Better than 4% Rule

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Knighted
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Better than 4% Rule

Post by Knighted » Fri Oct 20, 2017 11:31 am

So, I just read this paper:
https://web.stanford.edu/~wfsharpe/retecon/4percent.pdf

And I'm trying to understand the primary argument, but it's not clear to me from whence the inefficiencies in the 4% rule arise. I get that following the 4% rule will usually lead in excess funds (thus creating inefficiencies), and that they're arguing that it's not generally 100% safe (though I had thought that 4% was considered safe—but here the authors are arguing that a 75/25 stock/bond mix has a 30-year failure rate of 7.6%? Am I reading Table 1 correctly?) But how does one do better?

Is the argument that one can do better than the 4% rule by investing in derivatives instead of a stock/bond mix? Should an ordinary investor look into derivatives as an investment option?

I'm still pretty new to the world of investing and I'm attempting to be smart about it. The Bogleheads wiki has been a HUGE help.

Johm221122
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Re: Better than 4% Rule

Post by Johm221122 » Sat Oct 21, 2017 4:37 am

Knighted wrote:
Fri Oct 20, 2017 11:31 am
So, I just read this paper:


Is the argument that one can do better than the 4% rule by investing in derivatives instead of a stock/bond mix? Should an ordinary investor look into derivatives as an investment option?

I'm still pretty new to the world of investing and I'm attempting to be smart about it. The Bogleheads wiki has been a HUGE help.
Welcome to forum
Do you want to be investing in derivatives in your 70 and 80's?can you guarantee you will be mentally up to this?

AlohaJoe
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Re: Better than 4% Rule

Post by AlohaJoe » Sat Oct 21, 2017 5:13 am

Knighted wrote:
Fri Oct 20, 2017 11:31 am
Is the argument that one can do better than the 4% rule by investing in derivatives instead of a stock/bond mix? Should an ordinary investor look into derivatives as an investment option?
That seems a perverse conclusion to reach when derivatives weren't mentioned a single time in the article you read.

The argument is that withdrawing the same inflation-adjusted amount every year regardless of what markets do is dumb, so don't do that.
Once the cost of guaranteeing a specific amount to be spent in bad markets is fully understood, many retirees are likely to choose to spend less in such scenarios in order to be able to spend more in scenarios in which markets perform better.
There are many alternatives to using a constant inflation-adjusted withdrawal amount -- but most of them are variations on "spend a percentage of your portfolio". That is....something like:

"Spend 5% of your portfolio every year." If your portfolio is $1,000,000 then you get to spend $50,000. If your portfolio crashes to $500,000 then you only get to spend $25,000.

This article by Luke Delorme is a non-comprehensive overview of some of the options available: https://www.onefpa.org/journal/Pages/SE ... nding.aspx

cjking
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Re: Better than 4% Rule

Post by cjking » Sat Oct 21, 2017 6:25 am

AlohaJoe wrote:
Sat Oct 21, 2017 5:13 am
That seems a perverse conclusion to reach when derivatives weren't mentioned a single time in the article you read.
Use of call options was mentioned. I don't think actual derivatives can be used, as unless something has change since I last looked at options, 15 years ago, I don't think long-term call options are available. (If they are available I'll guess that they won't be cost-effective.)

I think they were suggesting that you could buy call options at one strike and sell them at a higher strike. The payouts you made when the higher strike ones expired in the money would eliminate excess profits (that you don't need) on the lower strike ones. The premiums from selling the higher strike ones would enable you to buy more lower strike ones. If actual returns caused the lower strike options not to pay out at all, those would be the scenarios where you got no income. (Years with no income occur occur with both the naive 4% approach and the options approach.)

I guess lowering the lower strike is an alternative use of the premiums that come from giving away the possibility of surpluses. i.e. instead of spending the premiums on raising your income, you can spend them on reducing your risk of no income in scenarios where investment returns are very poor.

I think the question now, is how do you implement this without actually buying/selling options. They do say that is possible using a dynamic strategy, I think that means a variable asset allocation. I have some vague ideas, but need to think about it a bit more.

cjking
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Re: Better than 4% Rule

Post by cjking » Sat Oct 21, 2017 6:41 am

OK, this is just an idea based on one minute's thought. Say you have $1 million you want to take 30 years income from and have no bequest motive, so money left at the end is of no use to you. You would like exactly 40K income. (You would take that even if the market is down 50% the year after you retire, which is crazy, but you have to to keep up with your friend who's following the 4% rule. :? ) You start off with the same asset allocation as your friend, but if at any point in your retirement you balance grows to a point that 40K per year can be funded by TIPS, at that point you sell your portfolio and convert to the safe asset. You give up all possibility of excess return and eliminate all possibility of income falling below your target.

Knighted
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Re: Better than 4% Rule

Post by Knighted » Sat Oct 21, 2017 8:38 am

cjking wrote:
Sat Oct 21, 2017 6:25 am
AlohaJoe wrote:
Sat Oct 21, 2017 5:13 am
That seems a perverse conclusion to reach when derivatives weren't mentioned a single time in the article you read.
Use of call options was mentioned. I don't think actual derivatives can be used, as unless something has change since I last looked at options, 15 years ago, I don't think long-term call options are available. (If they are available I'll guess that they won't be cost-effective.)

I think they were suggesting that you could buy call options at one strike and sell them at a higher strike. The payouts you made when the higher strike ones expired in the money would eliminate excess profits (that you don't need) on the lower strike ones. The premiums from selling the higher strike ones would enable you to buy more lower strike ones. If actual returns caused the lower strike options not to pay out at all, those would be the scenarios where you got no income. (Years with no income occur occur with both the naive 4% approach and the options approach.)

I guess lowering the lower strike is an alternative use of the premiums that come from giving away the possibility of surpluses. i.e. instead of spending the premiums on raising your income, you can spend them on reducing your risk of no income in scenarios where investment returns are very poor.

I think the question now, is how do you implement this without actually buying/selling options. They do say that is possible using a dynamic strategy, I think that means a variable asset allocation. I have some vague ideas, but need to think about it a bit more.
Thank you. This is helpful. So, basically, trying to follow their advice on how to improve on the 4% rule would basically be exceedingly difficult for the average investor?

Lately I've been looking at ways one might lower risk when one hits retirement age (I've personally got a bit of time yet), which got me interested in the article. I'm currently stewing on whether or not a SPIA or DIA might be worthwhile for the risk-averse, or might be useful as part of a larger retirement strategy. I know annuities often provide a poor return on investment, but I wonder if they might have a place. Is it always better to just invest in bonds or TIPS?

Johm221122
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Re: Better than 4% Rule

Post by Johm221122 » Sat Oct 21, 2017 8:52 am

SPIA and deferred annuity can be useful
SPIA is just recently mentioned here
viewtopic.php?f=1&t=230298&p=3581917#p3581917

Use search feature(top right),plenty of posts on this

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David Jay
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Re: Better than 4% Rule

Post by David Jay » Sat Oct 21, 2017 9:17 am

Knighted:

Since you say you have some time left, the 4% study (equivalent to 25x expenses in LMP) is a good rule of thumb (I would only treat 4% as a rule-of-thumb because it is not truly 100% for all historic retirement periods) and a very useful way to evaluate if you have enough to retire. Also remember that the 4% study was for a 30 year retirement.

For actual withdrawal planning, most here at BH would say that some level of flexibility is required, especially in the early retirement years, in the event of a major drop in portfolio value. This covers the sequence-of-returns risk.
Last edited by David Jay on Sat Oct 21, 2017 9:23 am, edited 1 time in total.
Prediction is very difficult, especially about the future - Niels Bohr | To get the "risk premium", you really do have to take the risk - nisiprius

AlohaJoe
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Re: Better than 4% Rule

Post by AlohaJoe » Sat Oct 21, 2017 9:19 am

Knighted wrote:
Sat Oct 21, 2017 8:38 am
Thank you. This is helpful. So, basically, trying to follow their advice on how to improve on the 4% rule would basically be exceedingly difficult for the average investor?
They said you can improve on the 4% rule by using dynamic withdrawals. That is something that is easy for the average investor to do.

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David Jay
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Re: Better than 4% Rule

Post by David Jay » Sat Oct 21, 2017 9:26 am

AlohaJoe wrote:
Sat Oct 21, 2017 9:19 am
Knighted wrote:
Sat Oct 21, 2017 8:38 am
Thank you. This is helpful. So, basically, trying to follow their advice on how to improve on the 4% rule would basically be exceedingly difficult for the average investor?
They said you can improve on the 4% rule by using dynamic withdrawals. That is something that is easy for the average investor to do.
Exactly. I am looking at "5% of remaining portfolio". That's not hard to implement...
Prediction is very difficult, especially about the future - Niels Bohr | To get the "risk premium", you really do have to take the risk - nisiprius

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Re: Better than 4% Rule

Post by goodenyou » Sat Oct 21, 2017 9:38 am

I would imagine that 4% is a ceiling and not a floor. While I am planning on 4% as a goal, my strategy is truly a modulated withdrawal rate. I wonder if anyone has looked at behavior during a sequence of bad returns. I would bet that most find a way to reduce their withdrawal rate. That’s why it is imperative to have as little fixed expenses in retirement as possible. That is my plan.
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Dottie57
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Re: Better than 4% Rule

Post by Dottie57 » Sat Oct 21, 2017 9:40 am

Take a look at a post on Variable Percent withdrawl

viewtopic.php?t=120430


(Sorry for naked link which is now clothed)
Last edited by Dottie57 on Sat Oct 21, 2017 12:39 pm, edited 1 time in total.

michaeljc70
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Re: Better than 4% Rule

Post by michaeljc70 » Sat Oct 21, 2017 9:46 am

I can live with a 7.6% failure rate. Keep in mind, failure means you cannot get out that (original adjusted) 4%. If there is a market tank, I feel I could easily adjust downward a small percentage if needed. In other words, if you calculated $75k and there were a few bad years in the market, you might be able to get back on track by drawing only $65k for a few years. It's not that in 7.6% of the possibilities you'll be broke and eating cat food.

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Re: Better than 4% Rule

Post by pkcrafter » Sat Oct 21, 2017 10:30 am

Knighted, have you looked at any other withdrawal studies? Dottie provided a link to VPR, and here's a link to some Wiki information.

https://www.bogleheads.org/wiki/Safe_withdrawal_rates

Paul
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Hyperborea
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Re: Better than 4% Rule

Post by Hyperborea » Sat Oct 21, 2017 10:52 am

michaeljc70 wrote:
Sat Oct 21, 2017 9:46 am
I can live with a 7.6% failure rate. Keep in mind, failure means you cannot get out that (original adjusted) 4%. If there is a market tank, I feel I could easily adjust downward a small percentage if needed. In other words, if you calculated $75k and there were a few bad years in the market, you might be able to get back on track by drawing only $65k for a few years. It's not that in 7.6% of the possibilities you'll be broke and eating cat food.
No, in all these studies failure almost always means that your portfolio drops to ZERO before the end of the retirement period. If you fail then you have nothing left. Also, in general success can mean going to ZERO the day after the retirement period. If you live a couple of years longer than the 30 you planned you may be out of luck.

I really recommend reading the recent really great series on retirement withdrawals at Early Retirement Now. He goes into a number of issues over 20 parts and counting. Very well done.

One other options for those thinking about variable withdrawals is perhaps a mixed system of part fixed and part variable. If you set the fixed amount to be at least equal to your base living costs and the variable handles everything else. The variable part is a percentage of the gains in the portfolio above the fixed withdrawal and an inflation adjustment to the portfolio. This was proposed and modelled by Peter Ponzo (often known as gummy) about 15-20 years ago. He called it sensible withdrawals. Unfortunately, his site is long gone but there are still some archives of it out there. He writes these in a fun way too. It's much like his applied math classes were when I was his student 30 or so years ago.

michaeljc70
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Re: Better than 4% Rule

Post by michaeljc70 » Sat Oct 21, 2017 10:58 am

Hyperborea wrote:
Sat Oct 21, 2017 10:52 am
michaeljc70 wrote:
Sat Oct 21, 2017 9:46 am
I can live with a 7.6% failure rate. Keep in mind, failure means you cannot get out that (original adjusted) 4%. If there is a market tank, I feel I could easily adjust downward a small percentage if needed. In other words, if you calculated $75k and there were a few bad years in the market, you might be able to get back on track by drawing only $65k for a few years. It's not that in 7.6% of the possibilities you'll be broke and eating cat food.
No, in all these studies failure almost always means that your portfolio drops to ZERO before the end of the retirement period. If you fail then you have nothing left. Also, in general success can mean going to ZERO the day after the retirement period. If you live a couple of years longer than the 30 you planned you may be out of luck.

I really recommend reading the recent really great series on retirement withdrawals at Early Retirement Now. He goes into a number of issues over 20 parts and counting. Very well done.

One other options for those thinking about variable withdrawals is perhaps a mixed system of part fixed and part variable. If you set the fixed amount to be at least equal to your base living costs and the variable handles everything else. The variable part is a percentage of the gains in the portfolio above the fixed withdrawal and an inflation adjustment to the portfolio. This was proposed and modelled by Peter Ponzo (often known as gummy) about 15-20 years ago. He called it sensible withdrawals. Unfortunately, his site is long gone but there are still some archives of it out there. He writes these in a fun way too. It's much like his applied math classes were when I was his student 30 or so years ago.
It may drop to zero because you made no adjustments to your withdrawal amount....and obviously if it is zero you cannot get out your planned withdrawal amount.

If you use a tool like the popular Flexible Retirement Planner it can account for reducing the withdrawal rate.

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Hyperborea
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Re: Better than 4% Rule

Post by Hyperborea » Sat Oct 21, 2017 11:22 am

michaeljc70 wrote:
Sat Oct 21, 2017 10:58 am
Hyperborea wrote:
Sat Oct 21, 2017 10:52 am
michaeljc70 wrote:
Sat Oct 21, 2017 9:46 am
I can live with a 7.6% failure rate. Keep in mind, failure means you cannot get out that (original adjusted) 4%. If there is a market tank, I feel I could easily adjust downward a small percentage if needed. In other words, if you calculated $75k and there were a few bad years in the market, you might be able to get back on track by drawing only $65k for a few years. It's not that in 7.6% of the possibilities you'll be broke and eating cat food.
No, in all these studies failure almost always means that your portfolio drops to ZERO before the end of the retirement period. If you fail then you have nothing left. Also, in general success can mean going to ZERO the day after the retirement period. If you live a couple of years longer than the 30 you planned you may be out of luck.

I really recommend reading the recent really great series on retirement withdrawals at Early Retirement Now. He goes into a number of issues over 20 parts and counting. Very well done.

One other options for those thinking about variable withdrawals is perhaps a mixed system of part fixed and part variable. If you set the fixed amount to be at least equal to your base living costs and the variable handles everything else. The variable part is a percentage of the gains in the portfolio above the fixed withdrawal and an inflation adjustment to the portfolio. This was proposed and modelled by Peter Ponzo (often known as gummy) about 15-20 years ago. He called it sensible withdrawals. Unfortunately, his site is long gone but there are still some archives of it out there. He writes these in a fun way too. It's much like his applied math classes were when I was his student 30 or so years ago.
It may drop to zero because you made no adjustments to your withdrawal amount....and obviously if it is zero you cannot get out your planned withdrawal amount.

If you use a tool like the popular Flexible Retirement Planner it can account for reducing the withdrawal rate.
The question is how long can you reduce your withdrawal? How long do you want to? If the portfolio is down for a long time period (great depression, 70's stagflation) how long do you keep withdrawing at a reduced rate? What if that's a decade or more?

The first part of this blog post has a nice discussion of the issues - https://earlyretirementnow.com/2017/08/ ... sed-Rules/

Knighted
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Re: Better than 4% Rule

Post by Knighted » Sat Oct 21, 2017 11:40 am

pkcrafter wrote:
Sat Oct 21, 2017 10:30 am
Knighted, have you looked at any other withdrawal studies? Dottie provided a link to VPR, and here's a link to some Wiki information.

https://www.bogleheads.org/wiki/Safe_withdrawal_rates
Yes, read that page and several of the studies (actually that's what got me posting here in the first place).

I actually think I'm going to use a VPW strategy, but modified in case:
a) I (or my wife) lives a very long time (my life expectancy is to mid-80's, but one never knows), or
b) Things go very poorly in the market

That's why I'm looking into stuff like SPIA, etc. I'd like to make sure we can cover our base expenses no matter what.

michaeljc70
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Re: Better than 4% Rule

Post by michaeljc70 » Sat Oct 21, 2017 11:47 am

Hyperborea wrote:
Sat Oct 21, 2017 11:22 am
michaeljc70 wrote:
Sat Oct 21, 2017 10:58 am
Hyperborea wrote:
Sat Oct 21, 2017 10:52 am
michaeljc70 wrote:
Sat Oct 21, 2017 9:46 am
I can live with a 7.6% failure rate. Keep in mind, failure means you cannot get out that (original adjusted) 4%. If there is a market tank, I feel I could easily adjust downward a small percentage if needed. In other words, if you calculated $75k and there were a few bad years in the market, you might be able to get back on track by drawing only $65k for a few years. It's not that in 7.6% of the possibilities you'll be broke and eating cat food.
No, in all these studies failure almost always means that your portfolio drops to ZERO before the end of the retirement period. If you fail then you have nothing left. Also, in general success can mean going to ZERO the day after the retirement period. If you live a couple of years longer than the 30 you planned you may be out of luck.

I really recommend reading the recent really great series on retirement withdrawals at Early Retirement Now. He goes into a number of issues over 20 parts and counting. Very well done.

One other options for those thinking about variable withdrawals is perhaps a mixed system of part fixed and part variable. If you set the fixed amount to be at least equal to your base living costs and the variable handles everything else. The variable part is a percentage of the gains in the portfolio above the fixed withdrawal and an inflation adjustment to the portfolio. This was proposed and modelled by Peter Ponzo (often known as gummy) about 15-20 years ago. He called it sensible withdrawals. Unfortunately, his site is long gone but there are still some archives of it out there. He writes these in a fun way too. It's much like his applied math classes were when I was his student 30 or so years ago.
It may drop to zero because you made no adjustments to your withdrawal amount....and obviously if it is zero you cannot get out your planned withdrawal amount.

If you use a tool like the popular Flexible Retirement Planner it can account for reducing the withdrawal rate.
The question is how long can you reduce your withdrawal? How long do you want to? If the portfolio is down for a long time period (great depression, 70's stagflation) how long do you keep withdrawing at a reduced rate? What if that's a decade or more?

The first part of this blog post has a nice discussion of the issues - https://earlyretirementnow.com/2017/08/ ... sed-Rules/
I agree, you cannot always reduce it enough to compensate. However, if you invest in equities moderately to heavily there is no 100% guarantee. What if we have a depression or financial crisis unlike any we've ever had before? Depending on what happens, even if all/mostly in bonds things can occur that have never happened in the past.

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Re: Better than 4% Rule

Post by pkcrafter » Sat Oct 21, 2017 1:20 pm

Knighted, I guess I'll have to admit Sharpe's study bothers me a bit. He seems to be penalizing a strategy that produces more than enough income--excess he calls waste and inefficient. I don't agree. Seems like excess at times can cover shortfalls at other times. He also shows that 0 volatility won't cover withdrawals. That would be a portfolio of cash. No, that won't work. Also, according to Sharpe, 100% equity isn't optimal either, but Phau and Kitces have done testing that shows high equity allocations, even 100%, are better than lower equity allocations in retirement. My approach is the Goldilocks approach--never too much or two little and stop worrying about it.

Paul
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Re: Better than 4% Rule

Post by cjking » Mon Oct 23, 2017 11:46 am

This is just a summary of how far I got with the options approach, before deciding I was probably wasting my time and working out what I think is a better way to meet the objective. I'll post the latter later.

Looking at the graph which showed no income for years when annualised returns were low rising almost immediately to desired returns in all years where returns were higher, I concluded that if there were someone to buy the options from, we would implement the strategy as follows:-

1. Conceptually have 30 separate "funds" each producing income for one of the 30 retirement years
2. Each fund would have two sets of call options, one bought at a lower strike and one sold at a higher strike
3. The lower strike should be initial_asset_price * (100% + risk_free_interest_rate)^year. (So if initial asset price were 100 and risk_free_rate were 0.5%, year 30's lower strike would be 100 * 100.5%^30. For simplicity I'm assuming asset price measures total return. And that perfectly customised options are possible. Note also that 0.5% as the risk-free rate is a replacement for 2% in the paper. Times have changed.)
4. Given that we are aiming to get income of 4% of initial balance for 30 years, it follows that we are (loosely speaking) counting on a return of RATE(30,4%,-1,0,0) = 1.2%, where RATE is the Excel function. I will call this implicit parameter required_return. Required_return should be significantly less than expected return, that makes it much more likely that we will hit our target income.
5. The strike for the higher-strike calls we are selling will be initial_asset_price * (100% + required_return)^year, so for year 30 it would be 100*101.2%^30.
6. I assume 1 option contract returns 1 dollar for each dollar the asset price is above the strike at expiry
7. The number of contracts required to produce a 40K income if our required_return is achieved is 40,000/(higher_strike-lower_strike.)
8. For each year, we sell the exact same number of higher-strike contracts as we buy lower-strike ones.
9. Any payouts we may have to make on the higher_strike contracts will be funded exactly by excess profits on the lower-strike ones, so the effect of the higher_strike call is to limit our return for the year to 40K.
10. The premium from selling the higher_strike calls is used to part-fund the purchase of the lower_strike ones.

Having defined the above options portfolio in Excel and calculated some theoretical option prices, based on the same risk-free rate of 0.5% for all durations, and a volatility of 15%, I get that the options portfolio should cost 401K. (A 15% volatility is what I assume for an all-equity portfolio, it's only a very rough working figure.)

Thinking about how this is going to work, it seems fairly obvious that later years are pretty much guaranteed to yield 40K income, whereas the early years have a high chance of yielding no income. For example, if the asset were the S&P500, I think there's something like a 30% historical likelihood of being down over a period of a year, in which scenario income would be zero at the end of year one. The paper claims the number of zero years should be unchanged, but the fact that they've been moved to the beginning of retirement from the end, where we might not have needed them as we might been dead, does seem to be a bit of a shortcoming.

It also doesn't really make sense to me to aim for no income in years where annualised return is less than the risk-free rate. Experimentally reducing all lower strikes by 99%, i.e to 1 * 100.5%^year, so that every year has some income, drives the cost of the options portfolio up to 822K. Which seems a more plausible cost for supporting a 40K a year income target.

Ignoring all those reservations, and setting the lower-strike back to the original value, I started pondering how we would simulate the overall combined options portfolio using the underlying asset and a risk-free asset. I calculated that a 1% move in the value of the asset would result in a $4,474 change in the value of the 401K options portfolio, therefore we would initially need a 447K investment in the underlying asset to delta-hedge the portfolio.

I vaguely understand that delta-hedging means our exposure to the underlying asset should be varied according to changes in the value of the notional options portfolio, but haven't really explored this.

It was at this point I got disillusioned and decided there must be a simpler answer to the original requirement.

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Re: Better than 4% Rule

Post by cjking » Mon Oct 23, 2017 12:44 pm

I see the requirement as being to fully utilise a given $1 million portfolio to as far as possible produce exactly 40K a year for 30 years, with nothing left at the end. This is my proposal.

1. Calculate required_return, as described in my post above, as RATE(30,4%,-1,0,0) = 1.2%.
2. At the end of year n, calculate income to be taken as "=MIN(40000,PMT(required_return,payments_left,-balance,0,1))". For example, at the end of year 1 (beginning of year 2) if our balance were now 945,432, our first income payment would be =MIN(40000,PMT(1.2191%,30,-945432,0,1)) = 37,362.
3. After deducting income each year, immediately consider whether remaining balance is sufficient to fund 40K a year income for the remaining years, using safe assets. If the risk-free rate is 0.5%, for the example above that calculation would be =PMT(risk_free_rate,payments_left,-balance,0,0) =PMT(0.5%,29,-(945432-37362),0,0)=33,716, so the answer would be no. If the answer were yes, we would sell our portfolio, invest in the risk-free asset, and be guaranteed 40K a year income for the rest of retirement.

Although it's not necessary in order to implement it, for the above strategy it is possible to calculate the amount of initial capital being devoted to produce each years income. The calculation for year n is that 40000/(100%+required_return)^year supports that year's returns . So for year 1 it is 39,518, and for year 30 it is 27,809, to give a couple of examples.

I haven't got my head around the meaning of this, I certainly didn't plan or expect it, but I notice that initial balances for each year are to the dollar identical to what would have been spent on buying the lower strike options in my previous post, if we had for all years set the lower strike as close as possible to zero. (In other words, the lower strike options would have cost 1 million, and we would have got back 175K from selling higher price options, resulting in a net options portfolio price of 825K.)

If we continue to imagine our portfolio as 30 sub-portfolios supporting each year, in this strategy we do not place a cap on the balance each sub-portfolio can reach. If there is a surplus, it is in effect donated to subsequent years. (It would be valid, if more complicated, to say each sub-portfolio should switch to safe assets when it's target of a 40K income had been achieved. But I'm not sure that would be an improvement on making the switch only when all sub-portfolios can satisfy their goals.) (Perhaps it would, in the sense that we are more likely to be dead in the later years, so it might be better to reduce shortfall risk for the early years by switching the sub-portfolio to safe assets as soon as possible, than to leave the balance at risk in the hope of generating a surplus that will reduce shortfall risk for later years.)
Last edited by cjking on Mon Oct 23, 2017 12:59 pm, edited 3 times in total.

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Re: Better than 4% Rule

Post by mickeyd » Mon Oct 23, 2017 12:54 pm

The so-called "4% rule" is not a rule, but a concept to begin with in case you have no clue where to start when you finally get around to addressing the idea of retirement income for yourself. Used as a guide, it's better than nothing (like the % in bonds concept) when beginning your search. I doubt that anyone here actually uses the "4% rule" to spend. We just spend as needed and hope it all works out In the end.
Part-Owner of Texas | | “The CMH-the Cost Matters Hypothesis -is all that is needed to explain why indexing must and will work… Yes, it is that simple.” John C. Bogle

Houe
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Re: Better than 4% Rule

Post by Houe » Mon Oct 23, 2017 1:07 pm

I think Dave Ramsey recommends and 8% withdraw rate.

Knighted
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Re: Better than 4% Rule

Post by Knighted » Mon Oct 23, 2017 1:16 pm

Thanks for doing that, CJKing,

It sounds like it really doesn't make sense to use the method Sharpe et al are espousing. I think they argue that it should be cheaper than $1 million to use their method to get 4%, but I suppose that's neither here nor there.

I'm thinking it may make a lot of sense to go for an SPIA at around age 75-80, so I'd really only need to make sure funds could last until then (and that there'd be enough leftover for the annuity). I suppose one could balance this against other low-risk investment options for maximum effect.

onthecusp
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Re: Better than 4% Rule

Post by onthecusp » Mon Oct 23, 2017 1:26 pm

I think the 4% rule is a great planning tool but actual spending should be modified in retirement.

How to modify?
Flexible withdrawal rules along with flexibility in discretionary spending and ability / willingness to work part time are the two levers I plan to pull.

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HomerJ
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Re: Better than 4% Rule

Post by HomerJ » Mon Oct 23, 2017 1:31 pm

Knighted wrote:
Fri Oct 20, 2017 11:31 am
Should an ordinary investor look into derivatives as an investment option?
No.

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HomerJ
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Re: Better than 4% Rule

Post by HomerJ » Mon Oct 23, 2017 1:40 pm

Hyperborea wrote:
Sat Oct 21, 2017 10:52 am
michaeljc70 wrote:
Sat Oct 21, 2017 9:46 am
I can live with a 7.6% failure rate. Keep in mind, failure means you cannot get out that (original adjusted) 4%. If there is a market tank, I feel I could easily adjust downward a small percentage if needed. In other words, if you calculated $75k and there were a few bad years in the market, you might be able to get back on track by drawing only $65k for a few years. It's not that in 7.6% of the possibilities you'll be broke and eating cat food.
No, in all these studies failure almost always means that your portfolio drops to ZERO before the end of the retirement period. If you fail then you have nothing left. Also, in general success can mean going to ZERO the day after the retirement period. If you live a couple of years longer than the 30 you planned you may be out of luck.
Those studies assume one spends the full amount no matter what is actually happening in the real world.

In the Boglehead world, "failure" means 5-10 years in you might start taking 2 vacations a year instead of 4. That's your big failure scenario.

Note I am assuming discretionary spending in the budget. If 4% represents bare-bones survival, it is indeed dangerous. But for most us here, we can cut back a little if the market drops 50%. I plan to be 40/60 stocks/bonds at that point anyway, so we're only talking a 20% portfolio drop. Maybe wait another couple of years to buy that new car, or replace that Europe trip with a domestic one, or go out to eat twice a week instead of four times a week.

No one here is going to end up eating cat-food under a bridge if 4% "fails". Absolute worst case, you buy a SPIA 15 years in with what's left of your money, and get a pretty good rate since you'll be in your 70s by then.

So the chance of your investments failing is small, and the impact if it does is small. And no one even mentioned the fact that you have a pretty good chance of not even living another 30 years. Which isn't a positive thing, but it certainly reduces your chances of outliving your money.
One other options for those thinking about variable withdrawals is perhaps a mixed system of part fixed and part variable. If you set the fixed amount to be at least equal to your base living costs and the variable handles everything else.
That seems like a good idea.
Last edited by HomerJ on Mon Oct 23, 2017 1:42 pm, edited 1 time in total.

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HomerJ
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Re: Better than 4% Rule

Post by HomerJ » Mon Oct 23, 2017 1:41 pm

onthecusp wrote:
Mon Oct 23, 2017 1:26 pm
I think the 4% rule is a great planning tool but actual spending should be modified in retirement.

How to modify?
Flexible withdrawal rules along with flexibility in discretionary spending and ability / willingness to work part time are the two levers I plan to pull.
This. 4% is just a guideline.

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Re: Better than 4% Rule

Post by randomguy » Mon Oct 23, 2017 2:32 pm

AlohaJoe wrote:
Sat Oct 21, 2017 9:19 am
Knighted wrote:
Sat Oct 21, 2017 8:38 am
Thank you. This is helpful. So, basically, trying to follow their advice on how to improve on the 4% rule would basically be exceedingly difficult for the average investor?
They said you can improve on the 4% rule by using dynamic withdrawals. That is something that is easy for the average investor to do.
You need to define improve.:) There is no scheme that can maximize payouts, leave a large bequest of heirs, have zero chance of running out of money, and have low variance in real payouts for just a couple qualities you would like in a distribution rule. Depending on your preferences/needs different schemes work better. Compare a VPW to the 4% rule. With a VPW, you start with higher payouts and will never run out of money. But you run the risk of having 25%+ less money for 10 years early on in your retirement. is that better than getting a steady check for ~25 years and then running out of money at 90? Well partly it depends on if you live to 90.:) Or in real life you would live it up from 65-80 and then make more drastic cuts after 80 (something most retirees do anyway). You need to decide how bad of bad you can deal with and how important is that the good can be better.

I am a bit suspect that you are going to do much better with call options. For that to work out we would either need a guaranteed ~2% real return (after costs) or some negative correlations with markets (i.e. you would have to have had plus real returns during the 1966-1980 time frame). I doubt either of those holds true. If you could be making 2% real risk free, nobody would be buying tips.

It should be noted that most studies don't use tips. I have seen studies that suggest if TIPS would have been available to the 1966 retiree, that SWR would be close to 5% instead of 4%. But those are using synthetic products that never existed. But common sense says making say .5-1% real (about what you are looking at today) instead of losing 1-2% real (that 1966 investor), is definitely going to change things up a bit. Being able to protect against on of the big risk factors (inflation and poor market returns/sequence of returns are the big factors) is a plus.

The more flexibility (cutting spending) and resources (i.e. some people talk about using a home equity loan in bad years) you have, the more risks you can take on in attempts to have more money. You just need to be able to deal with the downsides if things don't work out.

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Re: Better than 4% Rule

Post by michaeljc70 » Mon Oct 23, 2017 3:04 pm

Houe wrote:
Mon Oct 23, 2017 1:07 pm
I think Dave Ramsey recommends and 8% withdraw rate.
True. I think he also recommends 100% in stocks.

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Re: Better than 4% Rule

Post by randomguy » Mon Oct 23, 2017 3:50 pm

michaeljc70 wrote:
Mon Oct 23, 2017 3:04 pm
Houe wrote:
Mon Oct 23, 2017 1:07 pm
I think Dave Ramsey recommends and 8% withdraw rate.
True. I think he also recommends 100% in stocks.
To be fair to Dave Ramsey (and definitely Peter Lynch), I don't think he is talking about an 8% SWR they way we are. The couple times I have seen it heis taking out 8%/year out of an account and on average the account will grow fast enough so it doesn't get depleted. I would say that is like 1980s thinking:) and very simplistic with respect to things like sequence of returns problems but it isn't as quite as bad as people make out.

I still want to know why he is selling stuff though when he is making 12% in the market every year:)

michaeljc70
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Re: Better than 4% Rule

Post by michaeljc70 » Tue Oct 24, 2017 9:38 am

randomguy wrote:
Mon Oct 23, 2017 3:50 pm
michaeljc70 wrote:
Mon Oct 23, 2017 3:04 pm
Houe wrote:
Mon Oct 23, 2017 1:07 pm
I think Dave Ramsey recommends and 8% withdraw rate.
True. I think he also recommends 100% in stocks.
To be fair to Dave Ramsey (and definitely Peter Lynch), I don't think he is talking about an 8% SWR they way we are. The couple times I have seen it heis taking out 8%/year out of an account and on average the account will grow fast enough so it doesn't get depleted. I would say that is like 1980s thinking:) and very simplistic with respect to things like sequence of returns problems but it isn't as quite as bad as people make out.

I still want to know why he is selling stuff though when he is making 12% in the market every year:)
I wonder what the failure rate would be if you ran a Monte Carlo on his 8% withdrawal rate. The other thing is, since it is 100% in stocks, if the market tanks 30% you are getting 30% less to spend until it recovers. That is quite a bit of an adjustment. I figure if something bad happens in retirement I can withdraw less, but I was thinking like 10% less.

onthecusp
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Re: Better than 4% Rule

Post by onthecusp » Tue Oct 24, 2017 10:18 am

michaeljc70 wrote:
Tue Oct 24, 2017 9:38 am

I wonder what the failure rate would be if you ran a Monte Carlo on his 8% withdrawal rate. The other thing is, since it is 100% in stocks, if the market tanks 30% you are getting 30% less to spend until it recovers. That is quite a bit of an adjustment. I figure if something bad happens in retirement I can withdraw less, but I was thinking like 10% less.
When using Firecalc and choosing a portfolio with random performance I believe it is doing some sort of Monte Carlo analysis as opposed to the default historical sequences of returns. Using the random performance option gives widely different results every time it is run so I am reporting the average of a very few runs.

Anyway using firecalc I got, a 30 year failure rate of about:
Random (Monte Carlo?) 75% for an 8% vs. 8% for 4% withdrawal
Historical (Default Option) 79% for an 8% vs. 5% for a 4% withdrawal

So a greater spread between the two numbers when using historical data but maybe not so significant if I had averaged more runs.

michaeljc70
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Re: Better than 4% Rule

Post by michaeljc70 » Tue Oct 24, 2017 10:23 am

onthecusp wrote:
Tue Oct 24, 2017 10:18 am
michaeljc70 wrote:
Tue Oct 24, 2017 9:38 am

I wonder what the failure rate would be if you ran a Monte Carlo on his 8% withdrawal rate. The other thing is, since it is 100% in stocks, if the market tanks 30% you are getting 30% less to spend until it recovers. That is quite a bit of an adjustment. I figure if something bad happens in retirement I can withdraw less, but I was thinking like 10% less.
When using Firecalc and choosing a portfolio with random performance I believe it is doing some sort of Monte Carlo analysis as opposed to the default historical sequences of returns. Using the random performance option gives widely different results every time it is run so I am reporting the average of a very few runs.

Anyway using firecalc I got, a 30 year failure rate of about:
Random (Monte Carlo?) 75% for an 8% vs. 8% for 4% withdrawal
Historical (Default Option) 79% for an 8% vs. 5% for a 4% withdrawal

So a greater spread between the two numbers when using historical data but maybe not so significant if I had averaged more runs.
Thanks for running that. Wow. It is way higher than I thought it would be. I was guessing a 30%-40% failure rate. Is that 100% in stocks?

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Re: Better than 4% Rule

Post by Sandi_k » Tue Oct 24, 2017 1:38 pm

Houe wrote:
Mon Oct 23, 2017 1:07 pm
I think Dave Ramsey recommends and 8% withdraw rate.
DR is not correct, and his promoting that viewpoint is the most irresponsible thing he does. He's great for "get out of debt" guidance, and dangerously wrong in terms of retirement investing.

randomguy
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Re: Better than 4% Rule

Post by randomguy » Tue Oct 24, 2017 4:01 pm

michaeljc70 wrote:
Tue Oct 24, 2017 10:23 am
onthecusp wrote:
Tue Oct 24, 2017 10:18 am
michaeljc70 wrote:
Tue Oct 24, 2017 9:38 am

I wonder what the failure rate would be if you ran a Monte Carlo on his 8% withdrawal rate. The other thing is, since it is 100% in stocks, if the market tanks 30% you are getting 30% less to spend until it recovers. That is quite a bit of an adjustment. I figure if something bad happens in retirement I can withdraw less, but I was thinking like 10% less.
When using Firecalc and choosing a portfolio with random performance I believe it is doing some sort of Monte Carlo analysis as opposed to the default historical sequences of returns. Using the random performance option gives widely different results every time it is run so I am reporting the average of a very few runs.

Anyway using firecalc I got, a 30 year failure rate of about:
Random (Monte Carlo?) 75% for an 8% vs. 8% for 4% withdrawal
Historical (Default Option) 79% for an 8% vs. 5% for a 4% withdrawal

So a greater spread between the two numbers when using historical data but maybe not so significant if I had averaged more runs.
Thanks for running that. Wow. It is way higher than I thought it would be. I was guessing a 30%-40% failure rate. Is that 100% in stocks?
Nope it has a 100% success rate.:)

https://www.portfoliovisualizer.com/bac ... arket1=100

Again Dave isn't saying a 8% SWR is doable. It is saying 8% of the portfolio. This was how people in the 70s/80s though about the problem. On this board we are so used to the 4% rule frame work it is hard to remember it is a recent occurence.

In the end you will always be balancing income fluctuations and risk of running out of money. Dave (or VPW) will never run out of money. It might not meet your income needs. The 4% rule is the reverse. And there are numerous schemes that attempt to come to different balance points.

michaeljc70
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Re: Better than 4% Rule

Post by michaeljc70 » Tue Oct 24, 2017 4:07 pm

randomguy wrote:
Tue Oct 24, 2017 4:01 pm
michaeljc70 wrote:
Tue Oct 24, 2017 10:23 am
onthecusp wrote:
Tue Oct 24, 2017 10:18 am
michaeljc70 wrote:
Tue Oct 24, 2017 9:38 am

I wonder what the failure rate would be if you ran a Monte Carlo on his 8% withdrawal rate. The other thing is, since it is 100% in stocks, if the market tanks 30% you are getting 30% less to spend until it recovers. That is quite a bit of an adjustment. I figure if something bad happens in retirement I can withdraw less, but I was thinking like 10% less.
When using Firecalc and choosing a portfolio with random performance I believe it is doing some sort of Monte Carlo analysis as opposed to the default historical sequences of returns. Using the random performance option gives widely different results every time it is run so I am reporting the average of a very few runs.

Anyway using firecalc I got, a 30 year failure rate of about:
Random (Monte Carlo?) 75% for an 8% vs. 8% for 4% withdrawal
Historical (Default Option) 79% for an 8% vs. 5% for a 4% withdrawal

So a greater spread between the two numbers when using historical data but maybe not so significant if I had averaged more runs.
Thanks for running that. Wow. It is way higher than I thought it would be. I was guessing a 30%-40% failure rate. Is that 100% in stocks?
Nope it has a 100% success rate.:)

https://www.portfoliovisualizer.com/bac ... arket1=100

Again Dave isn't saying a 8% SWR is doable. It is saying 8% of the portfolio. This was how people in the 70s/80s though about the problem. On this board we are so used to the 4% rule frame work it is hard to remember it is a recent occurence.

In the end you will always be balancing income fluctuations and risk of running out of money. Dave (or VPW) will never run out of money. It might not meet your income needs. The 4% rule is the reverse. And there are numerous schemes that attempt to come to different balance points.
But what is a failure? I mean, you can get down to $1000 and be drawing $80! I mean, this could go on for 10 years where you are drawing pennies and I wouldn't call that a success. In my view, if you cannot meet at least your mandatory expenses for a year your plan has failed.

randomguy
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Re: Better than 4% Rule

Post by randomguy » Tue Oct 24, 2017 9:01 pm

michaeljc70 wrote:
Tue Oct 24, 2017 4:07 pm


But what is a failure? I mean, you can get down to $1000 and be drawing $80! I mean, this could go on for 10 years where you are drawing pennies and I wouldn't call that a success. In my view, if you cannot meet at least your mandatory expenses for a year your plan has failed.

Yes that is the question you have to ask about any variable withdrawal scheme. As I said there failure mode isn't running out of money. It is not giving you enough AND not giving it to you when you want it (you want to travel from 65-75 so you want money then not at 90+ when you in the home). The more flexibility with reducing expenses, the more aggressive you can be with starting with high rate and drop like a rock. If you have no flexibility to cut expenses 4% or so is about the best you can do.

onthecusp
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Re: Better than 4% Rule

Post by onthecusp » Tue Oct 24, 2017 10:20 pm

michaeljc70 wrote:
Tue Oct 24, 2017 10:23 am
onthecusp wrote:
Tue Oct 24, 2017 10:18 am
michaeljc70 wrote:
Tue Oct 24, 2017 9:38 am

I wonder what the failure rate would be if you ran a Monte Carlo on his 8% withdrawal rate. The other thing is, since it is 100% in stocks, if the market tanks 30% you are getting 30% less to spend until it recovers. That is quite a bit of an adjustment. I figure if something bad happens in retirement I can withdraw less, but I was thinking like 10% less.
When using Firecalc and choosing a portfolio with random performance I believe it is doing some sort of Monte Carlo analysis as opposed to the default historical sequences of returns. Using the random performance option gives widely different results every time it is run so I am reporting the average of a very few runs.

Anyway using firecalc I got, a 30 year failure rate of about:
Random (Monte Carlo?) 75% for an 8% vs. 8% for 4% withdrawal
Historical (Default Option) 79% for an 8% vs. 5% for a 4% withdrawal

So a greater spread between the two numbers when using historical data but maybe not so significant if I had averaged more runs.
Thanks for running that. Wow. It is way higher than I thought it would be. I was guessing a 30%-40% failure rate. Is that 100% in stocks?
Yes, I was surprised too, I also guessed 30%. The firecalc historical (default) option is 75% stocks. The random performance option, which I take to be a form of Monte Carlo analysis since it runs 222 simulations, is "A mean portfolio return of 10% and variability (standard deviation) of 10%. Assume an inflation rate of 3%." All three numbers in that are adjustable but I just went with the pre-populated numbers. I left the expense ratio at 0.18% too, believe that applies to any option you pick. I suppose if I put Ramsey's 12% and a lower std dev things would look better.

There is no option for a variable withdrawal in the form of a fixed percentage of the balance, so we are comparing simplistic apples with Ramsey's oranges. I say simplistic because I'm using firecalc in a way it was not really intended. I put nothing in for social security or other income, just retire now and a constant spend rate equal to 4 or 8% of the initial value.

michaeljc70
Posts: 1955
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Re: Better than 4% Rule

Post by michaeljc70 » Wed Oct 25, 2017 6:13 am

onthecusp wrote:
Tue Oct 24, 2017 10:20 pm
michaeljc70 wrote:
Tue Oct 24, 2017 10:23 am
onthecusp wrote:
Tue Oct 24, 2017 10:18 am
michaeljc70 wrote:
Tue Oct 24, 2017 9:38 am

I wonder what the failure rate would be if you ran a Monte Carlo on his 8% withdrawal rate. The other thing is, since it is 100% in stocks, if the market tanks 30% you are getting 30% less to spend until it recovers. That is quite a bit of an adjustment. I figure if something bad happens in retirement I can withdraw less, but I was thinking like 10% less.
When using Firecalc and choosing a portfolio with random performance I believe it is doing some sort of Monte Carlo analysis as opposed to the default historical sequences of returns. Using the random performance option gives widely different results every time it is run so I am reporting the average of a very few runs.

Anyway using firecalc I got, a 30 year failure rate of about:
Random (Monte Carlo?) 75% for an 8% vs. 8% for 4% withdrawal
Historical (Default Option) 79% for an 8% vs. 5% for a 4% withdrawal

So a greater spread between the two numbers when using historical data but maybe not so significant if I had averaged more runs.
Thanks for running that. Wow. It is way higher than I thought it would be. I was guessing a 30%-40% failure rate. Is that 100% in stocks?
Yes, I was surprised too, I also guessed 30%. The firecalc historical (default) option is 75% stocks. The random performance option, which I take to be a form of Monte Carlo analysis since it runs 222 simulations, is "A mean portfolio return of 10% and variability (standard deviation) of 10%. Assume an inflation rate of 3%." All three numbers in that are adjustable but I just went with the pre-populated numbers. I left the expense ratio at 0.18% too, believe that applies to any option you pick. I suppose if I put Ramsey's 12% and a lower std dev things would look better.

There is no option for a variable withdrawal in the form of a fixed percentage of the balance, so we are comparing simplistic apples with Ramsey's oranges. I say simplistic because I'm using firecalc in a way it was not really intended. I put nothing in for social security or other income, just retire now and a constant spend rate equal to 4 or 8% of the initial value.
I use Flexible Retirement Planner and didn't see an option to do this kind (% of total) of withdrawal. FRP does let you choose different spending models and put in a minimum % of your desired spending to consider it a success.

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