Withdrawal Rates

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Borker Boy's picture
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Joined: 2006-12-09

In the almost three years that I've been in this business, I've seen EDJ go from being very comfortable with a 6% withdrawal from mutual funds to all but implying that 4% is pushing our luck.
I've run a couple different hypos of clients' portfolios to try and give me some confirmation that they'll be okay withdrawing 6%. Every time I run a hypo with a 6% withdrawal over nearly any 20-25 year period imaginable, the investor comes out smelling like a rose.
 
Just for kicks, I ran ICA with $500,000 invested and a 14% withdrawal of the previous year's balance for the past 25 years, and the end results were:
 
$1,682,373 - received in income
$244,655 - remaining account balance
 
What in the world could I be missing? Have things really changed so much that 4% is the upper limit that can be withdrawn safely?
 
 

bspears's picture
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Joined: 2006-11-08

Run the hypos from 1966-1980 and see what the outcome is.

OldLady's picture
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Joined: 2006-11-19

What about "past performance is no indication of future performance" don't you understand? 

walking9's picture
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Joined: 2008-09-30

I saw a 28 page journal article last summer, where the actual rate is a little less than 4%.
Most clients will take more anyway. Property taxes, fix the roof, out of pocket medical. We are in the business of helping folks walk the middle road, and feel okay about it. If we can get them to an age where they are feeble-minded and don't care about running out of money, we have achieved success.

B24's picture
B24
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Joined: 2008-07-08

It ALL depends on your launch point.  No matter who tells you, what matters is the individual client.  Just because someone lays out a rule of thumb, doesn't mean it works in all cases.  Borker, I think this is one of your problems - you take everything that Jones says and run with it.  You still have to think for yourself.
 
What if your client retired in 1999?  2007? 1972? 1938?  1929? If they retired in these years, and started taking 6% withdrawals, they might run out of money.  That 6% turns into 8% pretty quickly if you need a static amount of income on a falling investment portolio.
 
Always keep the first 5 years withdrawals liquid (CD's, Govy's, MMKT, etc.).  The next 5 years should be relatively safe, and your equity investments should be for 10+ years out.  Think of it in buckets, not just straight DCA withdrawals from all investments. 
 
The other twist on this is to slice off and sell pieces of your portfolio into safe investments when you have big gain years, and stand pat in down years, only withdrawing from your "safe" money.  But it's really a twist on the same concept.  This is hard to do when you have a lot of clients, since it requires very active management.  This is why keeping that bucket of "safe" money at all times makes the most sense.
 
If you follow this process, you can safely start withdrawing larger amounts in the later years as you pass beyond the "danger zone" (5 years before and after retirement).

jamesbond's picture
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Joined: 2005-03-21

Anything more than 3% and you are probably asking for trouble. If you look careful at ICA's total return, you will see a good portion of it is from capital gains being reinvested, not capital appreciation or dividends. You are probably better off with straight bonds or annuities for income as opposed to letting it ride with equities.

walking9's picture
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Joined: 2008-09-30

Mr. Bond, I believe you are wrong about straight bonds. I'd like to see the research. You need to hedge against inflation risk. You might be able to do bonds or annuities at 3%, but you are leaving all of the upside on the table. That means  having no fun in retirement,  living like a fearful crab in a dark hole , waiting for scraps to float by.

B24's picture
B24
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Joined: 2008-07-08

jamesbond wrote: Anything more than 3% and you are probably asking for trouble. If you look careful at ICA's total return, you will see a good portion of it is from capital gains being reinvested, not capital appreciation or dividends. You are probably better off with straight bonds or annuities for income as opposed to letting it ride with equities.

This is the worst piece of analysis and advice I have ever seen.

anonymous's picture
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Joined: 2005-09-29

Just for kicks, I ran ICA with $500,000 invested and a 14% withdrawal of the previous year's balance for the past 25 years, and the end results were:
 
$1,682,373 - received in income
$244,655 - remaining account balance
 
What in the world could I be missing? Have things really changed so much that 4% is the upper limit that can be withdrawn safely?
 
Things haven't changed that much.  You just chose a 25 year period that had a high average rate of return and didn't start off poorly.  You could have dramatically different results simply by starting one year earlier or later or by changing the order of returns.  In short, you just did a "monte carlo simulation" with just one simulation.  It has zero meaning.
 
 

jamesbond's picture
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Joined: 2005-03-21

If your read my post carefully, I said for INCOME you are better off with straight bonds or annuities. You may be leaving the some of the upside on the table by using fixed income for income, but 0 of the downside. All of your clients money in one asset class is dangerous.

jamesbond's picture
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Joined: 2005-03-21

B24 , which part? The part about using fixed income for income or ICA? Check out the NAV, has gone up $7 in 38 years. Just making a point. 

walking9's picture
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Joined: 2008-09-30

All right bond, I stand corrected. Here is my definition of true wealth: living off dividends of (high yielding) stocks. As for annuites, I prefer not to subsidize the lease-back and labor costs at the home office skyscraper.

B24's picture
B24
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Joined: 2008-07-08

jamesbond wrote:B24 , which part? The part about using fixed income for income or ICA? Check out the NAV, has gone up $7 in 38 years. Just making a point. 
 
The entire thing.  Your "all-or-nothing" approach.  Your analysis.
 
I could care less what ICA does.  What if you didn't use ICA?  What if ICA blew up the year you retired?
 
Run 500,000 invested 01/01/1972.  Withdraw 14% per year.  Yes, you are left with $95,000 as of this month with 1.4mm in lifetime withdrawals.  However, your withdrawal DOLLARS went down almost every year.  By the end, your annual withdrawals were just a fraction of where they started 30+ years ago.  14% doesn't mean crap when the balance is getting smaller.  14% withdrawal from anything is going to leave you with more than zero.
 
Use 5%.  Increase it for inflation every year.  Much more consistent income.  Also didn't run out of money.

Anonymous's picture
Anonymous

There are many good points in this thread - I won't bother to repeat or elaborate on most of them.  However, when someone says to take a "4% withdrawal rate," it's very important to understand how that is supposed to be implemented.
 
4% is your withdrawal rate in YEAR 1.  So if you have $100,000, you are taking $4,000 in income the first year.
 
In YEAR 2, suppose your account value has doubled to $200,000.  You income withdrawal in YEAR 2 is NOT $8,000.  It is $4,000 x 1.035 (or whatever inflation factor you are using). 
 
Same for every year after that.  4% establishes your initial income withdrawal.  You adjust that hard number for inflation thereafter.
 
I know this point is pretty obvious to most - but I think it's a concept that gets confused quite frequently. 
 
Just to clarify my position on appropriate withdrawal rates - I do believe 4% is too high for a 60-65 y/o retiree with a relatively "normal" situation (health, etc.).  I tell my clients to shoot for 3.5%, and we can use 3.75% if we need to.  Of course, less is always better. 
 
I do this for a few reasons:
 
1.  There is a good chance right NOW that at least 1 member of a retiring couple will live to see age 90.  That's a 30 year retirement.  We have no idea how rapidly medical science is going to evolve.  Perhaps when today's 40 y/o people get to retirement age, their life expectancy will be 100.  I dunno, but I'd rather be planning for a 40 year retirement, and have EXTRA money if I'm wrong, than plan for a 30 year retirement, and be wrong. 
 
2.  We don't know what our future returns will be.  I think I have a pretty good portfolio to combat most economic downturns - but in any case, if we hit a 10 year stretch that really sucks (like now), I'd rather not be "living on the edge" with retiree money.
 
3.  And this may be the biggest factor...clients probably won't stick with 3.75%, even if I stress the importance of it.  I KNOW that down the road, there will be a "new roof" or a "once in a lifetime vacation" or a "new car I've always wanted" or a "vacation home."  By making their "regular paychecks" more conservative, they will be able to recover from ill-advised spending more easily.
 
Sorry, this was supposed to be a short post.

newnew's picture
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Joined: 2007-02-23

Hartford-Planco has a piece proving that if you simply REVERSE the last 20 years of annual returns (year 20,19,18etc instead of year 1,2,3 etc) you run out of money. If you do not reverse them you do not. At i think about a 5% withdrawal, the difference was over 1MM b/t the 2 scenarios.

HYPOS ARE USELESS--THAT IS NOT PROPER ANALYSIS

snaggletooth's picture
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Joined: 2007-07-13

I might also add that in bad markets, research shows that if you forego the inflation adjustment for several years, it will go a long way in helping you not run out of money.
 
I would post the research I read, but I've read so many things lately I have no idea where it is.  My office looks like Iraq right now.

jamesbond's picture
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Joined: 2005-03-21

B24,I think you confused me with the person who started the 14% WD. He used ICA and the 14% wd rate. The point i did not make clearly enough was that 14, 10, 9 8 etc are truly unrealistic assumptions to make for withdrawal in any kind of market. 3 -4 is probably safe if you are going to use equity funds to generate cash. The other point of my post is that the reason we have fixed income investments is just that, to generate income. Everyone has their own way they run their business, I personally have never been a fan of using equity funds to generate income. This doesn't make it right or wrong, just not what i believe for me and my clients is best.

B24's picture
B24
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Joined: 2008-07-08

JB,
 
That's all well and good.  I could build you a bond portfolio giving you 6% income.  But, like CD's, 15 years from now, you will still be getting 6% on your original principle (or whatever rates are at the time, based on your mix of bond maturities).
 
Bottom line, unless you can live STRICTLY on the interest from bonds, you NEED to have equities in your portfolio to grow the basis.  There is no one-size-fits-all approach to this.  There's plenty of rich people living off 4.25% tax-free muni coupons, because they don't need the growth or extra income (and the after-tax rate is huge).

newnew's picture
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Joined: 2007-02-23

At Jones, hypos rule for Seg 1-3. It drove me nuts. It is strictly a SALES TOOL; which is fine for  maximizing commissions. But trying to find a fund combo that a rep can tweak on a hypo until he can finally prove that a certain withdrawal scenario "worked" in the past is MEANINGLESS.
 
I'll bet plenty of reps that "proved" 6% is OK on a hypo are now finding that it was DANGEROUS as well (dangerous to principal preservation).

B24's picture
B24
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Joined: 2008-07-08

The hypo can't replace your plan.  The problem is, a hypo can't factor in which assets you withdraw from (well, it CAN, but cannot necessarily start and stop in certain years).  In other words, it can't illustrate just pulling from safe funds in the first 5-10 years, then adjusting moving forward.  Hypo's should not be used to rely on for an entire portfolio, but they can help identify asset mix, volatility, and long-term returns.  Just because you didn't know how to properly use hypos, doesn't mean that somehow Jones was wrong for using them.

jamesbond's picture
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Joined: 2005-03-21

You are correct. That is why i pointed out that you should  use fixed income for income. I never said it was the only asset class you should have but should be a part of any portfolio. Equity for growth, fixed income for income.

MinimumVariance's picture
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Joined: 2008-08-20

The results depend on whether you are runnning simulations where Terminal Wealth at death is =0, or has some positive value. Obviously if you assume the portfolio's compound rate of return exceeds the w/d rate then you are fine (w/ a min sized portfolio to begin with). The problem is the w/d rate for consumption purposes is usually a relatively fixed number (say $75k/yr in real terms) while the portolio return can vary into negative territory. You really should be estimating this using a MOnte Carlo model where you can estimate a portfolios std dev. How many of You even know what your clients portfolio's std dev is? Very few I would guess, let alone the thrid and fourth moments.

newnew's picture
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Joined: 2007-02-23

B24-
I never used hypos. I just listened to all the folks who sounded just like the first post on this thread-and I quote:
 
"I've run a couple different hypos of clients' portfolios to try and give me some confirmation that they'll be okay withdrawing 6%. Every time I run a hypo with a 6% withdrawal over nearly any 20-25 year period imaginable, the investor comes out smelling like a rose. "
 
MEANINGLESS

walking9's picture
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Joined: 2008-09-30

Right. Hypos are bs - meaningless.
 
My experience has brought it down to this :better to discuss fundamental strategies, and see what happens.
 
" I never promised you a rose garden. "

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