4% SWR rule….well, rules are there to be broken!

Bostonerimus1

DT2001 said:

Bostonerimus1 said:

michaels said:

OldScientist said:

michaels said:

OldScientist said:

Systematic methods of drawdown from a portfolio can possibly be split into three broad categories



* A portfolio of 60% UK stocks, 20% UK long bonds, and 20% UK cash was used as an illustration. Asset returns and UK inflation from macrohistory.net. While the details would be different for a different portfolio, the broad conclusions would not.

Do you know what the SWR was for this dataset?  It is worth fully considering that even the least variable withdrawal method required a halving of real income (that £1m pot and retirement at 60 quickly becomes a real income of 20k pa rather than the expected 40k) for large parts of the retirement journey - and this was for a 4% swr which many are saying is too conservative!

The 30 year MSWR (i.e., zero failures) was about 3.0% (about 3.3% for a 10% failure rate). It certainly fits with the idea of a ballpark 3.0 to 3.5% for the UK.

Either the complete failure (if the actual SWR turns out to be lower than the initial guess) or a 50% drop in real income with variable strategies is why I think flooring is so important. For example, taking your example of a £1m portfolio. With two state pensions (a total of about £20k for simplicity), the income from the portfolio dropping from £40k to £20k with a variable strategy means the overall income drops from £60k to £40k which would unpleasant for those expecting a lifestyle needing £60k per year, but not completely disastrous.

An RPI annuity (currently about 4% payout for joint life, 100% benefits, 65yo - edit: about 3.4% at 60yo) bought with half the portfolio would, together with the SP, give a floor of about £40k, with the remaining half of the portfolio providing an initial £20k dropping to £10k, i.e., the overall income of £60k dropping to £50k with is far more manageable. Of course in a good retirement, the purchase of the annuity will reduce the upside potential, but (again in my view), good retirements can look after themselves!

So basically an annuity currently gives a higher certain income than a 100% historic success SWR so is definitely a no brainer for an income floor

Not necessarily as many of those 100% success scenarios will give you and your heirs access to significant capital as well as income.

Is the purpose of your pension fund to provide for YOUR retirement or part of a combined retirement/inheritance plan? If it is the former then an annuity can give you certainty and you have, as another regular wise poster says, won the game and there is no need to continue to ‘play’.

My answer would be ideally your plan should be to fund retirement and leave some inheritance which is another argument for a hybrid strategy.

Bostonerimus1

DT2001 said:

Bostonerimus1 said:

OldScientist said:

michaels said:

OldScientist said:

Systematic methods of drawdown from a portfolio can possibly be split into three broad categories



* A portfolio of 60% UK stocks, 20% UK long bonds, and 20% UK cash was used as an illustration. Asset returns and UK inflation from macrohistory.net. While the details would be different for a different portfolio, the broad conclusions would not.

Do you know what the SWR was for this dataset?  It is worth fully considering that even the least variable withdrawal method required a halving of real income (that £1m pot and retirement at 60 quickly becomes a real income of 20k pa rather than the expected 40k) for large parts of the retirement journey - and this was for a 4% swr which many are saying is too conservative!

The 30 year MSWR (i.e., zero failures) was about 3.0% (about 3.3% for a 10% failure rate). It certainly fits with the idea of a ballpark 3.0 to 3.5% for the UK.

Either the complete failure (if the actual SWR turns out to be lower than the initial guess) or a 50% drop in real income with variable strategies is why I think flooring is so important. For example, taking your example of a £1m portfolio. With two state pensions (a total of about £20k for simplicity), the income from the portfolio dropping from £40k to £20k with a variable strategy means the overall income drops from £60k to £40k which would unpleasant for those expecting a lifestyle needing £60k per year, but not completely disastrous.

An RPI annuity (currently about 4% payout for joint life, 100% benefits, 65yo - edit: about 3.4% at 60yo) bought with half the portfolio would, together with the SP, give a floor of about £40k, with the remaining half of the portfolio providing an initial £20k dropping to £10k, i.e., the overall income of £60k dropping to £50k with is far more manageable. Of course in a good retirement, the purchase of the annuity will reduce the upside potential, but (again in my view), good retirements can look after themselves!

Soon after my divorce I started running retirement scenarios as the financial upheaval made me reassess everything. Up to that point I/we had just been ploughing money into a 60/40 index fund portfolio, so I/we were doing lots of the stuff required, but with little long term planning. I was uncomfortable with the probability distributions produced by the various simulations and wanted to guarantee my basic retirement income. This worry became acute after the 2007-2008 crash. So I set myself the goal of never needing to use any DC accumulations. I had both US social security and UK SP coming, but wanted something that would allow me to retire early and so I bought a rental property and took a job with a DB pension that could start at age 55 and continued to invest in DC and general accounts using low cost index funds; I believe that keeping things cheap and simple and not paying for advice from financial advisors has been the backbone of my success. Now that I'm retired I live off my DB pension and rental income and have the US and UK state pensions still to come. Because my DC drawdown is 0% I leave it mostly in index equity funds and simply don't worry about it at all because drawdown is only of academic interest. 

So I have used a fairly extreme hybrid approach to retirement income and it's why I advocate a mix of things like annuities for safety and stocks and bonds for growth and income. Also a long term horizon is useful so you can do things like paying off mortgages that reduce your need for income in retirement and take pressure off your drawdown investments. You need to solve the retirement income puzzle from both the spending and income generation perspectives.

With hindsight how would you have changed your approach to retirement? You have US and U.K. state pensions to come and a DC pension which you do not use so could you have retired even earlier with a bond/gilt/deposit ladder to avoid market fluctuations?
I like your guaranteed income base and am in the fortunate position to have at least matched ‘necessary’ expenditure with guaranteed income from a relatively early point in my plan but was aiming to draw variably from our investments for ‘desired/luxury’ spend 

I've always had a good job and been frugal and I've also been incredibly lucky to live through good stock market growth and to have had legislation uplift both my US and UK state pensions. I'm not sure I'd do much differently and I'm basically still doing the same wrt investing as I've done for the last 30 years, but with a higher equity allocation. I retired at 52 when I fully vested in my last employer's retirement benefits, so it would not have been wise to do it any earlier.  I'm glad that I've always stayed mostly invested in equities because of their growth - I never worried about market fluctuations after 2008 because I developed my plan to include the DB pension as well as stable rental income.

Hoenir

michaels said:

OldScientist said:

michaels said:

OldScientist said:

Systematic methods of drawdown from a portfolio can possibly be split into three broad categories



* A portfolio of 60% UK stocks, 20% UK long bonds, and 20% UK cash was used as an illustration. Asset returns and UK inflation from macrohistory.net. While the details would be different for a different portfolio, the broad conclusions would not.

Do you know what the SWR was for this dataset?  It is worth fully considering that even the least variable withdrawal method required a halving of real income (that £1m pot and retirement at 60 quickly becomes a real income of 20k pa rather than the expected 40k) for large parts of the retirement journey - and this was for a 4% swr which many are saying is too conservative!

The 30 year MSWR (i.e., zero failures) was about 3.0% (about 3.3% for a 10% failure rate). It certainly fits with the idea of a ballpark 3.0 to 3.5% for the UK.

Either the complete failure (if the actual SWR turns out to be lower than the initial guess) or a 50% drop in real income with variable strategies is why I think flooring is so important. For example, taking your example of a £1m portfolio. With two state pensions (a total of about £20k for simplicity), the income from the portfolio dropping from £40k to £20k with a variable strategy means the overall income drops from £60k to £40k which would unpleasant for those expecting a lifestyle needing £60k per year, but not completely disastrous.

An RPI annuity (currently about 4% payout for joint life, 100% benefits, 65yo - edit: about 3.4% at 60yo) bought with half the portfolio would, together with the SP, give a floor of about £40k, with the remaining half of the portfolio providing an initial £20k dropping to £10k, i.e., the overall income of £60k dropping to £50k with is far more manageable. Of course in a good retirement, the purchase of the annuity will reduce the upside potential, but (again in my view), good retirements can look after themselves!

So basically an annuity currently gives a higher certain income than a 100% historic success SWR so is definitely a no brainer for an income floor

An annuity is a pooled risk. The return is enhanced. Like the Traitors. The people who benefit are the ones that survive to the final round. 

Hoenir

Bostonerimus1 said:

michaels said:

OldScientist said:

michaels said:

OldScientist said:

Systematic methods of drawdown from a portfolio can possibly be split into three broad categories



* A portfolio of 60% UK stocks, 20% UK long bonds, and 20% UK cash was used as an illustration. Asset returns and UK inflation from macrohistory.net. While the details would be different for a different portfolio, the broad conclusions would not.

Do you know what the SWR was for this dataset?  It is worth fully considering that even the least variable withdrawal method required a halving of real income (that £1m pot and retirement at 60 quickly becomes a real income of 20k pa rather than the expected 40k) for large parts of the retirement journey - and this was for a 4% swr which many are saying is too conservative!

The 30 year MSWR (i.e., zero failures) was about 3.0% (about 3.3% for a 10% failure rate). It certainly fits with the idea of a ballpark 3.0 to 3.5% for the UK.

Either the complete failure (if the actual SWR turns out to be lower than the initial guess) or a 50% drop in real income with variable strategies is why I think flooring is so important. For example, taking your example of a £1m portfolio. With two state pensions (a total of about £20k for simplicity), the income from the portfolio dropping from £40k to £20k with a variable strategy means the overall income drops from £60k to £40k which would unpleasant for those expecting a lifestyle needing £60k per year, but not completely disastrous.

An RPI annuity (currently about 4% payout for joint life, 100% benefits, 65yo - edit: about 3.4% at 60yo) bought with half the portfolio would, together with the SP, give a floor of about £40k, with the remaining half of the portfolio providing an initial £20k dropping to £10k, i.e., the overall income of £60k dropping to £50k with is far more manageable. Of course in a good retirement, the purchase of the annuity will reduce the upside potential, but (again in my view), good retirements can look after themselves!

So basically an annuity currently gives a higher certain income than a 100% historic success SWR so is definitely a no brainer for an income floor

Not necessarily as many of those 100% success scenarios will give you and your heirs access to significant capital as well as income.

Families and money is a toxic mix. Brings out the worst in people. Particularly where inheritances are concerned. 

Bostonerimus1

Hoenir said:

michaels said:

OldScientist said:

michaels said:

OldScientist said:

Systematic methods of drawdown from a portfolio can possibly be split into three broad categories



* A portfolio of 60% UK stocks, 20% UK long bonds, and 20% UK cash was used as an illustration. Asset returns and UK inflation from macrohistory.net. While the details would be different for a different portfolio, the broad conclusions would not.

Do you know what the SWR was for this dataset?  It is worth fully considering that even the least variable withdrawal method required a halving of real income (that £1m pot and retirement at 60 quickly becomes a real income of 20k pa rather than the expected 40k) for large parts of the retirement journey - and this was for a 4% swr which many are saying is too conservative!

The 30 year MSWR (i.e., zero failures) was about 3.0% (about 3.3% for a 10% failure rate). It certainly fits with the idea of a ballpark 3.0 to 3.5% for the UK.

Either the complete failure (if the actual SWR turns out to be lower than the initial guess) or a 50% drop in real income with variable strategies is why I think flooring is so important. For example, taking your example of a £1m portfolio. With two state pensions (a total of about £20k for simplicity), the income from the portfolio dropping from £40k to £20k with a variable strategy means the overall income drops from £60k to £40k which would unpleasant for those expecting a lifestyle needing £60k per year, but not completely disastrous.

An RPI annuity (currently about 4% payout for joint life, 100% benefits, 65yo - edit: about 3.4% at 60yo) bought with half the portfolio would, together with the SP, give a floor of about £40k, with the remaining half of the portfolio providing an initial £20k dropping to £10k, i.e., the overall income of £60k dropping to £50k with is far more manageable. Of course in a good retirement, the purchase of the annuity will reduce the upside potential, but (again in my view), good retirements can look after themselves!

So basically an annuity currently gives a higher certain income than a 100% historic success SWR so is definitely a no brainer for an income floor

An annuity is a pooled risk. The return is enhanced. Like the Traitors. The people who benefit are the ones that survive to the final round. 

Yeah, if you have a gilt/cash ladder you'll pretty much be able to replicate the annuity payouts up to your predicted mortality. If you live longer than that the annuity will continue, but your ladder will have disappeared to nothing. The 100% drawdown from a mix of equity and bonds will have a very good chance of continuing for say 30 years (whatever the life span you put on it), but the longer you live past that the greater the chance of failure.

Bostonerimus1

Hoenir said:

Bostonerimus1 said:

michaels said:

OldScientist said:

michaels said:

OldScientist said:

Systematic methods of drawdown from a portfolio can possibly be split into three broad categories



* A portfolio of 60% UK stocks, 20% UK long bonds, and 20% UK cash was used as an illustration. Asset returns and UK inflation from macrohistory.net. While the details would be different for a different portfolio, the broad conclusions would not.

Do you know what the SWR was for this dataset?  It is worth fully considering that even the least variable withdrawal method required a halving of real income (that £1m pot and retirement at 60 quickly becomes a real income of 20k pa rather than the expected 40k) for large parts of the retirement journey - and this was for a 4% swr which many are saying is too conservative!

The 30 year MSWR (i.e., zero failures) was about 3.0% (about 3.3% for a 10% failure rate). It certainly fits with the idea of a ballpark 3.0 to 3.5% for the UK.

Either the complete failure (if the actual SWR turns out to be lower than the initial guess) or a 50% drop in real income with variable strategies is why I think flooring is so important. For example, taking your example of a £1m portfolio. With two state pensions (a total of about £20k for simplicity), the income from the portfolio dropping from £40k to £20k with a variable strategy means the overall income drops from £60k to £40k which would unpleasant for those expecting a lifestyle needing £60k per year, but not completely disastrous.

An RPI annuity (currently about 4% payout for joint life, 100% benefits, 65yo - edit: about 3.4% at 60yo) bought with half the portfolio would, together with the SP, give a floor of about £40k, with the remaining half of the portfolio providing an initial £20k dropping to £10k, i.e., the overall income of £60k dropping to £50k with is far more manageable. Of course in a good retirement, the purchase of the annuity will reduce the upside potential, but (again in my view), good retirements can look after themselves!

So basically an annuity currently gives a higher certain income than a 100% historic success SWR so is definitely a no brainer for an income floor

Not necessarily as many of those 100% success scenarios will give you and your heirs access to significant capital as well as income.

Families and money is a toxic mix. Brings out the worst in people. Particularly where inheritances are concerned. 

Families differ.

OldScientist

Albermarle said:

OldScientist said:

Systematic methods of drawdown from a portfolio can possibly be split into three broad categories

1) Constant inflation adjusted withdrawals ('SWR'): The amount withdrawn is known (the infamous '4%'), but the length of time over which it can be sustained is unknown and unknowable.
2) Percentage of portfolio withdrawals (constant percentage, VPW, ABW): The amount withdrawn is unknown in advance, but it will never go to zero.
3) Hybrid approaches (Guyton-Klinger, Vanguard dynamic, and many of the ones tested in McClung's book - referred to upthread). These have properties somewhere between the two - the variability of withdrawals is less and there is a reduced chance of portfolio exhaustion.

I've posted the following figure before. In the top panel the real (i.e, inflation adjusted) portfolio value* and in the lower panel the real withdrawal rate are plotted as a function of time for 5 different withdrawal strategies (CIAW=constant inflation adjusted withdrawals, GK=Guyton-Klinger, VG=vanguard dynamic, CP=constant percentage of portfolio, and MX is a 50/50 mix of CIAW and CP) for a single UK historical retirement case starting in 1937 (one of the worst for UK retirees).



The constant inflation adjusted strategy provided a constant inflation adjusted income until the portfolio ran out of money just under 20 years into retirement. The constant percentage of portfolio strategy delivered a highly variable income (ranging from 4% at the start to a minimum of 1.4% after about 20 years) but never ran out of money (in real terms, after 35 years, the portfolio was still worth about 50% of the initial value), while the hybrid methods (GK, VG, and MX) fell somewhere between CIAW and CP both in terms of the income delivered and the portfolio remaining after 35 years.

From a psychological point of view, the retiree following the SWR (CIAW) approach would have needed strong nerves to continue to take a constant real amount as the value of the portfolio declined (in real terms) to 50% after four years (resulting in a withdrawal of 8% of the remaining portfolio) and to 20% after 13 years (resulting in a withdrawal of 20% of the remaining portfolio). The retirement wouldn't have been nice for the other strategies, but at least withdrawals would have been cut in response to the drops in portfolio value over the first 20 years or so.

Which of these strategies is 'best' rather depends on the consequences of either variable income or complete portfolio exhaustion. My own preference has been to secure enough income floor in guaranteed income (DB pension and, eventually, SP - I haven't needed to add a RPI annuity) not to have to worry about variability in portfolio income, so I have ended up using ABW (which is a percentage of portfolio approach where the percentage increases with time, see https://www.bogleheads.org/wiki/Amortization_based_withdrawal of which, VPW is a better known case, see https://www.bogleheads.org/wiki/Variable_percentage_withdrawal ).



* A portfolio of 60% UK stocks, 20% UK long bonds, and 20% UK cash was used as an illustration. Asset returns and UK inflation from macrohistory.net. While the details would be different for a different portfolio, the broad conclusions would not.

Interesting that of the Hybrid approaches, the simplest one 'MX- a 50:50 split of CIPW and CP' performs better overall taking into account both graphs, than the supposedly more sophisticated GK and VD approaches.
Of course over a different period the result could be different, but just going 50:50 could be enough to largely cover all bases and easier to work out !

In my initial planning I was going to use a simple mix before I realised that we had more than enough flooring so could accept a lot of volatility in our portfolio income.

I should note that MX as plotted was a 50/50 mix of a 3.0% constant inflation adjusted withdrawal and a constant percentage of portfolio of 5%. Essentially it gives an inflation adjusted floor of 1.5% of the initial portfolio, which means it can still fail if the retirement was much worse than the one shown. Practically, for a £1m portfolio that is an initial withdrawal of £15k that is subsequently inflation adjusted and an initial variable withdrawal of £25k.

By way of contrast to the bad times, here's a plot of a 'good' historical retirement

The actual SWR is well above 4% for this retirement, so constant inflation adjusted withdrawals worked nicely, but, after 35 years, left a pot in real terms six times larger than the original one. CP, MX, and GK all behave fairly similarly (constant percentage takes the highest withdrawals and leaves the smallest pot, about 250% of the original, after 35 years), while the Vanguard approach of gradually increasing withdrawals under good conditions gives a rather different outcome to the others.

Bostonerimus1

OldScientist said:

Albermarle said:

OldScientist said:

Systematic methods of drawdown from a portfolio can possibly be split into three broad categories

1) Constant inflation adjusted withdrawals ('SWR'): The amount withdrawn is known (the infamous '4%'), but the length of time over which it can be sustained is unknown and unknowable.
2) Percentage of portfolio withdrawals (constant percentage, VPW, ABW): The amount withdrawn is unknown in advance, but it will never go to zero.
3) Hybrid approaches (Guyton-Klinger, Vanguard dynamic, and many of the ones tested in McClung's book - referred to upthread). These have properties somewhere between the two - the variability of withdrawals is less and there is a reduced chance of portfolio exhaustion.

I've posted the following figure before. In the top panel the real (i.e, inflation adjusted) portfolio value* and in the lower panel the real withdrawal rate are plotted as a function of time for 5 different withdrawal strategies (CIAW=constant inflation adjusted withdrawals, GK=Guyton-Klinger, VG=vanguard dynamic, CP=constant percentage of portfolio, and MX is a 50/50 mix of CIAW and CP) for a single UK historical retirement case starting in 1937 (one of the worst for UK retirees).



The constant inflation adjusted strategy provided a constant inflation adjusted income until the portfolio ran out of money just under 20 years into retirement. The constant percentage of portfolio strategy delivered a highly variable income (ranging from 4% at the start to a minimum of 1.4% after about 20 years) but never ran out of money (in real terms, after 35 years, the portfolio was still worth about 50% of the initial value), while the hybrid methods (GK, VG, and MX) fell somewhere between CIAW and CP both in terms of the income delivered and the portfolio remaining after 35 years.

From a psychological point of view, the retiree following the SWR (CIAW) approach would have needed strong nerves to continue to take a constant real amount as the value of the portfolio declined (in real terms) to 50% after four years (resulting in a withdrawal of 8% of the remaining portfolio) and to 20% after 13 years (resulting in a withdrawal of 20% of the remaining portfolio). The retirement wouldn't have been nice for the other strategies, but at least withdrawals would have been cut in response to the drops in portfolio value over the first 20 years or so.

Which of these strategies is 'best' rather depends on the consequences of either variable income or complete portfolio exhaustion. My own preference has been to secure enough income floor in guaranteed income (DB pension and, eventually, SP - I haven't needed to add a RPI annuity) not to have to worry about variability in portfolio income, so I have ended up using ABW (which is a percentage of portfolio approach where the percentage increases with time, see https://www.bogleheads.org/wiki/Amortization_based_withdrawal of which, VPW is a better known case, see https://www.bogleheads.org/wiki/Variable_percentage_withdrawal ).



* A portfolio of 60% UK stocks, 20% UK long bonds, and 20% UK cash was used as an illustration. Asset returns and UK inflation from macrohistory.net. While the details would be different for a different portfolio, the broad conclusions would not.

Interesting that of the Hybrid approaches, the simplest one 'MX- a 50:50 split of CIPW and CP' performs better overall taking into account both graphs, than the supposedly more sophisticated GK and VD approaches.
Of course over a different period the result could be different, but just going 50:50 could be enough to largely cover all bases and easier to work out !

In my initial planning I was going to use a simple mix before I realised that we had more than enough flooring so could accept a lot of volatility in our portfolio income.

I should note that MX as plotted was a 50/50 mix of a 3.0% constant inflation adjusted withdrawal and a constant percentage of portfolio of 5%. Essentially it gives an inflation adjusted floor of 1.5% of the initial portfolio, which means it can still fail if the retirement was much worse than the one shown. Practically, for a £1m portfolio that is an initial withdrawal of £15k that is subsequently inflation adjusted and an initial variable withdrawal of £25k.

By way of contrast to the bad times, here's a plot of a 'good' historical retirement

The actual SWR is well above 4% for this retirement, so constant inflation adjusted withdrawals worked nicely, but, after 35 years, left a pot in real terms six times larger than the original one. CP, MX, and GK all behave fairly similarly (constant percentage takes the highest withdrawals and leaves the smallest pot, about 250% of the original, after 35 years), while the Vanguard approach of gradually increasing withdrawals under good conditions gives a rather different outcome to the others.

When I did my planning I quickly realized that I could withstand even more volatility in my portfolio than when I was still saving for retirement because the utility of the DC accumulations was minimized by the floor of guaranteed income I had from DB/ SP etc. When I then read some studies by Pfau that modeled rising equity allocation retirement portfolios and showed that they could improve success rates it only reinforced my idea to go from a basic 60/40 asset allocation to a higher equity allocation. I did this mostly by just buying equities as I approached early retirement and stopping rebalancing. I'm now 10 years into retirement and my portfolio is almost 90% equity index funds.