Foolishness of the 4% rule

Thrugelmir

Terron said:

Deleted_User said:

There are 4 “buckets” that each retiree needs to think about:

1. Basic, routine needs.  Food. Shelter. Car if you need it. Books. Newspapers. Beer.  Those kinds of things.  This income is best secured by something actually safe. State pension. Other DB pension. Annuity. Government bond (sucks right now).   Stockmarket is highly variable and the future is unknown.  Stocks can’t do this job. Keep in mind that longevity  is a good thing but also a risk for someone who relies on highly volatile investments.  And if you are on a pension board then chances are you will live longer than an average Brit. 

2. Contingency.  Roof needs replacing.  Your son needs help. Not necessarily “emergency” but non-routine expenditure. This requires a liquid source of funds.  Your stocks are technically liquid but not if you use “4% rule”.  In that case your investments are needed to secure your future 4% withdrawals and can’t be touched.  For this pot you need a separate “slush fund” in cash. 

3. Discretionary income.  Things that are “nice to have”.  Annual holidays in Hawaii. New  Porsche every 5 years. Major upgrades to your property.  Stocks are perfect for this pot. They are volatile but do provide the best chance of long term growth. Given you already secured 1 and 2 with genuinely safe sources of funds, you can and should be invested aggressively. This pot should be 100% in stocks and depleted based on the size of the pot. 4% rule does not apply. If this pot goes up by a factor of 2 in 5 years or 4 in 20 years (as it often does), it would be dumb to withdraw based on its size 5 or 20 years ago. 

4. Legacy. This pot could be in stocks (and combined with 3).  Or it could be insurance. Or certain types of annuities. 

Drawdown seems to be the way that gives the greatest income from a given pot. Thus it is the method that works best for people with only a small pot. Work out what you need as a minimum to live on, on top of the SP. Using the 4% rule you then need at least 25 times that as a target. It is better to go for more but that is a good target.

A cake can only every be cut so many ways. When some want a bigger slice than others. Then somebody will miss out.  That's the nature of the American Exceptionalism culture that has polluted the Western world. 

bostonerimus

Thrugelmir said:

Terron said:

Deleted_User said:

There are 4 “buckets” that each retiree needs to think about:

1. Basic, routine needs.  Food. Shelter. Car if you need it. Books. Newspapers. Beer.  Those kinds of things.  This income is best secured by something actually safe. State pension. Other DB pension. Annuity. Government bond (sucks right now).   Stockmarket is highly variable and the future is unknown.  Stocks can’t do this job. Keep in mind that longevity  is a good thing but also a risk for someone who relies on highly volatile investments.  And if you are on a pension board then chances are you will live longer than an average Brit. 

2. Contingency.  Roof needs replacing.  Your son needs help. Not necessarily “emergency” but non-routine expenditure. This requires a liquid source of funds.  Your stocks are technically liquid but not if you use “4% rule”.  In that case your investments are needed to secure your future 4% withdrawals and can’t be touched.  For this pot you need a separate “slush fund” in cash. 

3. Discretionary income.  Things that are “nice to have”.  Annual holidays in Hawaii. New  Porsche every 5 years. Major upgrades to your property.  Stocks are perfect for this pot. They are volatile but do provide the best chance of long term growth. Given you already secured 1 and 2 with genuinely safe sources of funds, you can and should be invested aggressively. This pot should be 100% in stocks and depleted based on the size of the pot. 4% rule does not apply. If this pot goes up by a factor of 2 in 5 years or 4 in 20 years (as it often does), it would be dumb to withdraw based on its size 5 or 20 years ago. 

4. Legacy. This pot could be in stocks (and combined with 3).  Or it could be insurance. Or certain types of annuities. 

Drawdown seems to be the way that gives the greatest income from a given pot. Thus it is the method that works best for people with only a small pot. Work out what you need as a minimum to live on, on top of the SP. Using the 4% rule you then need at least 25 times that as a target. It is better to go for more but that is a good target.

A cake can only every be cut so many ways. When some want a bigger slice than others. Then somebody will miss out.  That's the nature of the American Exceptionalism culture that has polluted the Western world. 

Pooling risk with other people and giving up the possibility of passing money onto heirs should give the biggest incomes and some people will get the mortality credit. It's a shame that sensible pensions have been replaced by the largely US invention of the DC plan which was always sold as giving the individual freedom whereas it was mostly about shifting risk to the individual.

[Deleted User]

The main difference between DB and DC pensions is how much the employer contributes. Typically contributions to DC pensions are much lower. 

Other than that, DC pensions are great.  People do get more freedom and responsibility how to handle THEIR money.  Its just that a point comes when some of the short term risk needs to be shifted.  And there are perfectly good options for doing that if you have a DC pension.  

The alternative is for your employer and regulators to have all th3 decision making (DB pension).  Tends to work particularly well when the employer is local or national government. That means the taxpayer takes on all the risk. A good deal for the bureaucracy.  Even then employees might still carry risk.  Wouldn’t want to have a DB pension from some of municipalities in the US.  

In general, most of these DB funds RELY on returns far in access of 4%.  Kinda scary. 

Sea_Shell

Just something i've been pondering...

With regards to "the markets" as a whole.   Most graphs I've seen where there has been a "correction" or a "crash" show a short, sharp downward trend, followed by a steady recovery.  eg 25% drop over a short period.

Over time, the graphs show recovery back to where they were, and often surpass the old high point.

Have we ever had the sort of market behaviour whereby the reduction has been the same, overall (eg 25%), but it's been a slow drawn out affair, maybe only losing 1% a month for 25 months instead?   Does this happen?   A slow death, if you like, instead of a heart attack!!

If anyone has any examples, I'd be keen to see them.    Not individual shares, but markets, sectors or funds.   Or does the market just not work/respond in that way.

OldScientist

Deleted_User said:

The main difference between DB and DC pensions is how much the employer contributes. Typically contributions to DC pensions are much lower. 

Other than that, DC pensions are great.  People do get more freedom and responsibility how to handle THEIR money.  Its just that a point comes when some of the short term risk needs to be shifted.  And there are perfectly good options for doing that if you have a DC pension.  

The alternative is for your employer and regulators to have all th3 decision making (DB pension).  Tends to work particularly well when the employer is local or national government. That means the taxpayer takes on all the risk. A good deal for the bureaucracy.  Even then employees might still carry risk.  Wouldn’t want to have a DB pension from some of municipalities in the US.  

In general, most of these DB funds RELY on returns far in access of 4%.  Kinda scary. 

Do you mean withdrawals or returns in the last sentence. I ask because DB pensions get advantages in two 'dimensions' - firstly mortality credits, which for portfolio consisting of 60/40 US stocks/bonds a cohort of UK 65 year olds 50/50 male/female historically gave an SWR with no failures of 4.9% (this neglects fees).

Second, unlike with a DC pension where the retiree only gets one chance and one starting year, DB pensions get to combine multiple cohorts (i.e. multiple starting years) - for the same mortality stats as above, but combining 15 years worth of cohorts raised the SWR with no failures to 5.7% (I've not been able to model larger groupings than this, but this appears to be close to the upper limit).

An interesting recent development is the collective defined contribution pension, which are now legal in the UK (search google or have a look at the linked documents at https://www.aon.com/unitedkingdom/retirement-investment/defined-contribution/collective-defined-contribution.jsp

QrizB

Sea_Shell said:

With regards to "the markets" as a whole.   Most graphs I've seen where there has been a "correction" or a "crash" show a short, sharp downward trend, followed by a steady recovery.  eg 25% drop over a short period.
Have we ever had the sort of market behaviour whereby the reduction has been the same, overall (eg 25%), but it's been a slow drawn out affair, maybe only losing 1% a month for 25 months instead?   Does this happen?   A slow death, if you like, instead of a heart attack!!
If anyone has any examples, I'd be keen to see them.

How about 2001-2003?

Diplodicus

bostonerimus said:

Thrugelmir said:

Terron said:

Deleted_User said:

There are 4 “buckets” that each retiree needs to think about:

1. Basic, routine needs.  Food. Shelter. Car if you need it. Books. Newspapers. Beer.  Those kinds of things.  This income is best secured by something actually safe. State pension. Other DB pension. Annuity. Government bond (sucks right now).   Stockmarket is highly variable and the future is unknown.  Stocks can’t do this job. Keep in mind that longevity  is a good thing but also a risk for someone who relies on highly volatile investments.  And if you are on a pension board then chances are you will live longer than an average Brit. 

2. Contingency.  Roof needs replacing.  Your son needs help. Not necessarily “emergency” but non-routine expenditure. This requires a liquid source of funds.  Your stocks are technically liquid but not if you use “4% rule”.  In that case your investments are needed to secure your future 4% withdrawals and can’t be touched.  For this pot you need a separate “slush fund” in cash. 

3. Discretionary income.  Things that are “nice to have”.  Annual holidays in Hawaii. New  Porsche every 5 years. Major upgrades to your property.  Stocks are perfect for this pot. They are volatile but do provide the best chance of long term growth. Given you already secured 1 and 2 with genuinely safe sources of funds, you can and should be invested aggressively. This pot should be 100% in stocks and depleted based on the size of the pot. 4% rule does not apply. If this pot goes up by a factor of 2 in 5 years or 4 in 20 years (as it often does), it would be dumb to withdraw based on its size 5 or 20 years ago. 

4. Legacy. This pot could be in stocks (and combined with 3).  Or it could be insurance. Or certain types of annuities. 

Drawdown seems to be the way that gives the greatest income from a given pot. Thus it is the method that works best for people with only a small pot. Work out what you need as a minimum to live on, on top of the SP. Using the 4% rule you then need at least 25 times that as a target. It is better to go for more but that is a good target.

 It's a shame that sensible pensions have been replaced by the largely US invention of the DC plan which was always sold as giving the individual freedom whereas it was mostly about shifting risk to the individual.

Responsibility comes hand in hand with freedom and both are considered good things. Suits me, anyway.

Sea_Shell

QrizB said:

Sea_Shell said:

With regards to "the markets" as a whole.   Most graphs I've seen where there has been a "correction" or a "crash" show a short, sharp downward trend, followed by a steady recovery.  eg 25% drop over a short period.
Have we ever had the sort of market behaviour whereby the reduction has been the same, overall (eg 25%), but it's been a slow drawn out affair, maybe only losing 1% a month for 25 months instead?   Does this happen?   A slow death, if you like, instead of a heart attack!!
If anyone has any examples, I'd be keen to see them.

How about 2001-2003?

Ah Yes, 9/11.  If you focus on the 2001-03 period, where it lost almost half* its value over that period, with very little recovery in between.  It took until 2008 to recover....just in time for the banking crisis!!!

*about 6800 to 3600 by that graph, I think.

Was there more to it than 9/11 though.   Obviously that was a massive shock to global markets, but what made the downturn last so long, I don't recall?

QrizB

Sea_Shell said:

QrizB said:

Sea_Shell said:

With regards to "the markets" as a whole.   Most graphs I've seen where there has been a "correction" or a "crash" show a short, sharp downward trend, followed by a steady recovery.  eg 25% drop over a short period.
Have we ever had the sort of market behaviour whereby the reduction has been the same, overall (eg 25%), but it's been a slow drawn out affair, maybe only losing 1% a month for 25 months instead?   Does this happen?   A slow death, if you like, instead of a heart attack!!
If anyone has any examples, I'd be keen to see them.

How about 2001-2003?

Ah Yes, 9/11.  If you focus on the 2001-03 period, where it lost almost half* its value over that period, with very little recovery in between.  It took until 2008 to recover....just in time for the banking crisis!!!

*about 6800 to 3600 by that graph, I think.

Was there more to it than 9/11 though.   Obviously that was a massive shock to global markets, but what made the downturn last so long, I don't recall?

I think it was also the dot.com bubble around that time?

[Deleted User]

OldScientist said:

Deleted_User said:

The main difference between DB and DC pensions is how much the employer contributes. Typically contributions to DC pensions are much lower. 

Other than that, DC pensions are great.  People do get more freedom and responsibility how to handle THEIR money.  Its just that a point comes when some of the short term risk needs to be shifted.  And there are perfectly good options for doing that if you have a DC pension.  

The alternative is for your employer and regulators to have all th3 decision making (DB pension).  Tends to work particularly well when the employer is local or national government. That means the taxpayer takes on all the risk. A good deal for the bureaucracy.  Even then employees might still carry risk.  Wouldn’t want to have a DB pension from some of municipalities in the US.  

In general, most of these DB funds RELY on returns far in access of 4%.  Kinda scary. 

Do you mean withdrawals or returns in the last sentence. I ask because DB pensions get advantages in two 'dimensions' - firstly mortality credits, which for portfolio consisting of 60/40 US stocks/bonds a cohort of UK 65 year olds 50/50 male/female historically gave an SWR with no failures of 4.9% (this neglects fees).

Second, unlike with a DC pension where the retiree only gets one chance and one starting year, DB pensions get to combine multiple cohorts (i.e. multiple starting years) - for the same mortality stats as above, but combining 15 years worth of cohorts raised the SWR with no failures to 5.7% (I've not been able to model larger groupings than this, but this appears to be close to the upper limit).

An interesting recent development is the collective defined contribution pension, which are now legal in the UK (search google or have a look at the linked documents at https://www.aon.com/unitedkingdom/retirement-investment/defined-contribution/collective-defined-contribution.jsp

I mean returns.  Many DB pensions rely on market returns in excess of 8%.  If actual returns undershoot that number for a long period of time all these schemes will go bankrupt.  

Someone with a DC pension can also benefit from mortality credits. Thats what annuities are for.