Most analyses of "safe" withdrawal rates are concerned with withdrawing a certain percentage of your
original portfolio (we'll call that strategy [1]),
that amount increasing with inflation.
That'd make your portfolio income constant in today's dollars.
>By "constant in today's dollars" you mean constant in buying power.
Yes ... reduced for inflation. $10K, ten years from now, may buy what $7K would buy today: $7K would be $10K expressed in today's dollars.
Anyway, there's another strategy that's been around for a while (strategy [2])
that I always thought was pretty silly, namely withdrawing a fixed
percentage of your current portfolio. The claim is that you'd never run out of money if, for example,
you withdraw 5% of your current portfolio. While that's certainly true, it means that,
when your portfolio is down to $1.00, you'd withdraw just five cents.
>So?
So I've done some simulations and find the latter strategy pretty good.
>You learn something every day, eh?
Yes. I always thought that, when your portfolio drops to a few dollars and you're withdrawing a
few pennies, you'd be sorry you adopted that strategy.
>But it's better than trying to withdraw $20K from a $5.00 portfolio!
Exactly!
So here's the spreadsheet that I played with.
The nice thing is that ...
>So you like that strategy now?
Well, it's not my
favourite strategy,
but I like it better than the "usual" strategy where you
withdraw some amount (increasing with inflation) and completely ignore market fluctuations.
Indeed, what will often happen with the strategy [1] is that
your portfolio has grown from $500K to several million dollars but you're
still withdrawing $20K (for example).
>How do I get the spreadsheet?
To download a .ZIPd file, just RIGHTclick on the picture above and Save Target ...
>That's a fictitious set of stock prices, right?
Well, yes, but we could also use, say, the S&P 500 and a $100K portfolio.
Perhaps the worst 30 years was from about 1965, so if we use strategies
[1] or [2], with a
5% withdrawal rate, we'd run out of money in about 22 years
>That's with the first strategy, eh?
Yes. But, for about 20 years we'd be withdrawing less using [2]
and our portfolio has a chance to grow and it winds up, at the end of the 30 years, with over $350K.
>What's your inflation?
Oh, sorry. It's the actual annual inflation, for the years 1965  1995.
I should point out that the notorious 4% withdrawal rate would be okay, using strategy [1]
... but 5% ain't good.
In fact, with strategy [2], you're withdrawing more when the market is high and less when it's low.
>Buy low, sell high?
Well, sell high ...
 Figure 1

>Okay, so 1965 was a bad year to start your 30 year withdrawals, but what about ...??
Here are some other starting years, again with a S&P portfolio, starting at $100K and a 5% withdrawal:

>Wow! Look at the 1950s! You end up with over a million bucks!
Yes, and you're withdrawing just 1%, using strategy [1].
>And with strategy 2?
It's 5% of course. That's the strategy, eh? It's 5% every year. Look again at Figure 1.
The income chart looks like the portfolio chart. One is 5% of the other.

>And the 1990s look pretty good, eh? Even with strategy 2 you end up with ...
Over a million. Yes, those were the days, my friend. An annualized S&P 500 return of about 14% over that
10year time span ... and about 23% over the last halfdozen years.
>Well, suppose I definitely need a certain income, increasing with inflation and ...
Say, 3%, increasing with inflation ... just to pay the bills?
>Yes! I'll give up travel, restaurants, steak ...
Yes, I understand. You definitely need, say $15K per year from your portfolio and ...
>Yeah, but when the market is good I'd like to withdraw more for travel, steak and ..
Okay, I've actually added that to the above spreadsheet. Try it!
Figure 2 shows a typical example for this strategy [3]:
The blue graph (as we've mentioned) is similar to the portfolio chart. Notice that it starts off very well.
The green graph ignores this runup and withdraws a constant $20K (in today's dollars).
>Them's strategies [1] and [2]?
Actually, they're [2] and [1], respectively.
Now comes [3], where we withdraw just $15K (increasing with inflation)
but, each year, we calculate 5% of our current portfolio (as in [2]) and
if it's larger than our $15K we withdraw that amount.
That's the grey graph. There you withdraw more for your steak in those early years but then drop back to $15K
(in today's dollars) and ...
 Figure 2

>But that runs out of money too!
Yes. Sad, eh?
>So, what if I invest in something other than the S&P, like maybe ...?
Okay, using strategy [2] we'll withdraw 7% of our current portfolio for 30 years from that infamous
4 x 25 portfolio.
If we modify the "sensible withdrawal" spreadsheet described
here so that we're withdrawing 7%
of the current portfolio, then we'd get a Monte Carlo probability about 90% (of ending up with
the same portfolio that we started with).
>Aah, the same portfolio, eh? What about the probability of ending up with more than $0?
You mean the MC probability of our portfolio just surviving? That's 100%, of course! With
[2] it's always 100%.
>But, with [2], you could be withdrawing a few dollars each year, right?
Well, that's better than running out of money entirely! (However, in the thousands of simulations, starting
with a $1M portfolio, the minimum withdrawal was about $7K).
>Okay, but which thirty years?
It's Monte Carlo, remember? We select, at random, annual returns for each asset class from the years
1928  2000 and random sequences of 30 actual inflation rates and do thousands of MC simulations and ...
>And what if you just withdrew 5% of your original portfolio ... increasing with inflation? I mean strategy [1].
The MC probability of surviving (meaning more than $0, after 30 years) is 87%.
>And strategy [3], for that 4x25 portfolio?
I didn't try that ...
>And using some bond component or using years other than 19282000 or using different allocations or ...?
zzzZZZ
See Jonathan Clements' article on
Squeezing Out Cash In Retirement (Oct 12/03).
