Sustainable Withdrawal Rates

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

Post by Bylo Selhi » 19 Feb 2005 15:12

Decision Rules and Portfolio Management for Retirees: Is the 'Safe' Initial Withdrawal Rate Too Safe? [FPA Journal, Oct04] "This paper establishes new guidelines for determining the maximum "safe" initial withdrawal rate... [and] finds that applying these Decision Rules produces a maximum "safe" initial withdrawal rate as high as 5.8 percent to 6.2 percent depending on the percentage of the portfolio that is allocated to equities."

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nadreck
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Post by nadreck » 19 Feb 2005 16:43

Comments:

I for one don't think that basing withdrawal rates on the past performance of a variety of indexes is right for active investors. I think it does make sense for index investors or investors who see themselves as having the majority of their retirement funding comming from the sort of balanced portfolio of index equities and bonds and only a small pool of funds that they deploy actively from which they make withdrawals of that pool at their discretion but use some a plan like the one outlined to determine the rates of withdrawal from their 'sensible' plan.

For someone like myself, I like to take a different perspective and say that since I actively manage my investments I must consider my performance as a guide to determine withdrawal rates. Since I have much less history than the indexes in question I am starting off with a conservative rate. As well rather than specifying that my portfolio should have an arbitrary percentage in bonds I set asside my potential RRSP withdrawal each year in 5 year strips (still inside my RRSP) leaving me with a five year buffer of spending money planned out at any time and effectively about 20 - 30% of my RRSP in bonds (over and above any bonds I might own because they were of investment value to me). My rate of buying these strips I have set at 6.42% a year of the value of my RRSP, when actually withdrawn from the RRSP they are a lower percentage as long as I have acheived a the overall returns I expect.
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Maybe it's too risky - there's no sure answer

Post by adrian2 » 19 Feb 2005 19:41

I would say that no withdrawal rate is safe for a non-annuitized portfolio, maybe except for a 100% RRB amortized like a mortgage over a term equal to the RRB's term, and withdrawals calculated at the beginning as a percentage of the initial capital, assuming constant real rates over the term. The withdrawals would not be perfectly rising with inflation because of fluctuating real rates, but it should be pretty close.

As I've quoted Dr. Bernstein a few times, "any estimate of long-term financial success greater than about 80% is meaningless".

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Re: Maybe it's too risky - there's no sure answer

Post by nadreck » 19 Feb 2005 19:52

adrian2 wrote:I would say that no withdrawal rate is safe for a non-annuitized portfolio
So are you suggesting then that anyone who wants to live off of their assets rather than employment income, pogie, CPP, OAS or allowance from their sugar daddy should buy an annuity?

I certainly would not feel safe if I tied up a large amount of my portfolio in something that inflexible.
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Post by arthur » 19 Feb 2005 19:53

I had better not post my picture here, that's all I need is your wives and girlfriends chasing me.

I am never sure what is a safe Withdrawal Rate as I have not yet planned the date of my Death.

I do know that 15 years from now I will not be spending as much money on extras, that today is my only reality, that I won't plan for 25 years, not sure where I'll be.

FTR, I take out 5% of RRSP's, in future may decrease that amount, our needs are quite simple. :lol: javascript:emoticon(':lol:')
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Re: Maybe it's too risky - there's no sure answer

Post by adrian2 » 19 Feb 2005 19:58

nadreck wrote:So are you suggesting then that anyone who wants to live off of their assets rather than employment income, pogie, CPP, OAS or allowance from their sugar daddy should buy an annuity?
Nope. Just realize that the risk is there, whether you think of it or not. It's up to you how to weigh the alternatives.

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Post by yielder » 19 Feb 2005 20:01

my only reality, that I won't plan for 25 years, not sure where I'll be.
You might want to cover your bets a bit with things like living wills, powers of attorney, and some other details.

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Re: Maybe it's too risky - there's no sure answer

Post by Norbert Schlenker » 19 Feb 2005 20:08

adrian2 wrote:I would say that no withdrawal rate is safe for a non-annuitized portfolio ....
Safety has a broader meaning. If you annuitize, you are safe from outliving your money if the annuity provider keeps paying you.

Suppose you're very conservative so that an annuity looks like the right solution. You might also be so conservative that investing in, say, Sun Life bonds is beyond your risk tolerance. (Believe me, I run into people like this. GICs at the bank is their limit.)

Provincial insurance commissions try to ensure that Sun Life has enough money in reserve to pay out on claims, annuities included, whereas their bonds are not as well protected. OTOH, the bond has a maturity date while the obligation to pay on the annuity is open-ended.

To get back to my very conservative investor, should such a person purchase a Sun Life annuity? Is it really so much harder to believe that Sun Life won't stop paying on an annuity than that they won't stop paying on their bonds?

Disclaimer: This is no commentary on Sun Life's finances whatsoever. I picked 'em because they're big, not because they're shaky. I happen to own some of the stock myself, so I ain't worried.

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Re: Maybe it's too risky - there's no sure answer

Post by Bylo Selhi » 19 Feb 2005 20:26

Norbert Schlenker wrote:
adrian2 wrote:I would say that no withdrawal rate is safe for a non-annuitized portfolio ....
Safety has a broader meaning. If you annuitize, you are safe from outliving your money if the annuity provider keeps paying you
Bernstein's (and Adrian's) concern is broader still. We've been fortunate in North America to not have had a war on our soil in well over 100 years. But people in Europe, never mind lesser-developed parts of the world, have not been so fortunate. Who's to say that terrorism could get so bad in the coming decades that it threatens or brings down our economic system? Not likely based on the past 100 years, but look at what a single event like 9-11 did. Imagine what a nuke could do.

And what about a natural disaster such as a medical pandemic or another tsunami that hits the left coast or an earthquake that breaks it off completely from the continent?

No degree of conservative investing is going to mitigate those scenarios. Yet are they any less likely to occur than a meltdown at Sun Life?
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Re: Maybe it's too risky - there's no sure answer

Post by nadreck » 19 Feb 2005 23:12

adrian2 wrote:
nadreck wrote:So are you suggesting then that anyone who wants to live off of their assets rather than employment income, pogie, CPP, OAS or allowance from their sugar daddy should buy an annuity?
Nope. Just realize that the risk is there, whether you think of it or not. It's up to you how to weigh the alternatives.
Fair enough Adrian2, and the points about the other systemic risks are there, at age 25 I figured a "Mad Max" world was a 25% possibility in my lifetime, now I think it is only 10%. Since I refuse to get into the arm yourself mode, I simply think that owning your house outright, having a reasonable dry pantry stock as well as a freezer full and a 'victory' garden and neighbors who trust you is the best hedge against that alternative. How a colapse happens and how you cope in a post colapse society are rather chancy variables. I will take a path that leaves me able to look myself in the mirror and hope that I survive that eventuality..

As for the annuity, I think it is too restrictive and subject to errosion by inflation for me to plan on it. I am happy with the risk level I have and I suspect that I will take steps to reduce the level of risk (barring societal melt down) as I get older.
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Post by ghariton » 20 Feb 2005 01:26

Which gets me back to RRBs. Using RRBs as a reverse mortgage, as I am planning to do, allows a 4% withdrawal rate, even at the present low rate of return -- 4.4% for an annuity certain over 30 years, minus 0.4% for the inevitable frictions, selling some before maturity, etc.

There are risks, but therese are few. The main one would be government default. It's conceivable, but in my opinion very unlikely. As bylo says, there could be serious terrorism. But, to take just one example, the state of Israel does not seem to have defaulted (yet). As for natural catastrophes, even the recent tsunami has not endangered the finances of any of the affected countries (yet). THat leaves, to my mind, one real threat, that of a growing aging population, and a younger generation that is not willing to fund our pensions (or investments). But again, that is not a huge risk.

Other risks have been discussed ad nauseam at TWB. The government could fiddle the calculation of the CPI. But that would hurt MPs and public servants more than holders of RRBs, given that their indexed pensions are a larger part of their total wealth. The government could decide to redirect money to social programs.. But somehow I think that they would raise taxes or run a deficit before they touched RRBs.

Finally, you could run into an emergency, and need to sell off a wad of your RRBs long before maturity, thus taking a hit on the market value, if real returns have increased significantly. But using mostly 2021 maturities, as I do, reduces that risk. Historically, real returns have varied very slowly. Finally, emergencies could threaten any financial plan -- and it is unreasonable, in my opinion, to plan for the absolutely worst outcome possible. The second worst will do. :)

George

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Post by Bylo Selhi » 20 Feb 2005 08:39

ghariton wrote:the state of Israel does not seem to have defaulted (yet)
IIRC they did have a spate of hyper inflation a couple of decades ago that resulted in issuing new currency, etc. Would they have been able to honour their debt if a substantial amount was inflation-indexed?

In any case, I think we're in agreement. There are no absolute guarantees (apart from the usual two.) One plans as best one can and then one takes ones chances. So it is with life in general. Why should it be any different with retirement?
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Post by arthur » 20 Feb 2005 10:11

I think you are starting to see why we left a major urban centre, live close to sources of fresh water and foods and are not vulnerable to rampaging crowds or major foreign attacks.

Canadian Cities will become increasingly dangerous as Governments start to cut back on freebies and robbing older people becomes a viable alternative to people who see a Justice System as non threatening.

I strongly believe the BEST INVESTMENT you can make is a mortgage free home in a small rural community with access to Health Care.

I was recently rushed to the Emergency Department at Meaford as I had passed out due to Pneumonia, I was seen immediatly, got great care,a nd was allowed to leave after XRays.

Oh yeah, the drawback is the lifestyle is so damn healthy, you really do runa risk of outliving your money, but since the entertainment is mostly free, that is not a real problem :lol:

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Post by Rehan » 20 Feb 2005 10:36

I'm Howard wrote:I strongly believe the BEST INVESTMENT you can make is a mortgage free home in a small rural community with access to Health Care.
Just make sure those doctors aren't all planning to leave town... :?
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Post by arthur » 20 Feb 2005 11:22

Excellent point rehan, that is why the area you select must be chosen carefully, older people need access to Health Care.

This area affords easy access to 4 Hospitals, is less than 2 hours from TO for serious stuff, and is growing so rapidly that we are adding Surgeons and Physicians.

We searched for at least 5 years before picking this area, one of my Brothers chose Tillsonburg, one chose Salmon Arm, one chose Picton, the others are still in TO.

Do your homework, start loking for this Investment at least 5 years before retirement.

Friends of ours splt, he wanted Golf and Florida, she wanted downtown TO and the Art Gallery, be sure you are both on the same page. :shock:

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Post by yielder » 20 Feb 2005 11:23

I think you are starting to see why we left a major urban centre
We did the same thing, Howie so I tend to agree with your comments. However, I think that there is a unrecognized downside that has to do with your state of mind and how it changes to adapt to the new smaller, quieter, environment. Being out of that environment, you lose touch with it and increasing don't understand it. What we don't understand, threatens us and we withdraw. I'm not suggesting that this is a bad thing, only that we should probably be aware that we will increasingly lose touch with a certain, very dynamic aspect of the world in exchange for a different aspect of the world.

The tradeoffs between the big city and the smaller rural/semi-rural community are not all visible ones.

Mike

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Post by Shakespeare » 20 Feb 2005 11:29

The tradeoffs between the big city and the smaller rural/semi-rural community are not all visible ones.
IMO stress reduction is a very important part of the move. Had I not taken early retirement, I would probably be both richer and deader.

The FP weekend mentions the "Four-Hour Radius" - be within 4 hour's drive of a major center. I would reduce that to 2-1/2 hours. It is a problem with many otherwise attractive BC locations, depending on whether you define Kelowna as a "big-enough center" (it has Westjet service).

Added: Lethbridge is 2-1/2 hours from YYC.
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Post by nadreck » 20 Feb 2005 11:42

Does anyone think that we will see a bit of a diaspora from the major urban centres to rural and small town venues during the next 20-30 years which will relieve price pressures on 3 + bedroom homes in the urban (and their suburban surroundings) and create pressure to develop 2 bedroom houses in the rural and small town settings, particularly waterfront areas. Then, as the majority of baby boomers move into the stage of their life where they need more support and have less energy a return to the centres in condos and various levels of assisted care buildings leaving a lot of properties behind at relatively low prices.
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Post by Shakespeare » 20 Feb 2005 12:11

I'm not really too worried about the "4% rule". I think you use it as a general guide. But, as Bill Bernstein pointed out, there is no point in getting too high a certainty. Stuff happens.

Once you retire, an amzing number of expenses simply disappear, unless you want to travel extensively. Pension contributions and saving for retirement go. If you've got kids, if you're lucky they'll go. :twisted: If you've got a house, it's paid off. You've got all the "stuff" you need and just need a few goodies :wink: every once in a while. And, when you hit 60, you can turn CPP from red to black.

Meanwhile, if you manage your portfolio intelligently, you'll sell what's overpriced to book occasional profits, and drop your withdrawal rate if lean times come. Other than that, enjoy!
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Post by arthur » 20 Feb 2005 12:40

Yielder, Peterborugh and the area are benefiting from Migration of urbanites, thus there is a pool of people with whom you share commonalities.

retirees, stay away from small towns with low prices where there is very little migration in, you will always be a stranger.

The real losers in real Estate will be the large suburban homes, empty nesters don't need 5 bedrooms and, No, people will stay in the rural areas as long as they have good access to Health Care.

Cities, like Lindsay, Tillsonburg, have gone after the retiree market, they have built areas of one story homes to meet the needs of retirees, they have good Hospitals, and they are within reasonable drive from a major city.(shakes is right on with that one).

If you can afford waterfront, buy it, but with market value assesment, your taxes will be much higher.

Probus, sponsored by Rotary, is an excellent group to join, they can make transitioning into a new area very easy.

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Post by blonde » 20 Feb 2005 13:24

I am NOT a believer in 'RULES. Rules are designed for non-thinkers. The so-called 4% rule is mainly a mental gymnastic game.

Govt policy is and will be designed using the poor-boy/gal model. As a 10%er, it is mandatory to 'Look After #1'.

I move forward by 'guiding principles' and design the process, c/w metrics, to make the 'go/no go' decision.

The financial aim for retirement is to have a CASH FLOW, yes, CASH FLOW of the magnitude that all the money cannot be spent using the 'worse case' scenario.

For cash flow, dividends shud not be ignored.

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Post by blondo » 22 Feb 2005 11:15

I strongly believe the BEST INVESTMENT you can make is a mortgage free home in a small rural community with access to Health Care.

Howard I agree but don't forget a fully paid up boat and a small annuity to
cover the wharfage.

In BC and the present state of Health Care I am more concerned about outliving the Health Care system than outliving the money.

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Post by George$ » 22 Feb 2005 11:31

Blondo:
I am NOT a believer in 'RULES. Rules are designed for non-thinkers.
Does that statement not qualify as a "rule"? :?


Of course I agree that following anything blindly without thought or flexibility is rather dumb.

Instead of "rules" how about "guidelines" or "approximations"?

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Post by Shakespeare » 22 Feb 2005 11:33

or "approximations"?
Approximately blonde?

Oh dear....
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Post by blondo » 22 Feb 2005 20:32

George$

I think you meant to address Blonde who dwells on the flatlands, rather
than Blondo, who lives in the woods next to the Pacific.

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