Foolishness of the 4% rule

jamesd

Audaxer said:

But if you have a spouse, and you were to pass away before you had recouped the deferred pension, your overall pot left to your spouse could be much lower than it would have been if you hadn't deferred. Even more so if you had been more aggressive with your DC drawdown.

If your health is good you'll find that term life insurance is cheap. If it's not good enough for it to be cheap then deferring may well be unwise. So you can buy the insurance to protect the declining value of the amount forgone.

jamesd

Audaxer said:
  

But if you have a spouse, and you were to pass away before you had recouped the deferred pension, your overall pot left to your spouse could be much lower than it would have been if you hadn't deferred. Even more so if you had been more aggressive with your DC drawdown.

The spouse is presumably benefitting from the higher overall household spending so they aren't actually losing out.

It's a bit like those who were contracted out of the earnings-related part of the state pension in a scheme which used lower NI deductions rather than more scheme pension and are unhappy with their lower state pension, while ignoring decades of higher take home pay.

jamesd

Madrick said:

With the calculations on the pros and cons of deferred State Pension, are we also factoring in the annual growth of at least 2.5% increase.

Is the 5.8% on top of that or is it combined with the increase that everyone gets anyway? 🤔

While deferring the state pension does what it usually does:

1. for the portion up to the single tier cap, triple lock increases
2. for transitional protection amounts above this, CPI increases

When you stop deferring the calculated value of the state pension after all of those years of increases is calculated. You get 5.8% times the number of years deferred and pro-rated for parts of years in 9 week increments as extra state pension for life. The extra amount increases by CPI, not triple lock.

This describes only the situation for those reaching state pension age since April 2016, not the old rules approach. It also assumes living in a place which gets the annual increases, which are no longer added while deferring in many parts of the world.

There are three chief benefits from deferring for yourself:

1. the income is guaranteed and inflation protected for life at a rate almost double that of annuity purchase in the early years.

2. assorted people have observed that as you get more guaranteed income as a percentage of the income you must have for normal life, it's sensible to take more income from drawdown by using a lower success rate. Blanchett formalised this in a paper he wrote.

3. If you'd use low return investments like cash savings the payback for deferring can beat the alternative you'd use for the earlier income.

In addition a spouse can be protected by them or you paying for their own deferral, to provide them extra protection after your death.

jamesd

bostonerimus said:

I think the elephant in the room in this "4% foolishness" discussion is the cost of financial fees. They were mentioned in passing above, but it's important to consider that they might take 50% of you initial retirement income ie they could cut your spendable income in half...

That's not a likely reduction in SWR.

US first, the original US finding was actually around 4.15% and 4% actually ended up covering inexpensive costs. But in the UK the calculated value including (not deducting) all costs is 3.7% so that's not applicable here.

However, if you want to lose half of the 3.7% in costs (fees and investment charges) then you're postulating that they are around three times the 1.85% deduction, so 5.55% a year. That's possible but not likely.

The reason for this is that in the depleting capital value cases that set the limiting safe withdrawal rate, the capital value is decreasing. Since the costs are generally a percentage of invested capital, the costs each year are falling, so are no longer 100% of the costs on the initial capital value. Around thirty percent or a third turns out to be the effect on the relevant limiting cases used for the SWR.

What that implies is that 1.5% in total costs (including those incurred inside funds) would reduce the UKs 3.7% to 3.2% for you and 0.5% going in costs.

If you don't live through the bad times then the costs will be higher as a percentage but you're also getting a higher income if you use a variable SWR that makes increases or recalculate constant inflation-adjusted income.

jamesd

Deleted_User said:

18k isn't credibly low enough. The reason is what it takes to achieve the situation postulated.
A 70% one day drop in combined equity and bond markets is far worse than anything seen in the history used to develop the rules…

Who said “one day”?  In 1929 the stock market lost 85% so 70% is credible. Under SWR you keep withdrawing the same amount regardless so the speed of the crash isn’t all that relevant.  

Are you assuming 50% in bonds? In 1929 the interest rates dropped and bonds went up. Today the interest rates cant go much lower.  Some say we have a bubble in bonds. Given investors are guaranteed a loss in real terms, I see the logic in that argument. 

It was you who said one day, quoted by me from the part you didn't include in your quote asking me who said it, specifying a drop from a million Pounds to 300k on January 2nd 2023. 2nd January is one day.

 "Deleted_User said:

Lets say you have 1 million pounds at the start of your retirement in 2022. Your portfolio drops to 300K on January 2nd 2023.  How much are you going to withdraw? "


Under a SWR you don't keep withdrawing the same amount regardless. That depends on the rules being used and Guyton-Klinger won't keep drawing the same amount, while constant inflation-adjusted income will.

I'm assuming whatever you'd care to assume that produced a 70% drop in total portfolio value in one day, though preferably constrained to within the fifty to seventy-five percent equities range normally used for SWR research. 50:50 (original US 4% rule) would achieve it with a 90% equity drop and 50% bond drop. Or 80% equity drop and 60% bond drop. Or other permutations that come to just 30% remaining. Once you pick a possible case or ten then you'd need to think what real world events it would take to produce that outcome in such a short time. The extreme rapidity and magnitude for the whole portfolio was what made one day such a challenge and well outside the scope of the SWR testing that produced the SWRs.

1929 wasn't the worst US case - that was 1969 - so if in a 30 year plan you just kept on increasing with inflation each year you'd achieve your thirty years and have money left over, because the worst case result also works for the better cases like 1929. It happened and it's definitely credible that it could happen again. But it didn't happen in just one day, which is a far, far more severe scenario in the nuclear war or major asteroid impact sort of range. There was time and of course bond performance that allowed for less sequence of return negativity in the outcome for those years.


BTW, VPW deserves a thread of its own so I'll probably start one on that at some point, though I'd definitely prefer it if you did it after finding some good and reasonably succinct descriptions.

[Deleted User]

jamesd said:

Deleted_User said:

18k isn't credibly low enough. The reason is what it takes to achieve the situation postulated.
A 70% one day drop in combined equity and bond markets is far worse than anything seen in the history used to develop the rules…

Who said “one day”?  In 1929 the stock market lost 85% so 70% is credible. Under SWR you keep withdrawing the same amount regardless so the speed of the crash isn’t all that relevant.  

Are you assuming 50% in bonds? In 1929 the interest rates dropped and bonds went up. Today the interest rates cant go much lower.  Some say we have a bubble in bonds. Given investors are guaranteed a loss in real terms, I see the logic in that argument. 

It was you who said one day, quoted by me from the part you didn't include in your quote asking me who said it, specifying a drop from a million Pounds to 300k on January 2nd 2023. 2nd January is one day.

 "Deleted_User said:

Lets say you have 1 million pounds at the start of your retirement in 2022. Your portfolio drops to 300K on January 2nd 2023.  How much are you going to withdraw? "


Under a SWR you don't keep withdrawing the same amount regardless. That depends on the rules being used and Guyton-Klinger won't keep drawing the same amount, while constant inflation-adjusted income will.

1929 wasn't the worst US case - that was 1969 - so if in a 30 year plan you just kept on increasing with inflation each year you'd achieve your thirty years and have money left over, because the worst case result also works for the better cases like 1929. It happened and it's definitely credible that it could happen again. But it didn't happen in just one day, which is a far, far more severe scenario in the nuclear war or major asteroid impact sort of range. There was time and of course bond performance that allowed for less sequence of return negativity in the outcome for those years.

I'm assuming whatever you'd care to assume that produced a 70% drop in total portfolio value in one day, though preferably constrained to within the fifty to seventy-five percent equities range normally used for SWR research. 50:50 (original US 4% rule) would achieve it with a 90% equity drop and 50% bond drop. Or 80% equity drop and 60% bond drop. Or other permutations that come to just 30% remaining. 

BTW, VPW deserves a thread of its own so I'll probably start one on that at some point, though I'd definitely prefer it if you did it after finding some good and reasonably succinct descriptions.

Perhaps I didn’t express myself well. Sorry. What I meant was that you start with 1M on Jan 2nd 2022 and on Jan 2nd 2023 your portfolio is worth 300K. Really did not mean to suggest that it stays constant for a year and then drops 70% in 1 day. You withdraw your 40k at the beginning of 2022. Or 30k if you use 3% SWR. How much are you going to withdraw on Jan 2nd 2023? Its a similar example to the one referenced in the original post in this topic.  

Under SWR you withdraw the same inflation-corrected amount regardless of what the market does . Because its a safe rate.  Its in the name. 

dean350

Seeing your portfolio drop massively in retirement and carrying on drawing 4% does require big cojones. However its nearly the same psychology as during the accumulation phase when markets drop and you decide to up your share purchases. Relying on DC pots requires firstly faith and a good dose of mental self discipline.

Thrugelmir

Deleted_User said:

18k isn't credibly low enough. The reason is what it takes to achieve the situation postulated.
A 70% one day drop in combined equity and bond markets is far worse than anything seen in the history used to develop the rules…

Who said “one day”?  In 1929 the stock market lost 85% so 70% is credible. Under SWR you keep withdrawing the same amount regardless so the speed of the crash isn’t all that relevant.  

Are you assuming 50% in bonds? In 1929 the interest rates dropped and bonds went up. Today the interest rates cant go much lower.  Some say we have a bubble in bonds. Given investors are guaranteed a loss in real terms, I see the logic in that argument. 

If you weren't invested in the US markets in 1929. Which many global investors weren't at the time. You wouldn't have been impacted. Stock markets are a very different place today to a 100 years ago. 

[Deleted User]

dean350 said:

Seeing your portfolio drop massively in retirement and carrying on drawing 4% does require big cojones. However its nearly the same psychology as during the accumulation phase when markets drop and you decide to up your share purchases. Relying on DC pots requires firstly faith and a good dose of mental self discipline.

Nope. Purchasing during accumulation regardless of what the stock market is doing would be smart.  You are buying at a discount when the market drops.  Withdrawal SWR after a substantial drop in the early phases of retirement is dumb. You are depleting your pot. May never recover. Major risk of running out of funds. Sequence of return risk.  

Also, “deciding to up share purchases” implies market timing.  Does not work.

michaels

Deleted_User said:

dean350 said:

Seeing your portfolio drop massively in retirement and carrying on drawing 4% does require big cojones. However its nearly the same psychology as during the accumulation phase when markets drop and you decide to up your share purchases. Relying on DC pots requires firstly faith and a good dose of mental self discipline.

Nope. Purchasing during accumulation regardless of what the stock market is doing would be smart.  You are buying at a discount when the market drops.  Withdrawal SWR after a substantial drop in the early phases of retirement is dumb. You are depleting your pot. May never recover. Major risk of running out of funds. Sequence of return risk.  

Also, “deciding to up share purchases” implies market timing.  Does not work.

Withdrawing from cash/bonds when markets are down implies market timing.  Does not work?