I'm seeking comments on a withdrawal method I've thought up. In the end I hope it inspire other with similar or even better strategies. I've been reading the forums for a while and I've read many Variable Withdrawal Rate (VWR) threads. I've also read the Withdrawal Methods Wiki page. Yet, I was not satisfied with the methods.
Let be clear, my method is what I currently use (the accumulation phase so far.. not much to write home about). I do plan to continue using this method going into retirement in a good while.
I've done backtesting the method and done a Monte Carlo analysis. I'm not seeking a review of my study.
If you want to see the full study please let me know. I'll post a link. Otherwise it can be implemented fairly easily without it.
Here's the goal of the stratregy:
- Remove the risk of ruin >> done by going "percent withdrawal"
- Reduce the variability of the withdrawal. >> done by the main 3 sub-strategy
- Reduce the "retirement date paradox", that is a SWR retiree of 2007 gets a lot more than a 2008 retiree. >> done by looking at the accumulation phase, not just the decumulation phase. also the sub-strategy to smooth and cap increase
- Have a floor, but not let it be in the end an absolute anchor. In the end at 70-80 years old, why not lower it. >> done by the reserve
- remove hyperinflation risk. Honestly I don't believe that either US or Canada going's the face high inflation in the future. If they do, I hope this method deal with it regardless.
- Provide other method than "Asset Allocation" to manage "volatility of return" risk. If you have a single hammer in the tool box, you're gonna always it. However make no mistake, Asset Allocation I believe is a valid technique if you can't stomach the year to year Market Value.
So here's the strategy in short :
Three strategies to reduce the volatility of withdrawal are used in the ADD strategy.
o This is a well establish method in the DB pension world. It can be naively explained as taking the moving average over 5 years. The advantage is to have a lower the volatility and assess more prudently the fund. It has the effect of delaying the impact of short term gains/loss, hopefully taking advantage of any reversion to the mean.
- Increase Cap
o Since we take a percentage of the fund each year, exceptional returns would also imply exception increase in withdrawal. Instead, we cap the increase to a maximum versus the previous withdrawal.
- Capital Reserve
o This technique set aside money for economic hardship. The reserve will fund the gap between 95% previous withdrawal and current withdrawal. The reserve would kick-in to fund the deficit. In economic good times, the reserve grows. The 5% gap can be seen as a bonus. Bonuses are not guaranteed. They only are often paid.
I admit, this is not a simple run of the mill strategy. It's more complex than Safe Withdrawal Rate (SWR) or VWR. However, in the end I believe a sheet of paper would be sufficient to do most of it with rather ease.
Approximate Smoothing Market Value (SMV) by averaging last 5 years of Market Value * (1+Expected Return)^2 (note Expected return less Variance is better approximation)
Take a withdrawal of SMV * your selected withdrawal rate
Compare with last year withdrawal * (1+6%). This is the increase cap. Do not adjust for inflation.
Step 3 have a reserve of the fund at retirement of 25% of overall fund. Use this to provide a floor withdrawal if you feel Variable withdrawal drop too low.
My study goes into deeper technicality, but in essence you go a long way with these 3 steps. Another Highly recommend step is before retirment where you need to cap currently estimate withdrawal by 115% of previous year estimate withdrawal. This way a 30% increase in one year will not lead to 30% increase at retirment. This lowers the probability of reduction of withdrawals in the future.
I'll await comment I hope:
Here's the Google Drive and DropBox links for the spreadsheets with the strategy.