Foolishness of the 4% rule

itwasntme001

Deleted_User said:

itwasntme001 said:

Deleted_User said:

itwasntme001 said:

Deleted_User said:

Equities do normally protect from inflation.  Very well.  Over long term, as per usual.  In the short term they could fall as the inflation and interest rates go up.  

Try telling that to someone who retired in 1970 at the age of 60, heavily invested in a 60/40 portfolio, and was about to start on a 10 year spending spree to enjoy retirement before they became less able.

Yes thought you would change your mind about "equities do normally protect from inflation".

Firstly, I said “equities”.  Bonds are terrible when dealing with unexpected inflation.  So, “60/40” isn’t relevant.  

Secondly, William Bernstein has dealt with this better than I would in his “investing for adults” series.  It included this and other examples from a range of countries which experienced high inflation. Get back to me once you had a chance to read it. You’ll find that a globally diversified equity portfolio provides an excellent long term hedge against inflation.

But it is reasonable to expect a 60 year old retiree to have a decent chunk in fixed income assets and I think 60:40 is quite appropriate.

I am just giving an example where your thesis fails.  Even assuming a 100% stocks portfolio for a 60 year old in 1970 spending 4% a year.  That is a depletion of more than 40% of the value over a 10 year period.  Even more so if you adjust the 4% by inflation.  I haven't done the numbers, but I imagine it would be significantly more than a 40% depletion, probably in the region of 60%?

And all because equities did not keep up with inflation.  They fell.  I even assumed above equities did keep up exactly.

So Mr or Mrs 70 year old retiree in 1980 now has a pot that has depleted at least by half in nominal terms, even more in real terms and the favourable returns that are about to occur in the next few decades won't help a huge amount given the capital has been depleted so much.  Sequence of returns risk is very real.

You are a writer and not a reader but please read at least the title of this thread.  Whats the point of you telling me that a constant 4% withdrawal didn’t work?   The rest of my comments basically say that bonds are an inappropriate  form of fixed income for a retiree and you still insist on bonds in trying to prove something to me.  

Now, global stock market returned 132% in USD in the 1970s. Which beat inflation of 112%. So, by 1980 a 1970 retiree with a flat annuity covering his basic needs would have had to dip in his 100% stock portfolio.  In the early 70s the “dipping” would have been minimal.  By the late 70s inflation was a problem for his flat annuity.   His stock portfolio provided an excellent hedge against inflation.  

In the 70s “inflation” included house prices. Retirees do not buy bigger houses. Personal Inflation for the 1970 retiree would have been a lot less than 112%. 

Having said this, my personal opinion is that long term inflation at the 1970s levels isnt plausible. Central banks can behave badly for periods of time, but if really high inflation becomes a problem they know what to do. Now. They didn’t then. 

Do read the Bernstein series.  

Cool will check Bernstein out.

You seem to be confused about what I was trying to explain.  It was not about the 4% rule itself.  It was about how equities may not help to protect you from inflation.  Using the 1970s as an example and the 4% rule as being a perfectly valid withdrawal strategy at that time (as opposed to now).  Even back then in the 1970s you would have depleted much of your capital, despite the 20% or so return you got in real terms over that time frame (assuming your numbers are correct).  You have naively not taken into account the sequence of returns (and sequence of inflation) during that 10 year time period.

Not sure why you bring annuities.  I am working on the assumption that a retiree would need to draw 4% from a portfolio over and above any other income in order to enjoy life.  You know, what retirees should do after working for many decades.  It would be a shame to cut off "enjoyment" spending during the only time they will have to enjoy freedom whilst being able to not worry about their hips or knees - just so that they can maintain their spending through till they die.

Inflation was driven by a whole host of things, not just house prices.  Even if house prices were such a big weight in the index, personal consumption is what matters.  And it is these costs that would have rose.

Right, so what do you think will happen to asset prices (equities and bonds) to stave off any inflation fears so that it does not reach the debacle that occurred during the 1970s?  You guessed it, they will fall.  And that is assuming rate hikes even work - we don't have a good enough understanding of what inflation is driven by and how to tame it - I suspect it is because it becomes more political than anything else.

itwasntme001

Deleted_User said:

We have history of financial markets (that represents more or less the current form) going back a 100 years or so.

Given that money was different for most of the 100 year period, I would question this assertion. 

So how money was defined changed from a gold standard to a sort of gold standard to a floating currency system we have today.  But financial markets have existed through these periods in more or less a similar way as it functions today.  Just because you can now log into your brokerage account to buy anything you want pretty much whereas you couldn't do this a 100 years ago, does not mean financial market price discovery did not exist back then.

itwasntme001

bostonerimus said:

itwasntme001 said:

bostonerimus said:

itwasntme001 said:

Deleted_User said:

Equities do normally protect from inflation.  Very well.  Over long term, as per usual.  In the short term they could fall as the inflation and interest rates go up.  

Try telling that to someone who retired in 1970 at the age of 60, heavily invested in a 60/40 portfolio, and was about to start on a 10 year spending spree to enjoy retirement before they became less able.

Yes thought you would change your mind about "equities do normally protect from inflation".

A counter example would be the last 30 years in the USA. a 60/40 portfolio delivered average annual growth of 9% and average annual inflation was 2.4%. There is no guaranteed inflation link or protection from equities, bonds or a combination of the two, but many times they do beat inflation considerably. This is the bedrock of the 4% rule. Bengen did not come up with 4% for 1970s Japan.

The key point being last 30 years.

We have history of financial markets (that represents more or less the current form) going back a 100 years or so.

Yes and "normally" (more often than not in MonteCarlo simulations using the 100 years of data) a 60/40 portfolio has beaten inflation. 

More often than not is not enough to be comfortable with a 60/40 portfolio as your main source of income.  I would need more than that I am afraid.

itwasntme001

bostonerimus said:

itwasntme001 said:

Deleted_User said:

Equities do normally protect from inflation.  Very well.  Over long term, as per usual.  In the short term they could fall as the inflation and interest rates go up.  

Try telling that to someone who retired in 1970 at the age of 60, heavily invested in a 60/40 portfolio, and was about to start on a 10 year spending spree to enjoy retirement before they became less able.

Yes thought you would change your mind about "equities do normally protect from inflation".

Back in the 1970's people were still using DB plans and annuities to fund retirement and even if they did have a 60/40 portfolio they would have been foolish to not stress test their plan and have a good cash buffer, and a guaranteed income floor that would keep the wolf from the door. That is why all retirees should think about what they would do if their retirement date was the beginning of a decade like the 1970s. I did that and decided that a rental property and actively taking a job with a DB plan would secure enough income for me to live on in retirement. I also planned ahead and paid voluntary NICs. Others might look at SP and natural yield or even a small annuity (yikes)...This requires planning ahead and probably aggressive saving but just a 60/40 portfolio and a 4% withdrawal rate is foolish unless you understand, accept and enjoy the risks involved.

This is just waffle but seems to agree with what I have been saying?

itwasntme001

Thrugelmir said:

itwasntme001 said:

Deleted_User said:

Equities do normally protect from inflation.  Very well.  Over long term, as per usual.  In the short term they could fall as the inflation and interest rates go up.  

Try telling that to someone who retired in 1970 at the age of 60, heavily invested in a 60/40 portfolio, and was about to start on a 10 year spending spree to enjoy retirement before they became less able.

Yes thought you would change your mind about "equities do normally protect from inflation".

A 60/40 portfolio wasn't an option back then. A more recent invention. 

A lot has changed in the past decades. Assuming that the 70's 80's 90's  were the same as today is erroneous. Very very different in so many ways. 

Yes this is what concerns me.  I wonder how much of portfolio construction is based around what has worked in the recent past.  So portfolio construction ends up being a human behavioural thing rather than anything logical and meaningful.  40-50 years ago (I can't remember if it came after the 1970s inflation or not) a well diversified optimal portfolio was presented as being one that included things like real estate, commodities, precious metals, farmland and of course equities and bonds.  But equities and bonds were much smaller part of the portfolio than a typical one today (which is more or less 100%).

Linton

Deleted_User said:

I would only consider an annuity if my life expectancy was severely shortened or I reached a seriously old age without the money to sustain my needs for an extended poeriod.

In practice its the other way around. People tend to take out annuities if they are healthy.  A healthy 65 year old has an excellent chance of living past 100. The pool of people taking annuities is self-selected to have better than average mortality rates. 

Individual “Return” is unknown and unpredictable.  Its the wrong way of thinking about annuities.  What is your return on car insurance? House insurance?  What annuity does in real world is permit someone with a decent amount of money and long life expectancy to spend a lot more safely as a portion of asset allocation. 

Your comparison of annuities with car and house insurance does not seem appropriate to me.  With either you are paying a relatively small amount of money to protect yourself from effectively unlimited costs.   The peace of mind gained justifies the cost.  With an annuity the cost is a high % of any benefit you get. 

ISTM that inflation linked annuities could be worth considering as they do protect you against unlimited "costs".  Without inflation linking the risk of your future income being totally inadequate through inflation could well exceed the investment risk of cautious drawdown especially with a time outlook of 20+ years.

According to UK official statistics the chance of living to 100 is not "excellent", but simply rather better than you may have thought.  ONS cohort data from 2014 suggests the chance of someone aged 65 today living to 100 was estimated at about 8.5% but I believe values have decreased since then.

Thrugelmir

bostonerimus said:

Thrugelmir said:

itwasntme001 said:

Deleted_User said:

Equities do normally protect from inflation.  Very well.  Over long term, as per usual.  In the short term they could fall as the inflation and interest rates go up.  

Try telling that to someone who retired in 1970 at the age of 60, heavily invested in a 60/40 portfolio, and was about to start on a 10 year spending spree to enjoy retirement before they became less able.

Yes thought you would change your mind about "equities do normally protect from inflation".

A 60/40 portfolio wasn't an option back then. A more recent invention. 

A lot has changed in the past decades. Assuming that the 70's 80's 90's  were the same as today is erroneous. Very very different in so many ways. 

In the US the 60/40 Wellington fund has existed since 1929. Also it was perfectly possible to own a portfolio of equities, even equity index funds, and US T-bills in the 1970s, but few people were using that to fund retirement. The "SWR" work by Bengen (1994) and the Trinity study (1998) was a response to the increase in people using DC plans to fund retirement using portfolios of stocks and bonds which had been created in the US in 1978 in Internal Revenue Code Section 401(k). Those studies are exactly what this thread is all about and they claim to be nothing more than an analysis of the historical US stock and bond data applied to the funding of retirement. They present the probabilities of "success" given numerous arrangements of that data. Someone retiring in the 1970's might well fall into the 5% "failure" bucket, but picking out a single scenario misunderstands what Bengen and Trinity are saying. The studies can help you plan for your retirement, but you still have to live that retirement and you only get one shot at it rather than the thousands of shots created in the studies.

This isn't the USA though..........  open capital markets are actually more recent than many seem to understand.   

itwasntme001

Linton said:

Deleted_User said:

I would only consider an annuity if my life expectancy was severely shortened or I reached a seriously old age without the money to sustain my needs for an extended poeriod.

In practice its the other way around. People tend to take out annuities if they are healthy.  A healthy 65 year old has an excellent chance of living past 100. The pool of people taking annuities is self-selected to have better than average mortality rates. 

Individual “Return” is unknown and unpredictable.  Its the wrong way of thinking about annuities.  What is your return on car insurance? House insurance?  What annuity does in real world is permit someone with a decent amount of money and long life expectancy to spend a lot more safely as a portion of asset allocation. 

Your comparison of annuities with car and house insurance does not seem appropriate to me.  With either you are paying a relatively small amount of money to protect yourself from effectively unlimited costs.   The peace of mind gained justifies the cost.  With an annuity the cost is a high % of any benefit you get. 

ISTM that inflation linked annuities could be worth considering as they do protect you against unlimited "costs".  Without inflation linking the risk of your future income being totally inadequate through inflation could well exceed the investment risk of cautious drawdown especially with a time outlook of 20+ years.

According to UK official statistics the chance of living to 100 is not "excellent", but simply rather better than you may have thought.  ONS cohort data from 2014 suggests the chance of someone aged 65 today living to 100 was estimated at about 8.5% but I believe values have decreased since then.

I would agree with all this.

[Deleted User]

itwasntme001 said:

Linton said:

itwasntme001 said:

bostonerimus said:

itwasntme001 said:

Deleted_User said:

Equities do normally protect from inflation.  Very well.  Over long term, as per usual.  In the short term they could fall as the inflation and interest rates go up.  

Try telling that to someone who retired in 1970 at the age of 60, heavily invested in a 60/40 portfolio, and was about to start on a 10 year spending spree to enjoy retirement before they became less able.

Yes thought you would change your mind about "equities do normally protect from inflation".

I think the the critical word here is "normally".

What does normally even mean?  How do we know it is normal?

Nothing in the future is absolutely guranteed so you have to base your future plans in general and investing strategy in particular on assumptions about the world that you are prepared to accept.  A reasonable assumption backed up by theory and history is that equities will broadly over the long term increase by more than inflation.  If you did not wish to assume this it is difficult to see why you would rationally invest in equities at all.

Normally could be taken to be significantly greater than 50% probability historically. 

But how far back in history can we go back?  Is it really still significantly more than 50% that inflation rises with equities?  Is the history we have even enough to come to that conclusion?  I am not so sure.

I invest in equities because of progress in human ingenuity.  Not because of some absurd reason that equities will protect me from inflation.

You can look at stockmarkets in 100 countries and the statistical evidence for stocks protecting against inflation  is strong.  Its deflation that hurts equities.  The books I referenced do that analysis. 

[Deleted User]

Linton said:

Deleted_User said:

I would only consider an annuity if my life expectancy was severely shortened or I reached a seriously old age without the money to sustain my needs for an extended poeriod.

In practice its the other way around. People tend to take out annuities if they are healthy.  A healthy 65 year old has an excellent chance of living past 100. The pool of people taking annuities is self-selected to have better than average mortality rates. 

Individual “Return” is unknown and unpredictable.  Its the wrong way of thinking about annuities.  What is your return on car insurance? House insurance?  What annuity does in real world is permit someone with a decent amount of money and long life expectancy to spend a lot more safely as a portion of asset allocation. 

Your comparison of annuities with car and house insurance does not seem appropriate to me.  With either you are paying a relatively small amount of money to protect yourself from effectively unlimited costs.   The peace of mind gained justifies the cost.  With an annuity the cost is a high % of any benefit you get. 

ISTM that inflation linked annuities could be worth considering as they do protect you against unlimited "costs".  Without inflation linking the risk of your future income being totally inadequate through inflation could well exceed the investment risk of cautious drawdown especially with a time outlook of 20+ years.

According to UK official statistics the chance of living to 100 is not "excellent", but simply rather better than you may have thought.  ONS cohort data from 2014 suggests the chance of someone aged 65 today living to 100 was estimated at about 8.5% but I believe values have decreased since then.

1. I think the benefit of annuity to someone risking outliving his assets is huge.  Full dependence on the state or kids or having to die a little earlier because of money issues seems like more of a threat than having to pay for a new car out of pocket. 

2. You could also have a ladder of flat annuities to deal with your inflation concerns, if you are unprepared to rely on asset allocation for hedging inflation risks. 

3. 8.5% is a very high probability for nasty scenarios described in 1. But if you are a well off healthy 65 year old on an investment/pensions board, your chances of living longer are noticeably higher.