Flaws with 4% Rule?

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AverageInvestor1982
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Flaws with 4% Rule?

Post by AverageInvestor1982 » Tue Nov 12, 2019 3:08 pm

Can Bogleheads help distill this paper down to it's elements and then provide a reaction to it?

https://web.stanford.edu/~wfsharpe/retecon/4percent.pdf

I find Bogleheads to be one of the best places on the web to explain complicated things in straightforward manner, and am hoping someone can work their magic here. I started reading it and got impatient with the author's style, but thought his premise had enough merit to discuss.

I believe the general point to be that because the stock market is volatile, the idea of producing a non-volatile year-of-over year income stream from it is inefficient. This picks at the edge of something I can't quite put words to - something about the idea that when I retire, I know I will have some flexibility in spending, so any advice that doesn't take that flexibility into account is too broad to be applied to any single scenario. (Don't get me wrong, if I were giving advice to a broad group of people, I would immediately reference the 4%/Jack Bogle theories as the best possible starting point.)

But if I structure my retirement spending so that I could reduce costs by 25-50% in down years, doesn't that mean I could run "hot" on spending on up years? I imagine spending patterns where on an average year, I pay for a giant beach house for a week for all my kids and grand kids. On an "up year" we go to Europe for week. And on a down year, I invite the grand kids to my house for a week and tell parents to enjoy a week of kid-free living. Same goes for a vacation with me and DW - could be a stay-cation, trip to Cancun, Trip to Bora-Bora depending on market returns. How does building flexibility in spending patterns impact withdrawl rate strategy? Thoughts?

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JoeRetire
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Re: Flaws with 4% Rule?

Post by JoeRetire » Tue Nov 12, 2019 3:17 pm

AverageInvestor1982 wrote:
Tue Nov 12, 2019 3:08 pm
But if I structure my retirement spending so that I could reduce costs by 25-50% in down years, doesn't that mean I could run "hot" on spending on up years?
Maybe. It depends how "hot".

If you could actually reduce your costs in all the years needed by 50% you have a lot of built in flexibility.
I imagine spending patterns where on an average year, I pay for a giant beach house for a week for all my kids and grand kids. On an "up year" we go to Europe for week. And on a down year, I invite the grand kids to my house for a week and tell parents to enjoy a week of kid-free living. Same goes for a vacation with me and DW - could be a stay-cation, trip to Cancun, Trip to Bora-Bora depending on market returns. How does building flexibility in spending patterns impact withdrawl rate strategy? Thoughts?
I guess your "needs" must be very, very low compared to your "wants" with this budget.

I don't know anyone who actually withdraws a fixed 4% plus inflation every year of their retirement. Everyone I know is flexible (if not 50% flexible).
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dbr
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Re: Flaws with 4% Rule?

Post by dbr » Tue Nov 12, 2019 3:25 pm

If you want to contemplate a variable rate of withdrawal this approach may be of interest: https://www.bogleheads.org/wiki/Variabl ... withdrawal

I would add that the 4% "rule" doesn't have any flaws if taken on its own merits as a study of how portfolios might behave under withdrawal. This will involve assumptions and approximations, but that comes with the territory. The flaws are in how people interpret the result or miss-apply a study as a plan. There have been myriad extensions and modifications of the basic modeling, including ideas of spending rules as you are suggesting. Even FireCalc includes Bernicke, % of Portfolio, and Clyatt.
Last edited by dbr on Tue Nov 12, 2019 3:32 pm, edited 1 time in total.

MotoTrojan
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Re: Flaws with 4% Rule?

Post by MotoTrojan » Tue Nov 12, 2019 3:27 pm

dbr wrote:
Tue Nov 12, 2019 3:25 pm
If you want to contemplate a variable rate of withdrawal this approach may be of interest: https://www.bogleheads.org/wiki/Variabl ... withdrawal
+1 it sounds like OP would do well with a fixed percentage of current portfolio balance, which could be a good bit above 4%.

rich126
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Re: Flaws with 4% Rule?

Post by rich126 » Tue Nov 12, 2019 3:35 pm

There isn't a hard and fast rule. It depends on your risk tolerance and belief in your investments.

What is your definition of a down or up year?

If you have $1M and the market tanks 30% and now you have $700,000 what do you do? And if the next year it goes up 10% so now you have $770,000 is that an "up" year?

The data shows that you should be ok with 4%+inflation. If you are always going to be spending more on the up years, that means you lose a buffer on the down years and are more likely to run out.

If you have some expensive needs, put that money in a different bucket and spend that down separately and re-evaluate when it runs out.

Or just stick with the 4% method and then when surpluses add up in your account because you didn't spend all 4%, use it for something you want to do.

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Re: Flaws with 4% Rule?

Post by goodenyou » Tue Nov 12, 2019 3:45 pm

This may help you.

How to Withdraw Money In Retirement Using The Guyton Klinger Rule:

https://www.youtube.com/watch?v=OgYhime7TQQ
"Ignorance more frequently begets confidence than does knowledge" | Do you know how to make a rain dance work? Dance until it rains.

Small Savanna
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Re: Flaws with 4% Rule?

Post by Small Savanna » Tue Nov 12, 2019 3:50 pm

I think a better formulation of the 4% rule is the 25x rule. When your retirement assets are 25 times your estimate of how much income you need those assets to produce, you're in the zone for retirement. Mathematically they are the same, but 25x puts it in the context of a decision about whether to retire or wait. As others have noted, it's unlikely that you will stick to a 4% withdrawal rate after retirement. Your expenses will go up and down with age, and you will have new information each year based on how your investments are actually doing.

Having said that, 4%/25x is a rule of thumb and should be modulated by other considerations: is your house paid for, do you have a pension, how far away are you from social security, how do you fill the gap between retirement and Medicare, etc. And as the OP suggests, your 4% or 25x should include enough discretionary spending that belt tightening is possible.

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firebirdparts
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Re: Flaws with 4% Rule?

Post by firebirdparts » Tue Nov 12, 2019 5:28 pm

AverageInvestor1982 wrote:
Tue Nov 12, 2019 3:08 pm

I believe the general point to be that because the stock market is volatile, the idea of producing a non-volatile year-of-over year income stream from it is inefficient.
I would have called it brilliant rather than inefficient. The study was the product of people trying to get exactly what they all want. That assumes people can look at the trinity study, say “oh, thank you, I was wondering about that” and act accordingly. If on the other hand you imagine crazy and stupid people, then it’s easy to write articles criticizing them. You can just make that stuff up.

better to worry about unique future returns and the validity of simulations than to worry about jibber jabber.
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delamer
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Re: Flaws with 4% Rule?

Post by delamer » Tue Nov 12, 2019 5:33 pm

The more your basic expenses are covered by pension/Social Security/annuities, the better your plan for “hot” years will work.

If your core expenses for shelter, food, transportation, and medical can be paid from the above, then you can use your portfolio to pay for vacations, eating out, entertainment, etc. and vary those discretionary expenses depending on how your portfolio is doing.

But having a 25% to 50% “play” in your total expenses seems like a lot to me. My instinct says that if you can live decently on 50% of the money you spend in a “hot” year, then you are probably overspending in those years (or maybe underspending in the lean years).

In terms of vacations specifically, one option is to put aside a vacation fund to cover the next 10 years. If you want to spend $7500/year, then you’d need $75,000. You could then use your “hot” years to replenish the vacation fund.

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firebirdparts
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Re: Flaws with 4% Rule?

Post by firebirdparts » Tue Nov 12, 2019 5:48 pm

Is this not totally wrong?
An investor can guarantee a real dollar every year for thirty years by purchasing a series
of zero-coupon, risk-free bonds. The cost of this investment is the sum of the discounted
prices $1/(1.02) + $1/(1.02)squared + ... + $1/(1.02)to the 30th power , which amounts to a little less than
$22.40.....(and ta da the withdrawal rate is 4.5% we are oh-so-smart)
It’s hard to believe the whole paper was based on such a simple mistake. What am I missing? This formula is presented amateurishly in the article so you can’t say what assumptions you are being asked to agree to.

If you believed the above, it’s easy to see why you would be criticizing other investors.
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Artful Dodger
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Re: Flaws with 4% Rule?

Post by Artful Dodger » Tue Nov 12, 2019 6:51 pm

I agree with some of the posts above that you can only adjust so far. If there is a big downturn, you lose a lot of flexibility for the "hot" years.

I'm still in the entry approach to retirement, and have found using a retirement planner with built in capabilities to make adjustments for future spending to be more useful than the static 4% approach. I have built in greater spending for travel in ages 66 to 79, then reduced but not eliminated the budget. I include certain years to pay off student loans, and complete the mortgage, etc. What I have is a plan that will let me pull out 7-10% in the early years, then trend down to 3-4% in the later years. Some of these higher percent years are due to delaying SS. And, this is using a 90% success rate. I'm still pretty conservative, and the plan shows $800k+ at plan end (our ages 91 & 92).

am
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Re: Flaws with 4% Rule?

Post by am » Tue Nov 12, 2019 9:16 pm

I like 5% of portfolio balance with 3% inflation adjusted floor. Automatically allows you to spend more in good years and less in bad.

AlohaJoe
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Re: Flaws with 4% Rule?

Post by AlohaJoe » Tue Nov 12, 2019 10:00 pm

firebirdparts wrote:
Tue Nov 12, 2019 5:48 pm
Is this not totally wrong?
An investor can guarantee a real dollar every year for thirty years by purchasing a series
of zero-coupon, risk-free bonds. The cost of this investment is the sum of the discounted
prices $1/(1.02) + $1/(1.02)squared + ... + $1/(1.02)to the 30th power , which amounts to a little less than
$22.40.....(and ta da the withdrawal rate is 4.5% we are oh-so-smart)
It’s hard to believe the whole paper was based on such a simple mistake. What am I missing? This formula is presented amateurishly in the article so you can’t say what assumptions you are being asked to agree to.
I don't really follow what you think the mistake is.

In any case, they present their assumptions in the paragraph directly above the part you quoted.
A 2% risk-free real rate is broadly consistent with the historic record for U.S. Treasury STRIPS and TIPS investment returns.
I think the shortcoming in their argument is that retirees can't invest in "average risk-free real rates". They have to invest in the current, actual risk-free real rate. And right now 30-year TIPS don't have 2% real yields, they have 0.54% real yields. Plugging that into their equation and you get $27.62 = 3.6%. Except that's assuming you use entirely 30-year bonds. Shorter terms have lower real yields, so the 3.6% is a ceiling. The actual rate is somewhat less.

Nevertheless, their argument is the same one we see on Bogleheads all the time. People who are using Safe Withdrawal Rates lower than what a TIPS ladder can provide are some combination of insane and mathematically illiterate.

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Re: Flaws with 4% Rule?

Post by MotoTrojan » Tue Nov 12, 2019 10:05 pm

am wrote:
Tue Nov 12, 2019 9:16 pm
I like 5% of portfolio balance with 3% inflation adjusted floor. Automatically allows you to spend more in good years and less in bad.
This would be interesting to backtest but I feel this would be much more sensitive to asset allocation with low equity portfolios that normally are fairly robust to a flat 4%. For riskier portfolios I think this could certainly be a great way to go.

randomguy
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Re: Flaws with 4% Rule?

Post by randomguy » Tue Nov 12, 2019 11:46 pm

MotoTrojan wrote:
Tue Nov 12, 2019 10:05 pm
am wrote:
Tue Nov 12, 2019 9:16 pm
I like 5% of portfolio balance with 3% inflation adjusted floor. Automatically allows you to spend more in good years and less in bad.
This would be interesting to backtest but I feel this would be much more sensitive to asset allocation with low equity portfolios that normally are fairly robust to a flat 4%. For riskier portfolios I think this could certainly be a great way to go.
No matter what the AA, you run the risk of spending 5-10 years spending 30k instead of 40k. Plot out what happened to the 1966 retiree and how long they will spend at 3% waiting for the markets to recover to the point where 5% is greater than 3% real.

With any variable scheme you have a bunch of knobs you can turn in terms of how conservative you are during down periods and how aggressive you want to be during up periods. It is impossible to come up with a scheme that does everything people want (never runs out of money, has the highest min spending, spends all your money,....). You need to pick and choose what matters to you. If you are OK cutting spending by 25% for 5-10 years, you can be a lot more aggressive at taking out money. If you never want to cut, you need to be more conservative.

The paper is horribly written in terms of being long with weird analogies..:) At a very high level, the complaint is that that 4% often leaves extra money. Yep. And which is why the papers suggest that if you end up on a good path, you can spend more. There are numerous papers that suggest how do to that. The problem is that if you spend more early (say year 1), you will have to spend less later in the bad cases. If a 4% rule just barely works, if you take out 4.5% in year one, you will probably have some years where you need to cut to say 3.8% not to go broke. That is a trade off you might not want to make. For most people spending cuts are more painful than the benefits of increases. Going from 2 trips to 4 is pleasant but the pain of going from 2 trips to 0 is a lot worse.

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JoMoney
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Re: Flaws with 4% Rule?

Post by JoMoney » Wed Nov 13, 2019 12:24 am

Stocks are volatile. 4% isn't guaranteed. Nothing is.
It seems foolish to let our well-being ride on an uncertain endeavor nobody on earth knows the result of... but we don't really have a choice. I'll pick something that appears to work in the world as I've experienced or learned about it, and adapt as the world changes, or fail.
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Re: Flaws with 4% Rule?

Post by AlohaJoe » Wed Nov 13, 2019 12:45 am

MotoTrojan wrote:
Tue Nov 12, 2019 10:05 pm
am wrote:
Tue Nov 12, 2019 9:16 pm
I like 5% of portfolio balance with 3% inflation adjusted floor. Automatically allows you to spend more in good years and less in bad.
This would be interesting to backtest but I feel this would be much more sensitive to asset allocation with low equity portfolios that normally are fairly robust to a flat 4%. For riskier portfolios I think this could certainly be a great way to go.
Image
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The best case scenario seems to be something like 1966 where you have 6 years where you do materially better than VPW. 17% better in the 10th year, 15% better in the 14th year, 20% better in the 15th year, 16% better in the 16th year, 36% better in the 17th year, and 16% better in the 17th year.

We know that spending drops off in later years for a non-early retiree, which means those big spending years late in retirement with VPW are usually meaningless. It also means that even by the second decade of retirement, it is harder to reason about spending shortfalls.

Let's plot the same thing but add in Blanchett's "smile curve" showing how spending for actual retirees tends to go. In this case I'm assuming a $2 million portfolio and the retiree has 'targeted expenses' of $80,000 a year.

Image

But also keep in mind what a floor actually means. It means every year you withdraw a bigger and bigger percentage of your portfolio. "3% inflation adjusted of my original portfolio value" means you'll be withdrawing up to 10% of your portfolio in a given year using the floor.

Notice how using the floor (the orange line) leads to, IMHO, completely implausible withdrawal rates.

Image

No retiree is going to sit there at age 75 or 80 and go "I will withdraw 9% of my portfolio balance this year, because that's what my floor is"

Garfieldthecat
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Re: Flaws with 4% Rule?

Post by Garfieldthecat » Wed Nov 13, 2019 9:06 am

OP can also try the Rich, broke or Dead web page:

https://engaging-data.com/will-money-last-retire-early/

It has an option for spending flexibility, so you could put in the initial spending amount with 50% spending flexibility to see how it works out.

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Re: Flaws with 4% Rule?

Post by am » Wed Nov 13, 2019 9:56 am

AlohaJoe wrote:
Wed Nov 13, 2019 12:45 am
MotoTrojan wrote:
Tue Nov 12, 2019 10:05 pm
am wrote:
Tue Nov 12, 2019 9:16 pm
I like 5% of portfolio balance with 3% inflation adjusted floor. Automatically allows you to spend more in good years and less in bad.
This would be interesting to backtest but I feel this would be much more sensitive to asset allocation with low equity portfolios that normally are fairly robust to a flat 4%. For riskier portfolios I think this could certainly be a great way to go.
Image
Image
Image
Image
Image

The best case scenario seems to be something like 1966 where you have 6 years where you do materially better than VPW. 17% better in the 10th year, 15% better in the 14th year, 20% better in the 15th year, 16% better in the 16th year, 36% better in the 17th year, and 16% better in the 17th year.

We know that spending drops off in later years for a non-early retiree, which means those big spending years late in retirement with VPW are usually meaningless. It also means that even by the second decade of retirement, it is harder to reason about spending shortfalls.

Let's plot the same thing but add in Blanchett's "smile curve" showing how spending for actual retirees tends to go. In this case I'm assuming a $2 million portfolio and the retiree has 'targeted expenses' of $80,000 a year.

Image

But also keep in mind what a floor actually means. It means every year you withdraw a bigger and bigger percentage of your portfolio. "3% inflation adjusted of my original portfolio value" means you'll be withdrawing up to 10% of your portfolio in a given year using the floor.

Notice how using the floor (the orange line) leads to, IMHO, completely implausible withdrawal rates.

Image

No retiree is going to sit there at age 75 or 80 and go "I will withdraw 9% of my portfolio balance this year, because that's what my floor is"
Thanks for doing the work. Seems like VPW is preferred over the % withdrawal with floor. You have higher withdrawals most of the time and no risk of running out of money.

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Re: Flaws with 4% Rule?

Post by MnD » Wed Nov 13, 2019 10:20 am

AlohaJoe wrote:
Wed Nov 13, 2019 12:45 am
MotoTrojan wrote:
Tue Nov 12, 2019 10:05 pm
am wrote:
Tue Nov 12, 2019 9:16 pm
I like 5% of portfolio balance with 3% inflation adjusted floor. Automatically allows you to spend more in good years and less in bad.
This would be interesting to backtest but I feel this would be much more sensitive to asset allocation with low equity portfolios that normally are fairly robust to a flat 4%. For riskier portfolios I think this could certainly be a great way to go.
Image
Image
Image
Image
Image

The best case scenario seems to be something like 1966 where you have 6 years where you do materially better than VPW. 17% better in the 10th year, 15% better in the 14th year, 20% better in the 15th year, 16% better in the 16th year, 36% better in the 17th year, and 16% better in the 17th year.

We know that spending drops off in later years for a non-early retiree, which means those big spending years late in retirement with VPW are usually meaningless. It also means that even by the second decade of retirement, it is harder to reason about spending shortfalls.

Let's plot the same thing but add in Blanchett's "smile curve" showing how spending for actual retirees tends to go. In this case I'm assuming a $2 million portfolio and the retiree has 'targeted expenses' of $80,000 a year.

Image

But also keep in mind what a floor actually means. It means every year you withdraw a bigger and bigger percentage of your portfolio. "3% inflation adjusted of my original portfolio value" means you'll be withdrawing up to 10% of your portfolio in a given year using the floor.

Notice how using the floor (the orange line) leads to, IMHO, completely implausible withdrawal rates.

Image

No retiree is going to sit there at age 75 or 80 and go "I will withdraw 9% of my portfolio balance this year, because that's what my floor is"
Cherry-picking a few years and not indicating or showing later retirement and ending portfolio balance (which is $0) makes it easy to give the appearance that VPW has some sort of secret sauce in producing outsized income from portfolio. For the first 15 years of a relatively early retirement VPW and 5% of portfolio balance with 3% floor are virtually the same.
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Re: Flaws with 4% Rule?

Post by MichCPA » Wed Nov 13, 2019 10:24 am

A general 4% rule has been tested under a ton of circumstances, and there is no reason to believe that it won't provide a strong baseline into the future.

Reality is that any sensible plan will contain enough margin of safety to handle some market gyrations and many retirees can put off some discretionary spending and use sequence of expenses to balance sequence of return risk.

The major issues people have with 4% are primarily human behavior based rather than numbers based. Is choosing to go to Hawaii in an up year an increase in overall spending or could it be that a retiree was choosing to match sequence of spending to sequence of returns by going in a safe year? The answer could be either and the decision could be good or bad in a financial health sense, depending on the circumstances.

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Re: Flaws with 4% Rule?

Post by willthrill81 » Wed Nov 13, 2019 10:32 am

am wrote:
Wed Nov 13, 2019 9:56 am
Thanks for doing the work. Seems like VPW is preferred over the % withdrawal with floor. You have higher withdrawals most of the time and no risk of running out of money.
You can retain the benefit of being guaranteed to not prematurely deplete your portfolio but achieve smoother withdrawals than VPW by using the time value of money formula that VPW is based upon. Basically, instead of using the fixed return assumptions embedded into VPW, you use dynamic return assumptions such as 1/CAPE for stock returns and the current yield of 10 year TIPS. This can greatly smooth out one's withdrawals from one year to the next compared to VPW.
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Re: Flaws with 4% Rule?

Post by randomguy » Wed Nov 13, 2019 10:40 am

MnD wrote:
Wed Nov 13, 2019 10:20 am

Cherry-picking a few years and not indicating or showing later retirement and ending portfolio balance (which is $0) makes it easy to give the appearance that VPW has some sort of secret sauce in producing outsized income from portfolio. For the first 15 years of a relatively early retirement VPW and 5% of portfolio balance with 3% floor are virtually the same.
To some extent those are the only interesting years. To use VPW you have to decide if you can live on 25k/year for 5 year instead of 30k. It is one thing to cut spending by say 30% (45k->30k). It is another to do almost 50%. And no SS and pensions don't change any of this math. Sure cutting my total budget by 20% instead of 50% doesn't sound as bad. Cutting my discrentionary spending by 75% (i.e. I counted on my portfolio for say 10k of spending) though is worse. At some point you hit your limit


And yes portfolio value is normally ignored in these discussions but in reality it matters. VPW starts spending 10%+ of the portfolio in those last years. That is one of the strengths of VPW and to some extent we don't talk about what to do in the last 10-15 years much. It is a time though when annuities and bond ladders start making tons of sense. Of course you can also question who in the world wants to spend 25k/year from 70-80 and then spend 50k/year when they are 90. That isn't a spending pattern that many people want.

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Re: Flaws with 4% Rule?

Post by randomguy » Wed Nov 13, 2019 10:53 am

MichCPA wrote:
Wed Nov 13, 2019 10:24 am
A general 4% rule has been tested under a ton of circumstances, and there is no reason to believe that it won't provide a strong baseline into the future.

Reality is that any sensible plan will contain enough margin of safety to handle some market gyrations and many retirees can put off some discretionary spending and use sequence of expenses to balance sequence of return risk.

The major issues people have with 4% are primarily human behavior based rather than numbers based. Is choosing to go to Hawaii in an up year an increase in overall spending or could it be that a retiree was choosing to match sequence of spending to sequence of returns by going in a safe year? The answer could be either and the decision could be good or bad in a financial health sense, depending on the circumstances.
Are you able to put off discretionary spending for 10-20 years? It is important to remember that sequence of returns issues aren't caused by 2-3 bad years (2007-9,2000-2, 1973-4). They are caused by decade long sequences of poor returns (2000-9, 1966-1981). It is easy to deal with short term blips like 2007-9 and all the minor ones (2011). Avoiding SOR though pretty much always comes down to cutting spending and the cuts can be very long and deep. See VPW for the need to do 30%+ cuts for 10 years.

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Re: Flaws with 4% Rule?

Post by willthrill81 » Wed Nov 13, 2019 11:38 am

randomguy wrote:
Wed Nov 13, 2019 10:53 am
MichCPA wrote:
Wed Nov 13, 2019 10:24 am
A general 4% rule has been tested under a ton of circumstances, and there is no reason to believe that it won't provide a strong baseline into the future.

Reality is that any sensible plan will contain enough margin of safety to handle some market gyrations and many retirees can put off some discretionary spending and use sequence of expenses to balance sequence of return risk.

The major issues people have with 4% are primarily human behavior based rather than numbers based. Is choosing to go to Hawaii in an up year an increase in overall spending or could it be that a retiree was choosing to match sequence of spending to sequence of returns by going in a safe year? The answer could be either and the decision could be good or bad in a financial health sense, depending on the circumstances.
Are you able to put off discretionary spending for 10-20 years? It is important to remember that sequence of returns issues aren't caused by 2-3 bad years (2007-9,2000-2, 1973-4). They are caused by decade long sequences of poor returns (2000-9, 1966-1981). It is easy to deal with short term blips like 2007-9 and all the minor ones (2011). Avoiding SOR though pretty much always comes down to cutting spending and the cuts can be very long and deep. See VPW for the need to do 30%+ cuts for 10 years.
In order to address sequence of returns risk, it's true that spending cuts are generally needed, although they need not be both "long and deep." Derek Tharp noted that merely taking a 3% real spending cut when stocks were down for the year, basically foregoing one's inflation adjustment, bumped the '4% rule' up to above 4.5% for 60/40 portfolios. In fact, shallow and long spending cuts are probably more effective for most retirees than deep and short cuts. And, of course, this does not preclude one from increasing one's spending in subsequent years if one's portfolio recovers nicely.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: Flaws with 4% Rule?

Post by randomguy » Wed Nov 13, 2019 12:17 pm

willthrill81 wrote:
Wed Nov 13, 2019 11:38 am
randomguy wrote:
Wed Nov 13, 2019 10:53 am
MichCPA wrote:
Wed Nov 13, 2019 10:24 am
A general 4% rule has been tested under a ton of circumstances, and there is no reason to believe that it won't provide a strong baseline into the future.

Reality is that any sensible plan will contain enough margin of safety to handle some market gyrations and many retirees can put off some discretionary spending and use sequence of expenses to balance sequence of return risk.

The major issues people have with 4% are primarily human behavior based rather than numbers based. Is choosing to go to Hawaii in an up year an increase in overall spending or could it be that a retiree was choosing to match sequence of spending to sequence of returns by going in a safe year? The answer could be either and the decision could be good or bad in a financial health sense, depending on the circumstances.
Are you able to put off discretionary spending for 10-20 years? It is important to remember that sequence of returns issues aren't caused by 2-3 bad years (2007-9,2000-2, 1973-4). They are caused by decade long sequences of poor returns (2000-9, 1966-1981). It is easy to deal with short term blips like 2007-9 and all the minor ones (2011). Avoiding SOR though pretty much always comes down to cutting spending and the cuts can be very long and deep. See VPW for the need to do 30%+ cuts for 10 years.
In order to address sequence of returns risk, it's true that spending cuts are generally needed, although they need not be both "long and deep." Derek Tharp noted that merely taking a 3% real spending cut when stocks were down for the year, basically foregoing one's inflation adjustment, bumped the '4% rule' up to above 4.5% for 60/40 portfolios. In fact, shallow and long spending cuts are probably more effective for most retirees than deep and short cuts. And, of course, this does not preclude one from increasing one's spending in subsequent years if one's portfolio recovers nicely.
I am not sure how they do the math but there were 10 nominal down year in the first 16 for the 1929 retiree and 8 real down years for the 1966. Those little paper cuts add up over time. You go from spending 4.5% to like 3.6%. You have made good cases better at the expense of making the worst case worse.

I am not saying this is a bad scheme but it all comes down to how you view spending cuts. Going from 90k to 72k.year is going to crimp a lot of peoples vacation budgets. There are no free lunches when you have a bad sequence of returns.

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willthrill81
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Re: Flaws with 4% Rule?

Post by willthrill81 » Wed Nov 13, 2019 12:44 pm

randomguy wrote:
Wed Nov 13, 2019 12:17 pm
willthrill81 wrote:
Wed Nov 13, 2019 11:38 am
randomguy wrote:
Wed Nov 13, 2019 10:53 am
MichCPA wrote:
Wed Nov 13, 2019 10:24 am
A general 4% rule has been tested under a ton of circumstances, and there is no reason to believe that it won't provide a strong baseline into the future.

Reality is that any sensible plan will contain enough margin of safety to handle some market gyrations and many retirees can put off some discretionary spending and use sequence of expenses to balance sequence of return risk.

The major issues people have with 4% are primarily human behavior based rather than numbers based. Is choosing to go to Hawaii in an up year an increase in overall spending or could it be that a retiree was choosing to match sequence of spending to sequence of returns by going in a safe year? The answer could be either and the decision could be good or bad in a financial health sense, depending on the circumstances.
Are you able to put off discretionary spending for 10-20 years? It is important to remember that sequence of returns issues aren't caused by 2-3 bad years (2007-9,2000-2, 1973-4). They are caused by decade long sequences of poor returns (2000-9, 1966-1981). It is easy to deal with short term blips like 2007-9 and all the minor ones (2011). Avoiding SOR though pretty much always comes down to cutting spending and the cuts can be very long and deep. See VPW for the need to do 30%+ cuts for 10 years.
In order to address sequence of returns risk, it's true that spending cuts are generally needed, although they need not be both "long and deep." Derek Tharp noted that merely taking a 3% real spending cut when stocks were down for the year, basically foregoing one's inflation adjustment, bumped the '4% rule' up to above 4.5% for 60/40 portfolios. In fact, shallow and long spending cuts are probably more effective for most retirees than deep and short cuts. And, of course, this does not preclude one from increasing one's spending in subsequent years if one's portfolio recovers nicely.
I am not sure how they do the math but there were 10 nominal down year in the first 16 for the 1929 retiree and 8 real down years for the 1966. Those little paper cuts add up over time. You go from spending 4.5% to like 3.6%. You have made good cases better at the expense of making the worst case worse.

I am not saying this is a bad scheme but it all comes down to how you view spending cuts. Going from 90k to 72k.year is going to crimp a lot of peoples vacation budgets. There are no free lunches when you have a bad sequence of returns.
I don't see how reducing one's spending to 3.6% should be a problem for virtually everyone who would even consider implementing something akin to the '4% rule'. That's a mere 10% reduction, which should be easy for all but those with the very leanest of budgets to find. The trick is not to 'permanently' inflate one's lifestyle when starting at 4% or 4.5%.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: Flaws with 4% Rule?

Post by MichCPA » Wed Nov 13, 2019 3:15 pm

willthrill81 wrote:
Wed Nov 13, 2019 12:44 pm
randomguy wrote:
Wed Nov 13, 2019 12:17 pm
willthrill81 wrote:
Wed Nov 13, 2019 11:38 am
randomguy wrote:
Wed Nov 13, 2019 10:53 am
MichCPA wrote:
Wed Nov 13, 2019 10:24 am
A general 4% rule has been tested under a ton of circumstances, and there is no reason to believe that it won't provide a strong baseline into the future.

Reality is that any sensible plan will contain enough margin of safety to handle some market gyrations and many retirees can put off some discretionary spending and use sequence of expenses to balance sequence of return risk.

The major issues people have with 4% are primarily human behavior based rather than numbers based. Is choosing to go to Hawaii in an up year an increase in overall spending or could it be that a retiree was choosing to match sequence of spending to sequence of returns by going in a safe year? The answer could be either and the decision could be good or bad in a financial health sense, depending on the circumstances.
Are you able to put off discretionary spending for 10-20 years? It is important to remember that sequence of returns issues aren't caused by 2-3 bad years (2007-9,2000-2, 1973-4). They are caused by decade long sequences of poor returns (2000-9, 1966-1981). It is easy to deal with short term blips like 2007-9 and all the minor ones (2011). Avoiding SOR though pretty much always comes down to cutting spending and the cuts can be very long and deep. See VPW for the need to do 30%+ cuts for 10 years.
In order to address sequence of returns risk, it's true that spending cuts are generally needed, although they need not be both "long and deep." Derek Tharp noted that merely taking a 3% real spending cut when stocks were down for the year, basically foregoing one's inflation adjustment, bumped the '4% rule' up to above 4.5% for 60/40 portfolios. In fact, shallow and long spending cuts are probably more effective for most retirees than deep and short cuts. And, of course, this does not preclude one from increasing one's spending in subsequent years if one's portfolio recovers nicely.
I am not sure how they do the math but there were 10 nominal down year in the first 16 for the 1929 retiree and 8 real down years for the 1966. Those little paper cuts add up over time. You go from spending 4.5% to like 3.6%. You have made good cases better at the expense of making the worst case worse.

I am not saying this is a bad scheme but it all comes down to how you view spending cuts. Going from 90k to 72k.year is going to crimp a lot of peoples vacation budgets. There are no free lunches when you have a bad sequence of returns.
I don't see how reducing one's spending to 3.6% should be a problem for virtually everyone who would even consider implementing something akin to the '4% rule'. That's a mere 10% reduction, which should be easy for all but those with the very leanest of budgets to find. The trick is not to 'permanently' inflate one's lifestyle when starting at 4% or 4.5%.
+1, If a retirement plan doesn't have 10% margin of safety once you factor in housing, auto, and vacation costs, there was really an issue on day 1. If someone would really be put in jeopardy from 2001-2009, my first look would be at AA rather SWR and SOR.

People need to remember that 5 year CD rates from 2001-2009 would have produced most of the 4% SWR in interest (pre-tax, nominal values), and 10 year treasuries had even higher rates for most of that period. Furthermore, when interest rates dropped, bonds rose.

The 4% naysayers always seem to talk about 30-50% drops, but if AA is correct, those have not happened even when stock market returns have lagged for extended periods. A re balancing strategy would have further taken risk off the table during the decent years between the recessions.

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Re: Flaws with 4% Rule?

Post by randomguy » Wed Nov 13, 2019 5:01 pm

MichCPA wrote:
Wed Nov 13, 2019 3:15 pm
willthrill81 wrote:
Wed Nov 13, 2019 12:44 pm


I don't see how reducing one's spending to 3.6% should be a problem for virtually everyone who would even consider implementing something akin to the '4% rule'. That's a mere 10% reduction, which should be easy for all but those with the very leanest of budgets to find. The trick is not to 'permanently' inflate one's lifestyle when starting at 4% or 4.5%.
+1, If a retirement plan doesn't have 10% margin of safety once you factor in housing, auto, and vacation costs, there was really an issue on day 1. If someone would really be put in jeopardy from 2001-2009, my first look would be at AA rather SWR and SOR.

People need to remember that 5 year CD rates from 2001-2009 would have produced most of the 4% SWR in interest (pre-tax, nominal values), and 10 year treasuries had even higher rates for most of that period. Furthermore, when interest rates dropped, bonds rose.

The 4% naysayers always seem to talk about 30-50% drops, but if AA is correct, those have not happened even when stock market returns have lagged for extended periods. A re balancing strategy would have further taken risk off the table during the decent years between the recessions.
Which retirement is better

a) goes on 2 vacations/year for year 1-5 at 4k a piece, and then goes on 0 from year 6-30 (i.e. start at 4.5% and then cuts to 3.6 and has to cut out those 9k/year of vacations

b) goes on 1 4k vacation for years 1-30 (i.e. the steady 4%)

Did you gain enough by being aggressive early to make up for the loss later? That is the basic question you have to answer when you aggressive early. You make most cases better at the expense of making the worst cases worse.

And no unfortunately AA doesn't help. Look at the various AA for the 1966 retiree (i.e. the rate limiting year) and you will see that holding 30/70 or 70/30 pretty much gets you in the same spot. You don't go broke because of 30-50% market drops. You go broke because you have decade plus periods when stocks and bonds basically have 0% real returns.

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Re: Flaws with 4% Rule?

Post by texasdiver » Wed Nov 13, 2019 8:20 pm

JoeRetire wrote:
Tue Nov 12, 2019 3:17 pm

I don't know anyone who actually withdraws a fixed 4% plus inflation every year of their retirement. Everyone I know is flexible (if not 50% flexible).
My parents pretty much do that.

Of course being frugal folk they probably save 1/3 of it any given month so their taxable savings just keeps growing.

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Re: Flaws with 4% Rule?

Post by AlohaJoe » Thu Nov 14, 2019 4:26 am

texasdiver wrote:
Wed Nov 13, 2019 8:20 pm
JoeRetire wrote:
Tue Nov 12, 2019 3:17 pm

I don't know anyone who actually withdraws a fixed 4% plus inflation every year of their retirement. Everyone I know is flexible (if not 50% flexible).
My parents pretty much do that.

Of course being frugal folk they probably save 1/3 of it any given month so their taxable savings just keeps growing.
"Withdrawing it and then reinvesting it" isn't what anyone ever means when they talk about withdrawing money during retirement. They mean "withdraw and spend it so it is gone from your portfolio forever".

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Re: Flaws with 4% Rule?

Post by dbr » Thu Nov 14, 2019 9:36 am

AlohaJoe wrote:
Thu Nov 14, 2019 4:26 am
texasdiver wrote:
Wed Nov 13, 2019 8:20 pm
JoeRetire wrote:
Tue Nov 12, 2019 3:17 pm

I don't know anyone who actually withdraws a fixed 4% plus inflation every year of their retirement. Everyone I know is flexible (if not 50% flexible).
My parents pretty much do that.

Of course being frugal folk they probably save 1/3 of it any given month so their taxable savings just keeps growing.
"Withdrawing it and then reinvesting it" isn't what anyone ever means when they talk about withdrawing money during retirement. They mean "withdraw and spend it so it is gone from your portfolio forever".
Yes, sometimes the confusion is that people wrongly think of a Required Minimum Distribution being a withdrawal. It is not unless you actually go out and spend the money. Otherwise one can reinvest part or all of it in taxable assets. In that case the distribution is a transfer of money from tax deferred to taxable assets and is not a withdrawal. If the money only goes unspent into a checking account the logical treatment is that it is not withdrawn and the checking account is actually invested money. I personally add in the balance of my checking account to portfolio assets when I count everything at the end of the month. A person can follow whatever convention they want.

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Re: Flaws with 4% Rule?

Post by firebirdparts » Thu Nov 14, 2019 11:18 am

AverageInvestor1982 wrote:
Tue Nov 12, 2019 3:08 pm
Can Bogleheads help distill this paper down to it's elements and then provide a reaction to it?
Here's my honest effort. It's a strange article. It's embarrassing.

The article is based on Monte Carlo simulations of a 30 year retirement, and perhaps that part of it may be reasonable. It has two glaring, totally insane problems.
1. They compare the simulations, which I have to assume are reasonable, to a fantasy investment of 30 equal-face-value TIPS with a real return of 2% and maturity of 1 year and will always be available for 30 years. This fantasy investment has a safe withdrawal rate above 4%. All the work in the article depends on this.
2. They understand that the 4% rule, applied in the usual way, will produce an excess of money in all but the worst case scenario. They define this as a "bad thing". The more excess money you have, the worse it is. The "metrics" they came up with to describe this are unusual, so here is the explanation:
We will report three metrics for each pair of investment and spending strategies: the
failure rate, the cost of the surplus, and the overpayment for the spending distribution. A
strategy’s failure rate is the probability that the actual spending in the last year is less than
the spending goal.... Failure rates ....have been the main focus of previous investigators, and we
include them here for comparison. The final portfolio value, the surplus, is a function of
random market returns. Hence, we can use the machinery of derivative pricing to find its
fair price, the cost of funding the surplus. Similarly, we can compute the present value of
the actual spending and the price of an alternative investment that delivers the same
spending distribution [fbp I presume this to be the fantasy 1 year TIPS], but at the cheapest price. The difference in these prices is the
overpayment for the spending strategy. We refer the reader to Appendix A for more
details.
You would think that most people writing such an article would be selling an even more clever idea than 1 year 2% real TIPS that aren't available, but I don't see a cohesive vision at the end. They seem to just be satisfied with their new way to apply these metrics in the quoted paragraph.
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Re: Flaws with 4% Rule?

Post by texasdiver » Thu Nov 14, 2019 12:17 pm

AlohaJoe wrote:
Thu Nov 14, 2019 4:26 am
texasdiver wrote:
Wed Nov 13, 2019 8:20 pm
JoeRetire wrote:
Tue Nov 12, 2019 3:17 pm

I don't know anyone who actually withdraws a fixed 4% plus inflation every year of their retirement. Everyone I know is flexible (if not 50% flexible).
My parents pretty much do that.

Of course being frugal folk they probably save 1/3 of it any given month so their taxable savings just keeps growing.
"Withdrawing it and then reinvesting it" isn't what anyone ever means when they talk about withdrawing money during retirement. They mean "withdraw and spend it so it is gone from your portfolio forever".
I, of course, understand this. As do my parents. I'm just explaining what they do which is withdraw a fixed 4% from their retirement portfolio whether or not it gets spent.

What they actually do is have a guy who manages their retirement portfolio (mostly traditional IRAs) and he withdraws a regular amount (I think 4% annually) on a monthly basis and transfers it into their checking in the form of a direct deposit. He is also the same guy who does their taxes. So it is essentially like they are still getting a paycheck. However they rarely ever have use for all of this money so they simply save it. I think my dad puts it in a money market or something similar. It is their "savings" so if they need a new roof or one of their kids or grandkids has an emergency or something. Or they need a new car. Or I don't know what. It is their pool of possible spending money that they have personally available so they wouldn't have to call their financial manager and cash in more IRAs in an emergency. They might need the money. Who knows. It's really just a giant emergency fund I guess.

Is this uncommon? I don't even know.

I do know that they could, of course just withdraw less but then their portfolio is growing anyway so what would be the point? Just to be more frugal?

They could also just withdraw a variable amount each month based on what they are actually spending. But that would require more detailed coordination with their financial advisor and add complexity to what is now a simple and comfortable way to live. They just prefer having an "allowance" or paycheck to live within rather than something open-ended. And at their age in their late 80s they prefer not having direct access to their entire investment portfolio for fear of fraud, etc. and I think they are being prudent.

So, the point is that there are indeed those who follow a fixed percentage withdrawal. Even if it is simply taking money from tax-deferred IRA accounts and putting some of it into taxable savings.

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Re: Flaws with 4% Rule?

Post by willthrill81 » Tue Nov 26, 2019 12:01 pm

texasdiver wrote:
Thu Nov 14, 2019 12:17 pm
AlohaJoe wrote:
Thu Nov 14, 2019 4:26 am
texasdiver wrote:
Wed Nov 13, 2019 8:20 pm
JoeRetire wrote:
Tue Nov 12, 2019 3:17 pm

I don't know anyone who actually withdraws a fixed 4% plus inflation every year of their retirement. Everyone I know is flexible (if not 50% flexible).
My parents pretty much do that.

Of course being frugal folk they probably save 1/3 of it any given month so their taxable savings just keeps growing.
"Withdrawing it and then reinvesting it" isn't what anyone ever means when they talk about withdrawing money during retirement. They mean "withdraw and spend it so it is gone from your portfolio forever".
I, of course, understand this. As do my parents. I'm just explaining what they do which is withdraw a fixed 4% from their retirement portfolio whether or not it gets spent.

What they actually do is have a guy who manages their retirement portfolio (mostly traditional IRAs) and he withdraws a regular amount (I think 4% annually) on a monthly basis and transfers it into their checking in the form of a direct deposit. He is also the same guy who does their taxes. So it is essentially like they are still getting a paycheck. However they rarely ever have use for all of this money so they simply save it. I think my dad puts it in a money market or something similar. It is their "savings" so if they need a new roof or one of their kids or grandkids has an emergency or something. Or they need a new car. Or I don't know what. It is their pool of possible spending money that they have personally available so they wouldn't have to call their financial manager and cash in more IRAs in an emergency. They might need the money. Who knows. It's really just a giant emergency fund I guess.

Is this uncommon? I don't even know.

I do know that they could, of course just withdraw less but then their portfolio is growing anyway so what would be the point? Just to be more frugal?

They could also just withdraw a variable amount each month based on what they are actually spending. But that would require more detailed coordination with their financial advisor and add complexity to what is now a simple and comfortable way to live. They just prefer having an "allowance" or paycheck to live within rather than something open-ended. And at their age in their late 80s they prefer not having direct access to their entire investment portfolio for fear of fraud, etc. and I think they are being prudent.

So, the point is that there are indeed those who follow a fixed percentage withdrawal. Even if it is simply taking money from tax-deferred IRA accounts and putting some of it into taxable savings.
What you are describing is not the '4% rule' or a safe withdrawal rate approach. With such a withdrawal method, you withdrawal 4% of the portfolio in the first year of retirement and subsequently withdraw the same dollar amount, adjusted for inflation, in every subsequent year. So if the portfolio's value was cut in half after the first year and there was no inflation, the second year's withdrawal would be 8% of the current balance.

It seems that you are describing a fixed percentage withdrawal method (e.g. 4% of the portfolio's current balance every year), and that is indeed used by some people.
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Re: Flaws with 4% Rule?

Post by bowest » Tue Nov 26, 2019 12:40 pm

A bit of nonsense. 4% is a serviceable rule of thumb but not a straitjacket that has to be worn in a vacuum for 30, 40, or 50 years (plug if your mortality calculation here). YMMV.

The authors identify surpluses as a flaw. I'd be ok with that and willing to bear this inefficiency in exchange for the epic end-of-life bender that would result if my expiration date could be narrowed down with any certainty (say a 98% confidence interval). And if I'm not in a position to enjoy the bender I hope my heirs put the balance to good use. If overspending is the risk that emerges I should the ability to ratchet down outflows. I think most Bogleheads have this capability and mindset and can adjust accordingly.

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Re: Flaws with 4% Rule?

Post by dknightd » Tue Nov 26, 2019 3:11 pm

AverageInvestor1982 wrote:
Tue Nov 12, 2019 3:08 pm
Can Bogleheads help distill this paper down to it's elements and then provide a reaction to it?

https://web.stanford.edu/~wfsharpe/retecon/4percent.pdf

I find Bogleheads to be one of the best places on the web to explain complicated things in straightforward manner, and am hoping someone can work their magic here. I started reading it and got impatient with the author's style, but thought his premise had enough merit to discuss.

I believe the general point to be that because the stock market is volatile, the idea of producing a non-volatile year-of-over year income stream from it is inefficient. This picks at the edge of something I can't quite put words to - something about the idea that when I retire, I know I will have some flexibility in spending, so any advice that doesn't take that flexibility into account is too broad to be applied to any single scenario. (Don't get me wrong, if I were giving advice to a broad group of people, I would immediately reference the 4%/Jack Bogle theories as the best possible starting point.)

But if I structure my retirement spending so that I could reduce costs by 25-50% in down years, doesn't that mean I could run "hot" on spending on up years? I imagine spending patterns where on an average year, I pay for a giant beach house for a week for all my kids and grand kids. On an "up year" we go to Europe for week. And on a down year, I invite the grand kids to my house for a week and tell parents to enjoy a week of kid-free living. Same goes for a vacation with me and DW - could be a stay-cation, trip to Cancun, Trip to Bora-Bora depending on market returns. How does building flexibility in spending patterns impact withdrawl rate strategy? Thoughts?
Do what makes you happy

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Re: Flaws with 4% Rule?

Post by konic » Tue Nov 26, 2019 5:52 pm

When you are using a hammer to pound in a nail, miss it slightly and crush your finger ... do you blame the hammer? :mrgreen: :oops:

ps: my comment is in general about the whole argument about the 4% thingy

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