Understanding the 4% withdrawal assumptions...

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Rodc
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Post by Rodc » Thu Apr 17, 2008 8:28 am

Hi Bob, nice charts. If I could make a suggestion it would be to use the original style, but label the x-axis by replacing years by ranges, that is change 1926 to 1926-1955, 1927 to 1927-1956, etc. If you put the labels on a slant using format axis->alignment within the chart to set the slant at 45 degree it should look real nice.

Just a thought.
We live a world with knowledge of the future markets has less than one significant figure. And people will still and always demand answers to three significant digits.

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Post by retiredjg » Thu Apr 17, 2008 9:11 am

I guess that is what is called "full circle", huh?

My vote is for original chart with an explanatory sentence or RodC's suggestion. For example, I've just finished reading Ferri's All About Asset Allocation. Lots of charts. Without explanations (short), the charts would not have made sense. To me, anyway.

How about: "This chart indicates that an 8% withdrawal in the 30 year period starting in 19XX would have been safe. However, only a 4% withdrawal in the period starting in 19XX would have lasted the entire 30 years."

I love charts and yours are great. I do not think an unexplained chart is always understandable by people who are on the steep portion of the learning curve.

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The 4% Rule—At What Price?

Post by bobcat2 » Thu Apr 17, 2008 9:29 am

William Sharpe, Nobel Laureate and father of the CAPM model, has recently written a paper on the 4% SWR rule and its variants. Here are some of his conclusions regarding the 4% SWR rule.
The 4% rule and its variants finance a constant, non-volatile spending plan using a risky, volatile investment strategy....there appears to be no doubt that a better approach can be found than that offered by combinations of desired constant real spending and risky investment. Despite its ubiquity, it is time to replace the 4% rule with approaches better grounded in fundamental economic analysis.
Here's a link to the paper: http://www.stanford.edu/~wfsharpe/retecon/4percent.pdf

The following example illustrates some of the weaknesses of the 4% SWR rule.

Consider a 65 year old single male who is retiring this year. He has a financial portfolio worth $1.5 million. He wants to allocate $500,000 of the portfolio to a reserve fund for himself and a bequest to his favorite niece. He wants the remaining $1 million to fund his planned for 30 year retirement. He would like the income he receives from his portfolio to be a high inflation-adjusted constant amount over his planned 30 year retirement horizon.

Using a 50/50 portfolio and the 4% SWR rule he can receive $40,000/year in real income.

Now let’s consider an alternative strategy. He buys $400,000 in real life annuities. This gives him $24,800 in real income per year for life. With the remaining $600,000 he has a TIPS ladder of $30,000/year over the next 20 years. The TIPS have average real coupons of 2%. He can safely withdraw 4.4% from the TIP portfolio for the next 30 years. Therefore, in the first year he takes $26,400 out of the $30,000 in maturing 1 year TIPS and invests the remaining $3,600 plus all coupon interest in additional 20 year TIPS. These two investments together give him a guaranteed annual real income stream of $51,200/year for 30 years. This strategy provides a real income stream that’s 28.5% ($11,200/year) higher than the 4% SWR rule of $40,000/year.

Alternatively, you could have a guaranteed income stream of 40,000/year using this strategy and have a guaranteed real balance of $470,000 at the end of thirty years. Quite an improvement over the SWR that says you have a high probability of not running out of assets in 30 years, if you withdraw $40,000/year.

What’s important when planning for retirement is the asset allocation of the portfolio, not the application of an arbitrary rule to a risky retirement portfolio.

Bob K
Last edited by bobcat2 on Thu Apr 17, 2008 11:01 am, edited 1 time in total.
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dumbmoney
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Post by dumbmoney » Thu Apr 17, 2008 9:55 am

Here's an idea for a graph. For several different stock/bond ratios, find the withdrawal percentage (no floor or ceiling, constant percentage of annual portfolio value) which resulted in terminal wealth equal to starting (same as annualized return?). Plot the annual distributions from each portfolio on the same graph.

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More from the Sharpe paper

Post by bobcat2 » Thu Apr 17, 2008 10:26 am

Here's a quote from the Introduction of William Sharpe's recent paper, The 4% Rule---At What Cost?
A typical rule of thumb recommends that a retiree annually spend a fixed, real amount equal to 4% of his initial wealth, and rebalance the remainder of his money in a 60%-40% mix of stocks and bonds throughout a 30-year retirement period. For example, a retiree with a $1MM portfolio should confidently spend a cost of living adjusted $40K a year for 30 years, independent of stock, bond, and inflation gyrations. Confidence in the plan is often expressed as the probability of its success, e.g., in nine of ten scenarios, our retiree will sustain his spending. Modifications to this basic example include changing the amount to withdraw, the length of the plan, the portfolio mix, the rebalancing frequency, or the confidence level. However, all these variations have a common theme—they attempt to finance a constant, non-volatile spending plan using a risky, volatile investment strategy. For simplicity, we refer to this entire class of retirement strategies as 4% rules, the sobriquet of its first and most popular example.

Supporting a constant spending plan using a volatile investment policy is fundamentally flawed. A retiree using a 4% rule faces spending shortfalls when risky investments underperform, may accumulate wasted surpluses when they outperform, and in any case, could likely purchase exactly the same spending distributions more cheaply. The goal of this paper is to price these inefficiencies—we want to know how much money a retiree wastes by adopting a 4% rule.
The paper also contains informative summaries of Bengen's work on SWR's as well as the work on SWR's by the 'Trinity Study' authors.

Bob K
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Post by retiredjg » Thu Apr 17, 2008 10:41 am

Bob K. Thanks for posting the link above. I look forward to reading it.

What is a "real life annuity"? Same as an "immediate annuity"? jg

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Real life annuity

Post by bobcat2 » Thu Apr 17, 2008 10:53 am

Hi retiredjg,

A real life annuity is an immediate life annuity adjusted for inflation. It is the same as how SS benefits are adjusted for inflation. If last year your received $10,000 in income from your real life annuity and during the next 12 months inflation increased 3%, this year your real annuity would pay you $10,300. Last year's annuity payout amount plus a 3% increase for inflation.

Bob K
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Post by Rodc » Thu Apr 17, 2008 10:55 am

Supporting a constant spending plan using a volatile investment policy is fundamentally flawed. A retiree using a 4% rule faces spending shortfalls when risky investments underperform, may accumulate wasted surpluses when they outperform, and in any case, could likely purchase exactly the same spending distributions more cheaply.
I agree. The "4% rule" does not seem very sensible, even from the simplest view point. How can any rule that is started in year 1, and held without reconsideration and followed blindly for 30 years be optimal? How many believe they could at age 30 set down an investment/spending plan they would be willing to follow blindly and closely until age 60? Makes no sense.
We live a world with knowledge of the future markets has less than one significant figure. And people will still and always demand answers to three significant digits.

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Post by bob90245 » Thu Apr 17, 2008 11:00 am

retiredjg wrote:Bob K. Thanks for posting the link above. I look forward to reading it.

What is a "real life annuity"? Same as an "immediate annuity"? jg
Immediate annuities come in different flavors. The common flavor is to have the annual payout remain the same throughout the life of the annuitant. Another flavor, called a "real life annuity", is to begin with a relatively low payout. But this is compensated by having the low payout gradually rise over time. The rise will depend on the inflation rate during the preceding year.

Here's an example:

Image
Source: http://www.csmonitor.com/2006/1016/p13s02-wmgn.html

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Post by retiredjg » Thu Apr 17, 2008 11:15 am

Thanks Bob K. I'm looking for more info on annuities and the CSMonitor article looks like a good one to read. jg

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Post by dbr » Thu Apr 17, 2008 11:33 am

There are clearly two separate issues involved in this discussion. One issue, which is addressed by the many discussion of which the Sharpe paper is a recent example, is how should a retiree manage his investments and his spending. A different issue is how should a working person, especially a younger one, plan his savings strategy and estimate whether that strategy is adequate to meet his plans for retirement.

Historically it is this second question that seems to have been of concern to such as Bengen and the Trinity Study. Those analyses were also offered in the context of financial advisors giving people simple amortization analyses of retirement drawdown while using high return estimates that seem crazy today. Naturally answers to the first question (above) are needed to inform the second question. It does not follow that assumptions used to estimate the second question should be taken as recommendations for strategies retirees should actually implement in detail. It is interesting to note, as an example, that Financial Engines, a tool for computing accumulation stage strategy, assumes retirement will be financed by dumping the entirety of retirement assets into a fixed annuity.

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Post by bob90245 » Thu Apr 17, 2008 11:33 am

retiredjg wrote:I'm looking for more info on annuities and the CSMonitor article looks like a good one to read. jg
I was in the same boat you were, retiredjg. Though in my case, for research purposes only (I'm still 10 to 20 years away from reaching retirement age). I gathered many articles on immediate annuities that you can read here:

Immediate Annuities Links Page

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Post by retiredjg » Thu Apr 17, 2008 11:54 am

What are you trying to do? Give me so much to read that I can't watch "my programs"?

Seriously, thanks for the link. Not sure how I missed it before as I've been on your site several times. jg

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SWR RIP

Post by bobcat2 » Thu Apr 17, 2008 12:19 pm

dbr wrote:
There are clearly two separate issues involved in this discussion. One issue, which is addressed by the many discussion of which the Sharpe paper is a recent example, is how should a retiree manage his investments and his spending. A different issue is how should a working person, especially a younger one, plan his savings strategy and estimate whether that strategy is adequate to meet his plans for retirement.

Historically it is this second question that seems to have been of concern to such as Bengen and the Trinity Study.
I don't think that's true, I think in this thread many people are attempting to use the 4% SWR rule and its variants to manage their investments and spending in retirement.

But whether this is true or not is largely irrelevant. If you use the 4% SWR rule to answer only your second question, the answer is highly inaccurate. The SWR rule used in this context would say to generate $40,000/year real income in retirement for 30 years you need a $1 million retirement portfolio at retirement. But if a 65 year old male wants $40,000/year real in retirement and finances it with $400,000 in real annuities and the rest in a TIP ladder, he will need approximately a $741,000 portfolio at retirement. I don't think a rule that generates a portfolio target miss of 35% ($259,000) is very useful even in the context of solely answering the second question.

Bob K
Last edited by bobcat2 on Thu Apr 17, 2008 1:36 pm, edited 1 time in total.
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Post by bob90245 » Thu Apr 17, 2008 12:28 pm

Rodc wrote:If I could make a suggestion it would be to use the original style, but label the x-axis by replacing years by ranges, that is change 1926 to 1926-1955, 1927 to 1927-1956, etc.
This idea sounds promising. After I started putting it into the chart, I quickly realized that more programming changes will be needed to make it work with the other chart features. So it'll take more time to get this done. Stay tuned...

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Post by OptionAl » Thu Apr 17, 2008 12:45 pm

My problem with the charts: In my humble opinion, anyone who "needs" to be 50% in stocks probably shouldn't be retiring.
More specifically, if your bare bones survival needs require the returns that only a 50% position has typically yielded in the past, you are taking a big risk by retiring. If it just means that it will be a comfortable retirement with a legacy and you can cut back if need be, then it may be OK. In other words, if you truly have sufficient capital to retire, you should be able to get by (albeit in less than optimal circumstances) almost entirely on the fixed income portion of your portfolio plus annuities such as pensions and SS. Your other fixed assets, unless they are truly substantial, should be viewed only as your ultimate fallback insurance, e.g., downsizing or reverse mortgage.

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Post by retiredjg » Thu Apr 17, 2008 4:01 pm

dbr wrote:There are clearly two separate issues involved in this discussion. One issue, which is addressed by the many discussion of which the Sharpe paper is a recent example, is how should a retiree manage his investments and his spending. A different issue is how should a working person, especially a younger one, plan his savings strategy and estimate whether that strategy is adequate to meet his plans for retirement.

Historically it is this second question that seems to have been of concern to such as Bengen and the Trinity Study. Those analyses were also offered in the context of financial advisors giving people simple amortization analyses of retirement drawdown while using high return estimates that seem crazy today. Naturally answers to the first question (above) are needed to inform the second question. It does not follow that assumptions used to estimate the second question should be taken as recommendations for strategies retirees should actually implement in detail. It is interesting to note, as an example, that Financial Engines, a tool for computing accumulation stage strategy, assumes retirement will be financed by dumping the entirety of retirement assets into a fixed annuity.
Huh?

I think you are saying: "it's ok to use the 4% rule to estimate what you will need for retirement at a future time. But, there are better ways to arrange your portfolio and withdraw money, once you are retired, and get more than 4% without running out."

Is that what you are saying? Sorry. Sometimes I need things spelled out. jg

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Post by dbr » Thu Apr 17, 2008 4:25 pm

retiredjg wrote:
dbr wrote:There are clearly two separate issues involved in this discussion. One issue, which is addressed by the many discussion of which the Sharpe paper is a recent example, is how should a retiree manage his investments and his spending. A different issue is how should a working person, especially a younger one, plan his savings strategy and estimate whether that strategy is adequate to meet his plans for retirement.

Historically it is this second question that seems to have been of concern to such as Bengen and the Trinity Study. Those analyses were also offered in the context of financial advisors giving people simple amortization analyses of retirement drawdown while using high return estimates that seem crazy today. Naturally answers to the first question (above) are needed to inform the second question. It does not follow that assumptions used to estimate the second question should be taken as recommendations for strategies retirees should actually implement in detail. It is interesting to note, as an example, that Financial Engines, a tool for computing accumulation stage strategy, assumes retirement will be financed by dumping the entirety of retirement assets into a fixed annuity.
Huh?

I think you are saying: "it's ok to use the 4% rule to estimate what you will need for retirement at a future time. But, there are better ways to arrange your portfolio and withdraw money, once you are retired, and get more than 4% without running out."

Is that what you are saying? Sorry. Sometimes I need things spelled out. jg
I apologize for being a long winded writer who uses sentences that are much to long. Here are some more.

Yes, exactly what you said. I take the historical motivation behind Trinity, et. al. to be a debunking of people like Peter Lynch claiming people could retire on prospects of the stock market supposedly returning consistent 12% annual returns. Also the point is that 4% is a worst case kind of number in the view of those who have put it forward. (There is an argument that the future will be so bad for equities that the safe number right now in this context is less than 4%). The progress since then, as I understand it, is that people such as Milevsky and the authors of the current paper are pointing out that "risk free" investment strategies are better matched to retiree investment needs than balanced stock/bond portfolios, and that using better strategies retirees can in fact manage better than 4% incomes. A different question that has been much addressed, including Bengen, buckets strategies, etc., is how the withdrawal scheme can affect the ability to do better than 4%. That is not the same thing as the inefficency problem in retiring on volatile assets that the authors of the paper are addressing.

Naturally, if one is confident that a better strategy can safely achieve a better than 4% algorithm spending rate, then one would conclude that one's retirement nest egg could be smaller. I'm not sure I am reading that in the Sharpe paper, but Financial Engines may be doing exactly that. The problem is also related to how retirees who do not have pensions and may be dubious of Social Security should invest compared to those who do have pensions and are now collecting Social Security. The conclusion semmingly is that retirees without pensions may be well advised to purchase Real SPIA's. All that does is return the retiree to the condition of holding the coveted COLA pension, the gold standard for retirement income.

At least, this is what I think this is all about.

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Post by Midpack » Thu Apr 17, 2008 5:06 pm

OptionAl wrote:My problem with the charts: In my humble opinion, anyone who "needs" to be 50% in stocks probably shouldn't be retiring.
More specifically, if your bare bones survival needs require the returns that only a 50% position has typically yielded in the past, you are taking a big risk by retiring. If it just means that it will be a comfortable retirement with a legacy and you can cut back if need be, then it may be OK. In other words, if you truly have sufficient capital to retire, you should be able to get by (albeit in less than optimal circumstances) almost entirely on the fixed income portion of your portfolio plus annuities such as pensions and SS. Your other fixed assets, unless they are truly substantial, should be viewed only as your ultimate fallback insurance, e.g., downsizing or reverse mortgage.
I realize no risk would be ideal, but 50/50 seems pretty conservative to me at least at the start of a 30-40 year retirement. At what stock/bond mix would you think most would not "be taking a big risk by retiring?"
You only live once...

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Post by retiredjg » Thu Apr 17, 2008 5:18 pm

retiredjg wrote: Huh?

I think you are saying: "it's ok to use the 4% rule to estimate what you will need for retirement at a future time. But, there are better ways to arrange your portfolio and withdraw money, once you are retired, and get more than 4% without running out."

Is that what you are saying? Sorry. Sometimes I need things spelled out. jg
dbr wrote:I apologize for being a long winded writer who uses sentences that are much to long. Here are some more.

Yes, exactly what you said. I take the historical motivation behind Trinity, et. al. to be a debunking of people like Peter Lynch claiming people could retire on prospects of the stock market supposedly returning consistent 12% annual returns. Also the point is that 4% is a worst case kind of number in the view of those who have put it forward. (There is an argument that the future will be so bad for equities that the safe number right now in this context is less than 4%). The progress since then, as I understand it, is that people such as Milevsky and the authors of the current paper are pointing out that "risk free" investment strategies are better matched to retiree investment needs than balanced stock/bond portfolios, and that using better strategies retirees can in fact manage better than 4% incomes. A different question that has been much addressed, including Bengen, buckets strategies, etc., is how the withdrawal scheme can affect the ability to do better than 4%. That is not the same thing as the inefficency problem in retiring on volatile assets that the authors of the paper are addressing.

Naturally, if one is confident that a better strategy can safely achieve a better than 4% algorithm spending rate, then one would conclude that one's retirement nest egg could be smaller. I'm not sure I am reading that in the Sharpe paper, but Financial Engines may be doing exactly that. The problem is also related to how retirees who do not have pensions and may be dubious of Social Security should invest compared to those who do have pensions and are now collecting Social Security. The conclusion semmingly is that retirees without pensions may be well advised to purchase Real SPIA's. All that does is return the retiree to the condition of holding the coveted COLA pension, the gold standard for retirement income.

At least, this is what I think this is all about.
Well, dbr...

I appreciate the effort. When I first started on this board, almost everything was over my head. As for today, this is over my head. I'm going to save it for a couple of weeks and try again. Probably by that time, I'll "get it". Or maybe even tomorrow morning - I save my hardest reading for the mornings. I'm smarter then! jg

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Post by bob90245 » Thu Apr 17, 2008 6:27 pm

bob90245 wrote:
Rodc wrote:If I could make a suggestion it would be to use the original style, but label the x-axis by replacing years by ranges, that is change 1926 to 1926-1955, 1927 to 1927-1956, etc.
This idea sounds promising. After I started putting it into the chart, I quickly realized that more programming changes will be needed to make it work with the other chart features. So it'll take more time to get this done. Stay tuned...
I think this works.

Image
I want to thank everyone who offered their feedback. I'll be updating my website soon with the updated spreadsheet and charts.

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Post by Mel Lindauer » Thu Apr 17, 2008 8:44 pm

bob90245 wrote:
bob90245 wrote:
Rodc wrote:If I could make a suggestion it would be to use the original style, but label the x-axis by replacing years by ranges, that is change 1926 to 1926-1955, 1927 to 1927-1956, etc.
This idea sounds promising. After I started putting it into the chart, I quickly realized that more programming changes will be needed to make it work with the other chart features. So it'll take more time to get this done. Stay tuned...
I think this works.

Image
I want to thank everyone who offered their feedback. I'll be updating my website soon with the updated spreadsheet and charts.
Hi Bob:

I'd recommend the caption be changed to "The lowest SWR was 4.03%", since there were other periods where the figure was actually higher, and I think it should say "was" rather than "is", since "was" is historical and "is" sounds like it's predictive.

Regards,

Mel

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Post by retiredjg » Thu Apr 17, 2008 9:17 pm

Mel Lindauer wrote: Hi Bob:

I'd recommend the caption be changed to "The lowest SWR was 4.03%", since there were other periods where the figure was actually higher, and I think it should say "was" rather than "is", since "was" is historical and "is" sounds like it's predictive.

Regards,

Mel
I agree with Mel. jg

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Post by bob90245 » Thu Apr 17, 2008 9:34 pm

Done.

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Post by Mel Lindauer » Thu Apr 17, 2008 10:46 pm

bob90245 wrote:Done.
Great job, Bob! I think you've got a winner!

Best regards,

Mel

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Post by retiredjg » Fri Apr 18, 2008 10:16 am

dbr wrote:I apologize for being a long winded writer who uses sentences that are much to long. Here are some more.

Yes, exactly what you said. I take the historical motivation behind Trinity, et. al. to be a debunking of people like Peter Lynch claiming people could retire on prospects of the stock market supposedly returning consistent 12% annual returns. Also the point is that 4% is a worst case kind of number in the view of those who have put it forward. (There is an argument that the future will be so bad for equities that the safe number right now in this context is less than 4%). The progress since then, as I understand it, is that people such as Milevsky and the authors of the current paper are pointing out that "risk free" investment strategies are better matched to retiree investment needs than balanced stock/bond portfolios, and that using better strategies retirees can in fact manage better than 4% incomes. A different question that has been much addressed, including Bengen, buckets strategies, etc., is how the withdrawal scheme can affect the ability to do better than 4%. That is not the same thing as the inefficency problem in retiring on volatile assets that the authors of the paper are addressing.

Naturally, if one is confident that a better strategy can safely achieve a better than 4% algorithm spending rate, then one would conclude that one's retirement nest egg could be smaller. I'm not sure I am reading that in the Sharpe paper, but Financial Engines may be doing exactly that. The problem is also related to how retirees who do not have pensions and may be dubious of Social Security should invest compared to those who do have pensions and are now collecting Social Security. The conclusion semmingly is that retirees without pensions may be well advised to purchase Real SPIA's. All that does is return the retiree to the condition of holding the coveted COLA pension, the gold standard for retirement income.

At least, this is what I think this is all about.
Well, dbr...

I appreciate the effort. When I first started on this board, almost everything was over my head. As for today, this is over my head. I'm going to save it for a couple of weeks and try again. Probably by that time, I'll "get it". Or maybe even tomorrow morning - I save my hardest reading for the mornings. I'm smarter then! jg
OK, dbr. It took 4 readings, but I think I've figured out your meaning. Thanks for the response. (Glad I'm not your editor!) jg

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Lost in Transition

Post by rpike » Fri Apr 18, 2008 10:25 am

I guess this illustrates one of the characteristics lost in the transition from the Defined Benefit employer retirement plans (now well on the path to extinction) to Defined Contribution plans. A perpetuity managed properly can smooth out the payout rates between generation cohorts (as well as across members within a cohort), offering a higher payout to some recipients than they would otherwise have received based on retirement date and a lower payout to others.

Another Rick

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Post by dbr » Fri Apr 18, 2008 10:43 am

I am posing a question on another thread (http://www.diehards.org/forum/viewtopic ... 03c52bb543)
as to whether or not the first question a retiree should resolve concerning asset allocation is "What fraction of my wealth should be annuitized?"

An interesting obverse question is the one that comes up frequently:
"How should by AA take account of pensions and Social Security?"

I have no problem with the idea that this is a forum about investing in low cost, tax efficient, diversified equities and bonds and that retirement income streams and non-asset instruments are off topic, but the question is till there.

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Re: The 4% Rule—At What Price?

Post by hafis50 » Fri Apr 18, 2008 11:26 am

bobcat2 wrote:William Sharpe, Nobel Laureate and father of the CAPM model, has recently written a paper on the 4% SWR rule and its variants.
...
The following example illustrates some of the weaknesses of the 4% SWR rule.

Consider a 65 year old single male who is retiring this year. He has a financial portfolio worth $1.5 million. He wants to allocate $500,000 of the portfolio to a reserve fund for himself and a bequest to his favorite niece. He wants the remaining $1 million to fund his planned for 30 year retirement. He would like the income he receives from his portfolio to be a high inflation-adjusted constant amount over his planned 30 year retirement horizon.

Using a 50/50 portfolio and the 4% SWR rule he can receive $40,000/year in real income.

Now let’s consider an alternative strategy. He buys $400,000 in real life annuities. This gives him $24,800 in real income per year for life. With the remaining $600,000 he has a TIPS ladder of $30,000/year over the next 20 years. The TIPS have average real coupons of 2%. He can safely withdraw 4.4% from the TIP portfolio for the next 30 years. Therefore, in the first year he takes $26,400 out of the $30,000 in maturing 1 year TIPS and invests the remaining $3,600 plus all coupon interest in additional 20 year TIPS. These two investments together give him a guaranteed annual real income stream of $51,200/year for 30 years. This strategy provides a real income stream that’s 28.5% ($11,200/year) higher than the 4% SWR rule of $40,000/year.

Alternatively, you could have a guaranteed income stream of 40,000/year using this strategy and have a guaranteed real balance of $470,000 at the end of thirty years. Quite an improvement over the SWR that says you have a high probability of not running out of assets in 30 years, if you withdraw $40,000/year. Bob K
What happens to this strategy if government bonds, annuities and pensions become completely worthless?
It happened in the last century and I believe investors in RE and stocks had better chances to preserve (a fraction of) their wealth.

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hafis50

Post by bobcat2 » Fri Apr 18, 2008 11:54 am

I am not aware of US government bonds or US private annuities becoming completely worthless in the last century. In other countries I assume that has happened, but in other countries stock markets have completely collapsed.

Stock and RE investing is much riskier than investing in Treasury bonds or private life annuities. Don't just take my word for it, ask a Japanese stock or RE investor.:(


It's tritely true that there are no totally risk free investments. That doesn't mean that some investments aren't much safer than others. Anyone worried about US Treasuries and life annuities becoming completely worthless is much too risk adverse to ever venture a dollar into equity investing.

Bob K
In finance risk is defined as uncertainty that is consequential (nontrivial). | The two main methods of dealing with financial risk are the matching of assets to goals & diversifying.

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Post by retiredjg » Fri Apr 18, 2008 12:04 pm

I'm just wondering how to get $600,000 worth of a TIPs ladder with $30,000 maturing each year. Not sure that is possible any more. Isn't there a limit on purchasing those things now? Or am I confusing it with something else? jg

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Another strategy

Post by bobcat2 » Fri Apr 18, 2008 12:30 pm

Here's yet another alternative strategy for the $ 1 million retirement portfolio.
Invest $400,000 in real annuities, which gives a real payout of $24,800/year.
Invest $341,000 in a laddered TIPS. This gives a real payout of $15,200/year for 30 years. Together that's $40,000/year total payout combining the annuity and TIPS. Invest the remaining $259,000 in equites and real estate investments. This strategy also soundly beats the $40,000/year or 4% SWR from a 50/50 or 60/40 portfolio of $1 million.

Bob K
In finance risk is defined as uncertainty that is consequential (nontrivial). | The two main methods of dealing with financial risk are the matching of assets to goals & diversifying.

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retiredjg

Post by bobcat2 » Fri Apr 18, 2008 12:33 pm

You are confusing TIPS with Ibonds. Currently Ibonds, which are a type of US Savings Bonds, have a purchase limit of $10,000/year per person.

Bob K
In finance risk is defined as uncertainty that is consequential (nontrivial). | The two main methods of dealing with financial risk are the matching of assets to goals & diversifying.

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Post by dbr » Fri Apr 18, 2008 12:38 pm

retiredjg wrote:I'm just wondering how to get $600,000 worth of a TIPs ladder with $30,000 maturing each year. Not sure that is possible any more. Isn't there a limit on purchasing those things now? Or am I confusing it with something else? jg
I think you are confusing with I Bonds.

TIPS can be purchased from Treasury Direct or on the secondary market through a broker. Here are the maturity offerings and the auction schedule from TD:

Auction Pattern
5-year TIPS - April, *October

10-year TIPS - January, *April, July, *October

20-year TIPS - January, *July

* These are reopenings. In a reopening, we sell an additional amount of a previously issued security. The reopened security has the same maturity date and interest rate as the original security. However, as compared to the original security, the reopened security has a different issue date and usually a different purchase price.

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Re: retiredjg

Post by retiredjg » Fri Apr 18, 2008 12:54 pm

You are confusing TIPS with Ibonds. Currently Ibonds, which are a type of US Savings Bonds, have a purchase limit of $10,000/year per person.
I think you are confusing with I Bonds.
Thanks for clearing up my confusion! Somehow I had gotten the idea it was TIPs too. jg

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Re: hafis50

Post by dumbmoney » Fri Apr 18, 2008 1:32 pm

bobcat2 wrote:Anyone worried about US Treasuries and life annuities becoming completely worthless is much too risk adverse to ever venture a dollar into equity investing.
An annuity is an indirect investment in stocks, because insurance companies invest your money in stocks, and pay you from the stock returns (and bonds and whatever else they invest in).

I don't like the idea of "black box" investing. It doesn't remove risk; it just sweeps it under the carpet. If you can find an annuity which is 100% backed by TIPS, let me know.

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Re: hafis50

Post by bob90245 » Fri Apr 18, 2008 2:02 pm

dumbmoney wrote:An annuity is an indirect investment in stocks, because insurance companies invest your money in stocks, and pay you from the stock returns (and bonds and whatever else they invest in).
This is something I always wanted to learn more, i.e. how insurance companies finance their annuities. From the bits I've read in the past, insurance companies don't invest money earmarked for annuity payouts in stocks.

On a related topic, I have read that defined benefit pension funds do invest money in stocks.

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Re: hafis50

Post by bob90245 » Fri Apr 18, 2008 2:07 pm

bob90245 wrote:This is something I always wanted to learn more, i.e. how insurance companies finance their annuities. From the bits I've read in the past, insurance companies don't invest money earmarked for annuity payouts in stocks.
Perhaps we can infer from this chart that insurance companies invest the money earmarked for annuity payments in bonds:

Image
Source: http://www.annuityshopper.com/archives/ ... hopper.pdf

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dbr

Post by bobcat2 » Fri Apr 18, 2008 3:33 pm

Hi dbr,
You wrote:
I take the historical motivation behind Trinity, et. al. to be a debunking of people like Peter Lynch claiming people could retire on prospects of the stock market supposedly returning consistent 12% annual returns. Also the point is that 4% is a worst case kind of number in the view of those who have put it forward. (There is an argument that the future will be so bad for equities that the safe number right now in this context is less than 4%). The progress since then, as I understand it, is that people such as Milevsky and the authors of the current paper are pointing out that "risk free" investment strategies are better matched to retiree investment needs than balanced stock/bond portfolios, and that using better strategies retirees can in fact manage better than 4% incomes. A different question that has been much addressed, including Bengen, buckets strategies, etc., is how the withdrawal scheme can affect the ability to do better than 4%. That is not the same thing as the inefficency problem in retiring on volatile assets that the authors of the paper are addressing.

Naturally, if one is confident that a better strategy can safely achieve a better than 4% algorithm spending rate, then one would conclude that one's retirement nest egg could be smaller. I'm not sure I am reading that in the Sharpe paper, but Financial Engines may be doing exactly that. The problem is also related to how retirees who do not have pensions and may be dubious of Social Security should invest compared to those who do have pensions and are now collecting Social Security. The conclusion semmingly is that retirees without pensions may be well advised to purchase Real SPIA's. All that does is return the retiree to the condition of holding the coveted COLA pension, the gold standard for retirement income.
Yes, you can do as well or better than the SWR 4% rule applied to a volatile portfolio by using new strategies that rely on products such as TIPs and real annuities that are also less risky.

The one point I, and I suspect academics like Bodie and Sharpe, would disagree with what you wrote is, "All that does is return the retiree to the condition of holding the coveted COLA pension, the gold standard for retirement income. " In the US few government pensions were ever fully COLA'd and only some government pensions were partially COLA'd. In the private sector few pensions were even partially COLA'd. The fully COLA'd private pension was truly a 'rara avis' or completely nonexistent.

That being the case, we will not be returning to a COLA pension world that never existed in the first place. Instead we are moving to an improved system where pension like income will be inflation protected.

Bob K
In finance risk is defined as uncertainty that is consequential (nontrivial). | The two main methods of dealing with financial risk are the matching of assets to goals & diversifying.

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Post by dbr » Fri Apr 18, 2008 3:52 pm

Bob K, thanks for your comments.

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4% Withdrawal rate, all TIPS portfolio

Post by mikecupertino » Thu Apr 24, 2008 1:58 pm

Nisprius wrote:

First, If the interest rate on TIPS or I bonds is 1.31% or greater, then an all-TIPS or all-I-bonds portfolio will, all by itself, sustain a 4%-then-COLAed withdrawal rate for 30 years. At the 1.2% current I bonds rate, the sustainable withdrawal rate is 3.94%; at the 1.750% rate for 20-year TIPS, 4.24%.

This supposition seemed quite counterintuitive to me, so I wanted to try it out for myself. I constructed a spreadsheet and my result was that assuming a 4% withdrawal rate adjusted yearly for inflation, a TIPS rate of 1.08% was sufficient to support 30 years of inflation adjusted withdrawals (i. e. at the end of year 30, the remaining portfolio balance is zero).

I'm not technologically adept, so I don't know how to set up a link to my spreadsheet. Here's how I set up my spreadsheet:

column a: the year, a number from 1 to 30
column b: row 1 equal $1,000,000, subsequent rows equal column f from previous row
column c: $ withdrawal: -1,000,000 times 4% times (1+inflation rate) ^ (column a-1)
column d: investment return (column b+column c/2)*.0108
column e: TIPS inflation adjustment: .03*(column b + column c/2)
column f: ending balance sum(column a:column e)

When calculation returns and inflation adjustments, the withdrawal is divided by 2 on the assumption that withdrawals are taken monthly and the average balance for the year is the beginning balance minus 6 months withdrawals.

Given these calculations, a TIPS return of 1.08% results in a year 30 ending portfolio balance of $97 (close enough to zero for me).

This is quite significantly different from the Nisprius's result. What accounts for the difference? Am I misunderstanding something about the way TIPS work? I'd like to know where I went wrong.

Thanks in advance for your help.

Mikecupertino

:D

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Post by Rodc » Thu Apr 24, 2008 2:38 pm

That being the case, we will not be returning to a COLA pension world that never existed in the first place. Instead we are moving to an improved system where pension like income will be inflation protected.
Bob, I might add to this that I'm not so sure all that many people even got one of these non-cola'd pension, making the earlier claim you are refuting even more rare: you only a decent pension of any sort if you worked the same job for many years. While that was more likely in the past, the condition of long term employment at one company left a lot of people out in the cold I suspect.

At any rate, while easy to bemoan the lose of old time pensions, the new world while it does mean more work for some individuals also gives a chance of a decent retirement to people who change jobs where in the old world order they'd never build up a pension.

I am feeling hopeful that as demand grows, better and better products will be developed to fill the need for things like annuities with colas, combined annuity/long term care, what have you, and in fact for people will find retirement easier than previously. A guy can hope anyway. :)
We live a world with knowledge of the future markets has less than one significant figure. And people will still and always demand answers to three significant digits.

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Rodc

Post by bobcat2 » Thu Apr 24, 2008 2:57 pm

Yep :D

Bob K
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Post by grayfox » Thu Apr 24, 2008 3:12 pm

I think the difference is if the annual withdrawal all comes out at the beginning of the year or the way you did it.
mikecupertino wrote:This is quite significantly different from the Nisprius's result. What accounts for the difference? Am I misunderstanding something about the way TIPS work? I'd like to know where I went wrong.

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A better chart?

Post by zalzel » Thu Apr 24, 2008 8:23 pm

Image

Sorry... coming late to this converstation. Why not just change the chart header to:

"Safe Withdrawal Rate for 30 year period beginning in year:"?

Z.

P.S. I believe that the return data utilized to suggest the SWR does not include investment expenses. Thus, one needs to subtract portfolio e.r. from whatever SWR is believed to be the appropriate one.

edited to add P.S.
"What we can't say we can't say, and we can't whistle it either." | Frank P. Ramsey

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MINIMUM TIPS RATE REQUIRED TO SUPPORT 4% WITHDRAWAL

Post by mikecupertino » Fri Apr 25, 2008 6:17 pm

grayfox wrote:I think the difference is if the annual withdrawal all comes out at the beginning of the year or the way you did it.
mikecupertino wrote:This is quite significantly different from the Nisprius's result. What accounts for the difference? Am I misunderstanding something about the way TIPS work? I'd like to know where I went wrong.
Thanks for the tip. If I assume that the annual withdrawal all comes at the beginning of the year, I get a required TIPS interest rate of 1.349% which is pretty close to Nisprius's result.

I think this points up the importance of documenting all assumptions underlying whatever point is being made.

Mikecupertino

:D

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