SWR Come What May

zagfles

[Deleted User] said:

jim8888 said:

I wondered if there's anyone out there living off a Safe Withdrawal Rate "come what may" - in other words, they're taking 4% of their pot every year, regardless of whether they need the money or not, regardless of what the markets are doing, regardless of all factors in favour or against? It seems to me that there are plenty of us looking at living off a SWR, but I wondered how many actually do in practice? I know I don't (although I could). 

I'm sure that there are definitely some brave souls living off their Safe Withdrawal Rate like it's set in stone. But as Captain Barbossa says:

The 4% rule is more what you'd call "guidelines" than actual rules. Some follow it to the letter, others bend it when markets get rough, and then there's me – navigating retirement like a pirate on the high seas, adjusting course as I go. Welcome aboard the Black Pearl.

How many people are really living just off a SWR?  Most have / will get a state pension, so it would seem silly to ignore the interaction of the two.  And if you are going to do that, well why wouldn't you take account of other factors too?  Like how what the markets have done since you retired and how what you spend might change with age?

SWR is a great rule of thumb, but I'm not going to use my thumb to measure anything important.

Having a base of a state pension plus maybe DB pensions can enable you to take much more risk with equity drawdown. Someone with a decent base of state pension and DB may be able to take more risk than someone who is relying on drawdown to eat. 

OldScientist

Grumpy_chap said:

[Deleted User] said:

I'm not going to use my thumb to measure anything important.

You would have to if you wanted to know what a thumb's width was

On a serious note, why wouldn't someone do this?

[Deleted User] said:

 living off their Safe Withdrawal Rate like it's set in stone. 

There is nothing brave in living off a SWR.
It is not a SAFE withdrawal rate otherwise.
Now, whether the SWR is correctly set is another matter entirely.

FWIW, I always think that the SWR percentages generally mentioned are too conservative as the typical values referenced (4% or thereabouts) seem to be to preserve the original capital value and only spend growth.  I will be perfectly happy to spend the original capital value over the period of retirement.  At 4% withdrawal rate, growth could be zero and I still last 25 years...

'Safe' withdrawal rates are defined as the highest withdrawal amount (expressed as a percentage of the initial portfolio), subsequently adjusted for inflation, that do not prematurely exhaust the portfolio before the retirement planning horizon (typically 30 years) has expired.

In other words:
1) In the worst historical cases the capital is spent down to zero.
2) The results for historical retirements (back to those starting in 1994 for the 30 year case) are known (roughly 4% for the US and 3.0% to 3.5% for the UK). Future 'safe' withdrawal rates are unknown and unpredictable - in other words, one could choose 3.5% at the start of retirement and follow the process exactly, but still run out of money.

The sequence of real returns (i.e., returns adjusted for inflation) is critical. Poor returns early in the retirement have a much larger effect on whether the portfolio runs out of money than poor returns later on.

For example, imagine the case where a 5 year retirement is planned and inflation adjusted withdrawals of 20% are taken (i.e., £20k per year from a £100k portfolio)). Real returns are 0% per year until after the 4th withdrawal when the return is -50%. All values are inflation adjusted.

In this case, the retiree manages 4 full withdrawals of £20k (in real terms), but the final one is reduced to £10k (but is at least non-zero).

Now consider the case, where the -50% return occurs in the first year instead of the final one


In this case, the retiree manages 3 full withdrawals of 20k after which the portfolio is exhausted.

In each case, the total return over the period is identical.

To go back to the OP question, the problem for the retiree following the SWR method in the second case is a psychological one - after the first year do you continue to withdraw £20k or not? Bravery or idiocy?

ps Sorry if the table format was originally a bit messed up... I've now replaced them with pictures instead of text

zagfles

OldScientist said:

Grumpy_chap said:

[Deleted User] said:

I'm not going to use my thumb to measure anything important.

You would have to if you wanted to know what a thumb's width was

On a serious note, why wouldn't someone do this?

[Deleted User] said:

 living off their Safe Withdrawal Rate like it's set in stone. 

There is nothing brave in living off a SWR.
It is not a SAFE withdrawal rate otherwise.
Now, whether the SWR is correctly set is another matter entirely.

FWIW, I always think that the SWR percentages generally mentioned are too conservative as the typical values referenced (4% or thereabouts) seem to be to preserve the original capital value and only spend growth.  I will be perfectly happy to spend the original capital value over the period of retirement.  At 4% withdrawal rate, growth could be zero and I still last 25 years...

'Safe' withdrawal rates are defined as the highest withdrawal amount (expressed as a percentage of the initial portfolio), subsequently adjusted for inflation, that do not prematurely exhaust the portfolio before the retirement planning horizon (typically 30 years) has expired.

In other words:
1) In the worst historical cases the capital is spent down to zero.
2) The results for historical retirements (back to those starting in 1994 for the 30 year case) are known (roughly 4% for the US and 3.0% to 3.5% for the UK). Future 'safe' withdrawal rates are unknown and unpredictable - in other words, one could choose 3.5% at the start of retirement and follow the process exactly, but still run out of money.

The sequence of real returns (i.e., returns adjusted for inflation) is critical. Poor returns early in the retirement have a much larger effect on whether the portfolio runs out of money than poor returns later on.

For example, imagine the case where a 5 year retirement is planned and inflation adjusted withdrawals of 20% are taken (i.e., £20k per year). Real returns are 0% per year until after the 4th withdrawal when the return is -50%. All values are inflation adjusted.

Year Portfolio Spend Remaining Return

1 100000 20000 80000   0

2 80000  20000 60000    0

3 60000 20000 40000    0

4 40000 20000 20000  -50

5 10000 10000  0         0

In this case, the retiree manages 4 full withdrawals of £20k (in real terms), but the final one is reduced to £10k (but is at least non-zero).

Now consider the case, where the -50% return occurs in the first year instead of the final one

Year Portfolio Spend Remaining Return (%)

1 100000 20000 80000 -50

2 40000  20000 20000 0

3 20000 20000 0     0

4 0        0        0    0

5 0        0       0    0

In this case, the retiree manages 3 full withdrawals of 20k after which the portfolio is exhausted.

In each case, the total return over the period is identical.

To go back to the OP question, the problem for the retiree following the SWR method in the second case is a psychological one - after the first year do you continue to withdraw £20k or not? Bravery or idiocy?

ps Sorry if the table format is a bit messed up... it looked fine in the preview!

You have a point but the example is ridiculously exaggerated. Dynamic asset allocation can help with SORR, personally I'll be using Prime Harvesting, where IIRC the worst case historical scenario you won't be selling equities for a decade from a 60/40 equities/bonds starting point. 

There's no point having a strategy if you don't trust it. Obviously if something totally unprecedented happened, something that has never happened before, you may need to rethink. But changing strategy in a panic because of eg a market crash on a similar scale to ones we've seen several times in recent decades and which the "SWR" has been measured to cope with is no different to those who sell in a panic or stop investing whenever the market goes down. 

Albermarle

Triumph13 said:

You need to distinguish between those who have meticulously planned and researched their withdrawal strategy, like the regulars on here, and your random retiree who gets to retirement age and hasn't got a clue what to do.  I'm willing to bet that no-one in the former group will be blindly following an  SWR strategy.  We will all have modelled various scenarios for cutting back in a prolonged downturn.

A more interesting question might be what happens if we don't get a series of investment returns as bad as anything in history? That's what SWR was built to survive.  How many of us have a strategy for the point at which we would be comfortable to increase our drawings in the historically more likely scenario that our investments grow significantly post retirement?  
. 

Not an expert, but there alternatives to the rigid SWR withdrawal that takes into account more short/medium ups and downs of investment returns. The Guyton Klinger guardrail theory was mentioned more in the past on the forum, but the main advocate has stopped posting.
Vanguard have an easy to understand simplified explanation of different withdrawal strategies.
A guide to retirement withdrawal strategies | Vanguard

michaels

zagfles said:

westv said:

It isn't 4%'in the UK. More like 3-3.5%ish.

May as well buy an index linked annuity then. 

Is that a surprise given that an annuity pools longevity risk?

zagfles

[Deleted User] said:

zagfles said:

Having a base of a state pension plus maybe DB pensions can enable you to take much more risk with equity drawdown. Someone with a decent base of state pension and DB may be able to take more risk than someone who is relying on drawdown to eat. 

That's right.  But does it impact the "4%" (or whatever) SWR?  Or does it say you should use a different method of working out what you spend?

Yes. Because "safe" is a relative term. If you're relying on drawdown for essentials of life, then you'll want "safe" to be very safe, whereas if you're just using it for extra luxuries in life then "safe" could just be "fairly safe". 

So for example in the first case you might want a SWR that would have worked historically 100% of the time whereas for the latter 80 or 90% may do. 

And yes to work out the above you can split what you spend into "essentials" and "luxuries". 

zagfles

michaels said:

zagfles said:

westv said:

It isn't 4%'in the UK. More like 3-3.5%ish.

May as well buy an index linked annuity then. 

Is that a surprise given that an annuity pools longevity risk?

Not especially. Other than perhaps that equities won't necessarily beat gilts over several decades

Audaxer

coyrls said:

Grumpy_chap said:

 At 4% withdrawal rate, growth could be zero and I still last 25 years...

How do you know that when you don't know future inflation rates (SWR is the initial percentage, which is then increased by inflation each year)?

Exactly, and for those who retired 3 or 4 years ago on a 4% SWR, if they added the high inflation percentages in the last few years to their annual spend, it will now be a good bit higher than the initial 4%. 

MK62

Audaxer said:

coyrls said:

Grumpy_chap said:

 At 4% withdrawal rate, growth could be zero and I still last 25 years...

How do you know that when you don't know future inflation rates (SWR is the initial percentage, which is then increased by inflation each year)?

Exactly, and for those who retired 3 or 4 years ago on a 4% SWR, if they added the high inflation percentages in the last few years to their annual spend, it will now be a good bit higher than the initial 4%. 

It would, but then their investments may have grown more, leaving them in a relatively better position than before they started.
You have to look at both returns AND inflation.......ie real return. That said, applying real return may sometimes not be as simple as just subtracting inflation from portfolio returns........sometimes 2% inflation with 2% returns will not have the same effect on your position as 7% inflation with 7% returns, even though both are 0% real return......it depends on the overall makeup of your portfolio and income streams.

OldScientist

zagfles said:

You have a point but the example is ridiculously exaggerated. Dynamic asset allocation can help with SORR, personally I'll be using Prime Harvesting, where IIRC the worst case historical scenario you won't be selling equities for a decade from a 60/40 equities/bonds starting point. 

There's no point having a strategy if you don't trust it. Obviously if something totally unprecedented happened, something that has never happened before, you may need to rethink. But changing strategy in a panic because of eg a market crash on a similar scale to ones we've seen several times in recent decades and which the "SWR" has been measured to cope with is no different to those who sell in a panic or stop investing whenever the market goes down. 

The example can (and should for those wanting to see what happens 'if') be extended to a more sensible number of years than five (I wanted to keep the tables short, but illustrate the problem). A 50% reduction in real portfolio value is rare but not unprecedented, while persistent small or negative real returns are less dramatic, but, in the long run, equally problematic. According to McClung's own figures, Prime Harvesting either improved (by 40 basis points) or slightly decreased the SWR (10 bp) for US retirees (depending on what dataset was used), and improved it for UK (70 bp) and Japanese (50 bp) retirees. I also note it is possible for the retiree to end up with 100% equities if the bonds have been spent down and the equity returns have been insufficient to trigger a sale.

I'd agree that trust in the method is important. But I would contend that SWR is not trustworthy unless using very small withdrawal rates since while historical values are known (e.g., 3.0 to 3.5% for UK retirees) future values are not. For example, in the following graph the real value of the portfolio (upper panel) and the real withdrawal (lower panel) is shown for a UK retiree with a 60/20/20 (stocks/long bonds/cash - returns and inflation are from macrohistory.net) starting in 1937. I chose a conservative value of 3% for thew withdrawal rate.



The question you have to ask, is when would you decide to ditch SWR or otherwise panic? 10 years in when the portfolio has fallen, in real terms, to less than half of its initial value, after 15 years when it fell to just over 20% of the initial value, or after 20 years when it had fallen to about 15%? 

For anyone interested in real panic, then a search for 'Plan B' on the bogleheads forums during 2008-2009 is illuminating (in essence Plan B was getting out of equities and buying bonds during the prolonged and relentless market falls). This was directly contrary to the bogleheads stated aim of 'stay the course' and provoked heated discussion.