Index
SPIA: Single Premium Immediate Annuity
VPW: Variable Percentage Withdrawal
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Re: Variable Percentage Withdrawal (VPW)

Post by longinvest » Sat Aug 05, 2017 2:21 pm

Highly respected forum member Stlutz, popular for his awesome "The Final, Definitive Thread on ..." (Value, Dollar-Cost Averaging, Rebalancing) series of posts*, had some criticism regarding my insistence on looking at nominal charts in my reply to member Mortal.

* For members who have not read that series, it is really worth typing "stlutz the final definitive thread on" in this site's search box.

Here's the answer I provided, clarifying that I suggest to use nominal charts to assess the volatility of a withdrawal stream, but inflation-indexed charts to assess its sustainability.

In my post, I discuss things such as subtle differences between personal inflation and short-term variations in the Consumer Price Index (CPI).

I also remind readers that mathematically smoothing withdrawals (without smoothing the portfolio) means taking outsized withdrawals from the portfolio in times of market distress (not explicit in my post: without any assurance that markets will recover soon enough to mend the damage). Personally, I wouldn't have the temerity to do it.

viewtopic.php?f=10&t=222480&p=3433932#p3435290
longinvest wrote:Stlutz,
stlutz wrote:
Using a balanced portfolio (e.g. 50/50 stocks/bonds) will deliver a much smoother ride than a 70/30 or 80/20 portfolio when looking (rightfully) at the nominal withdrawal path. Looking at a CPI-adjusted withdrawal path is a mistake, as CPI is only an indirect measure of inflation, and it is quite volatile (often more so than bonds).
After agreeing with your earlier, I'm afraid I have to disagree with you on this point, longinvest.

When running a historical simulation, you need to adjust your results for inflation. Yes it is true that the CPI is different from my personal inflation rate, and frankly, I don't know if one's personal rate of inflation is even measurable. However, that's a lot different from just saying that 10% is functionally equal to 0%.
I did not say that all simulations should be done in nominal terms; I said that smoothness should be evaluated in nominal terms. It's not the same thing.

You'll note that the VPW backtesting spreadsheet actually provides both nominal and CPI-adjusted simulations on the same chart. This allows for evaluating the different aspects of a withdrawal path. A CPI-adjusted simulation is fundamental to evaluating the sustainability of the withdrawal path. What I am saying is that a nominal simulation is more appropriate to evaluate its smoothness.

Here's an example. If I gave you $50 each month, during the next 5 years, would you say that I am giving you a volatile stream of payments? Most people would say that, on the contrary, I was giving you a smooth stream of payments. But, if you decided to buy gas for your car using this monthly $50, the quantity you would be able to buy would fluctuate a lot. Does this make the $50 unsmooth? Personally, I say no; I say that gas prices are volatile, not the monthly 50$.

In real life, lots of prices that we pay everyday are quite volatile. Food, gas, etc. Yet, other prices are actually quite stable, such as mortgage payments. Note that mortgage payments are often a significant part of the budget of younger families.

CPI is just a wide-ranging average. Many of our expenses are often fixed for a period by contract. Regardless of how CPI fluctuates, mortgage payments don't change until the end of the contract. When the price of houses fluctuates, it mostly affects the ability of new buyers to buy them; people who already own a house don't get higher mortgage payments due to higher house prices. Yet, I'm sure CPI is partially affected by house price variations.

Inflation is insidious. It's not the impact of one year of inflation that kills one's purchase power, it's the cumulative effect of inflation over a few years. We often instinctively dodge many short-term effects of inflation through smart choices. The problem is that after a while, our options run out and we are impacted all at once by the cumulative increase in prices. For example, when we run out of affordable vegetables, we start paying for the higher price vegetables. The jump in prices that we experience at that point can be significant, because it represents the accumulation of many small increases.

So, just to try to make myself clear, again. I am not saying that it's smart to ignore inflation, or that inflation has no impact. I am saying that short-term price fluctuations should not be accounted into the smoothness of a stream of payments. That's all.
stlutz wrote:When I backtest the VPW approach, starting in 1967 does long look good in real terms regardless of the asset allocation. Which years were the worst can vary based on stock/bond allocation, but the fact is that your withdrawal in 1982 is much lower than it was in 1967, regardless of your bond weighting. That was a bad time for pretty much everything. Bonds did not in fact provide a very good portfolio cushion. Ignoring inflation isn't a particularly realistic way to deal with this problem.
Let's compare. Here's the 50/50 portfolio's VPW withdrawal path for a 1966 retirement (without Social Security):

Image

Here's the 100/0 portfolio's VPW withdrawal path for a 1966 retirement (without Social Security):

Image

First, let's look at the red lines which represent the CPI-adjusted VPW withdrawal paths. We can see that both streams did badly, in inflation-adjusted terms, in the 1975-1985 period, delivering something around $30K per year (sometimes a little more, sometimes a little less). This tells us that neither was more sustainable than the other.

Second, let's look at the blue lines which represent the nominal VPW withdrawal paths. It should be easy to see that the 50/50 line is much smoother than the 100/0 one.

You might have been able to say the same thing about the red lines, but it's not as clear cut, because inflation significantly affects the paths. One has trouble seeing that the balanced portfolio delivered a smooth stream of payments.

Let's make an exercise (in nominal terms). Imagine a retiree 100% invested in stocks. In January 1973, he gets a $70K VPW payment. He's happy and feels rich with his $1.1M portfolio. He tells his wife: "See how we're doing good; it's our 8th year of retirement and our initial $1M portfolio is now even bigger!" Unfortunately, 2 years later, in January 1975, he gets a $40K withdrawal and has to tell his wife: "We're not millionaires anymore. Markets are bad, we've lost half of a million dollars. Our portfolio is now $600K."

Imagine another retiree invested in a balanced portfolio, this time. She has quite a different experience during the same period. In January 1973, she gets a $60K VPW payment. She's happy and feels rich with her $1.1M portfolio. She tells her husband: "See how we're doing good; it's our 8th year of retirement and our initial $1M portfolio is now even bigger!" Unfortunately, 2 years later, in January 1975, she gets a $45K withdrawal and has to tell her husband: "We're not millionaires anymore. Markets are bad, we've lost quarter of a million dollars. Our portfolio is now $850K."

If we were to look purely at the numbers, some would say that the first retiree should be happier. (I'm only considering the 1973 and 1975 withdrawals, as a simplification). $70K + $40K = $110K in withdrawals is bigger than $60 + $45 = $105K. Yet, I personally would prefer to tell my wife that we lost quarter of a million and that we have to cut our budget by 25%, than tell her that we lost half of a million and that we have to cut the budget by 40%.

In the years that followed, 1976 to 1985, both the balanced and the 100% stocks portfolios delivered (mostly) increasing VPW payment streams in nominal terms, sometimes beating inflation a little, sometimes losing to inflation a little. Unfortunately, the harm had already been done in 1973-1975; payments remained low in inflation-adjusted terms.

Note that any mathematical smoothing of the 100% stocks path implies taking even more than $40K from a $600K remaining portfolio in 1975. Personally, I would definitely not have the temerity to do that; I would much prefer taking a (mathematically) unsmoothed $45K from a $850K portfolio.
stlutz wrote:Looking at '67ff in inflation-adjusted terms is a pretty good "worst case" scenario to test for a withdrawal plan. That doesn't mean that one should create the portfolio that would have worked best then, as a future worst case scenario would unfold differently.

All of that said, one would not actually factor the CPI into the withdrawals they take when actually executing VPW. Rather, the PMT formula provides you a withdrawal amount and that's what you can take. CPI doesn't come into play at all.
I think that we mostly agree, but that there was a misunderstanding. I was simply trying to explain that CPI-adjusted charts are misleading when trying to assess the smoothness of a stream of payments. I was also trying to explain the importance of a relatively stable portfolio, when one wants to extract a relatively stable stream of withdrawals from it.
Bogleheads investment philosophy | Lifelong Portfolio: 25% each of (domestic/international)stocks/(nominal/inflation-indexed)bonds | VCN/VXC/VAB/ZRR

longinvest
Posts: 2395
Joined: Sat Aug 11, 2012 8:44 am

Re: Variable Percentage Withdrawal (VPW)

Post by longinvest » Sat Aug 05, 2017 2:23 pm

Here's a follow-up post about assessing volatility in nominal terms:

viewtopic.php?f=10&t=222480&p=3433932#p3435377
longinvest wrote:Let me add that I'm not alone in generally considering smoothness in nominal terms, separately from inflation.

Typically, retirees living on the dividends paid by their 100% (selected) stocks portfolio are proud to claim that their dividend stream is much smoother than the income of retirees taking a percentage of portfolio withdrawal (out of a 100% stocks portfolio, of course). What interests them is that many dividend stocks pay relatively fixed dividends (in nominal terms) which are increased every year, or two, or three. They perceive this income as stable and increasing. As long as it grows fast enough to offset inflation over time, they're happy. They don't seek perfect CPI-indexed matching increases (and decreases) on every quarterly payment.

We live in a nominal dollar world. CPI is just an indirect measure of inflation. We don't perceive the impact of short-term CPI-U variations in real life as much as we perceive a nominal loss or gain on our quarterly brokerage statement.

In other words, there's no psychological gain to reduce a mostly-imperceptible volatility (that is due to CPI), when the problem we're trying to solve is a psychological aversion to income volatility (perceived in nominal term). Don't you agree?

Of course, when people look at CPI-adjusted charts, they want to see nice smooth lines on them. But, they often don't realize that this does not match what they perceive in real life, outside of the colorful charts.
Bogleheads investment philosophy | Lifelong Portfolio: 25% each of (domestic/international)stocks/(nominal/inflation-indexed)bonds | VCN/VXC/VAB/ZRR

longinvest
Posts: 2395
Joined: Sat Aug 11, 2012 8:44 am

Re: Variable Percentage Withdrawal (VPW)

Post by longinvest » Sat Aug 05, 2017 2:55 pm

Here's one last post (for now), written earlier today.

I'm copying it here because it explains important investing concepts which are central to the design of VPW. There's a paragraph discussing VPW in particular.

I conclude the post by disclosing what I consider a highly-diversified good-enough portfolio that could be used all lifelong, during both accumulation and retirement (using VPW, of course). Note that it is highly inspired from Taylor Larimore's awesome Three-Fund Portfolio, except that I've added inflation-indexed bonds, and that the resulting four funds have fixed equal allocations.

viewtopic.php?f=10&t=224979&p=3480314#p3480314
longinvest wrote:... snip ...
[P]eople put way too much weight on past returns, without taking a wider view of the context of these returns.

Let me expand on this.

I've learned from Bernstein's Four Pillars of Investing to avoid trying to project past returns into the future. His prestiti example (which took over a century to recover) was a good warning about projecting past returns into the future.

Instead, it is a good idea to study past investment history to open one's mind to the wide variety of unintuitive investment behaviors that can happen, with the caveat that past history is not an exhaustive repository of such things. For me, studying some of the past history was sufficient to humbly conclude that I am completely unable to predict future asset returns and that, as a consequence, I should mitigate unfavorable outcomes by diversifying my portfolio as widely as possible across investment-grade securities. I simply refuse to put money into purely speculative stuff such as commodities, cryptocurrencies, lottery tickets, etc. I also avoid investing into derivatives. As a consequence, I do not invest into currency-hedged investments (such as currency-hedged international bonds or stocks).

It is amazing to see all the dislike for bonds and the ignorance about the financial efficiency of inflation-indexed Single Premium Immediate Annuities bought in old age (near age 80), almost everywhere.

Instead of blindly looking at backtests of nominal bonds, it would be more appropriate to also look at the context. In the war/post-war era of the 1940s-1950s, annual inflation went up as high as 20% while interest rates were subject to price control at low 2% to 3% long-term yields: viewtopic.php?t=198245#p3030867. This would be vaguely similar to having new 30-year TIPS issued with a real yield to maturity of -17% (negative 17%)! It's far from a perfect similarity, but it helps getting the intuition of why future returns were bad for a pretty long while after that. Rational bond investors normally require nominal bonds to be issued with rates near the expected inflation (could be a little below, but not much, when they are mostly seeking capital preservation), or higher than inflation (when they're seeking some capital growth). At least, this is what they did in the past, except when forced otherwise in price-controlled eras. It would be interesting to read a comprehensive study of the real behavior of retail bond investors, at the time; did they really go and buy these bonds (were there new issues?), despite the government trying to incite people to redeem their bonds using artificially inflated bond prices? Intuitively, one would think that there was no black-market where people exchanged government bonds at yields close to inflation, because of the government's offer to redeem them at much higher prices.

People also use the behavior of nominal bonds in the 1970s to spread fear. But, here, a careful analysis of past returns reveals that nominal bonds behaved exactly as they are expected to do. I've written about this, before:

viewtopic.php?t=198245#p3030445
longinvest wrote: ...
Just for reference, here's a total-return chart I made, on another thread, to show the comparative growth of an intermediate-duration ladder-like bond fund and the S&P 500 in the worst high-inflation part of the 1970s to mid-1980s:

viewtopic.php?f=10&t=198104#p3027801
Image

By looking at a nominal chart, we can clearly see that at all along, the bond fund had positive annual total returns. The S&P 500 (with dividends reinvested), on the other hand, did as it always does, it fluctuated. In 1973-1975, it had a big down fluctuation, losing 30% while inflation was going up 20%, for example.
...
In the 1970s, rates went up as inflation went up. As expected from bond mathematics in a continuously rising rate environment, it took less than twice the average duration for bonds (a 10-to-2 year ladder-like bond fund) of intermediate duration to recover and match the cumulative inflation. This is exactly what we expect from nominal bonds, when rates match inflation.

In the same period, long-term bonds also did exactly as they are expected to do when considering their average duration. Looking ahead 15 to 20 years, we discover that long-term bonds recovered in inflation-adjusted terms. It was just longer, because that's how long-duration bond funds work. There is no surprise here.

On a related note, some people criticize VPW as delivering too volatile portfolio withdrawals, when it happens to be a purely logical approach to withdrawing money from a portfolio of assets for which we don't know the future returns. Of course, they backtest VPW on volatile stocks-heavy portfolios to back their claims. As an alternative, they propose methods based on arbitrary simplistic metrics to modulate withdrawals, downplaying the fact that they're simply engaging into predicting future returns using these simplistic metrics. They reject off-hand the idea of adding bonds to reduce the volatility of both the portfolio and, subsequently, withdrawals, and the idea of combining VPW withdrawals with stable non-portfolio income (or self-built time-limited stable income from a non-rolling bond, CD, or TIPS ladder).

It is tiresome to read all kinds of sure claims based on a blind look at backtested portfolios. I am all in favor of Bogleheads providing a fantastic backtest platform such as Simba's spreadsheet. But, I think that Bogleheads should also carry the burden of educating people about the danger of projecting past returns and correlations into the future.

I personally like to insist on the very few fundamental laws, based on logic and mathematics, available to us in investing. Let me list a few:
  • The law of supply and demand. That's the most fundamental law.
  • Professor William Sharpe's theorem about total-market indexing (The Arithmetic of Active Management).
  • Non-defaulting and non-called bonds mathematical properties.
Combining mathematics and an understanding of history helps us making sense of the awful returns of nominal bonds in the 1940-1980 period.

Looking ahead, I think that it is a mistake to ignore the existence of Treasury Inflation Protected Securities (TIPS). They're not riskless, but there is simply no justification to steer retirees and younger investors away from including a significant portion of bonds, especially TIPS, into their portfolios. Logic, mathematics, and a knowledge of history should drive us, instead, to avoid concentrating our portfolios into any single investment-grade asset class.

For the record, my personal portfolio is constructed accordingly. It is a 50/50 stocks/bonds portfolio, where stocks are evenly split between international stocks* and domestic stocks, and bonds are evenly split between domestic nominal bonds and inflation-indexed bonds.

* International stocks are exposed to currency fluctuations.
Bogleheads investment philosophy | Lifelong Portfolio: 25% each of (domestic/international)stocks/(nominal/inflation-indexed)bonds | VCN/VXC/VAB/ZRR

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