Using a 5y moving average to smooth withdrawals in VPW?

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mortal
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Using a 5y moving average to smooth withdrawals in VPW?

Post by mortal » Sun Jul 02, 2017 4:36 pm

Howdy folks,

Lately I've looking at various variable withdrawal strategies. The series I link to seems to have a pretty thorough analysis, but the cape strategy they favor seems to be pretty complex. I also don't know how to calculate or where to find cape for a diversified portfolio consisting of domestic (including small / mid cap value) as well as international. It's just too complicated in my opinion to be practical.

So, what's the alternative? I'd like to know what effect using a 5 year moving average would have in calculating a variable withdrawal rate? My intuition is that this would smooth out withdrawals, stretching out fluctuations over a longer time period and giving you more time to adjust to new spending levels. I've heard that prior attempts to smooth vpw failed, and it's very much a 'pay me now or pay me later' type of situation. I understand. I'm entirely ok withdrawing lower amounts for a longer time period provided the individual yearly adjustments aren't as severe or volatile.

My problem is that I don't know how to run the calculations or model it in a spread sheet. Is my intuition right here? What do you guys think?

GAAP
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Re: Using a 5y moving average to smooth withdrawals in VPW?

Post by GAAP » Mon Jul 03, 2017 12:11 pm

There's been a fair amount of discussion around smoothing VPW in this forum. The creator of the method doesn't like the idea at all -- smoothing is essentially incompatible with the expressed goal of spending down the entire portfolio in a specific time.

If, after more research, you still want to go down that path, then I suggest you play with the parameters in the underlying PMT function calculation -- smoothing the number of periods is probably the easiest way. Trying to smooth based upon portfolio performance sounds remarkably uncertain to me -- especially in a severe downturn.

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Re: Using a 5y moving average to smooth withdrawals in VPW?

Post by mortal » Mon Jul 03, 2017 1:07 pm

The creator of the method doesn't like the idea at all -- smoothing is essentially incompatible with the expressed goal of spending down the entire portfolio in a specific time.
Perhaps. I'm not heart set on a given outcome besides not running out of money. If I'm left with a quarter of my starting balance at the end of the planning period, that's ok (though I understand it could be harder to model). I stress again, I do not mind making adjustments. I think they're necessary for the health of the portfolio, but I think most people would a large amount of volatility. Some folks would say that's evidence they should have less in equities. I disagree with this, especially considering I'll likely retire early.

I've looked into coding my own office function. Sadly those functions seem to be written in some dialect of visual basic (yech). Still, it's better than the in cell convolutions I'd have to do otherwise.

John Z
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Re: Using a 5y moving average to smooth withdrawals in VPW?

Post by John Z » Mon Jul 03, 2017 1:16 pm

As I was approaching retirement I was researching withdrawal methods and VG Managed Payout Funds hit the streets. I believe they based the withdrawal amount over the last 3 years of performance so I was leaning in that direction: Starting with 4% and then varying the percentage each year based on the last 3 years' returns. But after a couple of years I simplified it to withdrawing, on average, 1% per quarter based on value at quarter end. I've found that withdrawals happen in clumps (new roof, new AC, new vehicle) so it's not a smooth 1% per quarter but I keep a running total of what the withdrawal amount should be ongoing so I know if I'm above or below the 1% average per quarter.

I did discover that the withdrawal amount is only part of the retirement equation. WHERE, WHEN and WHAT FUNDS to take the money from makes a difference which is brilliantly discussed in McClung's book Living Off Your Money where the first 3 chapters are a free download. There are 11 Chapters that cover not only best withdrawal methods but portfolio make up and just about all aspects of financial retirement.

http://livingoffyourmoney.com/

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Re: Using a 5y moving average to smooth withdrawals in VPW?

Post by GAAP » Mon Jul 03, 2017 1:40 pm

FWIW, my plan is to use a typical spreadsheet function that works in Excel or LibreOffice: PMT(Rate, NPER, PV, FV, Type).

For Rate I use the expected real return of my portfolio, based upon a 50-year historical period and modified by my asset allocation.

I set NPER to 1, Present Value to my portfolio value, Future Value to a negative portfolio value (multiply by negative 1), and Type to 1. This effectively says I want to withdraw the amount at the start of the year that leaves we with no net change in portfolio value at the end of the year after net returns (assuming I guessed right on real returns, of course). This sets my floor -- the minimum value I would withdraw. I multiply that value by 25% to determine the ceiling. I do not adjust the withdrawal amount the following year, unless that amount bumps against the ceiling or floor limits -- keeping it within that band. I do not expect to spend every dime, and do expect a terminal bequest amount to result.

In the past, I played with averaging life expectancy from the RMD tables and 120-age, which increases the reductions in withdrawals as time progresses, but doesn't really reduce the income variability that it sounds like you're concerned about.

Smoothing effectively trades some maximum portfolio utilization for reduced income volatility. To me, that is another way of saying that your actual withdrawal rate will vary, leading to a need to determine how much variance is appropriate. You could use other ways to determine the range than mine -- perhaps you would be more comfortable allowing VPW to fluctuate between a 40-year period and a 50-year period, for example.

I don't think you need visual basic to achieve what you want. The core of VPW is essentially the same calculation used for mortgages and car loans, without all the extra monthly periods. I don't use visual basic for any of my planning.

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siamond
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Re: Using a 5y moving average to smooth withdrawals in VPW?

Post by siamond » Mon Jul 03, 2017 3:22 pm

mortal wrote:So, what's the alternative? I'd like to know what effect using a 5 year moving average would have in calculating a variable withdrawal rate? My intuition is that this would smooth out withdrawals, stretching out fluctuations over a longer time period and giving you more time to adjust to new spending levels. I've heard that prior attempts to smooth vpw failed, and it's very much a 'pay me now or pay me later' type of situation. I understand. I'm entirely ok withdrawing lower amounts for a longer time period provided the individual yearly adjustments aren't as severe or volatile.

My problem is that I don't know how to run the calculations or model it in a spread sheet. Is my intuition right here? What do you guys think?
Previous attempts at convincing the VPW author to add an optional smoothing method to his spreadsheet did fail. Longinvest is very attached to the elegant simplicity of his model, and not terribly sensitive to the fact that its innate volatility presents a clear practical issue for many users and notably those eager to keep a good chunk of equity exposure in their Asset Allocation.

Ok, be it, but there are solutions indeed, which were discussed at length in this thread, and illustrated through backtesting. I ended up using one of those approaches for myself since then, and I know that several other folks on this forum do something similar. Since this thread was quite long, discussed both Guyton-Klinger and VPW/PMT, and ended up with rather 'animated' discussions, maybe I can summarize the findings here, in following posts, since this question pops up quite often. I need to refresh a bit my memory first though...

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siamond
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Re: Using a 5y moving average to smooth withdrawals in VPW?

Post by siamond » Mon Jul 03, 2017 4:06 pm

To begin, let's discuss short-term volatility. When the portfolio hiccups (up or down) for a year or two, and then comes back near where it was, which a fairly common occurrence, there is really little reason to change the annual withdrawal by much. Let's call such issues 'short-term volatility'. There are at least two ways to deal with that, keeping in mind that we can't know in hindsight if this is indeed a short-term issue, or a more sustained market change.

First way is essentially what the OP suggested, use a moving average of the past X years (I would suggest 3 years instead of 5 though). The idea is simple, you let VPW makes its normal recommendation, and archive the number each year. Then for your withdrawal of the current year, simply average the VPW recommendations for year N-2, year N-1 and current year. To bootstrap the process, just use the regular VPW recommendation for the first two years, or average them if you wish for year 2.

If you're inflation-savvy, then it would be a tad better to do the math in inflation-adjusted terms, but this really wouldn't change the outcome very much, unless we come back to a troubled period like the 70s.

Such approach has the virtue of simplicity, and works reasonably well. It will eliminate a lot of silly ups and downs for sure. One might argue it would be a tad slow to react to a long and sustained crisis (Japan-like) though, or overreact to a long bull market (like the 90s). But still, this will work out fine, I backtested it at length, and this is a reasonable approach.

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Re: Using a 5y moving average to smooth withdrawals in VPW?

Post by Sheepdog » Mon Jul 03, 2017 4:26 pm

I use a continuous moving average not just a 5 year. This is my process, which long time members here have read it before.

My 18 year withdrawal rate has certainly oscillated, but that was expected. For me, planning a big vacation in Europe or Asia, new autos, or buying and maintaining a lake cottage (all of which are in our history), requires discipline if you don't have excess assets which I don't. My withdrawal plan, a plan where I expected variable needs year to year, has worked. It requires an annual review of past spending and future needs to control withdrawals. My goal was for an AVERAGE annual withdrawal percentage of 4.6%, NOT adjusted for inflation, not a specific set annual withdrawal percentage. (Actually, I started with a 4.5%l plan, but increased it later as I was doing so well. I may do it again.) The withdrawals will be variable year to year, low in some years in order to pay for the large expenses in others, yet keep within the average of multiple years. It requires limiting spending after down market years. (Can you say 2008 and 2009?) That has worked for our lifestyle....good living, new autos on a regular basis, nice vacations and cruises when income is good, plus we want to enjoy sports and entertainment, etc. every year.

The plan was not to schedule any relatively expensive item (for me that means over $12K) unless that purchase will not increase my multi-year average much above my planned average withdrawal. For example, at the end of 2016, I had an excess of $28,945 available from the moving average. That means, I did not spend $28,945 in previous years from the 4.6% annual budget. I can use that for anything special without ruining a budget or cause excess reduction of assets.

Historically, my actual annual withdrawals have ranged from 3.11% to 7.52%, but the 18 year 4.59% moving average is very close to the original plan. The result has been that I have not wanted for anything and my investment total is worth more than when I retired.
Last edited by Sheepdog on Mon Jul 03, 2017 4:32 pm, edited 1 time in total.
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stlutz
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Re: Using a 5y moving average to smooth withdrawals in VPW?

Post by stlutz » Mon Jul 03, 2017 4:31 pm

First, I do recommend the very long thread on the subject:

viewtopic.php?t=120430

One of the main points that longinvest makes is that VPW should only be a part of your retirement income strategy. You really should have an income floor which can be provided by: Social Security, pensions, inflation-adjusted annuities, and some combination of TIPS, iBonds, and CDs (i.e. fixed income investments with limited inflation risk). With that taken care of, VPW really handles more discretionary expenses.

I am a fan of longinvest's point of view about averaging withdrawals. The fundamental point is to make withdrawals based on current reality, and not where the market was a year ago or 5 years ago. As a former BH poster used to say, "Markets don't consult the history books before deciding which way to move." If that's the case, why would you base current year consumption on last year's consumption as opposed to on how much money you actually have right now?

Sure, the market roared back pretty quickly in the second half of 2009 after the '08 crash. Was that necessarily the case? And will that necessarily be the case next time there is a significant market decline? I would say "no" in both cases. If so, where the market was in 2007 doesn't really matter if it's 2009. And conversely, if my portfolio has gone up in value a lot the past few years, I should feel free to take that round-the-world cruise as opposed to not spending money because the market was a lot lower back in 2013.

If you can't adjust your spending downward if the market goes down, then you may need to reconsider your asset allocation, whether to annuitize more etc.

One challenge in implementing VPW is the fact that expenses don't always come when you plan them to, whether that be a medical issue or needing a new roof, new AC, and a new sewer line all at the same time. But, if you spend more than the PMT function says you should in one year, then next year your recalculate your new withdrawal amount based on how much money you have then. Again, you base everything on the facts as they are right now.

The bigger challenge is around longevity. VPW is built around spending all of the money by the end year that you've planned for. If you live longer than that, well then the strategy fails. Ways around there are to buy a longevity annuity (which are pretty cheap all things considered), plan your VPW to out to age 110 instead of 85 or 90 (which in most cases defeats the strategy of spending the money while you're alive), or if you have another pot of money available that you were hoping to bequeath to your heirs or the like.

In short, VPW is part of a withdrawal strategy as opposed to being a strategy in and of itself. I think the desire to smooth things out probably suggests that you are asking it to do too much on it's own.

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siamond
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Re: Using a 5y moving average to smooth withdrawals in VPW?

Post by siamond » Mon Jul 03, 2017 4:40 pm

Another approach towards short-term volatility was provided (surprise!) by longinvest himself in this post. Let me duplicate the key formula.
PlainWithdrawal = portfolio x VPW percentage
ModifiedWithdrawal =
If PlainWithdrawal > LastYearWithdrawal : MAX( PlainWIthdrawal / 1.3, LastYearWithdrawal + ( PlainWIthdrawal - LastYearWithdrawal ) * 0.1 )
If PlainWithdrawal < LastYearWithdrawal : MIN( PlainWIthdrawal x 1.3, LastYearWithdrawal - ( LastYearWithdrawal - PlainWIthdrawal ) * 0.1 )

The slow 10% adjustment should give you the smoothing you seek, while the 30% band should protect the portfolio against catastrophic events.
While backtesting such approach (see details in the other thread), I ended up with the conclusion that the 10% parameter (0.1) was actually doing too much smoothing and 25% seemed more appropriate. While the second parameter (30%) didn't seem terribly useful, and actually introduced some occasional weird hiccup, and I think this simpler formula is perfectly fine:
PlainWithdrawal = portfolio x VPW percentage
ModifiedWithdrawal =
If PlainWithdrawal > LastYearWithdrawal : LastYearWithdrawal + ( PlainWIthdrawal - LastYearWithdrawal ) * 0.25
If PlainWithdrawal < LastYearWithdrawal : LastYearWithdrawal - ( LastYearWithdrawal - PlainWIthdrawal ) * 0.25
From the various tests I ran, I believe this approach is superior to the moving average. Less need for past years data, it is fairly reactive without overreacting, and it's really quite simple.

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siamond
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Re: Using a 5y moving average to smooth withdrawals in VPW?

Post by siamond » Mon Jul 03, 2017 4:55 pm

Now, there is a more complicated consideration. The short-term issues are the most glaring. But the more I ran backtesting cycles, the clearer it became that there is also a long-term volatility issue, some 'big waves' you can see on the trajectory of withdrawals, which are rather disturbing, and not quite necessary in hindsight. Trouble is there are other scenarios (e.g. Japan-like crisis) when things go downwards for decades, with no end in sight. And that's quite the conundrum.

Long story short, if one replaces the fixed rate of return in the PMT formula underlying the VPW logic by an expected return computation refreshed every year, then the problem of long-term volatility is largely mitigated while ALSO properly adjusting to catastrophic Japan-like scenarios. The core principle is simple, if the current value of one's portfolio falls by 50% in one year, then the expected returns are significantly higher than usual, and it makes little sense to stick to a constant rate. And the converse can be said for a crazy high like in the end of the 90s. Now if both price and (smoothed) earnings fall apart, then it is indeed time to tighten the belt...

I am not going to provide more details here, this is an approach which requires more mastery of the inner workings of VPW (which are actually extremely simple!) AND a leap of faith that some expected returns models (e.g 1/PE, bond yields) do have a solid kernel in truth in there, AND that the robustness of the PMT formula is such that the probabilistic nature of expected returns is actually quite fine for such use case. Interested folks can read more starting from this post and/or send me PMs.

One last thought: interestingly enough, this approach nicely mitigates long-term volatility, but ALSO does a decent job for short-term volatility. And is very adaptive towards an uncertain future. And doesn't require any math based on inflation or last year withdrawal or whatever. So... I personally settled on this. Time will tell!

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siamond
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Re: Using a 5y moving average to smooth withdrawals in VPW?

Post by siamond » Mon Jul 03, 2017 5:10 pm

stlutz wrote:In short, VPW is part of a withdrawal strategy as opposed to being a strategy in and of itself. I think the desire to smooth things out probably suggests that you are asking it to do too much on it's own.
No, this isn't quite true - or at least not for everybody. All the backtests I ran were based on real-life scenarios, with a basis of fixed income (SSA/Pension/etc) in addition to portfolio withdrawals. Yes, this makes withdrawal volatility less impactful, because what really matters is the variability of your spending budget (the sum of fixed income plus the withdrawal), but the outcome remains very difficult to accept imho. See details and numerous examples in the G-K/VPW thread. This post is a good starting point.

This being said, it certainly depends A LOT of one's personal circumstances and one's psychology/behavior. Personally, I strongly believe in providing options. We're all different in our needs and goals and behavior. The base VPW (as part of an overall retirement plan with fixed income) is perfectly fine for some people. While other people have different needs/requirements, and this does include forms of smoothing. There is no one-size-fits-all when it comes to retirement... So I tried to summarize the options I know of in the previous posts. I hope this helps the people who feel the problem is very real.

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Re: Using a 5y moving average to smooth withdrawals in VPW?

Post by longinvest » Mon Jul 03, 2017 5:30 pm

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.
Last edited by longinvest on Thu Apr 12, 2018 6:57 am, edited 5 times in total.
Bogleheads investment philosophy | Lifelong Portfolio: 25% each of (domestic/international)stocks/(nominal/inflation-indexed)bonds | VCN/VXC/VLB/ZRR

longinvest
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Re: Using a 5y moving average to smooth withdrawals in VPW?

Post by longinvest » Mon Jul 03, 2017 5:49 pm

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
Bogleheads investment philosophy | Lifelong Portfolio: 25% each of (domestic/international)stocks/(nominal/inflation-indexed)bonds | VCN/VXC/VLB/ZRR

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Re: Using a 5y moving average to smooth withdrawals in VPW?

Post by aristotelian » Tue Jul 04, 2017 8:19 am

OP,
Can you clarify, it appears you are talking about variable withdrawal (constant % based on variations of total portfolio size) like a nonprofit endowment. Variable percentage withdrawal would vary the %, usually according to age, as life expectancy declines (as above poster laid out). I believe you are talking about the first but you use the term VPW in the thread title.

I work for a nonprofit that does 5% based on 3 year moving average, invested over 90% in stocks. We have to live with major fluctuations that might be unacceptable to an individual in retirement, but so far the strategy has worked to grow the endowment over time.

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Re: Using a 5y moving average to smooth withdrawals in VPW?

Post by Top99% » Tue Jul 04, 2017 9:15 am

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.
Great post as always Longinvest. And a huge thank you for your efforts in creating VPW. VPW along with the approach described in the "delay Social Security to 70 / spend more money at 62" thread have had a profound positive impact on our plans and one of the reasons I am now working part time. :sharebeer
Adapt or perish

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Re: Using a 5y moving average to smooth withdrawals in VPW?

Post by stlutz » Tue Jul 04, 2017 12:04 pm

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%.

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.

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.

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Re: Using a 5y moving average to smooth withdrawals in VPW?

Post by longinvest » Tue Jul 04, 2017 6:21 pm

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.
Last edited by longinvest on Thu Apr 12, 2018 6:57 am, edited 5 times in total.
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Re: Using a 5y moving average to smooth withdrawals in VPW?

Post by longinvest » Tue Jul 04, 2017 7:47 pm

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.
Last edited by longinvest on Tue Jul 04, 2017 9:53 pm, edited 3 times in total.
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Re: Using a 5y moving average to smooth withdrawals in VPW?

Post by stlutz » Tue Jul 04, 2017 8:26 pm

Thanks for the clarifications, longinvest--that is very helpful!! :sharebeer

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Re: Using a 5y moving average to smooth withdrawals in VPW?

Post by AlohaJoe » Tue Jul 04, 2017 10:43 pm

mortal wrote:it's very much a 'pay me now or pay me later' type of situation.
This is not really an accurate summary. When you smooth income you are generating a kind of risk. The risk can be removed by either reducing withdrawals or by the market performing better. It is entirely possible that you smooth income and never have to "pay later". Actually, that's what happens the vast majority of the time. That said, there are possible scenarios where it does eventually catch up to you. If you follow a traditional 4% safe withdrawal rate strategy and run out of money that's the classic example of (extreme) income smoothing eventually having to "pay later".

I've come to believe that you can't really destroy risk in investing. But you can trade one kind of risk for another. And everyone has different risk tolerances for all the different kinds of risk out there. Income volatility is one kind of risk. Portfolio volatility is another. Longevity a third. There are dozens of kinds of financial risks and we have to figure out which ones we care about most and what tradeoffs we'll make when balancing the various risks.

Income smoothing trades one risk for another -- income volatility risk goes down but "lack of mean reversion" risk goes up.

Here's a series of withdrawals (in nominal dollars), showing "plain" VPW versus one that uses a 3-year rolling average. The red boxes highlight areas where plain-VPW had large single-year income drops that were quickly reversed. You can also see that any kind of income smoothing also is slower to adjust upward -- but few people are worried about that kind of risk. This is also an example where there was no "pay later".

Image

To get a sense for what income smoothing has been like historically, here's the same for 1920-1985 in five year increments (i.e. 1925, 1930, 1935, 1940...). It is an external link, since I don't want to clog up Bogleheads with 13 more charts:

http://imgur.com/a/Yrt6l

I looked at 3 different income smoothing schemes -- the one siamond mentioned above that longinvest created, rolling averages, and one suggested by Ken Steiner. Here's what they look like for someone who retired in 1921.

Image

I also looked at rolling averages using 2 through 7 years of data. I did not look at using varying rates in the PMT calculation as siamond suggests, though. I wrote it all up in a blog post:

https://medium.com/@justusjp/income-smo ... 0062771466

There is a spectrum of income smoothing. The traditional "4% Safe Withdrawal Rate" is one extreme end (where it is totally smooth, at least on an inflation-adjusted basis) and VPW or a constant percentage is the other end. When I looked at the historical record I came away convinced that moderate amounts of smoothing can paper over short-term market volatility without introducing meaningful amounts of other risks.

I didn't really write about these in my blog posts but here are a few other things to consider:
  • Even if you've convinced yourself that income smoothing is safe enough for you...will you really follow the plan when markets tank? Even among relatively level headed Bogleheads, there are many instances of fear and even panic during relatively normal/common market movements.
  • If you're willing to use VPW then you know that markets can crash and stay down for 2-3 years pretty easily. So you have built a retirement plan with a fair amount of flexibility. Spending you can cut, purchases you can delay, gratification that go unsatisfied. Is smoothing really buying you that much in the real world? Does income smoothing just mean you cut $3,000 instead of $6,000 this year?
  • Most models (like all of my charts above, the VPW spreadsheet, and many other places) assume annual withdrawals. That is, in January 2018 you'll sell $90,000 of stocks & bonds, put it in your checking account, and then spend it over the course of the year. Maybe some people do that? But I think more people make their withdrawal quarterly or even monthly. In that scenario then I think the case for income smoothing becomes stronger, because we know that intra-year market volatility is more pronounced than annual volatility.

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Re: Using a 5y moving average to smooth withdrawals in VPW?

Post by siamond » Wed Jul 05, 2017 10:07 am

Thank you, AlohaJoe, for a great study and for bringing back this topic to the OP's question.

Would be great to see your analysis extended to the adjusted smoothing formula I suggested above, and to see the charts both in nominal terms (for the psychological reasons longinvest and yourself mentioned) and in inflation-adjusted terms (to better capture the real goal, protect one's purchasing power and standard of living). Both perspectives are useful.

A technical note: standard-deviation analysis on a growing series of numbers is unfortunately rather skewed, and the nominal analysis is of course especially prone to that. I believe the human eye tends to adjust by comparing the trajectory to a much smoother line in our mind, with our uncanny ability to identify patterns out of noise. Translating that in a formula could be captured by looking at the std-deviation of the difference between the numbers and their regression. Trouble is this might have to be a polynomial regression. And this gets complicated... Fortunately, an inflation-adjusted trajectory is much easier to analyze.

Oh, and I agree that smoothing small variations is quite inconsequential in real life. It's really when markets get in a frenzy (deep crisis AS WELL AS big bull markets) that it gets really important to have a proper target in mind to guide one's decisions. And that's good, because this is the time where we get the most emotional. This may not prevent us from overreacting, but at least, we'll have solid guidelines to look at.

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Re: Using a 5y moving average to smooth withdrawals in VPW?

Post by icetrap » Tue Feb 27, 2018 1:07 pm

I'm also a strong believer in smoothing for withdrawals. I do plan to use it in my own retirement scheme. However, I too believe that we should too much focus on real $ given the current inflation projection and much more stable inflation of these past 25 years (Canada). What's good to adjust withdrawal by +2% when market crash of 08' said the world is ablazed. If I were a retiree I would be scared to give myself a pat in the back and give myself a 2% increase while my fund value is down by 30-50%. Why not instead do not increase the withdrawal? Why not follow the ebb and flow of the smoothed water? You can look at my study : https://whyvampiremustberich.blogspot.ca/ It basically expand the smoothing strategy and use two other adjustement to smooth out the withdrawals cash flow (using reserve for bad rainy days and capping of the withdrawal increase).

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Re: Using a 5y moving average to smooth withdrawals in VPW?

Post by longinvest » Tue Feb 27, 2018 1:09 pm

Smoothing VPW withdrawals is equivalent to "buy high, sell low". This is true regardless of the smoothing formula. As a consequence, smoothing is inefficient.
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Re: Using a 5y moving average to smooth withdrawals in VPW?

Post by icetrap » Mon Mar 05, 2018 8:36 pm

longinvest wrote:
Tue Feb 27, 2018 1:09 pm
Smoothing VPW withdrawals is equivalent to "buy high, sell low". This is true regardless of the smoothing formula. As a consequence, smoothing is inefficient.
I agree that smoothing VPW is equivalent to sell less high, sell more low. However, it's not true that this smoothing is bad or inefficient. It all depends on your objective and the full strategy of decumulation.

Safe withdrawal rate (SWR) for instance is based on a single starting Market Value measure. It then the initial withdrawal get increase by inflation each year. There's two issue with this.
1. The initial withdrawal in year 2 can be substantially more than 4%. Ex: Start withdrawing 40k out of 1 million :moneybag in year 0; Market crash in year 2 and fund is now 500k. withdraw 40,800$ in year 2 is about 8% of the fund :shock: ! 5 years Smoothing VPW would withdraw instead 36k. This would be better by about 5k than SWR.
2. If there's hyperinflation, SWR increase regardless of MV. getting a Smoothing VPW is better since it consider at least partially current MV.

Instead of SWR, if we look at a true constant MV % withdrawal, the retiree would be stuck with high volatility. While smoothing is less efficient, it does remove the risk of high volatility. Using the same market condition as above, the retiree would start withdrawing 40k in year 1 and 20k in year 2 :shock: ! Instead a smoothed VPW would withdraw 36k. If your purpose is to have stable withdrawal, I like better the smoothed withdrawal than the unsmoothed one.

Regardless, my ADD strategies have two others measure which reduce the "sell less high, sell more low." Having an increase cap allow for decreasing withdrawal in good year. Similarly if market is good, the reserve will only grow and not be spent.

In the end, I agree with you an unsmoothed strategy is more efficient. However, I believe that we should control the volatility of withdrawal. The volatility of withdrawal risk is greater than the reward of the "buy low, sell high".

Regards,

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Re: Using a 5y moving average to smooth withdrawals in VPW?

Post by longinvest » Mon Mar 05, 2018 9:00 pm

Dear Icetrap,
  • Inflation-adjusted stock volatility can be dampened by adding high-quality inflation-indexed bonds (TIPS) to a portfolio.
  • Nominal stock volatility can be dampened by adding high-quality nominal bonds to a portfolio.
  • I can save a little more to account for the likely reduction in average returns due to including bonds into my portfolio.
Personally, I wouldn't like to live retirement through a Japan-like scenario caused by things that were unpredictable (not even by PE ratios) with a high-stock portfolio and a "smoothed" variant of VPW. But, that's me.

As Taylor Larimore likes to say: There is more than one road to Dublin.

Good luck!
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Re: Using a 5y moving average to smooth withdrawals in VPW?

Post by siamond » Mon Mar 05, 2018 10:51 pm

icetrap wrote:
Mon Mar 05, 2018 8:36 pm
In the end, I agree with you an unsmoothed strategy is more efficient. However, I believe that we should control the volatility of withdrawal. The volatility of withdrawal risk is greater than the reward of the "buy low, sell high".
Indeed. In real life, there are many types of risks & rewards. The way we balance them is a highly personal decision. There is NO SUCH THING as a one-size-fits-all. Personally, I have very limited interest in a 'perfect' "buy low, sell high" algorithm. What I truly care about is much more down to earth, a good chance of higher growth on the long run, less variability of the income along the way than predicated by the 'perfect' algorithm, and decent mitigation of really bad scenarios without gating my life by them. Again, it's a personal balancing act. I don't expect to convince anybody, but me. To each their own.

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Re: Using a 5y moving average to smooth withdrawals in VPW?

Post by icetrap » Tue Mar 06, 2018 9:24 pm

longinvest wrote:
Mon Mar 05, 2018 9:00 pm
  • Inflation-adjusted stock volatility can be dampened by adding high-quality inflation-indexed bonds (TIPS) to a portfolio.
  • Nominal stock volatility can be dampened by adding high-quality nominal bonds to a portfolio.
  • I can save a little more to account for the likely reduction in average returns due to including bonds into my portfolio.
Personally, I wouldn't like to live retirement through a Japan-like scenario caused by things that were unpredictable (not even by PE ratios) with a high-stock portfolio and a "smoothed" variant of VPW. But, that's me.
I agree with you. Also note that Equity seems also somewhat correlated to inflation also (“Common Stocks as a Hedge Against Inflation”, Zvi Bodie 1975). Then again, I totally agree that we should accept our own tolerance for risk. Better to stick with a strategy that you can hold then a high equity allocation you cannot maintain. Beware of greed without knowledge of your own limit.

From what I gather TIPS were only offered after the high inflation of the 70's. I get that they were created in low inflation periods of the late 90's. I would be worry that in the next hyperinflation crisis they do not held their guarantee as they never been truly tested in period of high inflation. In similar fashion than the DB low solvency of recent years, only in harsh time can we see if they hold or fails.

Regardless, high-quality nominal bonds, TIPS still get some volatility. According to Vanguard, they seems to have similar volatility than T-Bills. If you go with a 50% equity/ 50% bonds (real), you drop volatility from 8.2% to 3,7% (50% S&P 50% T-Bills looking at 1954 to 2016 data). Smoothing 5 years seems to heavily reduce the volatility of such asset allocation.

For the Japan-like scneario, challenge accepted.

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Re: Using a 5y moving average to smooth withdrawals in VPW?

Post by AlohaJoe » Tue Mar 06, 2018 9:29 pm

icetrap wrote:
Tue Mar 06, 2018 9:24 pm
From what I gather TIPS were only offered after the high inflation of the 70's. I get that they were created in low inflation periods of the late 90's. I would be worry that in the next hyperinflation crisis they do not held their guarantee as they never been truly tested in period of high inflation.
This is typical "the world doesn't exist outside of America" thinking. America didn't invent inflation indexed bonds. They've been around since 1981. Their performance in the high inflation of the early 1980s is a matter of historical fact; there's no need to speculate or wonder what would happen. They have been tested.

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Re: Using a 5y moving average to smooth withdrawals in VPW?

Post by icetrap » Tue Mar 06, 2018 9:36 pm

siamond wrote:
Mon Mar 05, 2018 10:51 pm
icetrap wrote:
Mon Mar 05, 2018 8:36 pm
In the end, I agree with you an unsmoothed strategy is more efficient. However, I believe that we should control the volatility of withdrawal. The volatility of withdrawal risk is greater than the reward of the "buy low, sell high".
Indeed. In real life, there are many types of risks & rewards. The way we balance them is a highly personal decision. There is NO SUCH THING as a one-size-fits-all. Personally, I have very limited interest in a 'perfect' "buy low, sell high" algorithm. What I truly care about is much more down to earth, a good chance of higher growth on the long run, less variability of the income along the way than predicated by the 'perfect' algorithm, and decent mitigation of really bad scenarios without gating my life by them. Again, it's a personal balancing act. I don't expect to convince anybody, but me. To each their own.

I agree. Personnaly, I'm concerned that without a guide (strategy) during retirement, I may missbehave. Selling in panic and buying in high time. That's one of the reason I like so much the Index investing with contributing wihtout care of what the market is doing. Also I'm concerned about SWR strategy as it provides only one guide to deal with increase MV or decrease MV (that is stick with an inflation increase). If MV is twice the retirement MV, then I would be foolish (according to SWR) to double my withdrawal. However, I feel that is leaving much money on the table. VPW fixes this, but get hits by loads of volatility.

I believe that smoothing instead allow to see the VPW to fluctuates less. Ultimately my goal of a good VPW (real $) is to reduce VPW volatility, provides some moving floor to handle over aggresive assumption and conservative increase in good times.

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Re: Using a 5y moving average to smooth withdrawals in VPW?

Post by siamond » Tue Mar 06, 2018 9:45 pm

icetrap wrote:
Tue Mar 06, 2018 9:36 pm
Personnaly, I'm concerned that without a guide (strategy) during retirement, I may missbehave. Selling in panic and buying in high time. [...]
Yes, longinvest and myself have been going back and forth for a long time on this smoothing thing, but one topic I believe we both agree on is to seek a clear and formulaic withdrawal plan. It is rather strange to see people define an Investment Policy with great discipline and great detail, but then switch to a much less formal mode for withdrawals (and I am being polite here).
icetrap wrote:
Tue Mar 06, 2018 9:36 pm
I believe that smoothing instead allow to see the VPW to fluctuates less. Ultimately my goal of a good VPW (real $) is to reduce VPW volatility, provides some moving floor to handle over aggresive assumption and conservative increase in good times.
Been using a variation of the smoothing algorithm discussed above for a couple of years now. This applies to bull markets as well as bear markets... Still, for all the backtesting some of us did, I think we're all theorizing a bit here, and going through a deep crisis in real life will probably reset some theoretical thinking... Time will tell.

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Re: Using a 5y moving average to smooth withdrawals in VPW?

Post by icetrap » Tue Mar 06, 2018 10:03 pm

AlohaJoe wrote:
Tue Mar 06, 2018 9:29 pm
icetrap wrote:
Tue Mar 06, 2018 9:24 pm
From what I gather TIPS were only offered after the high inflation of the 70's. I get that they were created in low inflation periods of the late 90's. I would be worry that in the next hyperinflation crisis they do not held their guarantee as they never been truly tested in period of high inflation.
This is typical "the world doesn't exist outside of America" thinking. America didn't invent inflation indexed bonds. They've been around since 1981. Their performance in the high inflation of the early 1980s is a matter of historical fact; there's no need to speculate or wonder what would happen. They have been tested.
I didn't know that. Thanks for sharing it with me :) I'll sleep with more knowledge tonight. Indeed the indexed Gilt experience a few good inflation year (1981-1986) faced a 6,57% inflation . The inflation rate seems to have decline since then, constantly. 6,57% is very comparable to the 70's US average 7,41% inflation rate. Gilt have not faced the 77-81(guilty cherry picking) average inflation of 10,08% but still 6,57% is pretty high beginning.

Honestly, I doubt that hyper inflation is an issue going forward as long as the bank hold to their objective of maintaining inflation low (2% for Canada & US). Let's touch wood that they continue with their objective.

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Re: Using a 5y moving average to smooth withdrawals in VPW?

Post by icetrap » Tue Mar 06, 2018 11:27 pm

The evil :( Japanese scenario (using DQYDJ Nikei data from jan to jan from 1950 to 2016)


The volatility of the Nikkei is about 24% year to year. Using a 5 year smoothing, we reduce it to 7%. That's a 28% decrease in volatility. I guess it provides again a case for smoothing things out.

Now lets see what it does to various withdrawal strategy.

Using SWR I get a SWR of 0,99%.. I guess that would leave a lot using SWR in financial ruin.

Instead ADD (my VPW withdrawal strategy using smoothing), I can get away with 6,5% withdrawal (100% Nikkei) at the expense of having 100% of the run (year of retirement) where withdrawal are reduce by more than 95% of previous withdrawal (real). On average withdrawal are reduced by 69%. maximum reduction 6% of previous withdrawal (.. .thing got ugly). Using the same investment (150k 20 yr prior retirement and 5k investment inflated by 3% each year), the difference between 100% Nikkei (8,900$ (Yen real) vs a 50% Nikkei/50% Moody Seasoned AAA Corp bond yield (9,900$ (Yen real)) is pretty small.

Dropping the smoothing out of the ADD, produce mix results. Increase in risk at 6,5% withdrawal rate and 100% Nikkei and lower min withdrawal, but the 50%/50% allocation get boosted to 13k minimal withdrawal.. Not a bad increase.

If I drop to 3% using ADD strategy now the 50% Nikkei/50% US AAA bonds get adequate results. Average withdrawal of 36k out of avg fund of 1,3 million. No historical run where you need to drop less than 95% of prior withdrawal. (worst fund 555,600$ with a worst Initial withdrawal 9,300$) For the 100% Nikkei, results still are quite negative. (worse withdrawal 10,300$ (slight increase... but). On the good side, only 89% of the run get decrease below 95% of previous year (avg 55% of any previous withdral .

At 2% ADD withdrawal rate, I get the 70% Nikkei/ 30% US AAA bonds out of any drop lower than 95% withdrawal.

Regardless of any ADD withdrawal rate, having 0% ruin probability seems better than quasi insured ruin using SWR.

If any one has data on Japanese bond I would be happy to test with them.

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Re: Using a 5y moving average to smooth withdrawals in VPW?

Post by AlohaJoe » Tue Mar 06, 2018 11:49 pm

icetrap wrote:
Tue Mar 06, 2018 11:27 pm
If any one has data on Japanese bond I would be happy to test with them.
If you create a new thread instead of hijacking this one I'll give you Japanese bond data :D

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Re: Using a 5y moving average to smooth withdrawals in VPW?

Post by AtlasShrugged? » Wed Mar 07, 2018 7:23 am

Yes, longinvest and myself have been going back and forth for a long time on this smoothing thing, but one topic I believe we both agree on is to seek a clear and formulaic withdrawal plan. It is rather strange to see people define an Investment Policy with great discipline and great detail, but then switch to a much less formal mode for withdrawals (and I am being polite here).
Yes, this has been my 'heartburn'. Now I have many years to go before retirement, and am in the accumulation stage. But the question of withdrawals is one that is particularly troublesome. I think some of the problem is clarifying what you want out of your portfolio. Namely, do you want to leave anything for anyone (bequest). To me, bequest is what seems to throw a monkey wrench into the withdrawal question.

As I understand VPW, it is to be used in conjunction with an income floor, and does not plan for a bequest. You need to make a huge assumption on how long you will live (I guess if you pick 110, you are pretty much covered). Your annual withdrawal will fluctuate. The 'bulk' of the portfolio drawdown happens in the last 5 years, at a time when you are least likely to want to spend. The appeal I see with VPW is the simplicity of the method.

In using Simba's backtesting sheet, I have become intrigued by the 'maximum sustainable withdrawal' and 'perpetual withdrawal' numbers. Intuitively, I know that there is something very important there that can work with VPW, but it eludes me. I need to think about this. One other thing....I am definitely going to get 'Living off your money' as a birthday present to myself. The 'Prime Harvesting' strategy is one I need to investigate a lot more. The issue at hand is that his downloadable spreadsheet does not seem to work in Open Office. :confused
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Re: Using a 5y moving average to smooth withdrawals in VPW?

Post by longinvest » Wed Mar 07, 2018 8:58 am

siamond wrote:
Tue Mar 06, 2018 9:45 pm
Yes, longinvest and myself have been going back and forth for a long time on this smoothing thing, but one topic I believe we both agree on is to seek a clear and formulaic withdrawal plan. It is rather strange to see people define an Investment Policy with great discipline and great detail, but then switch to a much less formal mode for withdrawals (and I am being polite here).
I confirm my agreement with seeking a clear and formulaic portfolio withdrawal plan.

Among other things, this is important for keeping emotions out of it (especially during bad times) and avoiding behavioral mistakes.
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Re: Using a 5y moving average to smooth withdrawals in VPW?

Post by siamond » Wed Mar 07, 2018 9:29 am

icetrap wrote:
Tue Mar 06, 2018 11:27 pm
The evil :( Japanese scenario (using DQYDJ Nikei data from jan to jan from 1950 to 2016)

The volatility of the Nikkei is about 24% year to year. Using a 5 year smoothing, we reduce it to 7%. That's a 28% decrease in volatility. I guess it provides again a case for smoothing things out.

Now lets see what it does to various withdrawal strategy.

Using SWR I get a SWR of 0,99%.. I guess that would leave a lot using SWR in financial ruin.
The Nikkei data series you are referring to is price-only, it does NOT include dividends. And bonds were no life saver, heck, the bank of Japan kind of pioneered negative interest rates... If you check this blog article of mine (and the follow-up article), you'll get a better idea of the Japan situation. Which was dire for sure, but not as much as many people make it (because they are looking at the Nikkei data, not total return!).

Anyhoo, as AlohaJoe stated, this would make for a good thread on its own, we shouldn't sidetrack this thread (about VPW and smoothing) too much, as it is an important topic on its own.

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Re: Using a 5y moving average to smooth withdrawals in VPW?

Post by longinvest » Wed Mar 07, 2018 10:17 am

A huge weakness of smoothing methods based on averaging is that they don't elegantly deal with real life.

Our lives are messy and don't always fit neatly into a spreadsheet. Yes, we build plans, but life has a way to derail our plans.

VPW, by only considering the current state of the portfolio, not taking into account the withdrawal history, is able to adapt to the current situation, regardless of what it happens to be. If the investor has to liquidate part of the portfolio for an unexpected one-time expense, or if he receives an unanticipated windfall, VPW will naturally and automatically adapt future withdrawals accordingly: if the portfolio's bigger, withdrawals will be bigger; if the portfolio's smaller, withdrawals will be smaller.

This adaptability of VPW to the current state of things allows VPW to be used as an ongoing planning tool, like a budget. When unexpected things happen in life (job loss, etc.), we adapt our budget accordingly. Also, most people use their budget, not as a strict inflexible tool, but as a guide for their spending. VPW can be used similarly, to give a general indication of how much can be reasonably withdrawn from the portfolio without exposing it to premature depletion.
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Re: Using a 5y moving average to smooth withdrawals in VPW?

Post by icetrap » Wed Mar 07, 2018 11:31 am

AlohaJoe wrote:
Tue Mar 06, 2018 11:49 pm
icetrap wrote:
Tue Mar 06, 2018 11:27 pm
If any one has data on Japanese bond I would be happy to test with them.
If you create a new thread instead of hijacking this one I'll give you Japanese bond data :D
I've create the tread "Using VPW versus the great Japan depression" to discuss this stress test scenario I'll wait for the japanese bond data :)

According to wikipedia Japanese were 1000x lower economy than US in 1980. Based on Canada (1/10 of US GDP or about in 1980) investing strategy, it seems a diversify own country/rest of the world is a great way to reduce such "Japan scenario". However, Most Canadian over extend and are subject to country bias. Let's look at the worst first :)

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Re: Using a 5y moving average to smooth withdrawals in VPW?

Post by icetrap » Wed Mar 07, 2018 11:51 am

AtlasShrugged? wrote:
Wed Mar 07, 2018 7:23 am
Yes, this has been my 'heartburn'. Now I have many years to go before retirement, and am in the accumulation stage. But the question of withdrawals is one that is particularly troublesome. I think some of the problem is clarifying what you want out of your portfolio. Namely, do you want to leave anything for anyone (bequest). To me, bequest is what seems to throw a monkey wrench into the withdrawal question.
I would advice with going with a simple strategy if you want to leave nothing in bequest. Go with Annuity with an insurer. Most likely, you will be able to have ever greater withdrawal than a VPW or SWR strategy. The offshot of going with annuity is that if you die, it leave nothing to bequest (Hey that was the goal :) )

Another great strategy if you want to leave some bequest, why not go x% annuity (1-x%) with VPW strategy. SWR backtested by Bengen said that he had 96% of the scenario if more or equal money than at the start.

A third possibility, If you want guarantee x$ at death, why not go with a Life insurance. They exists for just that.

VPW by construction is going to leave a huge amount at death as long as withdrawal rate are lower than Return on Asset (RoA).
AtlasShrugged? wrote:
Wed Mar 07, 2018 7:23 am
As I understand VPW, it is to be used in conjunction with an income floor, and does not plan for a bequest. You need to make a huge assumption on how long you will live (I guess if you pick 110, you are pretty much covered). Your annual withdrawal will fluctuate. The 'bulk' of the portfolio drawdown happens in the last 5 years, at a time when you are least likely to want to spend. The appeal I see with VPW is the simplicity of the method.

In using Simba's backtesting sheet, I have become intrigued by the 'maximum sustainable withdrawal' and 'perpetual withdrawal' numbers. Intuitively, I know that there is something very important there that can work with VPW, but it eludes me. I need to think about this. One other thing....I am definitely going to get 'Living off your money' as a birthday present to myself. The 'Prime Harvesting' strategy is one I need to investigate a lot more. The issue at hand is that his downloadable spreadsheet does not seem to work in Open Office. :confused
I'm not sure about the floor plan in all VPW's. Some can, others not. Once you introduce a floor, I fear you gain too much ruin risk. That's why I don't have a hard fixed floor in the ADD strategy.

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Re: Using a 5y moving average to smooth withdrawals in VPW?

Post by longinvest » Wed Mar 07, 2018 12:59 pm

Icetrap,
icetrap wrote:
Wed Mar 07, 2018 11:51 am
VPW by construction is going to leave a huge amount at death as long as withdrawal rate are lower than Return on Asset (RoA).
Can you provide a reference for this statement?

Here's what I wrote in my first forum post about Variable Percentage Withdrawal (VPW):
longinvest wrote:
Thu Jul 25, 2013 11:12 pm
I'm seeking comments on a withdrawal method I've thought up. I've been reading the forums for a while and I've read many Safe Withdrawal Rate (SWR) threads. I've also read the Withdrawal Methods Wiki page. Yet, I'm not satisfied with the methods I've seen :
  • Constant-Dollar : I would need to make a huge leap of faith to start withdrawing 4% (or whatever %) of the my portfolio, and index it to inflation every year. (1) This is scary! I would be subject to bad sequence of return risk, and (2) there is a very high probability that I will leave much money unspent (if the bad sequence doesn't show up). I might be too old to spend it, once I realize that I have too big a pile of money.
  • Constant-Percentage : This one does not have as much sequence of return risk (I can still end up with a much lower amount to spend than I expected, if I chose too high a percentage). The problem is that I am, again, quite likely to underspend and leave a lot of money unspent.
  • Spend Only the Dividends : I would likely overspend my bonds and underspend my equities, unless, of course, I had a 50/50 portfolio and rebalanced it regularly. Yet, I would still be very likely to leave a lot of money unspent.
...
One of the main design objectives of VPW was to avoid underspending.
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Re: Using a 5y moving average to smooth withdrawals in VPW?

Post by longinvest » Wed Mar 07, 2018 1:16 pm

Off topic:
AtlasShrugged? wrote:
Wed Mar 07, 2018 7:23 am
Yes, this has been my 'heartburn'. Now I have many years to go before retirement, and am in the accumulation stage. But the question of withdrawals is one that is particularly troublesome. I think some of the problem is clarifying what you want out of your portfolio. Namely, do you want to leave anything for anyone (bequest). To me, bequest is what seems to throw a monkey wrench into the withdrawal question.
It can be very enjoyable to give away money while still alive. One could take advantage of any unneeded part of a VPW withdrawal (particularly after a good market year) to help loved ones or charitable organizations of one's choice, hopefully making a difference at a point when they need it.
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Re: Using a 5y moving average to smooth withdrawals in VPW?

Post by AtlasShrugged? » Wed Mar 07, 2018 1:29 pm

It can be very enjoyable to give away money while still alive.
Yeah, you're right about that. Even better, I have found, is spending OPM. :happy

That aside, you really came up with something very elegant with VPW, longinvest. I don't have occasion to use that word, elegant, very much - but it is very much the case here. VPW is an elegant solution. I salute you.
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Re: Using a 5y moving average to smooth withdrawals in VPW?

Post by icetrap » Wed Mar 07, 2018 2:11 pm

longinvest wrote:
Wed Mar 07, 2018 12:59 pm
Icetrap,
icetrap wrote:
Wed Mar 07, 2018 11:51 am
VPW by construction is going to leave a huge amount at death as long as withdrawal rate are lower than Return on Asset (RoA).
Can you provide a reference for this statement?
Happy to oblige :sharebeer

There’s no risk of ruin with ADD withdrawal. Say you start with a million dollar and take 5% each year as withdrawal. In addition, assume that the rate of return is 0%. The first year you would withdraw 50,000$(5%*1,000,000), the next 47,500$(5%*950,000). After 10 years, you would withdraw 31,512, after 50 years 4,049$ and after 100 years 312$. The fund never goes to 0. The downside is that the withdrawal can get arbitrarily low, but not 0. SWR instead hope for no ruin risk based on historical returns. However, if rate of return are 0%, a 5% withdrawal from SWR, we would withdraw 50,000$ for 20 years. Afterward, ruin would be guaranteed.

That is using a constant percent withdrawal. However, whatever the % you use (if not 100%) will never go to 0. If RoA> constant % withdrawal rate, then you certain to get back to your feet. If they are "equal" after ten years then you are good... by equal I mean 1/(1-withdrawal rate) equal. so a 5% withdrawal rate need an average 5,263% average.

Image

Using VPW, the math get the "avg geometric" vs "avg arithmetic dillema. If we play with VPW using subsequently 1%, 2%, 3%, 4%, 5%, 6%, 7%, 8%, 9%, 4,6835% in order to have an average geometric withdrawal of 5%.

Image

In brief, as long as VPW have greater than average geometric withdrawal, the fund goes along forever.

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Re: Using a 5y moving average to smooth withdrawals in VPW?

Post by icetrap » Wed Mar 07, 2018 3:00 pm

longinvest wrote:
Wed Mar 07, 2018 12:59 pm
Icetrap,
icetrap wrote:
Wed Mar 07, 2018 11:51 am
VPW by construction is going to leave a huge amount at death as long as withdrawal rate are lower than Return on Asset (RoA).
Can you provide a reference for this statement?
On an added note, VPW as define in bogleheads at age 98 have about an average geometric withdrawal of 8-9,2%. Any RoA above this level will ensure more than 100% fund value return at death. At age 99, 100% withdrawal rate is a bit extreme. Indeed at age 99 there's nothing left.

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Re: Using a 5y moving average to smooth withdrawals in VPW?

Post by longinvest » Wed Mar 07, 2018 3:06 pm

icetrap,
icetrap wrote:
Wed Mar 07, 2018 3:00 pm
On an added note, VPW as define in bogleheads at age 98 have about an average geometric withdrawal of 8-9,2%. Any RoA above this level will ensure more than 100% fund value return at death. At age 99, 100% withdrawal rate is a bit extreme. Indeed at age 99 there's nothing left.
I invite you to read more about Variable-Percentage Withdrawal, and how to use it during retirement, in the VPW forum topic. Here's part of a post which provides more information (click on the ↑ symbol after "longinvest wrote:" to see the full post):
longinvest wrote:
Sun Sep 03, 2017 10:43 am
...
One approach to build a workable retirement plan is to split it in two parts: (i) lifelong non-portfolio stable inflation-indexed income and (ii) variable portfolio withdrawals. To address longevity issues, part of the remaining portfolio can be converted into lifelong non-portfolio stable inflation-indexed income around age 80, when the payout of an inflation-indexed Single Premium Immediate Annuity (SPIA) becomes competitive with variable portfolio withdrawal percentages.
...
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Re: Using a 5y moving average to smooth withdrawals in VPW?

Post by siamond » Wed Mar 07, 2018 4:02 pm

longinvest wrote:
Wed Mar 07, 2018 10:17 am
A huge weakness of smoothing methods based on averaging is that they don't elegantly deal with real life.

Our lives are messy and don't always fit neatly into a spreadsheet. Yes, we build plans, but life has a way to derail our plans.

VPW, by only considering the current state of the portfolio, not taking into account the withdrawal history, is able to adapt to the current situation, regardless of what it happens to be. If the investor has to liquidate part of the portfolio for an unexpected one-time expense, or if he receives an unanticipated windfall, VPW will naturally and automatically adapt future withdrawals accordingly: if the portfolio's bigger, withdrawals will be bigger; if the portfolio's smaller, withdrawals will be smaller.
Let's not fall in hyperbole. The method described in this post doesn't require any past information. The method described in this post only requires one year, the past year's data. Large lump sums (in or out) derailing one's budget are typically very unusual. I am actually living through it, after a couple of years of withdrawals, I'll receive an inheritance this year. That won't happen again, that is for sure... :(

Ok, I'll use some basic common sense, and adapt. I am not going to use an obviously inadequate formula, and I think I'll be fine, thank you very much. This is not a 'huge weakness', this is a minor and very occasional issue, easily addressed. Way less impactful than a 30% drop in one's withdrawal because of a 30% drop in one's portfolio, and because of the use of a withdrawal method making a straight link between portfolio size and withdrawal. THAT is a true real-life problem.

This being said, I do agree with you that withdrawal methods requiring multiple years of history (moving average over 5 years, or something like that), or based on a single computation made many years ago (e.g. '4% rule') are very unfortunate. But this isn't what we're speaking of here. Finally, yes, VPW adaptiveness is indeed a great property, that is for sure.

EDIT: fixed flawed links.
Last edited by siamond on Thu Mar 08, 2018 11:27 am, edited 1 time in total.

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Re: Using a 5y moving average to smooth withdrawals in VPW?

Post by longinvest » Wed Mar 07, 2018 4:11 pm

Siamond,
siamond wrote:
Wed Mar 07, 2018 4:02 pm
I'll receive an inheritance this year. That won't happen again, that is for sure... :(
My sincere condolences.

longinvest
Last edited by longinvest on Wed Mar 07, 2018 6:02 pm, edited 1 time in total.
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Re: Using a 5y moving average to smooth withdrawals in VPW?

Post by longinvest » Wed Mar 07, 2018 4:33 pm

The whole point of "smoothing VPW", as I understand it, it to let the retiree use a high-stock allocation*.

Yet, if the stock market lost 80% of its value and stayed there, the "smoothing" would just delay the reduction in withdrawal by a year or two. The withdrawal method cannot magically create money that the market doesn't deliver. In the end, the retiree ends up with even less than if he had used plain VPW.

Actually, he ends up with a lot less than with plain VPW, in such a situation, because a VPW user wouldn't have used a high-stock allocation to start with, knowing that if the stock market was to drop severely, he would sustain an immediate reduction in withdrawals.

At the end of the day, smoothing accomplishes nothing, other than being inefficient, and potentially misleading its user into adopting a more agressive asset allocation due to artificially smooth behavior when backtesting on data that we know won't repeat in the future.

* I've showed, earlier in this thread, how VPW is already smooth, without any need for artificial smoothing, when applied on a 50/50 portfolio and combined with stable non-portfolio income: viewtopic.php?f=10&t=222480&p=3819071#p3433932
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Re: Using a 5y moving average to smooth withdrawals in VPW?

Post by AtlasShrugged? » Wed Mar 07, 2018 4:41 pm

longinvest....It just hit me. The 50/50 portfolio. What was the reasoning for 50/50 and not using 60/40 or some other mix? Sorry if this is a dumb question, but I would rather look dumb and ask, rather than wonder.
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