SWR Come What May

OldScientist

Linton said:

MK62 said:

In the end, in drawdown, variable expenditure (or income) may become unavoidable, unless your draw rate is so low that it can withstand almost any return/inflation scenario.......but then you'd be likely living well below your means unnecessarily.

Yes, if your pot is in a long term decline (say > 5 years) to a level where your ongoing drawdown is looking in doubt then a replan to respecify your needs could be essential.  However you should be able to avoid cutting expenditure during the normal once or twice a decade crash.

 For those of us who like a framework on which to hang decisions, can you quantify how much of a decline and how to distinguish between a normal and an abnormal crash?

In the following figure, the first 5 withdrawals for a historical UK based retirement are shown (60/20/20 stocks/long bonds/cash) - top panel is real portfolio value after withdrawal and lower panel is the real withdrawal. I've blanked out the years (although some might recognise the event).



The decision is now what to take for the 6th withdrawal. Do you continue to take an inflation adjusted 4.5% or not (btw, taking 3% for the first three years doesn't really make much difference to the value of the portfolio at the point of decision)?

MK62

Is that not a bit of a loaded question though, as it appears to assume each drawdown is drawn from each asset class in the same proportion.....faced with such declines on the equity portion of the portfolio, surely the bonds and/or cash would be called on to provide the bulk of the withdrawal(s) during that period.

Hoenir

Linton said:

MK62 said:

In the end, in drawdown, variable expenditure (or income) may become unavoidable, unless your draw rate is so low that it can withstand almost any return/inflation scenario.......but then you'd be likely living well below your means unnecessarily.

Yes, if your pot is in a long term decline (say > 5 years) to a level where your ongoing drawdown is looking in doubt then a replan to respecify your needs could be essential.  However you should be able to avoid cutting expenditure during the normal once or twice a decade crash.

Not the crash that's the issue. Recovery to previous market highs is. As an example. S&P 500 peaked in 2007. Only recovered to same level in 2013. Some 6 years later. 

kempiejon

Hoenir said:

Not the crash that's the issue. Recovery to previous market highs is. As an example. S&P 500 peaked in 2007. Only recovered to same level in 2013. Some 6 years later. 

I have in my mind that a 50% loss in capital and income will come along a few times in my retirement. I have a cashlike buffer part of the portfolio, when I'm living exclusively off my investments I'll have an equivalent to 3 years of income set aside. A 50% drop could be topped up for over 6 years provided it starts crawling back to previous levels over that time. so the S&P 2007 - 2013 would work. A similar collapse and recovery I saw in the FTSE100. Covid the bump was shorter lived, by the third year my portfolio had recovered, when the next hiccup comes I'll have contingencies before I need to worry about reducing my expenses. There's fat in my spending plan that I'd prefer to but do not need.

Linton

OldScientist said:

Linton said:

OldScientist said:

Linton said:

OldScientist said:

NoMore said:

jim8888 said:

NoMore said:

Its a deceptively simple answer to a extremely difficult problem, unfortunately you can't guarantee its the right answer.

I'm also pretty sure 90% (outside this thread/forum) misunderstand it and think it means 4% (or whatever SWR%) of your remaining portfolio every year not the correct method which is 4% of the initial portfolio and then adjust that number each year for inflation such that your spending power each year remains the same. 

Thanks for that clarification. I'd be in the 90% and I thought I knew about this stuff !

As I said its a common misconception, but if you did the 4% of remaining each year, your withdrawals could vary wildly depending on gains/losses. The SWR avoids this by setting a initial amount and then adjusting it for inflation. The idea is like a yearly wage its predictable what you will get, with a 4% of remaining you have no idea year to year what you will be withdrawing.

The predictability (or otherwise) of income is a critical point. Withdrawal strategies can broadly be divided into three categories
1) Inflation adjusted (of which constant inflation adjusted, i.e., SWR is the best known). From an income point of view, the advantage is that the income is known, but the disadvantage is that how long the income will last for is not.
2) Percentage of portfolio (e.g., constant percentage, bogleheads VPW or ABW, 1/N, possibly natural yield, etc.). The advantage is that, mathematically, income will be delivered for a lifetime, but the disadvantage is that real income will vary from year to year and, potentially, become small.
3) Hybrid methods, and there are loads, combine elements of inflation linked and percentage of portfolio methods (e.g., Guyton Klinger, Vanguard Dynamic, Carlson's endowment, Bengen’s floor and ceiling, etc.). Income is less variable than in the percentage of portfolio case (although can still get small in poor retirements) and there is less chance of portfolio exhaustion than in the inflation adjusted case.

However, whether you care about variability or failure in drawdown income depends on what fraction it forms of your spending (whether essential or the total of essential and discretionary).

For example

For a couple with two state pensions (£23k), and a combined pension pot of £150k (and an inflation adjusted income of ~£4.5k). If their state pensions cover their essential spending and at least some of their discretionary, then the drawdown income is just ‘icing on the cake’ and pretty well any withdrawal strategy could be adopted because variability or failure can easily be accommodated. I suspect a number of the denizens on these boards fall into this category.

However, for a couple with two state pensions (£23k), a combined pension pot of £800k (inflation adjusted income ~£24k), an essential spend of £40k, and a discretionary spend of a further £10k, things are a bit tricker since a portfolio failure would leave them with insufficient income to support their essential spend and percentage of portfolio methods might leave them short in some years. Playing around with different hybrid approaches might provide a solution, but there is always the possibility of failure. However, purchasing sufficient RPI protected income annuity to provide most or all of the essential spend (i.e., up to an additional £17k costing around £400-£450k for a joint life – even if payout rates fall back to 3%, this would still ‘only’ cost £560k) and then withdrawing the remaining pot using whatever method desired. Of course, an alternative approach might be to revise what is considered essential spending and what discretionary.

There is a 4th strategy.  Plan on taking what you need, invest for long term growth with a high global diversification, and ensure you have sufficient slack to last n years with zero equity growth.  Choose "n" and "need" on the basis of what you can afford and are prepared to accept in the knowledge that there is no investment based strategy that will work in all conceivable circumstances.

In my view the academic strategies are fine to boost the authors professional ratings, book sales, and earnings from the lecture circuit./  To be fair they may be helpful in giving you the confidence to jump.  But I find it difficult to believe that any but a very small number of people will put any of them into practice over the long term.

Does anyone here who has retired actually use an academic strategy? If so which one?

IMV, defining 'what you can afford' is one element of the withdrawal strategies.

In answer to your question, yes
1) Floor provided by an inflation protected DB pension (which will be added to once in receipt of the SP)
2) Portfolio withdrawals using a modified version of VPW (so withdrawals vary from year to year).
3) Inflation linked ladder (and life insurance) to cover the period before my OH gets their SP in the event of my death.

I don't know whether 1) counts as an 'academic' strategy, but had I not had a DB pension, I would have built as sufficient flooring using an annuity instead (does buying an annuity count as an 'academic' strategy?).

I am solely referring to long term strategies intended to manage drawdown from volatile investments. If you can meet your needs without it that is fine but its not what I am discussing..

As a basic principle I would argue against any strategy that imposes variable expenditure over time depending on the then current economic circumstances.  So that would rule out VPW (Variable % withdrawal) unless one had a sufficiently large buffer to cover the difficult times. 

Just to be clear, are you arguing for constant inflation adjusted withdrawals (i.e., some form of SWR) then, since any other type would introduce variable real expenditure?

The 'buffer' can come from guaranteed income (whether SP, DB pension, RPI annuity, Edit: or inflation linked gilt ladder) - i.e., a 'floor and upside' approach.

I am not arguing for constant inflation linked withdrawals.  That sounds too prescriptive. The aim is to be able to spend what one wants to spend when one wants to spend it.

What I am arguing for in other threads is a large lower risk buffer from which all income is taken.  The buffer is fed by interest/dividends from income funds,by annuities/SP and if necessary by lump sums from a growth portfolio.  So withdrawal from growth funds is a strategic decision, not a regular feed.

By decoupling expenditure from sale of growth funds one can take a medium term approach.with minimal disruption from isolated crashes and thus no need to slash expnditure at short notice.

Linton

OldScientist said:

Linton said:

MK62 said:

In the end, in drawdown, variable expenditure (or income) may become unavoidable, unless your draw rate is so low that it can withstand almost any return/inflation scenario.......but then you'd be likely living well below your means unnecessarily.

Yes, if your pot is in a long term decline (say > 5 years) to a level where your ongoing drawdown is looking in doubt then a replan to respecify your needs could be essential.  However you should be able to avoid cutting expenditure during the normal once or twice a decade crash.

 For those of us who like a framework on which to hang decisions, can you quantify how much of a decline and how to distinguish between a normal and an abnormal crash?

In the following figure, the first 5 withdrawals for a historical UK based retirement are shown (60/20/20 stocks/long bonds/cash) - top panel is real portfolio value after withdrawal and lower panel is the real withdrawal. I've blanked out the years (although some might recognise the event).



The decision is now what to take for the 6th withdrawal. Do you continue to take an inflation adjusted 4.5% or not (btw, taking 3% for the first three years doesn't really make much difference to the value of the portfolio at the point of decision)?

]
The key driver for withdrawals from growth equity is the behaviour of the buffer, the %IPV is irrelevent. If the buffer drops to say 6 years typical uncovered expenses there is a strategic decision to be made.  One could plan to reduce expenditure for the rest of one's life, or take a lump sum from the growth equity to put into the buffer, or move funds from growth to income.  The final option is what I have done several times in the past nearly 20 years on an ad hoc basis. mainly when the growth portfolio increased to unjustifiably high levels.

Triumph13

Linton said:

OldScientist said:

Linton said:

OldScientist said:

NoMore said:

jim8888 said:

NoMore said:

Its a deceptively simple answer to a extremely difficult problem, unfortunately you can't guarantee its the right answer.

I'm also pretty sure 90% (outside this thread/forum) misunderstand it and think it means 4% (or whatever SWR%) of your remaining portfolio every year not the correct method which is 4% of the initial portfolio and then adjust that number each year for inflation such that your spending power each year remains the same. 

Thanks for that clarification. I'd be in the 90% and I thought I knew about this stuff !

As I said its a common misconception, but if you did the 4% of remaining each year, your withdrawals could vary wildly depending on gains/losses. The SWR avoids this by setting a initial amount and then adjusting it for inflation. The idea is like a yearly wage its predictable what you will get, with a 4% of remaining you have no idea year to year what you will be withdrawing.

The predictability (or otherwise) of income is a critical point. Withdrawal strategies can broadly be divided into three categories
1) Inflation adjusted (of which constant inflation adjusted, i.e., SWR is the best known). From an income point of view, the advantage is that the income is known, but the disadvantage is that how long the income will last for is not.
2) Percentage of portfolio (e.g., constant percentage, bogleheads VPW or ABW, 1/N, possibly natural yield, etc.). The advantage is that, mathematically, income will be delivered for a lifetime, but the disadvantage is that real income will vary from year to year and, potentially, become small.
3) Hybrid methods, and there are loads, combine elements of inflation linked and percentage of portfolio methods (e.g., Guyton Klinger, Vanguard Dynamic, Carlson's endowment, Bengen’s floor and ceiling, etc.). Income is less variable than in the percentage of portfolio case (although can still get small in poor retirements) and there is less chance of portfolio exhaustion than in the inflation adjusted case.

However, whether you care about variability or failure in drawdown income depends on what fraction it forms of your spending (whether essential or the total of essential and discretionary).

For example

For a couple with two state pensions (£23k), and a combined pension pot of £150k (and an inflation adjusted income of ~£4.5k). If their state pensions cover their essential spending and at least some of their discretionary, then the drawdown income is just ‘icing on the cake’ and pretty well any withdrawal strategy could be adopted because variability or failure can easily be accommodated. I suspect a number of the denizens on these boards fall into this category.

However, for a couple with two state pensions (£23k), a combined pension pot of £800k (inflation adjusted income ~£24k), an essential spend of £40k, and a discretionary spend of a further £10k, things are a bit tricker since a portfolio failure would leave them with insufficient income to support their essential spend and percentage of portfolio methods might leave them short in some years. Playing around with different hybrid approaches might provide a solution, but there is always the possibility of failure. However, purchasing sufficient RPI protected income annuity to provide most or all of the essential spend (i.e., up to an additional £17k costing around £400-£450k for a joint life – even if payout rates fall back to 3%, this would still ‘only’ cost £560k) and then withdrawing the remaining pot using whatever method desired. Of course, an alternative approach might be to revise what is considered essential spending and what discretionary.

There is a 4th strategy.  Plan on taking what you need, invest for long term growth with a high global diversification, and ensure you have sufficient slack to last n years with zero equity growth.  Choose "n" and "need" on the basis of what you can afford and are prepared to accept in the knowledge that there is no investment based strategy that will work in all conceivable circumstances.

In my view the academic strategies are fine to boost the authors professional ratings, book sales, and earnings from the lecture circuit./  To be fair they may be helpful in giving you the confidence to jump.  But I find it difficult to believe that any but a very small number of people will put any of them into practice over the long term.

Does anyone here who has retired actually use an academic strategy? If so which one?

IMV, defining 'what you can afford' is one element of the withdrawal strategies.

In answer to your question, yes
1) Floor provided by an inflation protected DB pension (which will be added to once in receipt of the SP)
2) Portfolio withdrawals using a modified version of VPW (so withdrawals vary from year to year).
3) Inflation linked ladder (and life insurance) to cover the period before my OH gets their SP in the event of my death.

I don't know whether 1) counts as an 'academic' strategy, but had I not had a DB pension, I would have built as sufficient flooring using an annuity instead (does buying an annuity count as an 'academic' strategy?).

I am solely referring to long term strategies intended to manage drawdown from volatile investments. If you can meet your needs without it that is fine but its not what I am discussing..

As a basic principle I would argue against any strategy that imposes variable expenditure over time depending on the then current economic circumstances.  So that would rule out VPW (Variable % withdrawal) unless one had a sufficiently large buffer to cover the difficult times. 

In that case your only option is an annuity.  Any other approach will always impose variable expenditure if you have bad enough returns, it's just a question of the shape of the expenditure curve.  I personally would not be happy with that curve being a step function ie your expenditure never varies until suddenly it goes to zero because you have run out of money.

There is no clever solution that gets you round this fact.  All you can do is build a strategy that tries to minimise the risk of an unacceptable variation. Accepting smaller variations is one of the most powerful tools available to help you do that.  There are various strategies to reduce the impact of variable income, such as running the income through a cash buffer, but the best is probably annuitising a sufficient proportion of your planned spend that the variability in the remainder doesn't matter so much.

MK62

Fair enough.......but if the annuity (or partial annuity) approach was acceptable, presumably you'd already have gone down that path.

westv

Hoenir said:

Linton said:

MK62 said:

In the end, in drawdown, variable expenditure (or income) may become unavoidable, unless your draw rate is so low that it can withstand almost any return/inflation scenario.......but then you'd be likely living well below your means unnecessarily.

Yes, if your pot is in a long term decline (say > 5 years) to a level where your ongoing drawdown is looking in doubt then a replan to respecify your needs could be essential.  However you should be able to avoid cutting expenditure during the normal once or twice a decade crash.

Not the crash that's the issue. Recovery to previous market highs is. As an example. S&P 500 peaked in 2007. Only recovered to same level in 2013. Some 6 years later. 

Does that include reinvestment of income?

Linton

Triumph13 said:

Linton said:

OldScientist said:

Linton said:

OldScientist said:

NoMore said:

jim8888 said:

NoMore said:

Its a deceptively simple answer to a extremely difficult problem, unfortunately you can't guarantee its the right answer.

I'm also pretty sure 90% (outside this thread/forum) misunderstand it and think it means 4% (or whatever SWR%) of your remaining portfolio every year not the correct method which is 4% of the initial portfolio and then adjust that number each year for inflation such that your spending power each year remains the same. 

Thanks for that clarification. I'd be in the 90% and I thought I knew about this stuff !

As I said its a common misconception, but if you did the 4% of remaining each year, your withdrawals could vary wildly depending on gains/losses. The SWR avoids this by setting a initial amount and then adjusting it for inflation. The idea is like a yearly wage its predictable what you will get, with a 4% of remaining you have no idea year to year what you will be withdrawing.

The predictability (or otherwise) of income is a critical point. Withdrawal strategies can broadly be divided into three categories
1) Inflation adjusted (of which constant inflation adjusted, i.e., SWR is the best known). From an income point of view, the advantage is that the income is known, but the disadvantage is that how long the income will last for is not.
2) Percentage of portfolio (e.g., constant percentage, bogleheads VPW or ABW, 1/N, possibly natural yield, etc.). The advantage is that, mathematically, income will be delivered for a lifetime, but the disadvantage is that real income will vary from year to year and, potentially, become small.
3) Hybrid methods, and there are loads, combine elements of inflation linked and percentage of portfolio methods (e.g., Guyton Klinger, Vanguard Dynamic, Carlson's endowment, Bengen’s floor and ceiling, etc.). Income is less variable than in the percentage of portfolio case (although can still get small in poor retirements) and there is less chance of portfolio exhaustion than in the inflation adjusted case.

However, whether you care about variability or failure in drawdown income depends on what fraction it forms of your spending (whether essential or the total of essential and discretionary).

For example

For a couple with two state pensions (£23k), and a combined pension pot of £150k (and an inflation adjusted income of ~£4.5k). If their state pensions cover their essential spending and at least some of their discretionary, then the drawdown income is just ‘icing on the cake’ and pretty well any withdrawal strategy could be adopted because variability or failure can easily be accommodated. I suspect a number of the denizens on these boards fall into this category.

However, for a couple with two state pensions (£23k), a combined pension pot of £800k (inflation adjusted income ~£24k), an essential spend of £40k, and a discretionary spend of a further £10k, things are a bit tricker since a portfolio failure would leave them with insufficient income to support their essential spend and percentage of portfolio methods might leave them short in some years. Playing around with different hybrid approaches might provide a solution, but there is always the possibility of failure. However, purchasing sufficient RPI protected income annuity to provide most or all of the essential spend (i.e., up to an additional £17k costing around £400-£450k for a joint life – even if payout rates fall back to 3%, this would still ‘only’ cost £560k) and then withdrawing the remaining pot using whatever method desired. Of course, an alternative approach might be to revise what is considered essential spending and what discretionary.

There is a 4th strategy.  Plan on taking what you need, invest for long term growth with a high global diversification, and ensure you have sufficient slack to last n years with zero equity growth.  Choose "n" and "need" on the basis of what you can afford and are prepared to accept in the knowledge that there is no investment based strategy that will work in all conceivable circumstances.

In my view the academic strategies are fine to boost the authors professional ratings, book sales, and earnings from the lecture circuit./  To be fair they may be helpful in giving you the confidence to jump.  But I find it difficult to believe that any but a very small number of people will put any of them into practice over the long term.

Does anyone here who has retired actually use an academic strategy? If so which one?

IMV, defining 'what you can afford' is one element of the withdrawal strategies.

In answer to your question, yes
1) Floor provided by an inflation protected DB pension (which will be added to once in receipt of the SP)
2) Portfolio withdrawals using a modified version of VPW (so withdrawals vary from year to year).
3) Inflation linked ladder (and life insurance) to cover the period before my OH gets their SP in the event of my death.

I don't know whether 1) counts as an 'academic' strategy, but had I not had a DB pension, I would have built as sufficient flooring using an annuity instead (does buying an annuity count as an 'academic' strategy?).

I am solely referring to long term strategies intended to manage drawdown from volatile investments. If you can meet your needs without it that is fine but its not what I am discussing..

As a basic principle I would argue against any strategy that imposes variable expenditure over time depending on the then current economic circumstances.  So that would rule out VPW (Variable % withdrawal) unless one had a sufficiently large buffer to cover the difficult times. 

In that case your only option is an annuity.  Any other approach will always impose variable expenditure if you have bad enough returns, it's just a question of the shape of the expenditure curve.  I personally would not be happy with that curve being a step function ie your expenditure never varies until suddenly it goes to zero because you have run out of money.

There is no clever solution that gets you round this fact.  All you can do is build a strategy that tries to minimise the risk of an unacceptable variation. Accepting smaller variations is one of the most powerful tools available to help you do that.  There are various strategies to reduce the impact of variable income, such as running the income through a cash buffer, but the best is probably annuitising a sufficient proportion of your planned spend that the variability in the remainder doesn't matter so much.

There is a difference between short term variability and long term variability.  The former arises from short term variability in the market leading to SORR.  By decoupling withdrawal and expenditure that can be avoided.

On the other hand if underlying long term market returns were inadequate to meet your needs you would have no choice but to cut your needs over the long term as part of a replan of your retirement.  However it would seem that the  investment return assumptions usually made for retrirement planning are historically very pessimistic.  If they proved to be optimistic it would imply that globally industry was failing to make adequate profts which in turn could lead to very large scale unemployment and global financial collapse.  Under those circumstances it would be unreasonable to assume that your standard of living would not be affected.