Withdrawal Rate Using Endowment Rules?

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Post Reply
Topic Author
C.D. Gwyne
Posts: 13
Joined: Mon Jun 29, 2009 6:41 am

Withdrawal Rate Using Endowment Rules?

Post by C.D. Gwyne » Fri Jul 31, 2020 1:10 pm

Hello All,
Imagine for a moment that your retirement fund is a tiny endowment fund. Could you borrow some simple rules used by endowment funds
to decide on a safe percentage to withdraw?

Assume that your retirement fund is 60% bonds and 40% stocks. Also assume that withdrawing 4% of its value per year will allow the fund to grow.
This leads to greatly fluctuating income. How could the fluctuations be lessened?

The managers of the University of Michigan endowment fund follow two rules;
1) They average the value of the endowment over the previous 28 quarters, and take 4.5% of that.(This helped them during the crash of 2008.)
2) In a year when the market is down a lot, they take no more than 5.3% of the value of the endowment in that year. (This protects the principal.)

You might apply these rules to your "tiny endowment fund" in this way:
1) Average the year end value of your portfolio for the past seven years. Take 4% of that.
2) In a year when the market is down, take up to 4.5 % of the value of the your portfolio in that year.

What do you see as the pros, cons and alternatives?

C.D. Gwyne
Philadelphia

Mike Scott
Posts: 1351
Joined: Fri Jul 19, 2013 2:45 pm

Re: Withdrawal Rate Using Endowment Rules?

Post by Mike Scott » Fri Jul 31, 2020 1:16 pm

try the search box "perpetual withdrawal rate" for a lot of previous discussion

MrJedi
Posts: 199
Joined: Wed May 06, 2020 11:42 am

Re: Withdrawal Rate Using Endowment Rules?

Post by MrJedi » Fri Jul 31, 2020 1:18 pm

A key difference is that endowments generally still have income going into the fund.

gch
Posts: 77
Joined: Thu May 30, 2019 2:47 pm

Re: Withdrawal Rate Using Endowment Rules?

Post by gch » Fri Jul 31, 2020 1:37 pm

If you never took more than 4.5% or 5.3% or shoot even 99.9% of the value of your “endowment” in a year then you’d never run out.

ryman554
Posts: 1312
Joined: Sun Jan 12, 2014 9:44 pm

Re: Withdrawal Rate Using Endowment Rules?

Post by ryman554 » Fri Jul 31, 2020 2:44 pm

gch wrote:
Fri Jul 31, 2020 1:37 pm
If you never took more than 4.5% or 5.3% or shoot even 99.9% of the value of your “endowment” in a year then you’d never run out.
That's not quite true.

At $1m, withdrawing 99.9% gives:
$1000 after year 1
$1
0.1 cents after year 3

That last one likely rounds to 0. So, not so good.

And you know the OP was talking about Trinity study like withdrawal strategy to set up a perpetual income.

User avatar
celia
Posts: 11002
Joined: Sun Mar 09, 2008 6:32 am
Location: SoCal

Re: Withdrawal Rate Using Endowment Rules?

Post by celia » Fri Jul 31, 2020 2:51 pm

C.D. Gwyne wrote:
Fri Jul 31, 2020 1:10 pm
The managers of the University of Michigan endowment fund follow two rules;
1) They average the value of the endowment over the previous 28 quarters, and take 4.5% of that.(This helped them during the crash of 2008.)
2) In a year when the market is down a lot, they take no more than 5.3% of the value of the endowment in that year. (This protects the principal.)

You might apply these rules to your "tiny endowment fund" in this way:
1) Average the year end value of your portfolio for the past seven years. Take 4% of that.
2) In a year when the market is down, take up to 4.5 % of the value of the your portfolio in that year.
If most of your portfolio is in tax-deferred assets, RMDs reach 4% (of previous year ending value) at age72, 5% at age 79, and continue to increase each year, regardless of what the markets are doing.

Of course, you don't have to spend the withdrawal, but can just move it to savings. But for those who need (some of) it for living expenses, they need to find a way to make their money last as long as they do. And they need to consider the taxes owed on the RMD an expense.
A dollar in Roth is worth more than a dollar in a taxable account. A dollar in taxable is worth more than a dollar in a tax-deferred account.

Fclevz
Posts: 476
Joined: Fri Mar 30, 2007 11:28 am

Re: Withdrawal Rate Using Endowment Rules?

Post by Fclevz » Fri Jul 31, 2020 3:02 pm

I’ve always liked Bob Clyatt’s 4/95 rule. Take 4% each year. If you’re portfolio has a big down year and 4% of the new portfolio value would be too big a drop in income, then smooth out the amount by taking 95% of last year’s withdrawal.

http://www.workless-livemore.com/

sixtyforty
Posts: 472
Joined: Tue Nov 25, 2014 12:22 pm
Location: USA

Re: Withdrawal Rate Using Endowment Rules?

Post by sixtyforty » Sat Aug 01, 2020 2:34 pm

If I was interested in the endowment WD strategy I would want to know how they arrived at 4.5% and 5.3%. How did that WD strategy fare thorough the great depression and the 60's etc. I like the Time Value of Money approach for withdrawals.
"Simplicity is the ultimate sophistication" - Leonardo Da Vinci

aristotelian
Posts: 7779
Joined: Wed Jan 11, 2017 8:05 pm

Re: Withdrawal Rate Using Endowment Rules?

Post by aristotelian » Sat Aug 01, 2020 3:06 pm

The big problem with endowment strategies is that when the market goes down you have to cut your spending. Many people don't have the flexibility to cut their spending by 30% for years at a time.

User avatar
willthrill81
Posts: 19733
Joined: Thu Jan 26, 2017 3:17 pm
Location: USA

Re: Withdrawal Rate Using Endowment Rules?

Post by willthrill81 » Sat Aug 01, 2020 3:30 pm

sixtyforty wrote:
Sat Aug 01, 2020 2:34 pm
If I was interested in the endowment WD strategy I would want to know how they arrived at 4.5% and 5.3%. How did that WD strategy fare thorough the great depression and the 60's etc. I like the Time Value of Money approach for withdrawals.
I agree that the TVM approach makes the most all-around sense of all the withdrawal methods I've seen, and I've seen a bunch.

You want your withdrawals to last if you live to 120?

You want to leave behind at least X dollars?

You want to incorporate multiple income streams, such as SS benefits, starting or ending at various points in time?

You want some smoothing to your withdrawals?

All of that and more is possible with the TVM approach. And no, I'm not selling anything. :D
aristotelian wrote:
Sat Aug 01, 2020 3:06 pm
The big problem with endowment strategies is that when the market goes down you have to cut your spending. Many people don't have the flexibility to cut their spending by 30% for years at a time.
Yes, that can indeed be a problem with a percentage-of-portfolio approach that doesn't include any type of smoothing function. This is one of my biggest beefs with the VPW approach; the withdrawals are just as volatile as the portfolio's balance.

Some argue that the 'solution' is to reduce the volatility of the portfolio by increasing the fixed income allocation, but the problem there is that doing so also decreases your portfolio's expected returns and expected future withdrawals.

Thankfully, smoothing functions like using 1/CAPE for expected returns can be incorporated into a TVM approach to make withdrawals less volatile. Basically, when prices fall, expected future returns increase, and those higher expected returns can largely or even entirely offset a pullback in stock prices with regard to how much can be withdrawn at the current point in time.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

aristotelian
Posts: 7779
Joined: Wed Jan 11, 2017 8:05 pm

Re: Withdrawal Rate Using Endowment Rules?

Post by aristotelian » Sat Aug 01, 2020 3:44 pm

willthrill81 wrote:
Sat Aug 01, 2020 3:30 pm
aristotelian wrote:
Sat Aug 01, 2020 3:06 pm
The big problem with endowment strategies is that when the market goes down you have to cut your spending. Many people don't have the flexibility to cut their spending by 30% for years at a time.
Yes, that can indeed be a problem with a percentage-of-portfolio approach that doesn't include any type of smoothing function. This is one of my biggest beefs with the VPW approach; the withdrawals are just as volatile as the portfolio's balance.

Some argue that the 'solution' is to reduce the volatility of the portfolio by increasing the fixed income allocation, but the problem there is that doing so also decreases your portfolio's expected returns and expected future withdrawals.

Thankfully, smoothing functions like using 1/CAPE for expected returns can be incorporated into a TVM approach to make withdrawals less volatile. Basically, when prices fall, expected future returns increase, and those higher expected returns can largely or even entirely offset a pullback in stock prices with regard to how much can be withdrawn at the current point in time.
Regarding smoothing, my employer is an endowment based nonprofit. We budget off a three year rolling average of the portfolio value. Probably has a similar effect to using CAPE. One the one hand, when the portfolio has a big year you don't get to spend all those gains immediately. On the other hand, you also don't have to cut your budget by 50% in a bad year. You may have to cut your budget by 50% but it would be a gradual process over a few years.

User avatar
willthrill81
Posts: 19733
Joined: Thu Jan 26, 2017 3:17 pm
Location: USA

Re: Withdrawal Rate Using Endowment Rules?

Post by willthrill81 » Sat Aug 01, 2020 3:52 pm

aristotelian wrote:
Sat Aug 01, 2020 3:44 pm
willthrill81 wrote:
Sat Aug 01, 2020 3:30 pm
aristotelian wrote:
Sat Aug 01, 2020 3:06 pm
The big problem with endowment strategies is that when the market goes down you have to cut your spending. Many people don't have the flexibility to cut their spending by 30% for years at a time.
Yes, that can indeed be a problem with a percentage-of-portfolio approach that doesn't include any type of smoothing function. This is one of my biggest beefs with the VPW approach; the withdrawals are just as volatile as the portfolio's balance.

Some argue that the 'solution' is to reduce the volatility of the portfolio by increasing the fixed income allocation, but the problem there is that doing so also decreases your portfolio's expected returns and expected future withdrawals.

Thankfully, smoothing functions like using 1/CAPE for expected returns can be incorporated into a TVM approach to make withdrawals less volatile. Basically, when prices fall, expected future returns increase, and those higher expected returns can largely or even entirely offset a pullback in stock prices with regard to how much can be withdrawn at the current point in time.
Regarding smoothing, my employer is an endowment based nonprofit. We budget off a three year rolling average of the portfolio value. Probably has a similar effect to using CAPE. One the one hand, when the portfolio has a big year you don't get to spend all those gains immediately. On the other hand, you also don't have to cut your budget by 50% in a bad year. You may have to cut your budget by 50% but it would be a gradual process over a few years.
Yes, that seems like a good smoothing function. Most retirees seem to greatly prefer gradual changes, which is why I often wonder why the VPW method, which uses basically no smoothing, appears to appeal to as many as it does.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

Topic Author
C.D. Gwyne
Posts: 13
Joined: Mon Jun 29, 2009 6:41 am

Re: Withdrawal Rate Using Endowment Rules?

Post by C.D. Gwyne » Sun Aug 02, 2020 8:34 pm

Hello Bogleheads,
Thank you for your thoughts on the question.
Best Wishes,
C.D. Gwynne

User avatar
nisiprius
Advisory Board
Posts: 41389
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: Withdrawal Rate Using Endowment Rules?

Post by nisiprius » Sun Aug 02, 2020 9:02 pm

C.D. Gwyne wrote:
Fri Jul 31, 2020 1:10 pm
The managers of the University of Michigan endowment fund follow two rules;
1) They average the value of the endowment over the previous 28 quarters, and take 4.5% of that.(This helped them during the crash of 2008.)
2) In a year when the market is down a lot, they take no more than 5.3% of the value of the endowment in that year. (This protects the principal.)
The "con" I see is the real-world failure of the Vanguard Managed Payout Fund, which used a somewhat similar system. The original stated purpose of the fund was to create automatic, fairly stable monthly distributions from an aggressive portfolio, using a moving average system to smooth and govern the size of the withdrawals--drawing down capital in bad years and rebuilding it in good.

I think "failure" is a fair appraisal. The fund followed this rule (from the original draft prospectus)

Code: Select all

The formula to calculate the monthly  distribution
per share in a calendar year is as follows:



                                                       Average daily
Monthly distribution   =       5%        x     value of hypothetical account
                                                over prior 3 calendar years
                           -------------     ----------------------------------
per share                      12                 Number of shares held by
                                             hypothetical account at the end of
                                                  the prior calendar year
 
It is roughly similar to the University of Michigan rules. The averaging period was much shorter, 3 years instead of 6.5; the distribution percentage was 5% instead of 4.5%; and there was no "down market" rule. The portfolio composition varied during the years but the financial press often described it as resembling that of a university endowment.

The fund had a stated investment objective:
The Fund seeks to make monthly distributions of cash while providing inflation protection and capital preservation over the long term.
That it, is objective (not promised or guaranteed) was a perpetuity of 5% payouts, with both the payouts and the capital growing to keep pace with inflation.

The current portfolio is:

1 Total International Stock Index Fund Investor Shares 24.10%
2 Total Stock Market Index Fund Investor Shares 14.13%
3 Total Bond Market II Index Fund Investor Shares 11.44%
4 Alternative Strategies Fund 10.90%
5 Commodity Strategy Fund 7.62%
6 Total International Bond Index Fund Investor Shares 5.95%
7 Market Neutral Fund Investor Shares 4.99%
8 Small-Cap Value Index Fund Admiral Shares 4.99%
9 Value Index Fund Investor Shares 4.93%
10 Dividend Appreciation Index Fund 3.02%
11 High Dividend Yield Index Fund 2.90%
12 Emerging Markets Stock Index Fund Investor Shares 2.59%
13 Global Minimum Volatility Fund Investor Shares 2.50%

The fund fell short of meeting objectives. In 2014 the monthly distribution percentage was accordingly cut from 5% to 4%. In Feb. 2020, Vanguard abruptly announced that they were discontinuing the monthly distributions.

The fund still exists, but is now a regular mutual fund, renamed "Vanguard Managed Allocation Fund." Fund shareholders who do not choose to reinvest will just receive end-of-year distributions as with any other mutual fund, with no attempt to equalize or balance or use any moving averages. They are on their own as to how to create stable, automatic monthly income from the fund.

In short, the bad luck of 2008-2009 ruined the possibility of meeting the objectives despite the moving-average withdrawal system.

If Vanguard couldn't get it to work, that raises questions as to how well a do-it-yourself investor could.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

000
Posts: 950
Joined: Thu Jul 23, 2020 12:04 am
Location: Ursa Minor

Re: Withdrawal Rate Using Endowment Rules?

Post by 000 » Sun Aug 02, 2020 9:21 pm

nisiprius wrote:
Sun Aug 02, 2020 9:02 pm
I think "failure" is a fair appraisal.

[...]

If Vanguard couldn't get it to work, that raises questions as to how well a do-it-yourself investor could.
Hmmm, I seem to recall they changed the fund because most investors in it weren't using it that way. They were reinvesting the dividends. That is what Vanguard said. Do you have evidence that claim was false?

User avatar
willthrill81
Posts: 19733
Joined: Thu Jan 26, 2017 3:17 pm
Location: USA

Re: Withdrawal Rate Using Endowment Rules?

Post by willthrill81 » Sun Aug 02, 2020 9:42 pm

nisiprius wrote:
Sun Aug 02, 2020 9:02 pm
The fund had a stated investment objective:
The Fund seeks to make monthly distributions of cash while providing inflation protection and capital preservation over the long term.
That it, is objective (not promised or guaranteed) was a perpetuity of 5% payouts, with both the payouts and the capital growing to keep pace with inflation.
I'd say that Vanguard's problem was that their targets were just too high. 5% has not been remotely close to the perpetual withdrawal rate. 4% has been closer but still well above the historic 3%, the arguable PWR. If a DIY yokel like me knows this, the folks at Vanguard should have even more so.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

Post Reply