Real Value of Nest Egg

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coachz
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Real Value of Nest Egg

Post by coachz » Mon Jan 05, 2015 8:28 am

So, you saved up $1,000,000 and you consulted a variety of CFPs who use the 4% rule and say you should be fine to get $40,000 indexed for inflation for the next 35 years.

The problem is, the stock market is at an all time high of 18,000. Does this mean your $1,000,000 is not really the right number to be using? Should we instead be using an average of what the market has been over the last 5 or 10 years to get a "Real Value" of what the million dollars is truly worth?

Surely, a bad sequence of returns is much more likely when the market is at an all time high. I'm wondering why the CFPs don't seem to take this into account or is the 4% rule already incorporating that so all is good ?

Thanks ! :moneybag

flyingaway
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Re: Real Value of Nest Egg

Post by flyingaway » Mon Jan 05, 2015 8:55 am

IMO, if you are retiring now, you should have an appropriate asset allocation, e.g., more bonds, which will take care of the problem of all time high stock market.

scone
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Re: Real Value of Nest Egg

Post by scone » Mon Jan 05, 2015 9:00 am

I can't predict what the stock market will do, but I have a pretty good idea what my taxes will be when we retire, so I would focus on that to determine if 1 million was enough. Like it or not, Uncle Sam owns part of my 401k. :mrgreen:
"My bond allocation is the amount of money that I cannot afford to lose." -- Taylor Larimore

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coachz
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Re: Real Value of Nest Egg

Post by coachz » Mon Jan 05, 2015 9:00 am

sorry, let's assume that the asset mix is 50/50 stocks/bonds

jstrazzere
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Re: Real Value of Nest Egg

Post by jstrazzere » Mon Jan 05, 2015 9:10 am

coachz wrote:Surely, a bad sequence of returns is much more likely when the market is at an all time high.
A bad sequence of returns does not depend on what has happened with the market in the past week, month, or year, nor if the market is at a high or not. It could happen any time.

Do you have a source indicating otherwise?

dbr
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Re: Real Value of Nest Egg

Post by dbr » Mon Jan 05, 2015 9:29 am

This paper by Kitces discusses some of the "paradoxical" character of this issue:

https://www.kitces.com/may-2008-issue-o ... es-report/

I would recommend reading up papers from Michael Kitces and Wade Pfau for extended discussion of how to think about these things (Google for sources).

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coachz
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Re: Real Value of Nest Egg

Post by coachz » Mon Jan 05, 2015 9:42 am

jstrazzere wrote:
coachz wrote:Surely, a bad sequence of returns is much more likely when the market is at an all time high.
A bad sequence of returns does not depend on what has happened with the market in the past week, month, or year, nor if the market is at a high or not. It could happen any time.

Do you have a source indicating otherwise?
Good point. I don't. I only have my tiny brain that says an all time high has a higher chance of going down than up. :sharebeer

an_asker
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Re: Real Value of Nest Egg

Post by an_asker » Mon Jan 05, 2015 9:51 am

coachz wrote:
jstrazzere wrote:
coachz wrote:Surely, a bad sequence of returns is much more likely when the market is at an all time high.
A bad sequence of returns does not depend on what has happened with the market in the past week, month, or year, nor if the market is at a high or not. It could happen any time.

Do you have a source indicating otherwise?
Good point. I don't. I only have my tiny brain that says an all time high has a higher chance of going down than up. :sharebeer
Intuitively speaking, I agree with you. Based on what's been drummed into my head by statistics, I should not be doing so.

With big data etc, there should be research done by someone somewhere along the following lines:

- take the intra-day high value for all 'all time high days'
- for each of the above, get the market-close values for 1-yr, 3-yr, 5-yr and 10-yr (more if wanted) future dates
- calculate the returns in each case and get an average 1-yr, 3-yr, 5-yr and 10-yr performance (as well as standard deviation etc if wanted)
- add a caveat that past performance cannot guarantee future performance

Has this kind of analysis been performed that anyone is aware of? Does anyone have the resources to run the above algorithm? I for one would be mighty curious (for the Dow and the S&P500). Given that it has been a while since the NASDAQ was at an all time high, I don't know if that would prove useful for any optimist. :oops:

dbr
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Re: Real Value of Nest Egg

Post by dbr » Mon Jan 05, 2015 9:54 am

an_asker wrote:
coachz wrote:
jstrazzere wrote:
coachz wrote:Surely, a bad sequence of returns is much more likely when the market is at an all time high.
A bad sequence of returns does not depend on what has happened with the market in the past week, month, or year, nor if the market is at a high or not. It could happen any time.

Do you have a source indicating otherwise?
Good point. I don't. I only have my tiny brain that says an all time high has a higher chance of going down than up. :sharebeer
Intuitively speaking, I agree with you. Based on what's been drummed into my head by statistics, I should not be doing so.

With big data etc, there should be research done by someone somewhere along the following lines:

- take the intra-day high value for all 'all time high days'
- for each of the above, get the market-close values for 1-yr, 3-yr, 5-yr and 10-yr (more if wanted) future dates
- calculate the returns in each case and get an average 1-yr, 3-yr, 5-yr and 10-yr performance (as well as standard deviation etc if wanted)
- add a caveat that past performance cannot guarantee future performance

Has this kind of analysis been performed that anyone is aware of? Does anyone have the resources to run the above algorithm? I for one would be mighty curious (for the Dow and the S&P500). Given that it has been a while since the NASDAQ was at an all time high, I don't know if that would prove useful for any optimist. :oops:
I don't have a reference exactly to that question, but in general the literature on the subject is extensive. I would google Kitces and Pfau for starters. There is also an interesting discussion of the variable percentage withdrawal idea which is even in the Wiki now.

Random Walker
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Re: Real Value of Nest Egg

Post by Random Walker » Mon Jan 05, 2015 9:59 am

I agree with OP,
Current valuations matter. Today's higher current valuations result in lower future expected returns. I think a reasonable way to guesstimate a withdrawl rate would to make some long term estimate of the lower future expected returns and use Monte Carlo simulation. The more I learn, the more I realize that figuring out how to invest in accumulation phase is nothing compared to managing finances in / near retirement. It was looking toward retirement issues that partly convinced me I should go with an advisor.

Dave

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HomerJ
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Re: Real Value of Nest Egg

Post by HomerJ » Mon Jan 05, 2015 10:19 am

coachz wrote:is the 4% rule already incorporating that so all is good ?
The 4% "rule" is already a worst-case scenario (technically 3.7%). During good times (more than 50% of the 30-year retirement periods studied), you could pull 5% or 6%, and be fine... 4% was the bottom number... that's why it's the "rule of thumb". 4% worked during the Great Depression and 3.7% worked even you retired in 1966 (stagnant stock market for 15 years, plus rising interest rates, plus high inflation in the late 70s)...

And still 3.7% worked... 4% worked in 97 of the last 100 30-year periods, including the bad periods. and 3.7% worked in those 3 "really bad" periods (periods starting 1965-1967were the worst years to retire, I think)...

4% doesn't need good valuations to work... 4% is already a VERY conservative number.

Dandy
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Re: Real Value of Nest Egg

Post by Dandy » Mon Jan 05, 2015 10:30 am

4% adjusted for inflation is a nice guideline. I think you are right to question with todays high stock market and exceptionally low interest rates whether 4% might be a bit too high.

In reality there is no set it and forget it withdrawal strategy. You need to, on a regular basis, check you health, your expenses and your portfolio to determine if you current strategy makes sense. There does need to be a balance between set it and forget it and constant tinkering with your plan. For many life isn't "set it and forget it" simple and neither is retirement.

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Re: Real Value of Nest Egg

Post by The Wizard » Mon Jan 05, 2015 10:31 am

Save 20% additional as a pad against negative volatility and you should be fine...
Attempted new signature...

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coachz
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Re: Real Value of Nest Egg

Post by coachz » Mon Jan 05, 2015 10:41 am

The Wizard wrote:Save 20% additional as a pad against negative volatility and you should be fine...
Said as easily as "Work 20 more years" :mrgreen:

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Re: Real Value of Nest Egg

Post by Aptenodytes » Mon Jan 05, 2015 10:44 am

Swedroe and Ferri, among others, have offered intelligent thoughts in this forum on how valuations ought to inform our expectations regarding future returns. I think the way they'd go about tackling your question is not to fiddle with artificial and arbitrary adjustments to your balance, but to look at your AA and assign their best-guess returns by category. Ferri's and others' estimates are in the WIki though I'm pretty certain you can locate more recent estimates by searching within this forum (I tried quickly but failed; if you are more motivated you'll find them).

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WolfpackFan
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Re: Real Value of Nest Egg

Post by WolfpackFan » Mon Jan 05, 2015 10:51 am

Has economic growth stopped? That's what drives the market, and it seems to me the market goes up more than it goes down. That's the only reason I have money in it.

The stock market has been achieving new all time highs since the stock market inception.

Based on the upward trend and that you want to project what your nest egg is "worth" in the future I'd adjust it to be over 1 mil. Statistically speaking the odds are that I'll be right more times than you would be for adjusting it below 1 mil.

The key word to the 4% safe withdrawal rate is SAFE. The whole idea behind it is to withstand the ups and downs of the market.

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Re: Real Value of Nest Egg

Post by Swampy » Mon Jan 05, 2015 10:58 am

Read "High Expectations and False Dreams" by Otar.
If you fail to plan, you plan to fail. | Failure is not an option. | If I have seen further, it is because I was carried on the shoulders of giants.

MathWizard
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Re: Real Value of Nest Egg

Post by MathWizard » Mon Jan 05, 2015 11:00 am

Here is what I intend to do:

If the P/E of the Russel 3000 is greater than 16, and we are not in a recession, I intend to "deflate" the amount
of my equity position by multiplying it by 16 divided by that P/E , when I estimate whether I can retire.

E.g If I had $200K in equities, and the P/E is 20, and we are not in a recession, I would "value" the equities as
$200K times 16/20 which would be $160K.

I exclude recessions because P/E's skyrocket due to poor earnings in a recession, and would be a poor indicator of the actual value.
In that case, if I had to retire, I would take as little as possible up to 4% until after the recession recedes, and then use the 4%
inflation adjusted rule from then on.

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Peter Foley
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Re: Real Value of Nest Egg

Post by Peter Foley » Mon Jan 05, 2015 11:01 am

I too agree with the OP that "current" valuations matter. By "current" I mean the time at which the withdrawals are going to begin. Is there disagreement that a "current" S&P PE of 10 is less subject to a bad sequence of returns than a PE of 25?

Of greater concern to me, however, would be the percentage of the $1,000,000 referenced that is in deferred accounts. While this does not affect the withdrawal rate it may affect the amount of spendable cash that one has from a 4% withdrawal due to tax liabilities.

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HomerJ
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Re: Real Value of Nest Egg

Post by HomerJ » Mon Jan 05, 2015 11:06 am

Swampy wrote:Read "High Expectations and False Dreams" by Otar.
Withdrawing 4% is ALREADY assuming low returns going forward...

You don't need high returns for 4% to work...

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Re: Real Value of Nest Egg

Post by Johno » Mon Jan 05, 2015 11:24 am

scone wrote:I can't predict what the stock market will do, but I have a pretty good idea what my taxes will be when we retire, so I would focus on that to determine if 1 million was enough. Like it or not, Uncle Sam owns part of my 401k. :mrgreen:
I don't think this was what the OP had in mind but it's a good point. One is likely to map out retirement in terms of spending, and they don't accept pre-tax dollars at the grocery store or to pay the electric bill. So one clearly has to discount a $1mil in an tIRA or 401k for the tax liability.

Once it's after tax dollars I think everyone agrees a rule like 4% isn't independent of returns, and almost everyone agrees (everyone should :D ) that expected returns aren't independent of valuations. So even if 4% is 'very conservative' (many don't agree with that, judging from past threads), it's not *as* conservative when expected returns are lower as when they are higher. The ideal method of planning would somehow correct for this. But as between varying the withdrawal % and applying a discount to stock values (to somehow 'normalize' them to a 'standard valuation' at which 4% is conservative to some specified degree) it seems the financial research community heavily favors the former. Moreover they tend toward making it more complicated than just a rule of thumb %. And it surely is in some sense, though OTOH when you make stuff more complicated you leave some people behind. That's the central dilemma in a system based mainly on private investing decisions to fund retirement in the face of pandemic financial illiteracy. Macro-wise that is, most people here can figure out a reasonable course to the limited degree anybody can without knowing the future.

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Orion
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Re: Real Value of Nest Egg

Post by Orion » Mon Jan 05, 2015 11:51 am

The 4% rule is from history so it is a number that has survived the great depression, stagflation, etc. But whether it will survive "whatever comes next" will never be known. I think you have to go with your own sense of optimism or pessimism to some extent. I use a spreadsheet form of the trinity study where you can make adjustments - for example I plug in today's very low interest rates and then run that with nearly historical stock market returns - that I have reduced a little. This does reduce the safe withdrawal rate. Whether it will come true or not - who knows? But it gives me an extra feeling of comfort if I can stay within even those bounds. Of course, the more pessimistic/safe you want to be, the more you reduce those bounds and there's really no end to it until you get around 0%.

Of course these studies don't allow for things like: you may naturally (or purposefully) spend less in down years, the spending of older folks seems to go down anyway (though I'm not sure whether it's always by choice - though many older folks seem willing and happy to spend weeks repairing something that they just would have re-bought earlier), you may not actually rigidly follow the investment portfolios designed into the studies (which could be better or worse), etc.

After retiring in 2000 - which had higher valuations than today, and is considered by some possibly one of the worst times to retire - so far it seems to be going reasonably well. Though I still occasionally ponder "what could happen next?" and probably will for the rest of my life.

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Re: Real Value of Nest Egg

Post by BahamaMan » Mon Jan 05, 2015 11:55 am

The Wizard wrote:Save 20% additional as a pad against negative volatility and you should be fine...
+1.......

And use VPW, which is much safer than a Fixed SWR... Whether 2%, 3% or 4%...

And if you say that VPW could potentially offer a withdrawal amount that you couldn't live on the Fixed withdrawal amounts would also fail. You have to have enough cushion to handle the volatility. If you can't, you shouldn't retire or reduce your standard of living.

dbr
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Re: Real Value of Nest Egg

Post by dbr » Mon Jan 05, 2015 6:18 pm

coachz wrote:
The Wizard wrote:Save 20% additional as a pad against negative volatility and you should be fine...
Said as easily as "Work 20 more years" :mrgreen:
Alternatively budget for a contingency of 20% less, retire, and live on that. At some point it is easier to decide to live with what one has than to die ascending a never ending slope.

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patriciamgr2
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Re: Real Value of Nest Egg

Post by patriciamgr2 » Mon Jan 05, 2015 11:21 pm

Vanguard just released a blog entry on the 4% rule.
http://vanguardadvisorsblog.com/2015/01 ... ars-later/

The Vanguard estimates seem higher than others I've seen, although they are using an 85% success rate. I believe several recent studies on the 4% rule (including the work by Kitces, Pfau, Otar and others) regard 4% as aggressive due to (a) sequence of returns risk at any time in your retirement, but especially in the early years; (b) 30 years being too short of a time period for total depletion of assets; (c) backtesting of rule originally excluded international securities which have higher volatility; etc.

From a practical perspective, what I personally found most helpful in planning for my own retirement was adopting either (1) liability matching portfolio for absolute needs, & being flexible on withdrawing from the stock portfolio for other goals depending on market results each year; or (2) building flexibility into my drawdowns (eg avoid taking the inflation increase if your portfolio has shrunk). I went with an approach closer to #1.

Good Luck to each of us as we manage our "pension fund".

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