does this withdrawal method make any sense?

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euroman
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Joined: Thu Jan 30, 2014 7:28 am

does this withdrawal method make any sense?

Post by euroman »

I looked at the different withdrawel methods, but did not really like any of them, I therefore made my own withdrawal method, but I would appreciate feedback if it makes any sense:

I started with making a simple spreadsheet model for a 25-30 year period, with as (in my view conservative) input variables:
- start investment amount
- 4% nominal average return for 50/50 portfolio
- 1.5% inflation (therefore 2.5% real return)

If I start with a 4% withdrawal rate today, adjusted for yearly inflation, applied to the value of the investment portfolio left each year in this spreadsheet model, I do see my yearly income slowly drop but I end with a significant invested amount left after 25-30 years.

I do like this method because I rather have more income now than later in retirement, and the drop in income will be compensated in aprox. 15 years because of social security of my country kicking in.
With the investment amount left after 25-30 years (I will be in my late 70s) I could carry on depleting it or take an annuity (but this is too far in the future to plan for).

What do you think, is this a reasonable withdrawal method that could work for me? Thanks.
lack_ey
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Re: does this withdrawal method make any sense?

Post by lack_ey »

Sure, if you actually stick with taking only a fixed percentage of the remaining assets, you'll always be left with some. It's just that your spending may be more variable than you'd like (or even is possible to sustain, if the returns are poor enough, and fixed spending needs too high). In any case, this is a conservative withdrawal strategy as long as the withdrawal rates are initially high enough that it doesn't need to be abandoned if things get bad.

I disagree about the simple model being conservative, though, if you've implemented it as fixed values every year. Those look like reasonable ballpark figures that are somewhat likely to happen in the long run, but steady returns are exactly what you shouldn't expect. This hides the damage that a bad sequence of returns can cause, even one ending up with 4% nominal annualized portfolio returns. It's also possible for returns to be lower or inflation to spike up quite a bit higher than that at least for some years.
heyyou
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Re: does this withdrawal method make any sense?

Post by heyyou »

David Zolt published a similar method. Each year, he adds an inflation boost to his withdrawal(WD) if together they are less than the target percentage of the remaining portfolio, but if not, there is no boost added. Late in life, you will have reduced real income due to skipping those inflation boosts, but during retirement you will not have to spend less than the year before.

The VPW method shows ending portfolio values for the worst case retirement of 1966-1995. Perhaps you could run your method using those 30 annual returns.
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celia
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Re: does this withdrawal method make any sense?

Post by celia »

euroman, My comments have more to do with the definition of the 4% rule rather than your variation of it. I googled "4% withdrawal rule" and see that there is now some discussion on it still being relevant today. It assumes that the portfolio is invested 50/50 in stocks/bonds and that one could live off the interest/growth. Today, bonds are at historic low interest rates. If that applies to half of your assets, it could be a problem. (At the time the rule was invented, interest rates on bonds were 6%.)

It sounds like you are in your 40s (you mentioned 30 years from now when you would be in your 70s). Therefore, you would be expecting your portfolio to last more than 30 years. The longer you have to depend on it, the more time there is for unexpected events to happen, ie "black swans".

The rule was meant to be something easy for people to remember and apply, but a safer bet today is to take less than 4%.
A dollar in Roth is worth more than a dollar in a taxable account. A dollar in taxable is worth more than a dollar in a tax-deferred account.
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euroman
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Re: does this withdrawal method make any sense?

Post by euroman »

Thank you for the replies!

@lack_ey
You are correct that the model obviously disregards volatility, but I believe it can serve as a guidance (more below).

@heyyou:
I think you mean this article:
http://www.targetpercentage.com/wp-cont ... fe-WR1.pdf
I'll read it later in full, but the summary shows this method is indeed what I had in mind myself, nice to see my method being validated by a pro!
One of the drawbacks of the 4% rule in my opinion is that although history has shown it works, you are effectively running blind. I like to keep an eye on how good/bad I am doing. In my spreadsheet model I can compare actual portfolio value with modelled portfolio value, and while portfolio will fluctuate in short term, I do believe I can bet on long term returns (example: Credit suisse 2014 yearbook calculated 50 year real returns for international portfolio to be 6% for stocks, and 5% for bonds).
In the words of Mr. zolt:
''The Target % is used to determine whether the portfolio is ahead or behind target at any point during retirement. If the portfolio is ahead of target, the full inflation rate increase is taken in that year. If the portfolio is behind target, the inflation increase for that year is reduced or eliminated''.
I am planning to play with (inflation) increases too, depending on if my portfolio value is ahead or behind my fictive model value.

@celia:
You are right about the issue with bond returns. I already assumed lower returns for my portfolio compared to historic returns, with 5.5% nominal for stocks, and 2.5% nominal for bonds (in total 4% nominal, 2.5% real return). Maybe my bonds return is still on the high side, but for a 30 year period I would assume the historic low yields will eventually move up a bit. I admit I allocated part of my fixed income to two HY bond ETFs (but mainly BB/BBB rated bonds, eurozone and international dollar bonds), after having looked at the risks, and I do believe they are worth it.
I could indeed deplete my portfolio earlier than expected, but will receive social security at some point in my country. And actually I am too young to retire, I hope I can develop more income in coming years/decades. My portfolio income is my basic income.
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galeno
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Re: does this withdrawal method make any sense?

Post by galeno »

You withdraw method is fine. As long as your portfolio expenses are low a 4% AWR adjusted for inflation is fine.
KISS & STC.
furwut
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Re: does this withdrawal method make any sense?

Post by furwut »

Earlier this year Dirk Cotton, who writes a blog called the Retirement Cafe, posted a series of very interesting articles discussing game theory and its application to selecting a retirement income strategy.

This first post is a brief intro to game theory
A Tiny Bit of Game Theory

Then the first in the series, I believe, is this:
Dominated Strategies

At the end of each post in the series you should find a link to the next article. I hope you enjoy them as much as I did!
Dandy
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Re: does this withdrawal method make any sense?

Post by Dandy »

Ok to start with 4% plus inflation but remember it is not set it and forget it. Lots of financial and personal bumps in the road are likely ahead. So, every few years assess your health, expenses and portfolio and make sure your planned approach makes sense. Minor adjustments made early make a big difference. e.g. when the portfolio takes a hit not adjusting last year's withdrawal for inflation.
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galeno
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Re: does this withdrawal method make any sense?

Post by galeno »

As long as the OP's portfolio expenses are low and we don't suffer an economic event worse than the Great Depression, a 4% AWR indexed to inflation should do just fine for 30+ years.
KISS & STC.
Topic Author
euroman
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Re: does this withdrawal method make any sense?

Post by euroman »

Thanks again for the replies. I only use low cost ETFs.
@furwut: thank you, read the first one, it confirms my thinking to remain flexible with withdrawal rate.

One thing I was not sure about with making my simple spreadsheet model: if you look at quoted long term returns for the stockmarket, they are based upon dividends re-invested.
For example, the Credit Suisse 2014 yearbook calculated real return of international stocks to be 6% for the past 50 years, with dividend re-invested.
But as I use dividends as income, I assume I loose the long term compounding effect of dividends re-invested and I would assume my expected average long term return would be lower, or am I wrong?

Does anyone know what the (real or nominal) long term stockmarket return is for let's say 30 years or longer with dividends not re-invested?
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galeno
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Re: does this withdrawal method make any sense?

Post by galeno »

Our 60/40 port yields about 2%. That's a pretty low AWR if retired. Our AWR is about 4%.
KISS & STC.
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