Foolishness of the 4% rule

MK62

If you look at your example, instead of starting with 50k in cash and 200k invested, if you started with 25k in cash and 225k invested, after 3yrs you'd have £281k......if you took the other 25k cash then, you'd be left with 256k rather than 250k.......so the opportunity cost would have been 6k.
Of course, at the start you could not know markets would rise 25%.......

bostonerimus

Deleted_User said:

A year ago in Canada Vanguard introduced an ETF to deal with retirement withdrawal needs. Called VRIF. Its made up of stocks and bonds (50/50) and has a stable allocation to world trackers with extra weighting assigned to home market. The “dividend” is designed to start at 4% and then increase or decrease, depending on market movements. But the change is limited not to exceed X. 

So, its a much more sensible strategy than the 4% SWR. Not a bad product. Costs around 30 basis points, I think.  A bit high but tolerable (no other “platform” or trading charges  and you wouldn’t use an advisor if you buy this product). Quite popular, I believe. 

Still, I prefer “the bucket” approach and to manage non-DB withdrawals myself according to a transparent system.  

US Vanguard had a similar fund called the Managed Payout Fund, but they changed it to the Managed Allocation Fund and instead of paying 4% annually in monthly payments they went to a variable annual dividend. It has 60% equities. Then there are the conservative funds like Target Retirement Income which is 30/70 and the veritable Wellesley fund which is 40/60 and is a favorite of many US retirees. Its fees are 0.23%, but it has a history of consistent dividends and growth. Below are the average annual returns.

	1-yr	3-yr	5-yr	10-yr	Since inception 07/01/1970
	13.50%	9.71%	7.41%	7.76%	9.70%

Audaxer

MK62 said:

If you look at your example, instead of starting with 50k in cash and 200k invested, if you started with 25k in cash and 225k invested, after 3yrs you'd have £281k......if you took the other 25k cash then, you'd be left with 256k rather than 250k.......so the opportunity cost would have been 6k.
Of course, at the start you could not know markets would rise 25%.......

Yes, but if these 3 years had been negative and shown a 25% loss overall, and you had used up your £25k cash buffer, you would be left with investments worth £168,750 and no cash buffer. If you were looking to continue now with the same income, you would be starting at around £8,600 which is 5.1% of your current investment value. It might still be okay, but I'd be a bit concerned and I would think I needed to lower my withdrawals. 

That's why I'm thinking that if you can afford it, it's better to have cash to cover the first few years income as well as a cash buffer.

michaels

Any strategy where you change the mix between cash and equities depending on some perception of whether markets are 'high' or 'low' is 'timing the market'.  Most of the literature suggests that trying to time the market is as likely to lead to underperformance as overperformance - may be more so as it involves extra trades.

Sea_Shell

michaels said:

Any strategy where you change the mix between cash and equities depending on some perception of whether markets are 'high' or 'low' is 'timing the market'.  Most of the literature suggests that trying to time the market is as likely to lead to underperformance as overperformance - may be more so as it involves extra trades.

So to avoid this, should you instead "drawdown" your overall pot in direct proportion to how the pot is held, regardless of what the market is doing?

michaels

Sea_Shell said:

michaels said:

Any strategy where you change the mix between cash and equities depending on some perception of whether markets are 'high' or 'low' is 'timing the market'.  Most of the literature suggests that trying to time the market is as likely to lead to underperformance as overperformance - may be more so as it involves extra trades.

So to avoid this, should you instead "drawdown" your overall pot in direct proportion to how the pot is held, regardless of what the market is doing?

If you believe that the market moves in a random way then yes, the 'history' of whether the market was higher or lower last week or last year makes no difference to where it will be next week or next year.

This seems like an extreme assumption common sense says we can look at a long series of historic data and that the market shows an overall climb with fluctuations up and down from this and so if the market is below the long term trend then sometime in the future it will rise and vice-versa.

Problem in logic with this is that if you as an individual can see a chance for a profit because the market is low and therefore likely to rise in the medium term or high and likely to fall then so can everyone else and they will buy or sell shares (or drawdown form cash or equities) accordingly.  So imagine everyone thinks the market is high, the logical thing is to sell shares and keep more cash until it gets back to normal.  Everyone tries to do this and there are more sellers than buyers and down the market goes to the point where it no longer makes sense to sell because it is back to its 'correct' level.

So basically if you can for certain do better by moving from shares to cash then this winning strategy is obvious to everyone and so the very fact that everyone is trying to do it will remove the opportunity.

Not sure my explanation is very clear but the logic is certain.

Audaxer

michaels said:

Any strategy where you change the mix between cash and equities depending on some perception of whether markets are 'high' or 'low' is 'timing the market'.  Most of the literature suggests that trying to time the market is as likely to lead to underperformance as overperformance - may be more so as it involves extra trades.

I wasn't suggesting timing the market. I was saying that the safest option seems to be using cash as income for the first few years, and keeping a cash buffer, if you already have enough invested to subsequently fund your withdrawals

[Deleted User]

michaels said:

Any strategy where you change the mix between cash and equities depending on some perception of whether markets are 'high' or 'low' is 'timing the market'.  Most of the literature suggests that trying to time the market is as likely to lead to underperformance as overperformance - may be more so as it involves extra trades.

It does not matter what you call it.  The problem with “timing the market” is that humans were not designed for it and normal human emotions  lead to bad investment timing.  This fundamental problem could at least hypothetically  be mitigated by having a strict algorithm make decisions for you.  And using the cash wedge during market downturns does not result in extra trades.  

The main problem is that its hard to execute this strategy.  When the sky is falling and your cash is the only thing holding value, will you really be able to deplete this one resource that is working for you? I think its much easier if you have sufficient DB income to cover the bucket of your basic needs and the cash bucket is only there for contingencies. 

bostonerimus

Audaxer said:

michaels said:

Any strategy where you change the mix between cash and equities depending on some perception of whether markets are 'high' or 'low' is 'timing the market'.  Most of the literature suggests that trying to time the market is as likely to lead to underperformance as overperformance - may be more so as it involves extra trades.

I wasn't suggesting timing the market. I was saying that the safest option seems to be using cash as income for the first few years, and keeping a cash buffer, if you already have enough invested to subsequently fund your withdrawals

Having a cash buffer is all part of a Total Return retirement strategy. It means that you can delay having to sell when the market is down, but it also means having a significant amount of capital not earning very much. But if you need all of your money to be in the markets to generate enough income you should probably not be retired anyway.

This is all really a game of asset allocation that is significantly more complicated than when you were accumulating your pot and also because the tool of lifetime annuities has become such bad value to fund an entire retirement. When I looked at this problem my first ideas were to use dividend stocks, investment grade bonds and turn a small variable annuity I had into lifetime income (rates were better then), but I found myself desiring low risk income and so 15 years before I retired I bought a rental property with the goal of having the mortgage paid off before I retired and 10 years before I retired I took a job with a DB pension. I calculated that the rental income and the DB pension would provide a solid income floor largely independent of the financial markets. That has proved to be true and I was grateful over the last "pandemic year". The pension kept coming in and the rental was ok, although I did reduce the rent to help out my tenant for 3 months when she couldn't work. What I'm saying is that even as you are accumulating your pot you should be thinking of how you will use it to generate retirement income and some long term planning and make the transition a lot easier.

Linton

Deleted_User said:

michaels said:

Any strategy where you change the mix between cash and equities depending on some perception of whether markets are 'high' or 'low' is 'timing the market'.  Most of the literature suggests that trying to time the market is as likely to lead to underperformance as overperformance - may be more so as it involves extra trades.

It does not matter what you call it.  The problem with “timing the market” is that humans were not designed for it and normal human emotions  lead to bad investment timing.  This fundamental problem could at least hypothetically  be mitigated by having a strict algorithm make decisions for you.  And using the cash wedge during market downturns does not result in extra trades.  

The main problem is that its hard to execute this strategy.  When the sky is falling and your cash is the only thing holding value, will you really be able to deplete this one resource that is working for you? I think its much easier if you have sufficient DB income to cover the bucket of your basic needs and the cash bucket is only there for contingencies. 

The problem with predicting the market is deeper than humans not being designed to do it.  There cannot be an algorithm that could make optimal investment decisions for you no matter what the economic circumstances for the reason that Michaels gives - the use of any such algorithm will invalidate its own prediction.

Whether the market is random is difficult to prove. It probably isnt completely so in the short term as there seem to be momentum effects. However the best approach is in my view to assume that it is and so dont worry about it - treat it like the UK weather.  You need an asset allocation that you can live with no matter what the circumstances and keep to it through the good times and bad. In dealing with the weather you have appropriate clothing in your wardrobe that can deal with most things.  Just like the situation with the weather you have to accept that your wardrobe will not be able to protect you from the real extremes.