4% Drawdown If Preservation Of The Capital Is Not A Concern ?

OldScientist

Hoenir said:

OldScientist said:

As @Linton says, the 'safe' refers to historically safe and is different for different countries and different asset allocations (not only different ratios of stocks and bonds, but the maturity of bonds) - it is not a physical law!

The maximum inflation adjusted withdrawal rates that avoided running out of money before the end of the planning period for 60% UK stocks and 40% UK bonds (longish maturity) are given in the following graph (UK returns and UK inflation from macrohistory.net, my own calculations). SAFEMAX was about 2.9%.

[snip]

There were two problem periods:
1) Early 20th century (high inflation in WWI)
2) 1937 (stock market crash, WWII, and post-war currency and debt problems)

The relatively low SWR that the US simulators give in the mid-1960s were not present in the UK.

It is probably unlikely that anyone would invest solely in UK stocks nowadays, so here is the same graph with an allocation of 30% UK stocks, 30% US stocks, and 40% UK bonds (at some stage I'll get around to calculating a cap-weighted international index from the mactohistory.net dataset). The SAFEMAX was 3.3% for this allocation

[snip]

The worst cases remained centred around the same periods as before, but the SWR was now a little higher. However, not all retirements were improved by holding US stocks - e.g., the dip in the late 1960s is worse with US stocks than without.

Worth remembering that much of the data over that time frame is compiled not actual. Who knows what might have happened if investors were able to trade as they can do today. 

The data are based on prices and dividends (for shares) and prices and coupons for gilts, so reflect the returns that actually occurred. Whether individual investors would have been able to obtain those returns in a period a) where index funds did not exist (few people would have been able to diversify even to hold the FT30), and b) fees were large compared to today is a different question (I've ignored fees and taxes in the above analysis). Anecdotally, small investors appeared not to churn their investments and (in retirement) set them up to provide dividends and coupons. I agree with you - the effect of having more/different participants in the stock market is unknowable.

OldScientist

MK62 said:

OldScientist said:

As @Linton says, the 'safe' refers to historically safe and is different for different countries and different asset allocations (not only different ratios of stocks and bonds, but the maturity of bonds) - it is not a physical law!

The maximum inflation adjusted withdrawal rates that avoided running out of money before the end of the planning period for 60% UK stocks and 40% UK bonds (longish maturity) are given in the following graph (UK returns and UK inflation from macrohistory.net, my own calculations). SAFEMAX was about 2.9%.



There were two problem periods:
1) Early 20th century (high inflation in WWI)
2) 1937 (stock market crash, WWII, and post-war currency and debt problems)

The relatively low SWR that the US simulators give in the mid-1960s were not present in the UK.

It is probably unlikely that anyone would invest solely in UK stocks nowadays, so here is the same graph with an allocation of 30% UK stocks, 30% US stocks, and 40% UK bonds (at some stage I'll get around to calculating a cap-weighted international index from the mactohistory.net dataset). The SAFEMAX was 3.3% for this allocation



The worst cases remained centred around the same periods as before, but the SWR was now a little higher. However, not all retirements were improved by holding US stocks - e.g., the dip in the late 1960s is worse with US stocks than without.

Are those US equity return figures for a US based investor or a UK based investor.....just asking as the returns each might get, especially in drawdown, might be quite different.

Sorry, I should have been clearer. In the second example, the returns used are for a UK based investor. In other words, they include changes in exchange rate but they don't include dividend withholding or other taxes and only UK inflation is applied.

Cus

Personally I think a lot of the SWR thinking is just an attempt to feel in control of the uncontrollable, or worse trying to convince yourself that you can retire and start at 5% because the graphs say so. 

Reality might be that you should just assume no growth above inflation. Divide your pot by the number of years of retirement, and that's it. If things go better in the first few years then divide again.
Problem with this approach is that this just pushes retirement back for many, hence the comfort in SWR numbers etc

jamesd

The SWRs are used because they work and do handle the historic worst cases. Someone could try what you suggest but the Guyton-Klinger rules already adjust up or down based on what you really live through so better just to pick those.

Anyone can also recalculate whenever that seems sensible.

You can also use state pension deferring to reduce both investment and longevity risk (outliving your plan).

It's also worth considering how very cautious the SWR calculations are. Just average performance takes the US achievable rate to over 6% instead of the 4% rule's 4% plus annual inflation every year.

Of course someone could experience something worse than the historic worst but that can be adjusted for if it happens.

Linton

Cus said:

Personally I think a lot of the SWR thinking is just an attempt to feel in control of the uncontrollable, or worse trying to convince yourself that you can retire and start at 5% because the graphs say so. 

Reality might be that you should just assume no growth above inflation. Divide your pot by the number of years of retirement, and that's it. If things go better in the first few years then divide again.
Problem with this approach is that this just pushes retirement back for many, hence the comfort in SWR numbers etc

I agree very much that SWR thinking is a way of giving you the confidence to jump in a situation where the future is unknown. Whether that works for you is a matter of your psychology and ability to accept uncertainty. Some people will find a rigid pre-defined mechanistic approach helpful, others may worry more about the fundamental basis and details of the approach than the inherent uncertainty of planning the future. You need to find what works for you.

It would be interesting to know how people’s views on the way to manage the uncertainty have changed after they have retired or whether they are continuing to use the same methods they used when deciding to do so.

OldScientist

Linton said:

Cus said:

Personally I think a lot of the SWR thinking is just an attempt to feel in control of the uncontrollable, or worse trying to convince yourself that you can retire and start at 5% because the graphs say so. 

Reality might be that you should just assume no growth above inflation. Divide your pot by the number of years of retirement, and that's it. If things go better in the first few years then divide again.
Problem with this approach is that this just pushes retirement back for many, hence the comfort in SWR numbers etc

I agree very much that SWR thinking is a way of giving you the confidence to jump in a situation where the future is unknown. Whether that works for you is a matter of your psychology and ability to accept uncertainty. Some people will find a rigid pre-defined mechanistic approach helpful, others may worry more about the fundamental basis and details of the approach than the inherent uncertainty of planning the future. You need to find what works for you.

It would be interesting to know how people’s views on the way to manage the uncertainty have changed after they have retired or whether they are continuing to use the same methods they used when deciding to do so.

Highly variable stock/bond portfolios are not a good tool to provide a constant income (whether inflation adjusted or not). One way to reduce uncertainty is to provide an income floor in addition to SP and any DB pensions (search for floor and upside) through either
1) a ladder of inflation linked gilts (benefits: provides legacy before term of ladder expired, downside: could outlive planned ladder duration)
2) An RPI protected annuity (benefits: provides higher income than ladder for single retiree, while providing similar income to ladder for couple or with long guarantee period; downside notwithstanding FSCS protection, possibility of insurance company default).

Withdrawals from the remaining portfolio can be made using a variable approach (ranging from simple percentage of portfolio, Bogleheads VPW, G-K, etc.).

In both cases, flooring (currently) provides an income that is a little higher than worst historical case SWR, but well below even median cases (in other words, certainty can cost).

GazzaBloom

OldScientist said:

Linton said:

Cus said:

Personally I think a lot of the SWR thinking is just an attempt to feel in control of the uncontrollable, or worse trying to convince yourself that you can retire and start at 5% because the graphs say so. 

Reality might be that you should just assume no growth above inflation. Divide your pot by the number of years of retirement, and that's it. If things go better in the first few years then divide again.
Problem with this approach is that this just pushes retirement back for many, hence the comfort in SWR numbers etc

I agree very much that SWR thinking is a way of giving you the confidence to jump in a situation where the future is unknown. Whether that works for you is a matter of your psychology and ability to accept uncertainty. Some people will find a rigid pre-defined mechanistic approach helpful, others may worry more about the fundamental basis and details of the approach than the inherent uncertainty of planning the future. You need to find what works for you.

It would be interesting to know how people’s views on the way to manage the uncertainty have changed after they have retired or whether they are continuing to use the same methods they used when deciding to do so.

Highly variable stock/bond portfolios are not a good tool to provide a constant income (whether inflation adjusted or not). One way to reduce uncertainty is to provide an income floor in addition to SP and any DB pensions (search for floor and upside) through either
1) a ladder of inflation linked gilts (benefits: provides legacy before term of ladder expired, downside: could outlive planned ladder duration)
2) An RPI protected annuity (benefits: provides higher income than ladder for single retiree, while providing similar income to ladder for couple or with long guarantee period; downside notwithstanding FSCS protection, possibility of insurance company default).

Withdrawals from the remaining portfolio can be made using a variable approach (ranging from simple percentage of portfolio, Bogleheads VPW, G-K, etc.).

In both cases, flooring (currently) provides an income that is a little higher than worst historical case SWR, but well below even median cases (in other words, certainty can cost).

I think these posts are the crux of it. Make a plan where you hold the market risk and take the leap and have faith in the plan based around a starting SWR, holding firm in the inevitable headwinds, making spending adjustments if required. Or, take the comfort and more certainty of buying more fixed income such as an annuity.

if you take the annuity you are paying others to take on the market risk and ultimately you have to pay them for that comfort factor.

The inflation linked gilts ladder will reduce the uncertainty too, but will reduce the potential for longer term gains in exchange.

OldScientist

Just to illustrate the effect of making some choices (with apologies to the OP since it doesn't cover their scenario). Let's assume a 67 year old couple with combined state pensions of £21k (and no other guaranteed income). Assume they have a portfolio with £500k invested 30% UK stocks, 30% US stocks, and 40% UK gilts. Ignore the effects of fees and taxes. Also assume that both survive to 100 (i.e. a 33 year planning period), although some scenarios are affected more by the death of a parter than others. Modelling has been done using the historical returns at macrohistory.net.

If they decided to use a constant inflation adjusted withdrawal amount of 3.5% (slightly above the historical SAFEMAX), the outcomes at 0th (worst case), 10th, 25th, 50th (median), and 75th percentiles for portfolio value (upper panel) and total income, (i.e., combination of portfolio withdrawals and state pension (lower panel) are shown below



In most retirements they have a steady (inflation adjusted) income of just under £40k with final portfolio values (in real terms) that vary from 0 (in less than 10% of cases) to £500k (median case) to more than twice the original value (75th percentile). In the worst retirements, the portfolio was exhausted (i.e., no legacy) and the retirees would have had to rely on their state pensions for the last 5 or so years.

If they chose a variable withdrawal method (I've used a constant percentage of portfolio of 3.5% but smoothed the portfolio value over the previous 3 years - I note that a higher percentage could be used which would increase initial income at the expense of later income).



In this approach, the portfolio was not exhausted and the range of final values is narrower (from about £200k to just under £1000k). However, the income was considerably lower in the worst case retirement falling to about £27k in the middle years of retirement, while median cases saw higher income.

For the final example, the couple decided to use half of their portfolio to purchase a joint annuity with RPI protection and 100% survivor benefits (but no guarantee period). According to moneyhelper annuity tool, this has a payout rate of 3.73%. Therefore annuity income is a constant inflation adjusted £9.325k per year. Combining this with the state pension and portfolio withdrawals (from a residual pot of £250k and using the variable method as described above) gave the following outcomes



The first thing to note is that the portfolio available for legacy was now much smaller (halved) but was not exhausted in any case. Alternatively, the payout rate for an annuity with a 20 year guarantee period (i.e., to provide a bit more legacy in the event of early death of both retirees) has a rate of 3.67% (i.e., not a lot less that without a guarantee).
The second thing to note is that while the income was still variable, the range was now more constrained than without the annuity - in the worst historical retirement case, the income fell to just under £35k in the middle years of the retirement before recovering towards the end. However, the upside income (i.e., the 75th percentile) was reduced.

Which of these approaches is 'best' is likely to vary from retiree to retiree depending on their requirements - each has its own advantages and disadvantages that ought to be considered.

michaels

OldScientist said:

Just to illustrate the effect of making some choices (with apologies to the OP since it doesn't cover their scenario). Let's assume a 67 year old couple with combined state pensions of £21k (and no other guaranteed income). Assume they have a portfolio with £500k invested 30% UK stocks, 30% US stocks, and 40% UK gilts. Ignore the effects of fees and taxes. Also assume that both survive to 100 (i.e. a 33 year planning period), although some scenarios are affected more by the death of a parter than others. Modelling has been done using the historical returns at macrohistory.net.

If they decided to use a constant inflation adjusted withdrawal amount of 3.5% (slightly above the historical SAFEMAX), the outcomes at 0th (worst case), 10th, 25th, 50th (median), and 75th percentiles for portfolio value (upper panel) and total income, (i.e., combination of portfolio withdrawals and state pension (lower panel) are shown below



In most retirements they have a steady (inflation adjusted) income of just under £40k with final portfolio values (in real terms) that vary from 0 (in less than 10% of cases) to £500k (median case) to more than twice the original value (75th percentile). In the worst retirements, the portfolio was exhausted (i.e., no legacy) and the retirees would have had to rely on their state pensions for the last 5 or so years.

If they chose a variable withdrawal method (I've used a constant percentage of portfolio of 3.5% but smoothed the portfolio value over the previous 3 years - I note that a higher percentage could be used which would increase initial income at the expense of later income).



In this approach, the portfolio was not exhausted and the range of final values is narrower (from about £200k to just under £1000k). However, the income was considerably lower in the worst case retirement falling to about £27k in the middle years of retirement, while median cases saw higher income.

For the final example, the couple decided to use half of their portfolio to purchase a joint annuity with RPI protection and 100% survivor benefits (but no guarantee period). According to moneyhelper annuity tool, this has a payout rate of 3.73%. Therefore annuity income is a constant inflation adjusted £9.325k per year. Combining this with the state pension and portfolio withdrawals (from a residual pot of £250k and using the variable method as described above) gave the following outcomes



The first thing to note is that the portfolio available for legacy was now much smaller (halved) but was not exhausted in any case. Alternatively, the payout rate for an annuity with a 20 year guarantee period (i.e., to provide a bit more legacy in the event of early death of both retirees) has a rate of 3.67% (i.e., not a lot less that without a guarantee).
The second thing to note is that while the income was still variable, the range was now more constrained than without the annuity - in the worst historical retirement case, the income fell to just under £35k in the middle years of the retirement before recovering towards the end. However, the upside income (i.e., the 75th percentile) was reduced.

Which of these approaches is 'best' is likely to vary from retiree to retiree depending on their requirements - each has its own advantages and disadvantages that ought to be considered.

Your posts are always well constructed and informative.

A high level rule of thumb might be that one holds a mixture of stocks and bond in some sort of trade off between overall gains and volatility.  With a fixed DB/SP component of retirement income, is there an argument that the remaining subject to volatility pot should be more skewed towards equities than the modelled 60/40 portfolios as effectively a proportion of the overall pension is already completely protected against volatility so the bond holding in the variable bit is effectively superfluous?

MetaPhysical

Happy New Year all.  May god/providence bless you with health, happiness and financial well being for you and those you hold dear.

I think the bottom line is that no one knows.  There are always unknown's in life; how long will we live, what will growth be like, how low or high will inflation be, how many crashes in the markets, how long will we stay healthy etc etc.

What we *do* know with 100% certainty is that we are not getting any younger and I want to enjoy my go-go years in the 58-70 range if I get the opportunity.  My wife died at 51.  My fiancee's mum was diagnosed with MND at 74 in October  and these sorts of shattering news and life events bring home why it is important to enjoy your life to the fullest you can.  So, I am retiring when I am 58 and I am going to take 5% and let the pieces fall where they may and adjust accordingly.  I have my DB and SP of me and my soon-to-be-wife (and her small pensions and her SP) to fall back on if the DC pot should deplete. 

You nearly always regret the things you didn't do, not the ones you did.  "ars longa vita brevis"