SWR Question

jamesd

Deleted_User said:

jamesd said:

Given that the usual 4% rule is calculated for no failures, where does the 1 in 20 probability of failure come from?

The usual 4% rule is calculated with a 95% confidence level of not outliving your money within a 30 year period assuming the  future is like the past.  That translates to a 5% or 1 in 20 probability of failure. 

It would if it was calculated for 95% success but the usual calculation is for 100% success.

The 4% Rule And The Search For A Safe Withdrawal Rate  by Pfau explains:

'In the early 1990s, William Bengen read misguided claims in the popular press that average portfolio returns could guide the calculation of sustainable retirement withdrawal rates. If stocks average 7% after inflation, then plugging a 7% return into a spreadsheet suggests that retirees could withdraw 7% each year without ever dipping into their principal.

Bengen recognized the naivety of this calculation, because it ignores the real-world volatility experienced around that 7% return, and he sought to determine what would have worked historically for hypothetical retirees at different points in the past. He used Ibbotson Associates data extending back to 1926 for U.S. financial markets. His research introduced the concept of sequence of returns risk to the financial planning profession.

The problem he set up is simple: a new retiree makes plans for withdrawing some inflation-adjusted amount from their savings at the end of each year for a 30-year retirement period. For a 65-year old, this leads to a maximum planning age of 95, which Bengen felt was reasonably conservative.

What is the highest withdrawal amount as a percentage of retirement date assets that, with inflation adjustments, will be sustainable for the full thirty years? He looked at rolling thirty-year periods from history, such as 1926 to 1955, 1927 to 1956, and so on. He found that with a 50/50 asset allocation to stocks and bonds (the S&P 500 and intermediate term government bonds), the worst-case scenario experienced in U.S. history was for a hypothetical 1966 retiree who could have withdrawn 4.15% at most.

Thus we have what is known as the "4% rule."'

And surviving that worst case means 0% failures.

Of course people can use their choice of success rate and plan duration with tools like cFiresim or Firecalc but that's not the standard. 95% is pretty popular and for UK retirees its main effect is to eliminate WW2. Not much chance of failing to notice that you're living through that and adjust down if you do.

ac198179

Beginning to wish I hadn't posted my original question! I seem to have opened a can of warms!

jamesd

Not so much a can of worms as differing preferences and views. Have a slow read of Drawdown: safe withdrawal rates for links introducing the subject so you can decide for yourself.

Croeso69

ac198179 said:

Beginning to wish I hadn't posted my original question! I seem to have opened a can of warms!

The heat is on!

jamesd

Croeso69 said:

ac198179 said:

Beginning to wish I hadn't posted my original question! I seem to have opened a can of warms!

The heat is on!

Indeed, Mr. Foley / Murphy.

BritishInvestor

JohnWinder said:

Yes, it's worth reading more fully on this, as one would discover that 'safe' means the method fails in only 5% of circumstances based on history. That wouldn't be safe enough for me, but you only have drop to about 3.7% instead of 4% withdrawal to be 99% certain of never running out. And if one kept reading one discovers it's not designed for 50 years of withdrawal, but 30.

What fees and asset allocation are you assuming to get this? Sounds high.

jamesd

3.7% is the UK equivalent of fifty percent large cap and fifty percent intermediate bonds in the US. But both are before costs and the adjustment for that is to deduct a third of costs. And of course it's for thirty years, not fifty, so it is a bit high.

Guyton-Klinger at 99% success for for forty years starts at 5.5% with a 65% equities and 35% bonds mix.

I usually give 3.2% and 5% to allow for 1.5% total costs.

Croeso69

jamesd said:

3.7% is the UK equivalent of fifty percent large cap and fifty percent intermediate bonds in the US. But both are before costs and the adjustment for that is to deduct a third of costs. And of course it's for thirty years, not fifty, so it is a bit high.

Guyton-Klinger at 99% success for for forty years starts at 5.5% with a 65% equities and 35% bonds mix.

I usually give 3.2% and 5% to allow for 1.5% total costs.

I dont like bonds in the current environment. How good is G-K for 95% equity and 5% cash to fund drawdown?

jamesd

I use cash - a mortgage offset account - and P2P lending as bond substitutes at the moment.

Cash is part of the bonds cut when you're using it as a bond substitute. It's fine to do that in situations like the current one as long as you switch to bonds when they make sense again. We're currently in a situation comparable to the odd few historic cases where cash was a better choice than bonds.

Croeso69

jamesd said:

I use cash - a mortgage offset account - and P2P lending as bond substitutes at the moment.

Cash is part of the bonds cut when you're using it as a bond substitute. It's fine to do that in situations like the current one as long as you switch to bonds when they make sense again. We're currently in a situation comparable to the odd few historic cases where cash was a better choice than bonds.

Dont really like the idea of 35% cash, seems such a waste.