Future 60/40 Portfolio has a 43% Chance of Failing with 4% Withdrawal Rate

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Post Reply
User avatar
Topic Author
vineviz
Posts: 6782
Joined: Tue May 15, 2018 1:55 pm

Future 60/40 Portfolio has a 43% Chance of Failing with 4% Withdrawal Rate

Post by vineviz » Wed Apr 15, 2020 3:53 pm

I have not interest in predicting the future. It's a thing I can't do, and this post is NOT an attempt to do it.

Nor do I want to add any fuel to the hyperbole around the notion that "60/40 is dead". It's not dead, or least no deader than it was.

But I do think it is important for investors who are approaching or entering retirement to consider that market conditions going forward might be significantly different from the conditions to which they've grown accustomed. And that familiarity bias, left unchecked, might lead folks to make some assumptions (either explicit or implicit).

For context, let's roll back the clock to the early days of Vanguard Total Bond Market Index Fund (VBMFX) in the late 1980s: SEC yields were over 8% and expected inflation of 3-4%.

Flash forward to now: VBMFX has an SEC yield of just 1.75% and the 10-year breakeven inflation rate is just 1.29%.

So I think it's useful to a stress test of sorts on a classic 60/40 portfolio. A simple Monte Carlo analysis has plenty of faults, but let's just look at the results of one under some relatively uncontroversial assumptions.

First, let's define the 60/40 portfolio as simply as possible: 60% VFINX (aka S&P 500) and 40% VBMFX (aka total bond market).

Let's assume a 4% withdrawal rate from the portfolio (adjusting for inflation), which on a $1,000,000 portfolio is $3,333 per month of retirement income. Let's define the retirement period optimistically as 35 years. Assume that inflation averages 1.5%, the expected return of VFINX is 7.5%, and the expected return of VBMFX is 1.85% (the current yield when I ran the scenario). PortfolioVisualizer will graph the range of outcomes, plotting years into retirement on the x-axis and portfolio balance on the y-axis with different curves representing the median case (50th percentile) and more progressively more extreme cases (10th, 25th, 75th, 90th percentiles).

For reference, let's include the actual experience of a hypothetical investor with the same conditions who retired in 1985. Same portfolio, same withdrawal pattern, etc.

Image

In the stress test, over 30% of all outcomes were a "failure" (i.e. the portfolio was completely depleted before the end of the 35-year retirement). The typical confidence interval you'd use in a Monte Carlo analysis to estimate the "safe" withdrawal rate (SWR) is the 5th percentile. The SWR in this stress test is 2.7%, under the presented assumptions.

Retiring in 1985 was fortuitous for the US investor. Even with a steady stream of withdrawals, their portfolio balance skyrocketed fairly steadily. It's REALLY hard to envision a scenario in which people retiring in 2019 or 2020 will have a carefree time of it.

"60/40 and hope!" is not a legitimate investment strategy in my opinion.

Retirees or near-retirees who are expecting to have withdrawal rates of 2.5% or lower will probably be okay even under the worst of possible future paths. But anyone counting on a withdrawal rate much higher than that should, in my view, be making some serious plans for mitigating sequence of return risk and longevity risk.

If working longer and saving more are options, clearly they should be explored. For everyone else, every opportunity to expand portfolio diversification and/or maximize annuity streams (whether SPIAs , pensions, or Social Security benefits) should likely be embraced.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

flyingaway
Posts: 2732
Joined: Fri Jan 17, 2014 10:19 am

Re: Future 60/40 Portfolio has a 43% Chance of Failing with 4% Withdrawal Rate

Post by flyingaway » Wed Apr 15, 2020 4:24 pm

For the same portfolio and withdrawal rate, I wonder what was the chance of failing in January 2020?

User avatar
Raybo
Posts: 1903
Joined: Tue Feb 20, 2007 11:02 am
Location: San Francisco
Contact:

Re: Future 60/40 Portfolio has a 43% Chance of Failing with 4% Withdrawal Rate

Post by Raybo » Wed Apr 15, 2020 4:27 pm

How many of them fail at 30 year horizons?
No matter how long the hill, if you keep pedaling you'll eventually get up to the top.

User avatar
Topic Author
vineviz
Posts: 6782
Joined: Tue May 15, 2018 1:55 pm

Re: Future 60/40 Portfolio has a 43% Chance of Failing with 4% Withdrawal Rate

Post by vineviz » Wed Apr 15, 2020 4:29 pm

Raybo wrote:
Wed Apr 15, 2020 4:27 pm
How many of them fail at 30 year horizons?
About 79%.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

User avatar
birdog
Posts: 756
Joined: Fri Apr 07, 2017 1:35 pm

Re: Future 60/40 Portfolio has a 43% Chance of Failing with 4% Withdrawal Rate

Post by birdog » Wed Apr 15, 2020 4:32 pm

Isn't the 4% rule based on a 30 year retirement? It would be much more likely to fail if extended beyond that time frame. All the advice I've heard is to lower the withdrawal percentage if extending retirement beyond the 30 years used in the original study.

User avatar
Topic Author
vineviz
Posts: 6782
Joined: Tue May 15, 2018 1:55 pm

Re: Future 60/40 Portfolio has a 43% Chance of Failing with 4% Withdrawal Rate

Post by vineviz » Wed Apr 15, 2020 4:38 pm

birdog wrote:
Wed Apr 15, 2020 4:32 pm
Isn't the 4% rule based on a 30 year retirement?
It was based on a 30-year retirement, though it's not clear that most people are accounting for that fact. We can't (usually) control the date of our death, and 35 years is much closer to the average length of retirement for a couple than 30 years is.

In any case, the graph can easily be read to assume 30 years instead of 35 if that's a preference.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

AZAttorney11
Posts: 711
Joined: Wed Jan 21, 2015 12:12 pm

Re: Future 60/40 Portfolio has a 43% Chance of Failing with 4% Withdrawal Rate

Post by AZAttorney11 » Wed Apr 15, 2020 4:38 pm

Great thread and analysis. Certainly something to ponder. Thanks!

User avatar
Topic Author
vineviz
Posts: 6782
Joined: Tue May 15, 2018 1:55 pm

Re: Future 60/40 Portfolio has a 43% Chance of Failing with 4% Withdrawal Rate

Post by vineviz » Wed Apr 15, 2020 4:39 pm

flyingaway wrote:
Wed Apr 15, 2020 4:24 pm
For the same portfolio and withdrawal rate, I wonder what was the chance of failing in January 2020?
Roughly the same? Bond yields were slightly higher but the expected equity risk premium was lower. It's likely not a perfect wash, but it's pretty close.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

User avatar
birdog
Posts: 756
Joined: Fri Apr 07, 2017 1:35 pm

Re: Future 60/40 Portfolio has a 43% Chance of Failing with 4% Withdrawal Rate

Post by birdog » Wed Apr 15, 2020 4:48 pm

That low yield on the bond fund has to be the killer here, correct?

Dinosaur Dad
Posts: 194
Joined: Wed Feb 22, 2017 6:05 pm
Location: Connecticut

Re: Future 60/40 Portfolio has a 43% Chance of Failing with 4% Withdrawal Rate

Post by Dinosaur Dad » Wed Apr 15, 2020 5:18 pm

I think many of us here are thinking about this issue...and that was before all of the recent market issues. We're all susceptible to market conditions...particularly low bond yields...so what are the ways to mitigate the many risks here? I think each of us has our own approach. For me, as a soon-to-retire 64 year old, steps I'm taking: (1) already delayed retirement, am still working; (2) plan to delay social security for me and my wife until 70; (3) potentially some Roth conversions before RMDs and Social Security start to lower tax rate; (4) reconsidering whether purchasing that vacation house makes sense; (5) keeping some investments completely separate from my retirement income plan, just in case!

I've read a good book on this subject: Safety-First Retirement Planning by Wade Pfau. He talks about a number of ways to use instruments like annuities, reverse mortgage for reserve, etc. to mitigate the risk, and points out the very issue you've identified. I haven't quite figured out the exact mix of levers to pull here. The Boglehead philosophy is simplicity first of course. And some of these "levers" (e.g. variable annuities, whole life insurance) are frowned upon here as expensive and unnecessary.

Hard to predict the future. I think this plan has to be a living, breathing thing. Who knows whether this long period of low interest rates will continue, and who knows what's on the other side of what we're facing today...can we expect the traditional "business cycle" in the future?
"Take calculated risks - that is quite different from being rash." | General George S. Patton

User avatar
Topic Author
vineviz
Posts: 6782
Joined: Tue May 15, 2018 1:55 pm

Re: Future 60/40 Portfolio has a 43% Chance of Failing with 4% Withdrawal Rate

Post by vineviz » Wed Apr 15, 2020 5:42 pm

birdog wrote:
Wed Apr 15, 2020 4:48 pm
That low yield on the bond fund has to be the killer here, correct?
It’s the biggest drag, for sure, but there’s no easy fix. You’d need a lot more yield BUT not a lot more market risk to bring the SWR up significantly.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

User avatar
Uncorrelated
Posts: 749
Joined: Sun Oct 13, 2019 3:16 pm

Re: Future 60/40 Portfolio has a 43% Chance of Failing with 4% Withdrawal Rate

Post by Uncorrelated » Wed Apr 15, 2020 5:56 pm

Low bond yields aren't actually the issue here. A term premium of zero (the difference between short and long term bonds) is not a rare occurrence.

The reason why this backtest performs worse than expected is twofold:
An average stock market return of just 5% above inflation was used. The historical (arithmetic) average return is 8.5% above inflation since 1871. Changing the portfolio visualizer assumptions to this number shows a success rate of 92% over 30 years, which is about what I'd expect.
The simulation uses normally distributed returns. Regardless of whether you believe that this is a valid market model or not, fact is that long-term historical data did not follow a normal distribution in the past. Rather, it has followed a normal distribution on time horizons of about 5-10 years and strong mean reversion after that. This has definitely helped the trinity study (which is based on historical returns).

As can be observed in the FRED chart below, the current conditions of bond yields ≈ inflation were introduced in 2010, but were also visible in between 1970 and 1980. I conclude that bond investors are no worse off than investors in those time periods. The image doesn't go back further than 1970, but as can be observed in this blog, bonds returned basically nothing (real) between 1900 and 1980. Therefore, the possibility of bonds returning nothing over the next decade should not come as a surprise to those well versed in historical data. Indeed, the trinity study included several of those periods.
Image
https://fred.stlouisfed.org/graph/?g=qJkS

The real outlier is the period 1980~2010, where bond yields (both long and short) massively outpacing inflation.

At least today, it's possible to hedge your interest rate exposure with TIPS.

User avatar
nisiprius
Advisory Board
Posts: 41108
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: Future 60/40 Portfolio has a 43% Chance of Failing with 4% Withdrawal Rate

Post by nisiprius » Wed Apr 15, 2020 6:03 pm

Back when I was seriously playing around with these things--mostly with the Fidelity Retirement Income Planner--I discovered that the results I got were very sensitive to changes in withdrawal rate, and hardly sensitive at all to asset allocation unless you got very close to the extremes.

How do your results change as function of withdrawal? What do you consider to be an "acceptable" failure rate in a simulation, and by how much do you need to decrease withdrawal rate to achieve that failure rate?

If I assume 0.000% inflation, a portfolio of 100.00% physical currency, and a 25.000 years in retirement, then a withdrawal rate of 4.01% will fail 100% of the time, but a withdrawal rate of 3.99% will succeed 100% of the time.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

Enzo IX
Posts: 286
Joined: Wed Jul 23, 2008 4:07 am

Re: Future 60/40 Portfolio has a 43% Chance of Failing with 4% Withdrawal Rate

Post by Enzo IX » Wed Apr 15, 2020 6:08 pm

We are just going to have to increase equity percentages if we want to withdraw the 4% a year.

AlphaLess
Posts: 2627
Joined: Fri Sep 29, 2017 11:38 pm
Location: Kentucky

Re: Future 60/40 Portfolio has a 43% Chance of Failing with 4% Withdrawal Rate

Post by AlphaLess » Wed Apr 15, 2020 6:19 pm

nisiprius wrote:
Wed Apr 15, 2020 6:03 pm
Back when I was seriously playing around with these things--mostly with the Fidelity Retirement Income Planner--I discovered that the results I got were very sensitive to changes in withdrawal rate, and hardly sensitive at all to asset allocation unless you got very close to the extremes.

How do your results change as function of withdrawal? What do you consider to be an "acceptable" failure rate in a simulation, and by how much do you need to decrease withdrawal rate to achieve that failure rate?

If I assume 0.000% inflation, a portfolio of 100.00% physical currency, and a 25.000 years in retirement, then a withdrawal rate of 4.01% will fail 100% of the time, but a withdrawal rate of 3.99% will succeed 100% of the time.
This makes total sense.

Some of the more fancy calculators, which had things like CAPE, 10-year yield, etc, as well as average ER of portfolio, you could see that changing BASIS points in WR made huge difference.

OP should try WR of:
- 3.75%
- 3.50%
- 3.25%
- 3.00%

I think somewhere around 2.75% to 3.25%, survival rates will go up big.

Actionable items:
- save more,
- spend less,
- work longer.
"A Republic, if you can keep it". Benjamin Franklin. 1787. | Party affiliation: Vanguard. Religion: low-cost investing.

smitcat
Posts: 5930
Joined: Mon Nov 07, 2016 10:51 am

Re: Future 60/40 Portfolio has a 43% Chance of Failing with 4% Withdrawal Rate

Post by smitcat » Wed Apr 15, 2020 6:32 pm

vineviz wrote:
Wed Apr 15, 2020 4:38 pm
birdog wrote:
Wed Apr 15, 2020 4:32 pm
Isn't the 4% rule based on a 30 year retirement?
It was based on a 30-year retirement, though it's not clear that most people are accounting for that fact. We can't (usually) control the date of our death, and 35 years is much closer to the average length of retirement for a couple than 30 years is.

In any case, the graph can easily be read to assume 30 years instead of 35 if that's a preference.
"We can't (usually) control the date of our death, and 35 years is much closer to the average length of retirement for a couple than 30 years is."
Not sure what is 'average' but here is some data on both singles and couples amount of time in retirement...
https://www.fool.com/retirement/2018/02 ... our-m.aspx

March2009
Posts: 58
Joined: Sat Mar 21, 2020 7:04 pm

Re: Future 60/40 Portfolio has a 43% Chance of Failing with 4% Withdrawal Rate

Post by March2009 » Wed Apr 15, 2020 6:39 pm

I have ran the 60/40 portfolio through firecalc and got the same results as the trinity study. In addition, I looked at projected stock returns (future dividends) and projected bond returns (current yields) against expected inflation. The average of that was a little worse than trinity (stocks and bonds are relatively expensive at this time). I then looked at a 50% market crash and that passed ok. But your analysis is a new twist with the current low real bond yield baked into past scenarios. I can see that performing worse than trinity. Thanks for sharing. It is worth considering and I think regardless of a retiree's withdrawal rate, they should always have a plan B for worst-case scenarios.
In bear markets, stocks return to their rightful owners. - J.P. Morgan

User avatar
Raybo
Posts: 1903
Joined: Tue Feb 20, 2007 11:02 am
Location: San Francisco
Contact:

Re: Future 60/40 Portfolio has a 43% Chance of Failing with 4% Withdrawal Rate

Post by Raybo » Wed Apr 15, 2020 7:00 pm

The question always comes back to how much "not living" risk should one take to overcome "projection" risk? That is, how much should I cut back spending, extend my retirement date, and/or increase my stock percentage for the sake of raising the simulated percentage chance of my withdrawal rate being sustainable?

First off, if it is true that the simulator in question uses a normal distribution to represent market returns, then why would anyone put any credence on its projections? Why not use the daily high temperature on Wall Street or the number of chocolate chips in Nabisco Chips Ahoy. Who knows, these might actually simulate true stock market movements better than a normal distribution. One thing is certain, stock market returns aren't normally distributed.

Next, are you comfortable predicting that interest rates and inflation will stay low for the next 35 years?

Hey, cut back if you want. But, I see no reason to spend much time thinking about the results being described here.
No matter how long the hill, if you keep pedaling you'll eventually get up to the top.

ruud
Posts: 295
Joined: Sat Mar 03, 2007 1:28 pm
Location: san francisco bay area

Re: Future 60/40 Portfolio has a 43% Chance of Failing with 4% Withdrawal Rate

Post by ruud » Wed Apr 15, 2020 7:04 pm

vineviz wrote:
Wed Apr 15, 2020 3:53 pm
Retirees or near-retirees who are expecting to have withdrawal rates of 2.5% or lower will probably be okay even under the worst of possible future paths. But anyone counting on a withdrawal rate much higher than that should, in my view, be making some serious plans for mitigating sequence of return risk and longevity risk.
At a 2.5% withdrawal rate (portfolio size 40x annual withdrawal), wouldn't you just put it all in TIPS and basically have a guaranteed success?
.

sixtyforty
Posts: 463
Joined: Tue Nov 25, 2014 12:22 pm
Location: USA

Re: Future 60/40 Portfolio has a 43% Chance of Failing with 4% Withdrawal Rate

Post by sixtyforty » Wed Apr 15, 2020 7:11 pm

In this example, at 35 years with 60/40 has a success rate of 68.94%. If you change the allocation to 80/20, the success rate only increases to 74.2% Increasing equity in this example, doesn't appear to be the answer. A variable withdrawal strategy would definitely be needed under these conditions.
"Simplicity is the ultimate sophistication" - Leonardo Da Vinci

User avatar
HomerJ
Posts: 14774
Joined: Fri Jun 06, 2008 12:50 pm

Re: Future 60/40 Portfolio has a 43% Chance of Failing with 4% Withdrawal Rate

Post by HomerJ » Wed Apr 15, 2020 7:16 pm

vineviz wrote:
Wed Apr 15, 2020 3:53 pm
A simple Monte Carlo analysis has plenty of faults, but let's just look at the results of one under some relatively uncontroversial assumptions.
Sorry, simple Monte Carlo has so many faults, the results are worthless.

Garbage in, Garbage out.
A Goldman Sachs associate provided a variety of detailed explanations, but then offered a caveat, “If I’m being dead-### honest, though, nobody knows what’s really going on.”

User avatar
2pedals
Posts: 1164
Joined: Wed Dec 31, 2014 12:31 pm

Re: Future 60/40 Portfolio has a 43% Chance of Failing with 4% Withdrawal Rate

Post by 2pedals » Wed Apr 15, 2020 7:24 pm

As far as I know their is no reason to use a fixed withdrawal rate in retirement. 4% (25x spending, 1m * 0.04=40k, 40k * 25 = 1m) has been used as retirement rule of thumb method to help people decide if they have saved enough. If one is conservative on the spending side (assume you want more than you need) their is no reason to be conservative on the savings side but you can if you are a belt and suspenders kind of guy.

User avatar
2pedals
Posts: 1164
Joined: Wed Dec 31, 2014 12:31 pm

Re: Future 60/40 Portfolio has a 43% Chance of Failing with 4% Withdrawal Rate

Post by 2pedals » Wed Apr 15, 2020 7:28 pm

vineviz wrote:
Wed Apr 15, 2020 4:29 pm
Raybo wrote:
Wed Apr 15, 2020 4:27 pm
How many of them fail at 30 year horizons?
About 79%.
21% fail over 30 years rather than 43% over 35 years, right?

User avatar
JoMoney
Posts: 9339
Joined: Tue Jul 23, 2013 5:31 am

Re: Future 60/40 Portfolio has a 43% Chance of Failing with 4% Withdrawal Rate

Post by JoMoney » Wed Apr 15, 2020 7:44 pm

FWIW, a 55 year old male, that has about 30 years on a life expectancy table, can buy a SPIA right now paying just shy of $48,000 (effectively a 4.4% withdrawal rate) fixed/nominal for as long as he lives.
A portfolio would need to earn a little more than 2.5% a year to amortize out making those payments for 30 years.
To get the possibility of taking an inflation adjustment, the investor would have to take more risk... which means the possibility of the portfolio failing. :?
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

drummerboy
Posts: 151
Joined: Wed Apr 20, 2016 1:08 pm

Re: Future 60/40 Portfolio has a 43% Chance of Failing with 4% Withdrawal Rate

Post by drummerboy » Wed Apr 15, 2020 8:03 pm

JoMoney wrote:
Wed Apr 15, 2020 7:44 pm
FWIW, a 55 year old male, that has about 30 years on a life expectancy table, can buy a SPIA right now paying just shy of $48,000 (effectively a 4.4% withdrawal rate) fixed/nominal for as long as he lives.
A portfolio would need to earn a little more than 2.5% a year to amortize out making those payments for 30 years.
To get the possibility of taking an inflation adjustment, the investor would have to take more risk... which means the possibility of the portfolio failing. :?
Can you provide more details? $48k a year. Any COLA adjustment per year? What is the cost of this policy?

Thanks

User avatar
Nicolas Perrault
Posts: 209
Joined: Thu Sep 27, 2018 12:33 pm
Location: Oxford, UK

Re: Future 60/40 Portfolio has a 43% Chance of Failing with 4% Withdrawal Rate

Post by Nicolas Perrault » Wed Apr 15, 2020 8:07 pm

HomerJ wrote:
Wed Apr 15, 2020 7:16 pm
vineviz wrote:
Wed Apr 15, 2020 3:53 pm
A simple Monte Carlo analysis has plenty of faults, but let's just look at the results of one under some relatively uncontroversial assumptions.
Sorry, simple Monte Carlo has so many faults, the results are worthless.

Garbage in, Garbage out.
Would you mind elaborating or point to an article where I can read more on this?

User avatar
HomerJ
Posts: 14774
Joined: Fri Jun 06, 2008 12:50 pm

Re: Future 60/40 Portfolio has a 43% Chance of Failing with 4% Withdrawal Rate

Post by HomerJ » Wed Apr 15, 2020 8:22 pm

Nicolas Perrault wrote:
Wed Apr 15, 2020 8:07 pm
HomerJ wrote:
Wed Apr 15, 2020 7:16 pm
vineviz wrote:
Wed Apr 15, 2020 3:53 pm
A simple Monte Carlo analysis has plenty of faults, but let's just look at the results of one under some relatively uncontroversial assumptions.
Sorry, simple Monte Carlo has so many faults, the results are worthless.

Garbage in, Garbage out.
Would you mind elaborating or point to an article where I can read more on this?
Stock market returns are not independent. A simple Monte Carlo is a pure random simulation. When you run ten thousand simulations, you will get quite a few that have 3-5 (or more) negative years in a row, which is very rare in real life (so far - 4 negative years in a row is the record - happened once in 1929-1932).

Historical numbers are a limited dataset, but they are a real dataset.

Both methods have issues, but I would never trust a simple Monte Carlo simulation enough to work 10 more years because I was scared of going broke in retirement.

Running out of time is a real risk too.. Just as real as running out of money.

In real life, 4%, so far, has always worked... Even in low yield bond times, even with rising interest rates, even with double-digit inflation, even with low stock market returns for 16 years...

You only need like 1% (less?) annual real returns for 4% withdrawals to work 30 years. Yes, the next 30 years may be worse than any 30 years in U.S. history, but there's no way that chance is 43%. (Edit: or even 21%)
A Goldman Sachs associate provided a variety of detailed explanations, but then offered a caveat, “If I’m being dead-### honest, though, nobody knows what’s really going on.”

User avatar
JoMoney
Posts: 9339
Joined: Tue Jul 23, 2013 5:31 am

Re: Future 60/40 Portfolio has a 43% Chance of Failing with 4% Withdrawal Rate

Post by JoMoney » Wed Apr 15, 2020 8:35 pm

drummerboy wrote:
Wed Apr 15, 2020 8:03 pm
JoMoney wrote:
Wed Apr 15, 2020 7:44 pm
FWIW, a 55 year old male, that has about 30 years on a life expectancy table, can buy a SPIA right now paying just shy of $48,000 (effectively a 4.4% withdrawal rate) fixed/nominal for as long as he lives.
A portfolio would need to earn a little more than 2.5% a year to amortize out making those payments for 30 years.
To get the possibility of taking an inflation adjustment, the investor would have to take more risk... which means the possibility of the portfolio failing. :?
Can you provide more details? $48k a year. Any COLA adjustment per year? What is the cost of this policy?

Thanks
No COLA adjustment. Sorry, I forgot to specify it was a $1mil quick quote from https://www.immediateannuities.com/ for a 55 year old male living in AZ. I would not recommend putting more than your states insurance protection limits with any one insurance company, and I wouldn't go all in on a SPIA at all, but I do like to see what a "safe" rate would be for lifetime income as quoted by an insurance company that expects to be able to profit on the arrangement, just to see how far out of line a riskier portfolio might be. Personally, if I was drawing income from my portfolio I would consider something like a SPIA as an alternative to bonds or some portion of bonds in my portfolio.
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

garlandwhizzer
Posts: 2865
Joined: Fri Aug 06, 2010 3:42 pm

Re: Future 60/40 Portfolio has a 43% Chance of Failing with 4% Withdrawal Rate

Post by garlandwhizzer » Wed Apr 15, 2020 9:31 pm

Jo Money wrote:

FWIW, a 55 year old male, that has about 30 years on a life expectancy table, can buy a SPIA right now paying just shy of $48,000 (effectively a 4.4% withdrawal rate) fixed/nominal for as long as he lives.
A portfolio would need to earn a little more than 2.5% a year to amortize out making those payments for 30 years.
In this example of a 4.4% withdrawal rate, for the first 22.7 years the annuity company is just giving you back your own money. Except you paid in real dollars inflation adjusted at the date of purchase in 2020. They pay out in nominal dollars decreased by cumulative inflation since purchase. 22.7 years later that 48K/yr. payment is discounted by 22.7 years of compound inflation in terms of real purchasing power. If inflation averages 2%/yr compounded at that point the 48K payout is discounted by 50% in real terms to 24K/yr. which is 2.2% of what you paid in inflation adjusted dollar terms almost 23 years ago. Inflation could certainly be less than 2% but it could also be greater. The problem is that it is not predictable beforehand. That's called risk. There is also the very real chance that the buyer dies before age 85 and the company then gets to pocket the windfall, so no legacy for heirs or charities. Annuities offer the illusion of safety, not the real thing which a TIPS ladder offers. Inflation, if significant, will dwarf SPIA payouts in real dollars over a long time span, plus the companies benefit if your longevity turns out to be shorter than anticipated.

The companies offering them are adept at running the numbers and evaluating survival tables. They offer annuities that are sure to make a profit, one reason why so few offer inflation adjusted annuities which shifts the inflation risk from the investor to the company. Annuities are not for me until I'm at least 75 - 80 for a SPIA, but for others they might be right as a portion of the plan. Finally the newer annuities, more complex than SPIA with lots of bells and whistles, are loaded with higher fees. Beware of them. If you are around 75 - 80 and still in relatively good health, SPIA are a good deal and there isn't enough survival time left for inflation to severely impact you.

Garland Whizzer

User avatar
Nicolas Perrault
Posts: 209
Joined: Thu Sep 27, 2018 12:33 pm
Location: Oxford, UK

Re: Future 60/40 Portfolio has a 43% Chance of Failing with 4% Withdrawal Rate

Post by Nicolas Perrault » Wed Apr 15, 2020 9:34 pm

HomerJ wrote:
Wed Apr 15, 2020 8:22 pm
Stock market returns are not independent. A simple Monte Carlo is a pure random simulation. When you run ten thousand simulations, you will get quite a few that have 3-5 (or more) negative years in a row, which is very rare in real life (so far - 4 negative years in a row is the record - happened once in 1929-1932).
Good point, I agree.
HomerJ wrote:
Wed Apr 15, 2020 8:22 pm
Both methods have issues, but I would never trust a simple Monte Carlo simulation enough to work 10 more years because I was scared of going broke in retirement.
If your situation is such that running out of money is not a total disaster (because of social security, etc.), I would tend to agree. Bringing the risk of running out of money from 10% to 1% or from 1% to 0.1% can cost you 10 years of work. But if your situation is such that running out of money means panhandling and eating Alpo, I would feel that working 10 years more is worth it to bring 10% down to 1%, especially if you like your job. That said, one has alternatives to working more, such as spending less, especially when the market is down.
HomerJ wrote:
Wed Apr 15, 2020 8:22 pm
Historical numbers are a limited dataset, but they are a real dataset.
Luckily we have data from other developed countries too.
HomerJ wrote:
Wed Apr 15, 2020 8:22 pm
In real life, 4%, so far, has always worked... Even in low yield bond times, even with rising interest rates, even with double-digit inflation, even with low stock market returns for 16 years...
With 100% developed Pacific stocks (or 60/40 Pacific stocks/cash), starting in January 1990, 4% lasted until end 2004 (or end 2014), 3% until December 2009 (or end 2019), 2% until end 2020 as you've got 1.2% the original amount left in real terms as of March 2020 (with 60/40 you've got 32.7% the original amount left in real terms). I swapped bonds for cash in the portfoliovisualizer backtest because it seems unlikely that at current rates bonds will go on another raging bull. So with a 60/40 allocation stocks/cash, 3% just barely gets you to the 30-year line.
HomerJ wrote:
Wed Apr 15, 2020 8:22 pm
You only need like 1% (less?) annual real returns for 4% withdrawals to work 30 years.
I don't think this is always correct, 100% Pacific stocks returned 1.43% real between 1987 and 2017, but if you pulled out 4% a year you would have ran out of money at the end of 2013. The sequence of returns is important, as the annualized return between 1987 and 2013 was less than 1%.
Last edited by Nicolas Perrault on Wed Apr 15, 2020 9:44 pm, edited 3 times in total.

typical.investor
Posts: 2041
Joined: Mon Jun 11, 2018 3:17 am

Re: Future 60/40 Portfolio has a 43% Chance of Failing with 4% Withdrawal Rate

Post by typical.investor » Wed Apr 15, 2020 9:36 pm

Nicolas Perrault wrote:
Wed Apr 15, 2020 8:07 pm
HomerJ wrote:
Wed Apr 15, 2020 7:16 pm
vineviz wrote:
Wed Apr 15, 2020 3:53 pm
A simple Monte Carlo analysis has plenty of faults, but let's just look at the results of one under some relatively uncontroversial assumptions.
Sorry, simple Monte Carlo has so many faults, the results are worthless.

Garbage in, Garbage out.
Would you mind elaborating or point to an article where I can read more on this?
An effect of the current crash is that expected future returns are up.

Monte Carlo will model as though they are up, down, and even.

And when valuation are high, expected future returns are down. Again, Monte Carlo will model them as though they are up, down and even.

This is why you see truly unrealistic best case numbers. Do you think the bad case numbers are any more meaningful?

There is a point to be made about the low expectations from bonds. However, I don’t know that Monte Carlo is a good way to look at it.
Last edited by typical.investor on Wed Apr 15, 2020 9:38 pm, edited 1 time in total.

User avatar
birdog
Posts: 756
Joined: Fri Apr 07, 2017 1:35 pm

Re: Future 60/40 Portfolio has a 43% Chance of Failing with 4% Withdrawal Rate

Post by birdog » Wed Apr 15, 2020 9:38 pm

HomerJ wrote:
Wed Apr 15, 2020 8:22 pm
Nicolas Perrault wrote:
Wed Apr 15, 2020 8:07 pm
HomerJ wrote:
Wed Apr 15, 2020 7:16 pm
vineviz wrote:
Wed Apr 15, 2020 3:53 pm
A simple Monte Carlo analysis has plenty of faults, but let's just look at the results of one under some relatively uncontroversial assumptions.
Sorry, simple Monte Carlo has so many faults, the results are worthless.

Garbage in, Garbage out.
Would you mind elaborating or point to an article where I can read more on this?
Stock market returns are not independent. A simple Monte Carlo is a pure random simulation. When you run ten thousand simulations, you will get quite a few that have 3-5 (or more) negative years in a row, which is very rare in real life (so far - 4 negative years in a row is the record - happened once in 1929-1932).

Historical numbers are a limited dataset, but they are a real dataset.

Both methods have issues, but I would never trust a simple Monte Carlo simulation enough to work 10 more years because I was scared of going broke in retirement.

Running out of time is a real risk too.. Just as real as running out of money.

In real life, 4%, so far, has always worked... Even in low yield bond times, even with rising interest rates, even with double-digit inflation, even with low stock market returns for 16 years...

You only need like 1% (less?) annual real returns for 4% withdrawals to work 30 years. Yes, the next 30 years may be worse than any 30 years in U.S. history, but there's no way that chance is 43%. (Edit: or even 21%)
Very good points. The 4% rule has never failed in any 30 year rolling cohorts.

User avatar
KEotSK66
Posts: 343
Joined: Wed Mar 11, 2020 7:03 pm

Re: Future 60/40 Portfolio has a 43% Chance of Failing with 4% Withdrawal Rate

Post by KEotSK66 » Wed Apr 15, 2020 9:41 pm

to grow the portfolio with inflation (1.5%) and as a result the draw (4%) with inflation a return of 5.73% is needed over short periods, which doesn't seem too high a hurdle

for the 60% s&p and 40% tbm portfolio my guess is the 60% in the s&p is the culprit, it is volatile and its income production is a bit light

getting 4% income to cover the draw from a typical balanced portfolio isn't so easy though
"i just got fluctuated out of $1,500", jerry

User avatar
Sandtrap
Posts: 11033
Joined: Sat Nov 26, 2016 6:32 pm
Location: Hawaii No Ka Oi , N. Arizona

Re: Future 60/40 Portfolio has a 43% Chance of Failing with 4% Withdrawal Rate

Post by Sandtrap » Wed Apr 15, 2020 9:45 pm

As long as one is able to and has the assets, it would seem prudent to consider different baselines (rules of thumbs) such as:

3% is the new 4% withdrawal rate

A variable withdrawal rate with a 3% baseline

30X at retirement at age 65 with no pension, etc, is the new 25X

j :happy
Wiki Bogleheads Wiki: Everything You Need to Know

fennewaldaj
Posts: 950
Joined: Sun Oct 22, 2017 11:30 pm

Re: Future 60/40 Portfolio has a 43% Chance of Failing with 4% Withdrawal Rate

Post by fennewaldaj » Wed Apr 15, 2020 10:02 pm

Since most bogleheads have significant social security this is not that big of an issue right? Just pick a variable withdrawal method and be prepared to cut back if you have to. As was pointed out by others how much not living should you do to protect from low probability events.

User avatar
KEotSK66
Posts: 343
Joined: Wed Mar 11, 2020 7:03 pm

Re: Future 60/40 Portfolio has a 43% Chance of Failing with 4% Withdrawal Rate

Post by KEotSK66 » Wed Apr 15, 2020 11:22 pm

how much not living will you want to do during your last years
"i just got fluctuated out of $1,500", jerry

User avatar
Stef
Posts: 965
Joined: Thu Oct 10, 2019 10:13 am

Re: Future 60/40 Portfolio has a 43% Chance of Failing with 4% Withdrawal Rate

Post by Stef » Wed Apr 15, 2020 11:43 pm

Nicolas Perrault wrote:
Wed Apr 15, 2020 9:34 pm
With 100% developed Pacific stocks (or 60/40 Pacific stocks/cash), starting in January 1990, 4% lasted until end 2004 (or end 2014), 3% until December 2009 (or end 2019), 2% until end 2020 as you've got 1.2% the original amount left in real terms as of March 2020 (with 60/40 you've got 32.7% the original amount left in real terms). I swapped bonds for cash in the portfoliovisualizer backtest because it seems unlikely that at current rates bonds will go on another raging bull. So with a 60/40 allocation stocks/cash, 3% just barely gets you to the 30-year line.
HomerJ wrote:
Wed Apr 15, 2020 8:22 pm
You only need like 1% (less?) annual real returns for 4% withdrawals to work 30 years.
I don't think this is always correct, 100% Pacific stocks returned 1.43% real between 1987 and 2017, but if you pulled out 4% a year you would have ran out of money at the end of 2013. The sequence of returns is important, as the annualized return between 1987 and 2013 was less than 1%.
MSCI World data goes back to 1969. Are there any backtests for that?

User avatar
Topic Author
vineviz
Posts: 6782
Joined: Tue May 15, 2018 1:55 pm

Re: Future 60/40 Portfolio has a 43% Chance of Failing with 4% Withdrawal Rate

Post by vineviz » Thu Apr 16, 2020 6:36 am

2pedals wrote:
Wed Apr 15, 2020 7:28 pm
vineviz wrote:
Wed Apr 15, 2020 4:29 pm
Raybo wrote:
Wed Apr 15, 2020 4:27 pm
How many of them fail at 30 year horizons?
About 79%.
21% fail over 30 years rather than 43% over 35 years, right?
Yes, my mistake: the success rate was 79%.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

petulant
Posts: 1329
Joined: Thu Sep 22, 2016 1:09 pm

Re: Future 60/40 Portfolio has a 43% Chance of Failing with 4% Withdrawal Rate

Post by petulant » Thu Apr 16, 2020 6:43 am

fennewaldaj wrote:
Wed Apr 15, 2020 10:02 pm
Since most bogleheads have significant social security this is not that big of an issue right? Just pick a variable withdrawal method and be prepared to cut back if you have to. As was pointed out by others how much not living should you do to protect from low probability events.
This is a good point. vineviz has contributed an interesting analysis on the viability of a safe fixed withdrawal rate, and it's interesting to see people pick at it. However, most Americans are not using a single investment portfolio with a fixed withdrawal rate. Instead, they've got some combination of a portfolio, house, social security, and a pension, along with a business or the opportunity for continuing to work, possibly part time. Specific financial planning considers all of these and will need to continue doing so. However, it's also helpful to have the rule of thumb about SWR for retirement expenses.

restingonmylaurels
Posts: 513
Joined: Tue Apr 14, 2015 11:02 am

Re: Future 60/40 Portfolio has a 43% Chance of Failing with 4% Withdrawal Rate

Post by restingonmylaurels » Thu Apr 16, 2020 7:26 am

vineviz wrote:
Wed Apr 15, 2020 3:53 pm
"60/40 and hope!" is not a legitimate investment strategy in my opinion.

Retirees or near-retirees who are expecting to have withdrawal rates of 2.5% or lower will probably be okay even under the worst of possible future paths. But anyone counting on a withdrawal rate much higher than that should, in my view, be making some serious plans for mitigating sequence of return risk and longevity risk.

If working longer and saving more are options, clearly they should be explored. For everyone else, every opportunity to expand portfolio diversification and/or maximize annuity streams (whether SPIAs , pensions, or Social Security benefits) should likely be embraced.
vineviz,

You are using only TBM for all of your 40% bonds. What if you modified your bond holdings to include X% of riskier bonds (corps, high yield, EM)?

These all have SEC yields above and in some cases far above TBM (even allowing for defaults). I have done this for decades and have no complaints.

(Please, let us not have the risky bonds are equities discussion again now, let's just see what the result is).

aristotelian
Posts: 7626
Joined: Wed Jan 11, 2017 8:05 pm

Re: Future 60/40 Portfolio has a 43% Chance of Failing with 4% Withdrawal Rate

Post by aristotelian » Thu Apr 16, 2020 7:30 am

If you set the expected return below average for both asset classes, it makes sense you would see higher failure rate. I do agree there are some reasons to make that assumption in the current historical-economic environment. Would be curious to hear thoughts on this post I made on the FIRE reddit at the beginning of the coronavirus crisis.

One piece I will add is that if you are going to use the current market as a basis for your return assumptions on bonds, shouldn't you do the same for stocks? Arguably, with the market down now, you could say stocks have above average expected return. Of course that is a dangerous assumption!


Does SWR Apply with Record Low Interest Rates?

The 10 Year Treasury which is the basis for SWR research is currently sitting at a record low of 0.74%. Not just below average, but all time record low. I am curious to hear some discussion of what this might mean for SWR research and FIRE strategies.

With bond yields at record lows, FIRE investors are faced with a choice between locking up a large portion of their portfolio in risk free assets with an expected nominal return of under 1%, or take their chances with a more aggressive stock allocation. (You might look at 10-15 year performance of bond funds and note that they have returned more than their yield, but that is only due to the long term trend of lower interest rates, culminating in what we are seeing today).

The Good

Record low interest rates is an indication of low underlying inflation. Institutions are only willing to loan money so cheap if they have confidence that the principal will have the same value with the interest paid back. Arguably, this new world of low yields is only possible with the removal of one of the principal threats to retirement success. This also means things like cheaper mortgages and other debt.

The Bad

However, this means there is no historical precedent for such low income (actually negative real return) coming from the bond side of the portfolio. Perhaps more importantly, the larger macroeconomic context is unprecedented, so we just don't know what effects this trend could have. For example, the Fed may have less room to stimulate the economy in the event of a recession. In that scenario, bonds (which go up in price as interest rates drop) could lose much of their diversification power with interest rates already at zero. A market crash when interest rates are already effectively zero could potentially be larger in scale and longer in duration than previous events we have seen (on the other hand, it is possible that the Fed is getting ahead of the potential recession, propping up the economy to pre-empt a major crash. This seems to be what the Fed is thinking with its emergency rate cut this week).

While SWR research is based on 100's of years of backtesting data, the current situation is unprecedented. I submit that we simply cannot say for sure that the SWR research will hold up.

Possible Strategies

Shift to higher yielding corporate bonds. However, corporate bonds are riskier and more correlated with the market than Treasuries, therefore expected to produce lower risk-adjusted returns. Muni bonds may have the same issue.

Increase your stock allocation. However, you will be more vulnerable to sequence of returns risk, especially in the scenario above where the Fed has no ability to correct a major market event.

Shift to TIPS. At least TIPS will be guaranteed to match inflation (although I have seen some reports of TIPS starting to sell with negative real rates). However, TIPS are somewhat less un-correlated with the market than traditional Treasuries and don't do as well in backtesting.

Explore annuities. Annuities can provide guaranteed income. However, they are subject to inflation risk, can be costly, and you lose the ability to pass the principal on to your heirs.

Basically, I don't see a good option that does not involve saving more. I am curious to hear thoughts on how FIRE folks are strategizing and coping with this inherent uncertainty.


https://www.reddit.com/r/financialindep ... est_rates/

restingonmylaurels
Posts: 513
Joined: Tue Apr 14, 2015 11:02 am

Re: Future 60/40 Portfolio has a 43% Chance of Failing with 4% Withdrawal Rate

Post by restingonmylaurels » Thu Apr 16, 2020 7:40 am

JoMoney wrote:
Wed Apr 15, 2020 7:44 pm
FWIW, a 55 year old male, that has about 30 years on a life expectancy table, can buy a SPIA right now paying just shy of $48,000 (effectively a 4.4% withdrawal rate) fixed/nominal for as long as he lives.
A portfolio would need to earn a little more than 2.5% a year to amortize out making those payments for 30 years.
To get the possibility of taking an inflation adjustment, the investor would have to take more risk... which means the possibility of the portfolio failing. :?
JoMoney,

Can I ask a simple question?

I never have considered an annuity, as I cannot understand how giving a bunch of money to someone else, having them deduct their expenses/profit, and then giving it back to you slowly can possibly be financially more advantageous than investing that money yourself.

This must mean either that the insurance company has investing options/expertise not available to you or you are making less than you could.

In what scenario would your overall net worth be improved by purchasing a SPIA?

User avatar
Topic Author
vineviz
Posts: 6782
Joined: Tue May 15, 2018 1:55 pm

Re: Future 60/40 Portfolio has a 43% Chance of Failing with 4% Withdrawal Rate

Post by vineviz » Thu Apr 16, 2020 7:42 am

Uncorrelated wrote:
Wed Apr 15, 2020 5:56 pm
The simulation uses normally distributed returns
Actually, I used an autoregressive (GARCH) model to reduce the problems inherent in assuming a fully normal distribution. And I intentionally reported 10th and 90th percentile outcomes precisely because of the extreme outliers that Monte Carlo can produce deeper into the tails.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

index2max
Posts: 286
Joined: Mon Jan 21, 2019 11:01 pm

Re: Future 60/40 Portfolio has a 43% Chance of Failing with 4% Withdrawal Rate

Post by index2max » Thu Apr 16, 2020 7:43 am

I believe the most realistic thing to plan for is living off interest or dividends in retirement with a margin of safety included for when business goes bad in a recession.

CurlyDave
Posts: 1732
Joined: Thu Jul 28, 2016 11:37 am

Re: Future 60/40 Portfolio has a 43% Chance of Failing with 4% Withdrawal Rate

Post by CurlyDave » Thu Apr 16, 2020 7:43 am

Uncorrelated wrote:
Wed Apr 15, 2020 5:56 pm

...The reason why this backtest performs worse than expected is twofold:
An average stock market return of just 5% above inflation was used. The historical (arithmetic) average return is 8.5% above inflation since 1871. Changing the portfolio visualizer assumptions to this number shows a success rate of 92% over 30 years, which is about what I'd expect...
+1

From memory, for about the last decade supposedly knowledgable people have been predicting lower than average market returns going forward. Some down in the "really miserable" category.

And, for the past decade when these predictions have collided with reality they have come out really crumpled and dented. But somehow the doomsayers never change their ways and continue to find lurking disaster just ahead. I am no longer believing in these predictions.

User avatar
Topic Author
vineviz
Posts: 6782
Joined: Tue May 15, 2018 1:55 pm

Re: Future 60/40 Portfolio has a 43% Chance of Failing with 4% Withdrawal Rate

Post by vineviz » Thu Apr 16, 2020 7:47 am

restingonmylaurels wrote:
Thu Apr 16, 2020 7:40 am
JoMoney wrote:
Wed Apr 15, 2020 7:44 pm
FWIW, a 55 year old male, that has about 30 years on a life expectancy table, can buy a SPIA right now paying just shy of $48,000 (effectively a 4.4% withdrawal rate) fixed/nominal for as long as he lives.
A portfolio would need to earn a little more than 2.5% a year to amortize out making those payments for 30 years.
To get the possibility of taking an inflation adjustment, the investor would have to take more risk... which means the possibility of the portfolio failing. :?
JoMoney,

Can I ask a simple question?

I never have considered an annuity, as I cannot understand how giving a bunch of money to someone else, having them deduct their expenses/profit, and then giving it back to you slowly can possibly be financially more advantageous than investing that money yourself.

This must mean either that the insurance company has investing options/expertise not available to you or you are making less than you could.

In what scenario would your overall net worth be improved by purchasing a SPIA?
The goal of insurance isn't to improve your net worth. The goal of insurance is to reduce the risk of really bad events, and that's what a SPIA does: it reduces both sequence of return risk and longevity risk for the retiree.

Annuatizing part or all of your fixed income portfolio increases (and smooths) your retirement income and increases your expected terminal wealth (i.e. how much money you leave to your heirs when you die).
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

User avatar
Topic Author
vineviz
Posts: 6782
Joined: Tue May 15, 2018 1:55 pm

Re: Future 60/40 Portfolio has a 43% Chance of Failing with 4% Withdrawal Rate

Post by vineviz » Thu Apr 16, 2020 7:57 am

Uncorrelated wrote:
Wed Apr 15, 2020 5:56 pm
An average stock market return of just 5% above inflation was used. The historical (arithmetic) average return is 8.5% above inflation since 1871. Changing the portfolio visualizer assumptions to this number shows a success rate of 92% over 30 years, which is about what I'd expect.
Realized inflation isn't the appropriate number to use as the risk-free rate in an asset pricing model.

From 1935 to present, the equity risk premium computed as stocks minus intermediate-term US Treasuries has averaged roughly 5.5% as an annualized geometric mean and 7% as an arithmetic mean.

The current yield on 5-year treasuries is about 0.5%.

0.5% + 7.0% = the 7.5% expected return I used in my simulations. It's a reasonable base case given where we are.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

User avatar
JoMoney
Posts: 9339
Joined: Tue Jul 23, 2013 5:31 am

Re: Future 60/40 Portfolio has a 43% Chance of Failing with 4% Withdrawal Rate

Post by JoMoney » Thu Apr 16, 2020 8:02 am

restingonmylaurels wrote:
Thu Apr 16, 2020 7:40 am
JoMoney wrote:
Wed Apr 15, 2020 7:44 pm
FWIW, a 55 year old male, that has about 30 years on a life expectancy table, can buy a SPIA right now paying just shy of $48,000 (effectively a 4.4% withdrawal rate) fixed/nominal for as long as he lives.
A portfolio would need to earn a little more than 2.5% a year to amortize out making those payments for 30 years.
To get the possibility of taking an inflation adjustment, the investor would have to take more risk... which means the possibility of the portfolio failing. :?
JoMoney,

Can I ask a simple question?

I never have considered an annuity, as I cannot understand how giving a bunch of money to someone else, having them deduct their expenses/profit, and then giving it back to you slowly can possibly be financially more advantageous than investing that money yourself.

This must mean either that the insurance company has investing options/expertise not available to you or you are making less than you could.

In what scenario would your overall net worth be improved by purchasing a SPIA?
It's more about insuring income for the rest of your life, than improving your net worth.
That said, the rates typically offered are often better than what a bond portfolio would offer if you tried to build a ladder of bonds to cover the same expected number of years. If I tried to build the bond portfolio and 'self insure', and live longer than an actuarial life-table suggests, I would have no income and no recourse. if I buy a SPIA and die earlier than expectations, it's of little consequence to me.
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

User avatar
Clever_Username
Posts: 1658
Joined: Sun Jul 15, 2012 12:24 am
Location: Southern California

Re: Future 60/40 Portfolio has a 43% Chance of Failing with 4% Withdrawal Rate

Post by Clever_Username » Thu Apr 16, 2020 8:09 am

vineviz wrote:
Wed Apr 15, 2020 3:53 pm
For reference, let's include the actual experience of a hypothetical investor with the same conditions who retired in 1985. Same portfolio, same withdrawal pattern, etc.

Image
How is that person getting so rich off of the current situation with a 60/40 portfolio? I am confused by the y-axis in particular.
"What was true then is true now. Have a plan. Stick to it." -- XXXX, _Layer Cake_ | | I survived my first downturn and all I got was this signature line.

User avatar
Topic Author
vineviz
Posts: 6782
Joined: Tue May 15, 2018 1:55 pm

Re: Future 60/40 Portfolio has a 43% Chance of Failing with 4% Withdrawal Rate

Post by vineviz » Thu Apr 16, 2020 8:13 am

restingonmylaurels wrote:
Thu Apr 16, 2020 7:26 am
You are using only TBM for all of your 40% bonds. What if you modified your bond holdings to include X% of riskier bonds (corps, high yield, EM)?
Historically, high-yield bonds like those held by Vanguard High-Yield Corporate (VWEHX) have returned about 1.6% more than intermediate Treasuries and 3.6% less than stocks.

Replacing total bond completely with high-yield under those assumption brings the failure rate up to roughly 30% from 43%.

It's a big boost in expected return but a smaller boost in sustainable withdrawal rate because the increase yields come at a cost of increased correlation with the stocks. Sequence of returns risk is still the elephant in the room, and it is function of two things: expected returns of the assets and the expected covariance of the assets.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

Post Reply