Foolishness of the 4% rule

Linton

Deleted_User said:

but there's not really much flexibility with an annuity. 

Agree with DT that there could be much more flexibility for someone who has basic needs covered with annuity type income.

A proper withdrawal strategy which is 100% stocks and bonds means that your equity isn’t as liquid as it appears.  You shouldn’t be withdrawing more than the paltry 3.5% (or whatever it is) because those funds are spoken for.  They are your future 3.5% withdrawals. 

Disagree fundamentally.......
The objective of a plan based on an SWR or any other predetermined withdrawal strategy is simply and solely to make the decision on whether to retire or not.  Having made that decision you are then in a totally different environment and need a different approach to your financial management.

After a year or two of retirement the assumptions and analysis on which you made your decision will have changed.  You will probably find that you have more money in your pot than planned bvecause the initial plans should have been made on very pessimistic assumptions.  You will be one year older and will have probably avoided one year of potential crashes.  So if you are using SWRs, the SWR will be higher.  Actual experience of retirement may change your  assessment of requirements. Actual inflation will probably be different to your initial assumptions. Your circumstances may have changed because of an unplanned inheritance or major expenditure. etc etc

Therefore if the changes are sufficient to make the effort worthwhile (and if you have your spreadsheets properly set up the effiort should be minimal) you replan to set new spending limits for the following year. 

[Deleted User]

Disagree fundamentally.......
The objective of a plan based on an SWR or any other predetermined withdrawal strategy is simply and solely to make the decision on whether to retire or not. 

You are using the abbreviation but what you are actually describing isn’t SWR at all. 

Perhaps we should let the man behind SWR define what it’s for.  Bergen did it in his original paper and subsequent books, extensively, in excruciating level of detail.  The answer: its to manage withdrawals after retirement. In fact, he clearly states what financial advisors should and shouldn’t let their clients spend.  And its not recommended to change it from year to year. 

Check it out for yourself: https://www.amazon.com/Conserving-Client-Portfolios-During-Retirement/dp/0975344838

Incidentally, in this 2006 book Bergen said that SWR should be 4.5%. 

Here is the key quote from the original paper meant for advisors whose clients’ portfolios have grown enormously due to stellar returns 10 years into their 30-year retirement:

So the "star" clients are ones who must be advised to refrain from making any radical changes in their asset alloca- tion or withdrawal pattern. Some in- crease in withdrawals are probably in- evitable, but need not be fatal to the retirement plan, if they are moderate. They must understand that excess re- turns earned today will probably be needed to offset losses in the future.

Linton

Deleted_User said:

Disagree fundamentally.......
The objective of a plan based on an SWR or any other predetermined withdrawal strategy is simply and solely to make the decision on whether to retire or not. 

You are using the abbreviation but what you are actually describing isn’t SWR at all. 

Perhaps we should let the man behind SWR define what it’s for.  Bergen did it in his original paper and subsequent books, extensively, in excruciating level of detail.  The answer: its to manage withdrawals after retirement. 

Check it out for yourself: https://www.amazon.com/Conserving-Client-Portfolios-During-Retirement/dp/0975344838

Incidentally, in this 2006 book Bergen said that SWR should be 4.5%. 

My point is that I find it difficult to believe that people would actually blindly implement a long term SWR policy based on the initial data. I cant remember anyone on this forum having reported doing so.  After a small number of years reality will not correspond to any of the underlying historical scenarios.  So it would make obvious sense to recalibrate. ISTM your argument is a Strawman.

That doesnt mean that SWR should be rejected as a concept.  It is fine as a model that may give some people the confidence to retire.  In order to retire most people need a prediction of the future but any investment pot-based retirement prediction is of necessity based on dubious assumptions as the future is completely unknown.  I personally thnk that once you bring in the add-on strategies to SWR it's too complex to be justified by the validity of the underlying data and In practice historically pessimistic assumptions of return and inflation are good enough for the purpose, or as good as you are going to get.  Though SWR does have the advantage of highlighting the Sequence Of Returns risk.

In reality retirees will have to manage as best as they can with whatever turns up.  Both SWR and modelling on assumptions should put you in a better position than simply using gut feelings.  However ultimately if all one's neighbours are queueing up at the soup kitchens it is unreasonable to think one would not be in the same position.

MK62

Three years after retiring, are you three years into a 30 year plan, or at the start of a 27 year plan? ....

bostonerimus

As someone who often also makes this error the guy who came up with 4% rule is Bengen, not Bergen

Terron

Deleted_User said:

When talking about essential spending it can't be reduced, because it is essential, and an increase beyond inflation is likely not essential.  So the only option that makes sense is for unwavering index-linked withdrawal. 

You are assuming that essential spending is going up with whichever “index” you prefer.  In practice its unlikely to be true.  A couple of holidays a year might me essential for a 65 year old but an 85 year old might not be interested at all. Rental pricing or petrol might not be relevant at all. 

As people get older, the “inflation” which impacts them the most is healthcare. There isn’t a real market for healthcare; most countries have the government as one and only or the dominant buyer (even in the US).  The government has strong incentive to not let inflation impact healthcare.  Even as population ages and demand soars, prices are actually going down. Market retaliates by creating a shortage of supply and we get implicit healthcare rationing and having an indexed pension won’t help here.  

Its complicated but as discussed above, the cost of  retirees basic needs tends to go down as they age. 

It may go down or it may go up if you need care. Assuming it stays the same works as a first approximation. 
In the UK health costs drop to zero on state retirement age as you no longer need to pay NI and even in England prescription charges drop to zero. Inflation does affect health costs for the NHS but not for retirees. 

Terron

Deleted_User said:

Disagree fundamentally.......
The objective of a plan based on an SWR or any other predetermined withdrawal strategy is simply and solely to make the decision on whether to retire or not. 

You are using the abbreviation but what you are actually describing isn’t SWR at all. 

Perhaps we should let the man behind SWR define what it’s for.  Bergen did it in his original paper and subsequent books, extensively, in excruciating level of detail.  The answer: its to manage withdrawals after retirement. In fact, he clearly states what financial advisors should and shouldn’t let their clients spend.  And its not recommended to change it from year to year. 

Check it out for yourself: https://www.amazon.com/Conserving-Client-Portfolios-During-Retirement/dp/0975344838

Incidentally, in this 2006 book Bergen said that SWR should be 4.5%. 

Here is the key quote from the original paper meant for advisors whose clients’ portfolios have grown enormously due to stellar returns 10 years into their 30-year retirement:

So the "star" clients are ones who must be advised to refrain from making any radical changes in their asset alloca- tion or withdrawal pattern. Some in- crease in withdrawals are probably in- evitable, but need not be fatal to the retirement plan, if they are moderate. They must understand that excess re- turns earned today will probably be needed to offset losses in the future.

When asked why he did the study Bengen said

By 1993 I had been a financial advisor for about five years. Most of my clients were of similar age- Baby Boomers. At that time they were just beginning to think seriously of retirement, and had questions: How much should I save? What kind of income can I expect from my retirement investments? How should my retirement investments be allocated?

I searched through all my resources, including my CFP textbooks, and could find no good answers anywhere. Not surprising, as my generation was the first to expect such a long life in retirement; prior to that, it was live ten years after retirement, then die. I decided to do the research myself, which launched me on a totally unexpected journey.

As a rule of thumb, first approximation the 4.0% rule works to answer two of those questions.
He actually came up with a figure of 4.2% and later adjusted that to 4.5%. He said

The 4.5% rule has very limited applicability, because of all the assumptions which underlie it. It assumes, to begin with, that the retiree’s expenses and other income all with grow with the inflation rate. If either the expenses or other income grow faster or slower than inflation, than some other percentage would apply. In addition to considerations of expenses and other income, there are many other variables which could affect the SWR: portfolio asset allocation, portfolio tax rate, frequency of rebalancing, time horizon, desired minimum terminal balance, withdrawal scheme, etc. All these, if different than my original assumptions, would require an adjustment to the SWR.

Many of these assumptions have been examined since the original work. 

Note he mentions withdrawal scheme as an assumption. He did not examine different schemes to find the best. He only considered the one. The 4% rule applies if you follow that scheme and his instructions were about how to follow it. He had no evidence to say it was better than others, though he had better evidence to back it than others around at that time.

bostonerimus

Terron said:

Deleted_User said:

When talking about essential spending it can't be reduced, because it is essential, and an increase beyond inflation is likely not essential.  So the only option that makes sense is for unwavering index-linked withdrawal. 

You are assuming that essential spending is going up with whichever “index” you prefer.  In practice its unlikely to be true.  A couple of holidays a year might me essential for a 65 year old but an 85 year old might not be interested at all. Rental pricing or petrol might not be relevant at all. 

As people get older, the “inflation” which impacts them the most is healthcare. There isn’t a real market for healthcare; most countries have the government as one and only or the dominant buyer (even in the US).  The government has strong incentive to not let inflation impact healthcare.  Even as population ages and demand soars, prices are actually going down. Market retaliates by creating a shortage of supply and we get implicit healthcare rationing and having an indexed pension won’t help here.  

Its complicated but as discussed above, the cost of  retirees basic needs tends to go down as they age. 

It may go down or it may go up if you need care. Assuming it stays the same works as a first approximation. 
In the UK health costs drop to zero on state retirement age as you no longer need to pay NI and even in England prescription charges drop to zero. Inflation does affect health costs for the NHS but not for retirees. 

The idea behind this is spot on, but OAPs do still contribute to the NHS budget as a lot of it comes from general taxation. Still I look at my tax burden in the US and it is higher than I'd pay in the UK on a similar income because there's Federal, State and local taxes to pay and my equivalent of UK council tax is now $8k pa...and I have to pay $100 per month for health insurance (which is incredibly inexpensive for the US). However, the UK does have the very worrying and potentially expensive issue of social care in old age. That's a cost that many people now have as they age. This wasn't an issue for my grandparents in the UK in the 1970s as they had local authority/NHS paid for places in retirement homes when they needed them. My Father did have to worry about it a bit, but got hospice care. My Mum died suddenly at home. I'm in the US and the provision is just as bad/expensive as in the UK, but at least in the US I have a long term care insurance policy which should cover most of the cost.

Thrugelmir

MK62 said:

Three years after retiring, are you three years into a 30 year plan, or at the start of a 27 year plan? ....

You might never know.....

Thrugelmir

bostonerimus said:

Terron said:

Deleted_User said:

When talking about essential spending it can't be reduced, because it is essential, and an increase beyond inflation is likely not essential.  So the only option that makes sense is for unwavering index-linked withdrawal. 

You are assuming that essential spending is going up with whichever “index” you prefer.  In practice its unlikely to be true.  A couple of holidays a year might me essential for a 65 year old but an 85 year old might not be interested at all. Rental pricing or petrol might not be relevant at all. 

As people get older, the “inflation” which impacts them the most is healthcare. There isn’t a real market for healthcare; most countries have the government as one and only or the dominant buyer (even in the US).  The government has strong incentive to not let inflation impact healthcare.  Even as population ages and demand soars, prices are actually going down. Market retaliates by creating a shortage of supply and we get implicit healthcare rationing and having an indexed pension won’t help here.  

Its complicated but as discussed above, the cost of  retirees basic needs tends to go down as they age. 

It may go down or it may go up if you need care. Assuming it stays the same works as a first approximation. 
In the UK health costs drop to zero on state retirement age as you no longer need to pay NI and even in England prescription charges drop to zero. Inflation does affect health costs for the NHS but not for retirees. 

However, the UK does have the very worrying and potentially expensive issue of social care in old age. 

If people were paid decent wages and given employment rights. The USA would be in a very similar position.