Sustainable Withdrawal Rates

Preparing for life after work. RRSPs, RRIFs, TFSAs, annuities and meeting future financial and psychological needs.
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StuBee
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Re: Sustainable Withdrawal Rates

Post by StuBee »

Sure I will humour you!

6% = (.65 x ?% +.35 x 3%) - 2% - 2%
Solving for ? ...............................13.75% :shock: :shock: :shock: :shock:
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Re: Sustainable Withdrawal Rates

Post by ig17 »

BRIAN5000 wrote:
I used 6% real in my estimate
I get confused when people use a number like this.

Someone humour me please approximate numbers only, with 2% Inflation, 2% Tax, lets make it about 65/35 split, (or 2/3-1/3) 3% on fixed income (per Dan) what return on the equity portfolio do I need to make 6% real return? (after tax, after Inflation)
I estimated 6% real for equities only, not the total portfolio. 6% is after inflation but before taxes.

Equities: 6% real (8% nominal - 2% inflation)
Bonds: 1% real (3% nominal - 2% inflation)

60/40 split

0.06 * 0.6 + 0.01 * 0.4 = 0.036 + 0.004 = 0.04 or 4% real. That's before tax.
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Re: Sustainable Withdrawal Rates

Post by Springbok »

Dan,
I appreciate your detailed reply. And I understand that the audience here on a mainly DIY forum is different from the public as a whole.

I have access to a computer spreadsheet that models the retirement drawdown phase and includes current tax rules. I am sure Steves could do it better, but I ran a few cases. One for example for a couple who each have $1million of which 75% is in RRIF. They desire an after tax income of $100k from investments and pensions (inflation adjusted). CPP/OAS total is about $30k. They also wish to have $500k left as either buffer for inaccuracies in predictions, or inheritance for kids.

I ran this with a series of widely different inflation and real return numbers. What became evident, and this comes back to one of my earlier points, is that the draw down of the capital is the major factor. Changing the numbers quite widely just moves the date that assets are depleted to chosen level by a few years. 90-95 or so starting at 73. However, unlike the data that the 4% rule was based on, this model assumes stable capital with no market volatility so is not something I would hang my hat on! But nevertheless shows that we should not get too hung up on portfolio yield once in retirement.

One other thing. I came across an interesting studythat looked at the 4% rule based on data from different countries around the globe for the period 1900-1979 The highest so called Safemax withdrawal rate was in Canada! It was 4.42% vs 4.02% in USA (who were in 4th place). It is also interesting to note that except for the worst case (1969, I believe) starting withdrawal at any other time would have allowed a higher SWR. Sometimes much higher, which indicates that the 4% figure is/was quite conservative.
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Re: Sustainable Withdrawal Rates

Post by BRIAN5000 »

Solving for ? ...............................13.75% :shock:
That was what I was thinking :shock: almost 14% till " ig17 " explained

Made me go and look at my numbers again. I need 9% return on my equity to make 5% portfolio return with 3% interest (35/65) but only 7% with 4% interest
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Re: Sustainable Withdrawal Rates

Post by BRIAN5000 »

Will Low Investment Returns Wreck Retirement?

http://www.thinkadvisor.com/2015/05/04/ ... page_all=1

The front yard analogy is appropriate for a retiree worried about getting run over by wandering out into the street. Using this simulation technique, Blanchett finds that even at higher levels of equity exposure the best retirees can hope for is a 60% probability that they’ll be able to sustain a 4% inflation-adjusted spending rate over a 30-year time horizon. As I mentioned before, with no stocks a retiree has a 100% chance of failure.

The good news is that retirees do not have to follow the 4% rule. They can spend more by partially annuitizing—especially through products that hedge against later life income risk such as deferred income annuities (DIAs). Varying spending in response to portfolio returns can reduce the chance that retirees will run out of money if they experience a bear market, and delaying Social Security can provide an important bump in inflation-adjusted income. All of these strategies are part of a more sustainable retirement income plan. A low-return environment makes exploring them even more important for clients.
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Re: Sustainable Withdrawal Rates

Post by ghariton »

BRIAN5000 wrote:Will Low Investment Returns Wreck Retirement?
According to the article, a 4% SWR, based on a portfolio of 100% TIPS will run out after 27 years. Since I am currently 69, that would take me to 96. Running out of money at age 96 doesn't seem so bad to me.

(I'm not advocating a 4% SWR, I'm just noting that there are a lot of scare stories out there.)

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Re: Sustainable Withdrawal Rates

Post by BRIAN5000 »

ghariton wrote: Running out of money at age 96 doesn't seem so bad to me.

(I'm not advocating a 4% SWR, I'm just noting that there are a lot of scare stories out there.)

George
I don't think this is a scare story if that's what you are inferring, looks pretty well reasoned to me BWTFDIK.

Hmmm 58 + 27 gets me to 85, wife (55 + 27) can fend for herself I guess.
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Re: Sustainable Withdrawal Rates

Post by Springbok »

Some think the 4% SWR is too high given current rates. But with rates so low, perhaps retirees actually need to withdraw more than 4% just to meet living costs. It's a no win situation.
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Re: Sustainable Withdrawal Rates

Post by ghariton »

More or less on topic. Larry Swedroe on the low returns investors can expect going forward.

He estimates returns on equities going forward at 4.2% real or 6.2% nominal. For bonds he estimates - 0.3% real or 1.7% nominal.

What to do? The usual nostrums
-- Differentiate Between Desires And Needs
-- Extend Stay in Workforce
-- Raise Your Saving Rate
-- Delay Taking Social Security Benefits Until Age 70

I do have a question. Why plan on a negative real return on bonds when you can get a positive, albeit very small, real return on TIPS or RRBs?

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Re: Sustainable Withdrawal Rates

Post by Spudd »

Springbok wrote:Some think the 4% SWR is too high given current rates. But with rates so low, perhaps retirees actually need to withdraw more than 4% just to meet living costs. It's a no win situation.
What do rates have to do with living costs? I'm confused.
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Re: Sustainable Withdrawal Rates

Post by Peculiar_Investor »

Tip of the hat to our NormR in his G&M article Study finds flaws in 4% rule on investing for retirement - The Globe and Mail [$$$].
Financial planner William Bengen wrote a paper in 1994 called Determining Withdrawal Rates Using Historical Data. He figured that, for a balanced portfolio of stocks and bonds, a 4-per-cent initial annual withdrawal rate, subsequently adjusted for inflation, could be maintained safely for at least 30 years without running out of money.

Problem is, his results were based on U.S. data, and the U.S. market was one of the best-performing ones in the world since 1900.

When applied to international markets, the 4-per-cent rule runs into trouble, according to a new paper called The Retirement Glidepath by Prof. Javier Estrada of the IESE Business School in Barcelona, Spain.
I found the original paper by Prof. Estrada at SSRN, The Retirement Glidepath: An International Perspective and have started working my way through it to further educate myself. For those that want the quick answer,
Norm Rothery in G&M wrote:Like the United States, Canada was unusually kind to investors. The failure rate north of the border was just 1.2 per cent based on data from 1900 through 2009.

But I hasten to add that the next century might not be as friendly to Canadians as the last one was.
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Re: Sustainable Withdrawal Rates

Post by ghariton »

Thank you for the link to Estrada's paper. From Exhibit 4, I note that a 4% withdrawal rate, historically, has been completely safe for Canada and New Zealand, and pretty safe for Australia, the U.S., the U.K. (all Anglo-American countries), and also for South Africa and Denmark (perhaps an honorary Anglo-American country?).

More importantly, while 4% was not safe for many countries (France, Germany, Belgium, Italy, Japan -- World Wars, perhaps?), for a "world" portfolio, 4% was a pretty safe rate (probability of running out of money before 30 years was 6.2%). That suggests to me the importance of global diversification.

Upon reflection, it is striking how many of these studies are U.S. centric and or focussed on a single country at a time, and so ignore international diversification.

Norm is right that past returns are a poor indicator of future returns. However, if war was indeed the main reason for the 4% strategy failing in many countries, it is worth contemplating the odds of war in North America any time soon. We must always be mindful of tail risks, but we shouldn't go overboard in guarding against them.

Finally, annuitization at some point between ages 75 and 85 is, to my mind, the best protection against longevity risk. The question should really be rephrased as: "What is a safe withdrawal rate so that a sufficient amount is left for me to buy an annuity at 75 or 85?" The answer will vary, of course, but I bet that the answer would be higher than 4% for most people.

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Re: Sustainable Withdrawal Rates

Post by NormR »

ghariton wrote:Thank you for the link to Estrada's paper. From Exhibit 4, I note that a 4% withdrawal rate, historically, has been completely safe for Canada and New Zealand, and pretty safe for Australia, the U.S., the U.K. (all Anglo-American countries), and also for South Africa and Denmark (perhaps an honorary Anglo-American country?).
According to the paper the 30-year failure rate of a 60/40 portfolio in the UK is 24%, which doesn't seem so safe to me.

Note that Exhibit 4 shows the best case failure rate for all of the asset allocation strategies tested, which strikes me as potentially misleading. I suspect a table with the worst cases rates would be a good deal closer to 100%.
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Re: Sustainable Withdrawal Rates

Post by SQRT »

@George. Given the very good results historically for Canada, it seems to me that the data actually seems to suggest that international diversification may not be such a good thing? Maybe you will get stuck with that lunch bill after all? Obviously, past performance, etc, etc.
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Re: Sustainable Withdrawal Rates

Post by 8Toretirement »

There is no safe withdrawal rate except a strategy that uses safe investments. The only one that comes to mind would be a spread of GIC ladders within CDIC coverage at each bank. Any other strategy is not safe. Annuities would be another route but subject to inflation over the long run. Purchasing inflation protected annuities is rather expensive which would lower the amount available for living.

If the goal is to protect against running out of funds later in life then working until one has enough using GIC's, and taking CPP and OAS at 70 would be optimal starts.

This brings us to the trade off, accepting lower returns for increased security. The crux of the argument is what is more devastating, a lower withdrawal rate or a complete loss of personal assets in later years.

Monte Carlo simulations are garbage during for real world determinations, guarantees are the only sure fire winning method. Everything else is a gamble. Too many investors have gone through the 2008-2009 financial crisis, survived; and now think they can handle anything.

A 100% Monte Carlo simulation of success using a combination of stocks and bonds does not guarantee a 100% value, statistics don't work that way although many people believe they do. Since the simulation is using past variables which relies on multiple variables it overlooks the place of chance, bad programming, sequence of withdrawal returns from entirely new events, multi factors that lead to different determinant outliers, and finally, new variables that were not included in the simulation of past events. What happens if we have multiple terrorist attacks, a financial and housing meltdown, and stocks don't recover for a decade.

It's all speculation. You increase the odds in your favour but don't guarantee an outcome using Monte Carlo Simulation.
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Re: Sustainable Withdrawal Rates

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8Toretirement wrote:There is no safe withdrawal rate except a strategy that uses safe investments. The only one that comes to mind would be a spread of GIC ladders within CDIC coverage at each bank. Any other strategy is not safe.
I used to think that. Safety is a relative thing. Historically, stocks have returned more over long periods of time, arguably making them safer against the ravages of inflation over longer periods than GICs -- not to mention rapidly rising inflation, the illiquidity of GICs, the 30-year bull market on fixed income, and the major tax disadvantages in taxable accounts. I do not believe that any one asset class or type of investment is truly safe, even for shorter periods. It's comforting to believe that, but unless you are planning to achieve, say, a 0%-0.25% real return in retirement, GICs are probably not getting you there. Each class carries certain types of risk that even scaredy cats like myself have to learn to live with. (Which is why I probably hold more GICs, as a percentage of our portfolio, than most people here do -- and I have and will take a hit for that decision. So I understand the emotional side all-too-well, even while logically knowing it's probably not the way to go.)
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Re: Sustainable Withdrawal Rates

Post by Flaccidsteele »

I don't think inflation will be coming back any time soon.

The Paul Volcker era has been replaced with the complete opposite.
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Re: Sustainable Withdrawal Rates

Post by SQRT »

8Toretirement wrote:There is no safe withdrawal rate except a strategy that uses safe investments. The only one that comes to mind would be a spread of GIC ladders within CDIC coverage at each bank. Any other strategy is not safe.


This brings us to the trade off, accepting lower returns for increased security. The crux of the argument is what is more devastating, a lower withdrawal rate or a complete loss of personal assets in later years.
I think you have to understand that "safety" is a relative thing. To be absolutely safe is impossible. To get close to absolute personal safety would require never leaving your home. Hardly a worthy goal. Likewise with withdrawal rates, we accept a reasonable risk of running out of money and compare that to the alternative certainty of a very low spending rate. Most people chose something in between based on their personal risk aversion. Life involves trade offs as does investing and retirement.
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Re: Sustainable Withdrawal Rates

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SQRT wrote:
8Toretirement wrote:There is no safe withdrawal rate except a strategy that uses safe investments. The only one that comes to mind would be a spread of GIC ladders within CDIC coverage at each bank. Any other strategy is not safe.


This brings us to the trade off, accepting lower returns for increased security. The crux of the argument is what is more devastating, a lower withdrawal rate or a complete loss of personal assets in later years.
I think you have to understand that "safety" is a relative thing. To be absolutely safe is impossible. To get close to absolute personal safety would require never leaving your home. Hardly a worthy goal. Likewise with withdrawal rates, we accept a reasonable risk of running out of money and compare that to the alternative certainty of a very low spending rate. Most people chose something in between based on their personal risk aversion. Life involves trade offs as does investing and retirement.
You are correct about absolutes, however, once you have enough then risk should be absolutely minimized. Stocks in the long run become more risky the longer you hold them. Bonds, especially at these rates are absolutely risky for the retiree since as interest rates rise, withdrawals will eat away at diminishing bond prices due to the inverse nature between interest rate increases and bond prices.

I still submit that reaching for higher withdrawal rates increases the portfolio risk at the worst time, when the retree can ill afford large losses.
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Re: Sustainable Withdrawal Rates

Post by SQRT »

8Toretirement wrote:
SQRT wrote:
8Toretirement wrote:There is no safe withdrawal rate except a strategy that uses safe investments. The only one that comes to mind would be a spread of GIC ladders within CDIC coverage at each bank. Any other strategy is not safe.


This brings us to the trade off, accepting lower returns for increased security. The crux of the argument is what is more devastating, a lower withdrawal rate or a complete loss of personal assets in later years.
I think you have to understand that "safety" is a relative thing. To be absolutely safe is impossible. To get close to absolute personal safety would require never leaving your home. Hardly a worthy goal. Likewise with withdrawal rates, we accept a reasonable risk of running out of money and compare that to the alternative certainty of a very low spending rate. Most people chose something in between based on their personal risk aversion. Life involves trade offs as does investing and retirement.
You are correct about absolutes, however, once you have enough then risk should be absolutely minimized. Stocks in the long run become more risky the longer you hold them.
I don't think I agree with these two points. The concept of "enough" is difficult to decide on. Most people could use a little more but don't want to incur too much risk to achieve it. In my case I certainly have enough and could convert my portfolio to an annuity and live very well for the rest of my life. I dont intend to do that and really at this point, I am managing the portfolio for the next generation.

Not sure why you think equities become more risky the longer you hold them? I've had my portfolio for about 20 years and it has returned about 12% CAGR over this period. The first $1,000 I invested (TD bank) is now worth over $16,000 (divs reinvested)

For me at least, risk is not a 4 letter word. Risk certainly needs to be understood and managed. I have been a successful investor over a fairly long period. Absolutely minimizing risk was not something I would have felt comfortable with. But hey, it takes all kinds.
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Re: Sustainable Withdrawal Rates

Post by 8Toretirement »

I was looking for Zvi Brodie's research on long term stock risk.

You might find this link an an interesting read. I will see if I can rustle up the original, but it is technical.

http://www.wsj.com/articles/SB100014240 ... 2377253224

William Bernstein has stated many times that when you have enough funds for retirement you should re-evaluate and get out of the game insofar as any further risk could create havoc on retirement plans. He defines risk this way, what you gain, and what the consequences of a large loss would create including running out of money in retirement. One is catastrophic, the other has little bearing on retirement plans.

The idea of enough is simply a basis for defining your monetary needs on a yearly basis. As I stated earlier, using deferral of CPP and OAS will manage some of the later requirements where funding is circumspect. If you don't have an idea of enough then you are hoping that your retirement funds will increase to offset some sort of funding deficiency, which by itself guarantees you are increasing your risk. I'm not even factoring the withdrawal process.
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Re: Sustainable Withdrawal Rates

Post by Flaccidsteele »

I saw this when reading about the 4% withdrawal criteria. Please put in financial porn if better there.

Bloomberg: How to Retire at 40: Three early retirees tell their story of living on 4 percent or less.
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Re: Sustainable Withdrawal Rates

Post by longinvest »

8Toretirement wrote:I was looking for Zvi Brodie's research on long term stock risk.

You might find this link an an interesting read. I will see if I can rustle up the original, but it is technical.

http://www.wsj.com/articles/SB100014240 ... 2377253224
I've read Bodie's "Risk Less and Prosper" lately; it's an interesting book.

He is on the extreme side of the safety-first approach (from the linked WSJ article):
Today's low-interest-rate environment poses some difficult challenges even with a bare-bones safety net in place. Today, TIPS and I Bonds do not yield more than the rate of inflation.
...
If you don't think you can create a safety net that's big enough, there are other steps you can consider, although they can be tough. You might spend less today to save more for tomorrow. You might work extra jobs, move to a higher-paying career or retire later. You can also try scaling back your definition of needs.
In other words, if one won't be able to cover non-discretionary expenses putting all his investments into Real Return Bonds (RRBs) maturing when the money is needed, when considering future CPP and OAS, one should simply cut spending and save more or work longer, unless one is able to somehow increase his salary/income (like find a better paying job or work two jobs).

If I remember correctly, in the book he plans to use the accumulated RRBs to eventually buy inflation-indexed annuities to eliminate longevity risk. It's coherent with his safety-first approach.

Only when one is already saving enough to cover future non-discretionary expenses can he start to invest additional savings into a traditional stock and bond portfolio. Pretty conservative guy!
8Toretirement wrote:William Bernstein has stated many times that when you have enough funds for retirement you should re-evaluate and get out of the game insofar as any further risk could create havoc on retirement plans. He defines risk this way, what you gain, and what the consequences of a large loss would create including running out of money in retirement. One is catastrophic, the other has little bearing on retirement plans.
Bernstein worries about the risk that an insurance company would fail and stop paying its promised inflation-index annuity payments just at the wrong time, when a structural problem happens and many insurance companies fail (probably along with a market crash in stocks). In other words, he worries that Assuris would fail too. So, unlike Bodie, he is not fond of using annuities. He is in favor of delaying Social Security (e.g. CPP/OAS) to age 70, but beyond that, he would construct a 30-year RRB ladder. This leaves a longevity risk for which he does not provide a "safe" answer.
8Toretirement wrote:The idea of enough is simply a basis for defining your monetary needs on a yearly basis. As I stated earlier, using deferral of CPP and OAS will manage some of the later requirements where funding is circumspect. If you don't have an idea of enough then you are hoping that your retirement funds will increase to offset some sort of funding deficiency, which by itself guarantees you are increasing your risk. I'm not even factoring the withdrawal process.
Personally, I like the idea of delaying CPP/OAS to age 70. One could use a ladder of individual RRBs maturing in the interim period between retirement and age 70 to cover the missing payments. As RRBs are issued in 5-year intervals, one will have to invest 80% of each maturing RRB into a non-rolling 4-year GIC ladder trying to match inflation to fund an entire 5-year period.

As for the rest, I simply plan to keep a flexible budget which varies with my income, as I've had so far in my life. I invest my savings into a well-diversified balanced portfolio and I'll use a portfolio withdrawal method (finiki: VPW) which has no risk of premature depletion, but which delivers variable withdrawals depending on market returns.

Between age 70 and 80, I might buy inflation-indexed annuities to make sure CPP+OAS+annuity covers non-discretionary expenses to eliminate longevity risk. I'll wait as long as possible because annuities get cheaper with age, and because I might end up not needing to buy any.
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Re: Sustainable Withdrawal Rates

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Re: Sustainable Withdrawal Rates

Post by ghariton »

NormR wrote:Note that Exhibit 4 shows the best case failure rate for all of the asset allocation strategies tested, which strikes me as potentially misleading. I suspect a table with the worst cases rates would be a good deal closer to 100%.
Sorry for the late reply, but I didn't notice your post.

Yes, Exhibit 4 shows best cases. I should have referred to Exhibit 3. It shows that a consistent allocation model of 100% equities, diversified worldwide, would have had a failure rate of 6.2% under a 4% withdrawal rate. I still consider that safe. (We statisticians conventionally work with 95% confidence intervals.:wink:)

It's true that concentrating in just one country, the U.S., would have produced a lower failure rate of 3.7%. But as you have said, the U.S. had a particularly fortunate century. International diversification historically has included wars and other long-tail events and so is perhaps more reliable going forward as a representation of what might happen. That's why I think that the 6.2% failure rate on a worldwide portfolio is "better" than a 3.7% failure rate in a single country, even one as important as the U.S.

That said, a portfolio that is 100% U.S. based is already pretty widely diversified when viewed internationally. I am open to the a4rgument that an all-U.S. equity portfolio can pretty safely support a 4% SWR. (I should have followed Warren Buffett's advice all those years ago. But that doesn't fit my psychology. I'm much closer to Zvi Brodie. :wink:)

FWIW, even today, a 100% RRB portfolio still supports a 4% SWR if the horizon is shortened to 25 years from 30 years. Given that I'm now 70, perhaps 25 years is more than I can expect.

Anyhow (1) I don't believe in formulaic SWRs, but rather in withdrawal rates that vary with a portfolio's real performance (2) as we all agree, history is a very imperfect guide to the future.

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