Growth Rate in Drawdown

Thrugelmir

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.

In 2004 Long Dated gilts averaged a yield of 4.66%. As of this week around 1.53%. Not only would you have you enjoyed the income from holding an element of fixed interest securities but also have on paper a notional capial gain. Same principle applies to corporate (blue chip) bonds and open ended fixed interest debenture stocks.

[Deleted User]

All Monte Carlo does = predicts probability using random sampling. VPW is even simpler. One does not need to understand equations behind the Monte Carlo simulation but an intuitive feel for the laws of probability and statistical noise are necessary for financial success. As is knowledge of financial history going back to different times, eg 1970s or 1930s.

Many IFAs have traditionally advised that 4% withdrawal is safe. Using such simplistic rules of thumb is dangerous. Nobody has any clue what the next 10 or 20 years are going to be like.

Thrugelmir

Deleted_User wrote: »

Many IFAs have traditionally advised that 4% withdrawal is safe.

That's based on a historical study that was focussed on the US markets alone with a 60/40 allocation split.

[Deleted User]

bostonerimus wrote: »

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.
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More than 5%. And even if it were, 1 in 20 chance of running out of money is not good. And once people experience decimation of their portfolios in those early years (not a short sharp event but over several years), they tend make mistakes making it even worse. All of us, unless we are emotionally detached thanks to Asperger syndrom.

bostonerimus

Deleted_User wrote: »

More than 5%. And even if it were, 1 in 20 chance of running out of money is not good. And once people experience decimation of their portfolios in those early years (not a short sharp event but over several years), they tend make mistakes making it even worse. All of us, unless we are emotionally detached thanks to Asperger syndrom.

95% success rate is a standard input to the model, but you can make it what you want. The fact is that using historical data and probabilistic outcomes isn't much use to someone who needs to know what's going to happen to them.....not some average population of people. But in the absence of a DB pension or an annuity you have to make some educated guesses and maybe plan on the conservative side, or pay someone to do that for you.

I'm certainly not emotionally detached which is why I've set up my retirement so I can live off income from rent and a DB pension and I don't have to worry about investment returns to keep body and soul together. Also I use a simple index fund portfolio that I don't touch. I've even stopped rebalancing and I'm drifting up passed 75% equities as having my retirement income covered form other sources I'm ok with a volatile portfolio. I still hate it when my portfolio size goes down, but I've trained myself not to do anything about it and since I retired I actually look at it far less often.

[Deleted User]

Yes, I noticed that a lot of people stopped rebalancing. Last 10 years have been so good that many have portfolios in multiple millions, at which point they don’t have to lose any sleep over bear markets. Others just have a fixed allocation to fixed income (e.g. to provide 5 years’ worth of coverage). I kinda like that approach’s that’s what I use. Puts most at >80% equity. Besides, high equity allocation provides better protection against long term risks. I still rebalance between geographies, but mostly with new contributions.

[Deleted User]

“95% success rate is a standard input to the model” thirty year old model, which was based on (I am guessing) 5 30-year periods and projected having money left at the end of 30 years. We don’t know that there won’t be systematic changes in the future and, crucially, people have a good chance of living far longer than 30 years. And given that people drift from 60/40, the model doesn’t apply.

In summary,probability of running out of cash is quite high if one follows the 4% rule. Bernstein provides a neat overview in deep risk.

Linton

Deleted_User wrote: »

All Monte Carlo does = predicts probability using random sampling. VPW is even simpler. One does not need to understand equations behind the Monte Carlo simulation but an intuitive feel for the laws of probability and statistical noise are necessary for financial success. As is knowledge of financial history going back to different times, eg 1970s or 1930s.

Monte Carlo simulation in this area may make you feel happy but I do not believe the probability theory behind it has much justification. What is the probability of say a 50% equity crash in the next 10 years? It is impossible to say, its a meaningless statistic. It will either happen or not happen. If it happens it could well be a "black swan" event - some external event that bears no relationship to the normal operation of the market and cannot be predicted from historical market data.



Lets take an example - someone in retirement for 20 years during some of the 20th century had very roughly a 50% chance of having to deal with the effects of a world war. Should we use that statistic in designing our retirement strategy? After all its based on 100 years of data and 50% is a very high probability.


VPW doesnt help either. It doesnt actually tell you whether the pot of money you hold is sufficient to ensure a comfortable retirement. How solely by using VPW could you decide whether to retire now or wait til 10 years time?



A better way of dealing with major events is to simply model the possible effects. Its pretty easy to do - simply see what happens to your model if your equity assets drop by 50% at some point. You can get to the point at which your strategy can deal with some major calamities but beyond that you have to shrug your shoulders and say that should something really nasty happen one will have to deal with it at the time.

Many IFAs have traditionally advised that 4% withdrawal is safe. Using such simplistic rules of thumb is dangerous. Nobody has any clue what the next 10 or 20 years are going to be like.

Have they? Any evidence? They certainly havent on this forum.


I agree that no-one has any idea what the next 20 years is going to be like. What do you do about it? Probabilistic analysis of extreme events is meaningless though if it gives you some comfort that is fine. Decide that everything is far too risky and so one had better not retire? For planning purposes rules of thumb are as good a a basis as anything else we have.

[Deleted User]

Japanese and German bondholders saw losses of more than 95%; during and immediately after the Second World War; stocks in both nations fell by about 90%.

In the forty years between 1940 and 1979, French investors saw the real value of their bills decrease by 96% (-7.8% annualized) and of their bonds by 84% (-4.5% annualized).

Between January 1990 and June 2013, large cap Japanese stocks experienced a return (in real terms) of -58.2%.

In the UK long treasuries lost 73% over 40 years to 1981.

US stocks have been known to fall by over 90%.

In 2008-9 assets world over experienced falls of around 50% (although it was a short event).

My point is that assuming long term money weighted return (be it 3% or whatever) is meaningless as sequence of returns defines ones chances of staying afloat.

Major drops are not “extreme”. Designing ones retirement strategy in a manner that can deal with them is important in my book. Assumed fixed withdrawal rate ensures one runs out of money under many plausible scenarios (unless you have other sources of income, like Boston). Most of us do, but often it’s not enough. VPW ensures this does not happen.

bostonerimus

Deleted_User wrote: »

“95% success rate is a standard input to the model” thirty year old model, which was based on (I am guessing) 5 30-year periods and projected having money left at the end of 30 years. We don’t know that there won’t be systematic changes in the future and, crucially, people have a good chance of living far longer than 30 years. And given that people drift from 60/40, the model doesn’t apply.

In summary,probability of running out of cash is quite high if one follows the 4% rule. Bernstein provides a neat overview in deep risk.

Straight historical simulations with 100 years of data could come up with 70 rolling 30 year investment periods, but Monte Carlo can use the historical data to come up with as many sets of investment data over as many years as you want.

It's important to grasp what modelling can and cannot do. At best it can point you in the right direction, but it won't tell you everything about the actual path you follow. So you need to live with uncertainty and mitigate the risk where you can.