SWR Question

Albermarle

I presume that if you can largely avoid sequence of returns risk by having a large cash buffer to use during a downturn, then this will decrease the risk/increase the SWR?

Prism

michaels said:

Two little known issue with the SWR:

1) It effectively assumes perfect foresight during the drawdown period - in some scenarios about half way in the pot gets down to only 3 or 4 years worth of withdrawals but a market boom makes it all work out in the end.  In reality if you were living through that 'sequence' you would very definitely have cut expenditure before things got so tight hence actually you can't be certain that you would really take a constant  inflation adjusted' income despite what the history tells us.

2) Constant real terms income actually falls behind average earnings over a long retirement - you could quite easily retire on 'average income' and after 20-30 years be below the poverty line.

Yes, if you map out the SWR 4% starting in 2000 it gets pretty uncomfortable very quickly but all works out in the end by around 2012 when it at least stops dropping. Most people would have cut back if possible during the low points.

Prism

Albermarle said:

I presume that if you can largely avoid sequence of returns risk by having a large cash buffer to use during a downturn, then this will decrease the risk/increase the SWR?

I have found that in the worse cases, being the only ones we really care about a cash buffer doesn't help that much unless it is really big - like 5-10 years of spending. One of the problems is also regenerating the cash buffer for next time.

Let take 2000 as an example, with only a 3 year buffer you spend it all at the start and then have to start eating into equities at the very bottom. When do you get chance to build up the buffer back to 3 years? 4 years later you get hit with the GFC and you are down again drawing equities.

If we look at the original 50/50 or 60/40 models and assume that a cash buffer might take the place of some or all of the bonds then we are talking about somewhere between 10-15 years cash and bonds which would have been the most optimal solution for the first half of this century and was almost essential for retirements starting in the late 1960's.

gm0

Yes indeed cash bufffers are the worst plan ever apart from the plan where you don't have one or an alternative set of strategies in mind. In many ways holding cash buffers as a SORR contingency is just like the fire insurance -  Cheaper fire insurance that doesn't pay out (no cash buffer) is much better in all the other scenarios where there isn't actually a fire.

More seriously a bad sequence hitting on a high indexed income taken from an inflated pot (which has reached "the number" only because it is over long term valuation trend) is a recipe for occasional and serious disappointment for some cohorts. The fact that average returns are OK later due to a recovery when you are already depleted doesn't help you but makes the arithmetic of average returns look OK

I think you need to pick a poison or indeed a cocktail of possibilities (all of which come with compromises of one sort or another)

- Lower starting WR to 100% safe (MSWR) or failure rate du choix
- Accepting variable income or indexation skips along the way - GK or EM or VPW or other methods for variable income
- Consuming cash buffers and halting deaccumulation investment sales during the initial plummet of a major correction
- Fuse portfolios of less or better non-correlated assets to core holdings
- Earlier downsizing of home to release capital (if there is any)
- Compromise of any inheritance motivation as may exist (expectation of non-depleted funds disappears)
- Changing inheritance approach from still living parents (deed of variation is not used to skip a generation as the IHT issue has been replaced with a diminished retirement)

It doesn't matter what you choose to your circumstances - but you should have something in mind to deal with - what do I do if there is a 60-80% equities valuation correction (the long term "sine"-wave overlaid on upward growth trend)

SouthCoastBoy

"More seriously a bad sequence hitting on a high indexed income taken from an inflated pot (which has reached "the number" only because it is over long term valuation trend) is a recipe for occasional and serious disappointment for some cohorts. "

Isnt the swr meant to negate this? I.e. it doesnt matter when you start withdrawal as long as you keep at 3 to 3.5% as the long term average.

jamesd

Yes, it does. When you start doesn't matter and you can recalculate using your remaining plan duration whenever you like. That's because the methods calculate their safe rate based on the worst starting point seen in the analysis period.

We can look at starting conditions and get some idea of what to expect because the cyclically adjusted price/earnings ratio is inversely correlated with ten year returns. Start when it's low and you're likely to be able to increase your income. Start high and you may well have to stick with the starting level.

jamesd

ac198179 said:

 Assume a 4% SWR, I thought that each year you took out 4% of your pot (plus adjustment each year for inflation, but let's ignore inflation just for now). But is it actually that each you take out 4% of your starting balance at retirement? E.g. say I retire at 57 with a pot of £100k, 4% of which is of course £4k - is that how much I withdraw on each of the following years, or do I withdraw 4% of the new balance each year? So, assuming no growth at all between year 0 and year 1, do I then withdraw 4% of £96k?

4% of the starting balance each year plus those inflation increases. Ignore year on year value changes. Do adjust down to get some extra safety margin if you experience a horrible initial five to ten years. The rates are safe but there's strictly no rule preventing you from the misfortune of experiencing something worse.

But be aware:
1. That is for a US investor using a fifty fifty mixture of equities and government bonds

2. Adding substantial small cap weight increased it to 4.5%
3. The UK equivalent to 4% is 3.7% using UK investments

4. It's for a thirty year plan, you need to start lower for say forty years

5. It ignores costs. Deduct one third of costs to allow for them

6. It's for 100% success within the analysis period. If you're willing to adapt if you live through bad times you can use 99%, 90% or 75% or even 50% success rate to get a higher starting level. Something like fifty percent success might work for a person with all core needs covered by guaranteed income who's flexible about this part.

JohnWinder

Albermarle said:

I presume that if you can largely avoid sequence of returns risk by having a large cash buffer to use during a downturn, then this will decrease the risk/increase the SWR?

If you were going to run into a bad SOR in your early years of withdrawals then you'd definitely benefit from a large cash buffer. But if the bad SOR didn't hit, the 4% rule might fail you because too much is in cash which costs you lost earnings from bonds and stocks. Since the 'rule' was developed without a big cash holding, you have to use the same no/tiny cash holding as the portfolio of the 'rule' developers to be following the rule. Sadly, there's no way around it.

The 'rule' is very useful for anyone having no idea if they have enough to retire on; beyond that it's not much use, because not many people have un-fluctuating income needs during 30 years of retirement. As well, any half sensible person would cut their spending during bad return times and loosen it thereafter, if they can. But for anyone without a clue as to whether they have enough to retire on: if you've got 25 times your anticipated annual needs, you're probably ok (although for a UK based investor one version of the 'rule' says about 30 times).  https://retirementresearcher.com/4-rule-work-around-world/

But no one willingly and sensibly severs other income sources to rely on an inflexible spending 'rule' based on so many assumptions and conditions that you or I couldn't hope to meet.   And the 'rule', according to simulations, leaves a large minority (or more) of people arriving at 30 years after retirement with more than they started with. That's crazy unless planned - it's just a guide.

jamesd

Prism said:

I have found that in the worse cases, being the only ones we really care about a cash buffer doesn't help that much unless it is really big - like 5-10 years of spending. One of the problems is also regenerating the cash buffer for next time.

Let take 2000 as an example, with only a 3 year buffer you spend it all at the start and then have to start eating into equities at the very bottom. When do you get chance to build up the buffer back to 3 years? 4 years later you get hit with the GFC and you are down again drawing equities.

If we look at the original 50/50 or 60/40 models and assume that a cash buffer might take the place of some or all of the bonds then we are talking about somewhere between 10-15 years cash and bonds which would have been the most optimal solution for the first half of this century and was almost essential for retirements starting in the late 1960's.

Say we do take 2000 and have three years of cash with 3% dividends. That implies no cash use if drawings are below 3% of the pot. Say they are 5% of the pot, 4% or lower originally, I'm assuming some depletion. Three years of 100% income at that same 5% is 15%. With only a 2% a year subsidy from cash needed, that's seven and a third years before the cash is gone and drawing switches to bonds. It's never have got close to equities unless very low cash plus bonds percentage was being used.

jamesd

Albermarle said:

I presume that if you can largely avoid sequence of returns risk by having a large cash buffer to use during a downturn, then this will decrease the risk/increase the SWR?

You could but that part of the bond split being in cash would lower the SWR compared to bonds, because cash has lower total return than bonds, usually. Also remember that dividends and interest top up the cash so a year is likely to last three years.

But you can do better. In Drawdown: safe withdrawal rates the last paragraph of the first post and the core of the third are dedicated to Guyton's sequence of risk reduction method. I've used it, you could too. 

Abraham Okusanya's Cash reserve buffers, withdrawal rates and old wives’ fables for retirement portfolios has useful material on the negative aspects of cash buffers, none of the scenarios he modelled seems to have been cash replenished by interest and dividends mainly.