Growth Rate in Drawdown

Linton

Deleted_User wrote: »

Variable withdrawal strategy assigns a percentage you can withdraw - of your total fund in any given year. As long as you follow the schedule, you succeed. If the portfolio halves next year, your “income” halves too. That’s always a possibility. In fact, most people cut their spending in such circumstances.

Retirees who don’t use this approach tend to underspend, live the lifestyle below what they can actually afford and end up with too much money they can’t spend at the end. And it make sense - assuming a constant rate of withdrawal upfront leads to failure in too many scenarios. So they have to be too conservative.

From what you say would it be fair to say this comes from reading books rather than personal experience?




Most people would not be prepared to "buy" a pension scheme which could halve their income at the drop of a hat on a year by year basis. They could not simply halve their expenditure. Likewise if their income suddenly rises would they use the extra wisely or simply spend it on things they would not otherwise want? In real life what people really want is a fairly steady inflation matching income sufficient to meet their needs. If this means that in some years they are receiving less than they theoretically could be I think that is a price they would be happy to accept.


The next point to repeat is that just because your plan says you drawdown a fixed inflation matching amount each year does not mean that is what you actually do in practice. What I am doing is as my wealth increases beyond the original plan I am replanning based on increased planned expenditure for the rest of my life. The reverse would apply if there was a drop in wealth. You dont simply continue to withdraw the fixed amount because that is what the plan says. Working in this way means you are not subject to possibly wild fluctuations in income as the changes are spread over a long time period.


It has other advantages as well. Blindly applying a variable withdrawal strategy does not account for ones approaching death. As you get older the fact their your income strategy is not sustainable in the long term doesnt matter - there is no long term. You also have the complication that towards end of life your expenses could rise sustantially as you pay for care in a home, or preferably, pay for care in your own home. These can be included in the plan.

bostonerimus

Linton wrote: »

Since I retired nearly 14 years ago the average IRR ( which accounts for buys and sells) is 6.4% My portfolio consists of a wide range of different types of investment and so the rate of return is less than a pure equity one would achieve. Note that this time period includes the Great Crash.


As to inflation, I have found CPI more than adequate to match my actual expenditure. CPI has averaged 2.3%. So both my assumptions of 3% inflation and 4% return have proved to be very pessimistic. However I have not changed them for future planning. Who knows what the futrure will bring.

I'm in a similar position. I retired 5 years ago and since then my portfolio of around 75% global equities and 25% US bonds has averaged a 7% annual return. But you need to be careful as there is a big variation in annual returns, my returns are 1 year 3.3%. 5 year 7%, 10 year 10.6%. This shows why it's good to have a cash withdrawal buffer and/or alternative sources of retirement income. like rent, DB pensions, annuities or state pension.

[Deleted User]

Linton wrote: »

From what you say would it be fair to say this comes from reading books rather than personal experience?

Most people would not be prepared to "buy" a pension scheme which could halve their income at the drop of a hat on a year by year basis. They could not simply halve their expenditure. Likewise if their income suddenly rises would they use the extra wisely or simply spend it on things they would not otherwise want? In real life what people really want is a fairly steady inflation matching income sufficient to meet their needs. If this means that in some years they are receiving less than they theoretically could be I think that is a price they would be happy to accept.


The next point to repeat is that just because your plan says you drawdown a fixed inflation matching amount each year does not mean that is what you actually do in practice. What I am doing is as my wealth increases beyond the original plan I am replanning based on increased planned expenditure for the rest of my life. The reverse would apply if there was a drop in wealth. You dont simply continue to withdraw the fixed amount because that is what the plan says. Working in this way means you are not subject to possibly wild fluctuations in income as the changes are spread over a long time period.


It has other advantages as well. Blindly applying a variable withdrawal strategy does not account for ones approaching death. As you get older the fact their your income strategy is not sustainable in the long term doesnt matter - there is no long term. You also have the complication that towards end of life your expenses could rise sustantially as you pay for care in a home, or preferably, pay for care in your own home. These can be included in the plan.

Correct, I am not retired. This comes from books, but also from the experience of retirees who are applying this strategy. A few points:

1. If one requires constant real income, then he should take out an inflation protected annuity. There will be issues if there is a spouse or need for a legacy, but it can all be done. All other options always have a risk of pension value halving. Even with annuities or DB there are such risks, linked to company and your country’s fortunes. The whole job of selecting a strategy is to minimise the probability of such disasters.

If you are in the market then there simply isn’t a strategy which ensures that in real terms the value of your portfolio won’t halve.

2. You say that in reality people always vary withdrawals. Agreed. Variable withdrawal strategy allows for more realistic planning.

3. The real problem comes if you withdraw x percent of the original value after portfolio halves (or worse). Then portfolio stays down for a number of years, you keep withdrawing at a predetermined level. The probability may be low, but it’s possible. Then you run out of money. One has to be prepared for possibility of variations in lifestyle, unless the portfolio is worth 10M or do.

4. On approaching death - variable withdrawal strategy suggests putting the balance of your portfolio into an inflation protected annuity once you reach 80 or 85. This is done to mitigate longevity and senility risks.

None of it is done “blindly”, plus there are income smoothing approaches people use within this strategy.

[Deleted User]

Here are brief summaries of how the strategy can be implemented with links to more detailed info and experiences of people using it:

https://www.bogleheads.org/wiki/Variable_percentage_withdrawal
https://www.finiki.org/wiki/Variable_percentage_withdrawal
https://www.financialwisdomforum.org/forum/viewtopic.php?f=30&t=117200

The links are to Canadian/US experience. I am sure people are using this in Britain too.

pensionpawn

bostonerimus wrote: »

I'm in a similar position. I retired 5 years ago and since then my portfolio of around 75% global equities and 25% US bonds has averaged a 7% annual return. But you need to be careful as there is a big variation in annual returns, my returns are 1 year 3.3%. 5 year 7%, 10 year 10.6%. This shows why it's good to have a cash withdrawal buffer and/or alternative sources of retirement income. like rent, DB pensions, annuities or state pension.

Yes, the yearly returns can vary quite wildly, demonstrably so over the last couple of years where growth of ~15% has been tempered by 0% growth. So using your TFLS to put aside 12-24 months 'pension income' is critical to the overall success of anyone's plan. Unless your withdrawals are so small in comparison to the pot size that it just keeps growing then monitoring and adjusting your plan, as appropriate, is a must.

Linton

Deleted_User wrote: »

Correct, I am not retired. This comes from books, but also from the experience of retirees who are applying this strategy. A few points:

1. If one requires constant real income, then he should take out an inflation protected annuity. There will be issues if there is a spouse or need for a legal, but it can all be done. All other options always have a risk of pension value halving. Even with annuities or DB there are such risks, linked to company and your country’s fortunes. The whole job of selecting a strategy is to minimise the probability of such disasters.

If you are in the market then there simply isn’t a strategy which ensures that in real terms the value of your portfolio won’t half.

I would agree with the implication of what you say that inflation protected annuities could be a more sensible choice than drawdown for many people. Sadly they are historically unusually expensive at the moment due to their 100% guarantee and low safe interest rates and so other more affordable options need to be considered. Also their inflexibility limits their usefulness.


In the end nothing is absolutely safe. Global economic collapse will destroy your retirement plans no matter what they are. The best one can hope for is to be in a better position than most other people.

2. You say that in reality people always vary withdrawals. Agreed. Variable withdrawal strategy allows for more realistic planning.

3. The real problem comes if you withdraw x percent of the original value after portfolio halves (or worse). Then portfolio stays down for a number of years, you keep withdrawing at a predetermined level. The probability may be low, but it’s possible. Then you run out of money. One has to be prepared for possibility of variations in lifestyle, unless the portfolio is worth 10M or do.

But you dont keep withdrawing money at a constant rate until you run out of money. You take long term action to deal with long term trends. Running out of money before death or leaving excess money at death are the result of long term trends. You can take short term action in the form of a cash buffer to deal with short term events. Dealing with events purely by year to year fluctuations in income is not a practical alternative unless your expenditure is way above your needs.

4. On approaching death - variable withdrawal strategy suggests putting the balance of your portfolio into an inflation protected annuity once you reach 80 or 85. This is done to mitigate longevity and senility risks.

The inflexibility of annuities makes them inadequate for handling care costs. If you spend your money on one at 80 and need care at 85 to help you through the onset of some illness that will cause you to die early you are stuck. Yes an annuity could be a partial solution but its not sufficient.

None of it is done “blindly”, plus there are income smoothing approaches people use within this strategy.

The original strategy is "blind" and mechanistic just like the strawman alternative of a fixed withdrawal regardless of events. Once you start to bring in income smoothing you dilute its theoretical purity and effectiveness.


To some extent it is a matter of priorities. Do you focus on maximising income in particular years and then tweak to try to reduce the bad effects of income fluctuation or do you focus on stability and tweak to prevent excess or insufficient wealth being left at end of life? I am advocating the latter on the grounds that its easier for managing your life.

[Deleted User]

I think the primary objective of VPW strategy is to minimise the probability of running out of money before death.

Linton

Deleted_User wrote: »

I think the primary objective of VPW strategy is to minimise the probability of running out of money before death.

That, or rather ensuring that one has a healthy but not excessive balance at death, is a given for any sensible strategy. The question is how to achieve it.

shinytop

As usual, great information and debate from this forum. Personally, my future departed self won't mind having some money left, as long as I'd spent as much as I needed when alive!

I'd be interested to hear what the IFAs on the forum typically advise their clients regarding expected growth. I doubt most clients would be able to, or would want to, understand Monte Carlo simulation and Variable Withdrawal Strategies.

bostonerimus

Deleted_User wrote: »

I think the primary objective of VPW strategy is to minimise the probability of running out of money before death.

...but they are often promoted as a way to increase the withdrawal rate.

The classic "4% rule" a la Trinity bakes in a failure probability of maybe 5% and those failure scenarios usually have significant investment losses early on.

As far as annuities go most people simply can't afford them right now. I can see them as useful tools towards the end of life when costs are fixed and longevity insurance becomes paramount, but if you've mess up drawdown you might not have enough to buy a reasonable annuity.

Not enough emphasis is placed on budgeting and controlling living costs. Everyone should have a prioritized list of expenses so they can easily cut things out in a bad year without having to think in the moment.