Author Topic: Kiplinger - Make Your Retirement Savings Last a Lifetime (dynamic drawdowns)  (Read 5870 times)

a1smith

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Interesting article with some variations and discussion on 4% rule.  They suggest ways to dynamically vary your annual drawdown to make your funds last longer.

http://www.kiplinger.com/article/retirement/T037-C000-S004-make-your-retirement-savings-last-a-lifetime.html#hye9T4KR28qCeAsw.99
« Last Edit: March 07, 2015, 11:07:58 AM by a1smith »

bacchi

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Quote
Consider a 65-year-old female in average health with a 40% stock allocation who is paying 1% in money-management fees and has a desired probability of success of 80%.

There's so much wrong with that sentence.

Anyway, isn't this what the VPW method does? It's on cFiresim.

arebelspy

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Interesting article with some variations and discussion on 4% rule.  They suggest ways to dynamically vary your annual drawdown to make your funds last longer.

http://www.kiplinger.com/article/retirement/T037-C000-S004-make-your-retirement-savings-last-a-lifetime.html#hye9T4KR28qCeAsw.99

I like how they talk about a dynamic draw down, then link to a simplified spreadsheet that just tells you one flat SWR you should use.

The life expectancy calculator in it was somewhat interesting though.
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tomsang

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The calculator does not appear to work at all.  If you put in an 80% equity, .2% portfolio fees, 80% success, and a 100 year retirement it will show a negative .12%. 

arebelspy

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The calculator does not appear to work at all.  If you put in an 80% equity, .2% portfolio fees, 80% success, and a 100 year retirement it will show a negative .12%.

You need to keep adding to your stache each year in that case.  ;)

We are two former teachers who accumulated a bunch of real estate, retired at 29, and now travel the world full time with two kids.
If you want to know more about me, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

DK

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So to sorta hijack this thread....does my tentative plans make sense:

3ish years in cash/cds/bonds, rest in stocks.
Every quarter move 1% out of stocks to this cash/cd/bond mix, minus if the market has dropped 20%+. Once market recovers start rebuilding 3 yr mix.

This ignores the smaller volatility, still keeps with the 4% rule, and allows a buffer to not withdraw when the market is in one of it's inevitable crashes.


arebelspy

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So to sorta hijack this thread....does my tentative plans make sense:

3ish years in cash/cds/bonds, rest in stocks.
Every quarter move 1% out of stocks to this cash/cd/bond mix, minus if the market has dropped 20%+. Once market recovers start rebuilding 3 yr mix.

This ignores the smaller volatility, still keeps with the 4% rule, and allows a buffer to not withdraw when the market is in one of it's inevitable crashes.

Cash bucket strategies have been studied and found to be mathematically inferior, but perhaps psychologically superior depending on your constitution.  Do what makes you comfortable.  :)
We are two former teachers who accumulated a bunch of real estate, retired at 29, and now travel the world full time with two kids.
If you want to know more about me, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

DK

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So to sorta hijack this thread....does my tentative plans make sense:

3ish years in cash/cds/bonds, rest in stocks.
Every quarter move 1% out of stocks to this cash/cd/bond mix, minus if the market has dropped 20%+. Once market recovers start rebuilding 3 yr mix.

This ignores the smaller volatility, still keeps with the 4% rule, and allows a buffer to not withdraw when the market is in one of it's inevitable crashes.

Cash bucket strategies have been studied and found to be mathematically inferior, but perhaps psychologically superior depending on your constitution.  Do what makes you comfortable.  :)

Any links/articles that I could look into it more that you know of?

Considering back in the 2008ish era I was increasing my 401k contributions when my co-workers were decreasing or stopping contributing should tell you a bit on my 'constitution'. I would rather do the most efficient route. :-)

arebelspy

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Any links/articles that I could look into it more that you know of?

I've run across a few articles and studies - search the E-R.org forums and you should find them.  :)
We are two former teachers who accumulated a bunch of real estate, retired at 29, and now travel the world full time with two kids.
If you want to know more about me, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
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brooklynguy

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a1smith

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I like how they talk about a dynamic draw down, then link to a simplified spreadsheet that just tells you one flat SWR you should use.

The life expectancy calculator in it was somewhat interesting though.

You use the spreadsheet each year of retirement to calculate a SWR for that year.  You can't calculate the dynamic SWR's a priori because you don't know what's going to happen in the future.

Here is the whole Journal of Financial Planning paper by David M. Blanchett; he is the head of retirement research at Morningstar Investment Management.  The Kiplinger article left out a lot of detail.  Blanchett's main point is that the two formulas he derived capture 99.9% of the benefit of more complicated dynamic SWR algorithms which makes it simpler for people to use on their own.

http://www.onefpa.org/journal/Pages/Simple%20Formulas%20to%20Implement%20Complex%20Withdrawal%20Strategies.aspx

a1smith

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The calculator does not appear to work at all.  If you put in an 80% equity, .2% portfolio fees, 80% success, and a 100 year retirement it will show a negative .12%.

The years of retirement entry is how many more years you will live (be retired), not your life expectancy.  So, when you entered 100 years, even for a 30 year old FIRE person you are saying they will live to be 130.  I'm sure that is outside the range he derived the formulas for.

Use the life expectancy table to estimate a retirement period.  Enter your age under the appropriate gender and then choose the life expectancy you want based on % certainty.  He highlights in blue the 50% probability values because that is what most people use.  Looking at his note in the spreadsheet he is also adding 2 years to the 50% probability as a measure of safety.

So, let's do an example.  We'll use MMM's values. 90% stock allocation, 0.1% fees, age 39.  So, 50% probability retirement period is 46 years (age 85).  So, use 48 years as retirement period in yellow cell (B25).

From the paper, Returns for the simulation were based approximately on Ibbotson Associates’ 2012 capital market assumptions, where the assumed returns for stocks was 10 percentą with a standard deviation of 20 percent. The assumed return for bonds was 4 percent with a standard deviation of 7 percent, inflation was assumed to be 2.5 percent, and the correlation between the returns of stocks and bonds was .10.

Leaving the probability of success at the default 80% the calculated SWR is 2.71% for this year of retirement.  Using goal seek in Excel you find that for 4.0% SWR the probability of success is 51%.

The available safety margins MMM mentions in http://www.mrmoneymustache.com/2012/05/29/how-much-do-i-need-for-retirement/ apply here as well.

DK

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Any links/articles that I could look into it more that you know of?

Here's a good one:

https://www.kitces.com/blog/research-reveals-cash-reserve-strategies-dont-work-unless-youre-a-good-market-timer/

Interesting. Not quite what I was planning on doing but it was a good perspective. I guess what I was thinking was about a 90/10 allocation to start. I think since the cash/conservative amount is lower it would not be a big drag. Of course just generically taking 1% a quarter will throw that off eventually.....hmmm.

tomsang

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The calculator does not appear to work at all.  If you put in an 80% equity, .2% portfolio fees, 80% success, and a 100 year retirement it will show a negative .12%.

The years of retirement entry is how many more years you will live (be retired), not your life expectancy.  So, when you entered 100 years, even for a 30 year old FIRE person you are saying they will live to be 130.  I'm sure that is outside the range he derived the formulas for.

Use the life expectancy table to estimate a retirement period.  Enter your age under the appropriate gender and then choose the life expectancy you want based on % certainty.  He highlights in blue the 50% probability values because that is what most people use.  Looking at his note in the spreadsheet he is also adding 2 years to the 50% probability as a measure of safety.

So, let's do an example.  We'll use MMM's values. 90% stock allocation, 0.1% fees, age 39.  So, 50% probability retirement period is 46 years (age 85).  So, use 48 years as retirement period in yellow cell (B25).

From the paper, Returns for the simulation were based approximately on Ibbotson Associates’ 2012 capital market assumptions, where the assumed returns for stocks was 10 percentą with a standard deviation of 20 percent. The assumed return for bonds was 4 percent with a standard deviation of 7 percent, inflation was assumed to be 2.5 percent, and the correlation between the returns of stocks and bonds was .10.

Leaving the probability of success at the default 80% the calculated SWR is 2.71% for this year of retirement.  Using goal seek in Excel you find that for 4.0% SWR the probability of success is 51%.

The available safety margins MMM mentions in http://www.mrmoneymustache.com/2012/05/29/how-much-do-i-need-for-retirement/ apply here as well.

Based on the trinity study and cfiresim you should be very safe at 4%. Saying that it only has a 52% success rate shows something is wrong. Also at some point having 50 years or 250 years should have a minimal change to the SWR. I will stick to cfiresim until a better model comes out.

arebelspy

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Thanks for your explanations a1smith. Quite helpful.

Also at some point having 50 years or 250 years should have a minimal change to the SWR. I will stick to cfiresim until a better model comes out.

Good point. If my WR is 1%, that should last, regardless of my length of retirement. If it's telling me a lower WR for 69 years of FIRE than 70, something may be off.
We are two former teachers who accumulated a bunch of real estate, retired at 29, and now travel the world full time with two kids.
If you want to know more about me, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

a1smith

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Based on the trinity study and cfiresim you should be very safe at 4%. Saying that it only has a 52% success rate shows something is wrong. Also at some point having 50 years or 250 years should have a minimal change to the SWR. I will stick to cfiresim until a better model comes out.

Some food for thought - in MMM's post http://www.mrmoneymustache.com/2012/05/29/how-much-do-i-need-for-retirement/ he shows the 4.04% SAFEMAX value in Figure 2.1.  Actually, that figure is derived from William Bengen's work in 1994 (the author, Wade Pfau, extended the results to 1981 using data up to 2010), not the Trinity study.  The Trinity study occurred four years after Bengen's seminal work.  The only difference between their work is the bond indices they chose.  With Bengen, he showed 100% success at 4.15% WR; the Trinity study showed a 95% success rate at 4% WR (not 100%!!!).

If you go to the webpage MMM got that figure from, it redirects to http://retirementresearcher.com/the-trinity-study-and-portfolio-success-rates/.  Looking at Table 2.1, you can see that at 4% withdrawal rates you have 100% success at 30 years, but only 96% at 35 years and 85% at 40 years.

I tried a really simple experiment in cFIREsim and obtained comparable results.  I started with 2015-2045 for a 30 year retirement, with $100 portfolio, $4 spending (4%) with inflation adjust , 50/50 stocks/bonds, no fees, and everything else set to zero. That matches the study parameters. I then ran simulations for 30, 35, 40, ...., 70, and 75 year retirements. I stopped at 75 years for two reasons: most people won't be retired that long and also the data starts to be statistically insignificant because at 75 years only 70 cycles are ran, 80 years gives 65 cycles, etc.

Well, the results were so bad for 50/50 stock/bond allocation I also ran 70/30.  The results are shown in the table below.  As you can see the success rate keeps dropping and it is not clear to me that there is an asymptotic limit.  I'm not sure where the assumption that if the money lasts 30 years it will last forever came from but I consider it suspect.  If someone can post some hard calculations or a research paper that shows this I would appreciate it.

Years Retired50/50 Success70/30 Success
3090.4%93.9%
3582.7%90.9%
4067.6%84.8%
4565.0%80.0%
5063.2%81.1%
5560.0%82.2%
6060.0%82.4%
6555.0%80.0%
7053.3%78.7%
7550.0%77.1%

Also, I ran the MMM values in cFIREsim that I used in the spreadsheet.  90/10 allocation, 4% spend, 0.1% fees, inflation adjust, 46 year retirement. I got an 83.84% success rate with cFIREsim.  Higher than the simple spreadsheet but still not 100%.

So, the safety factors MMM mentions in article listed above are not safety factors; they are an absolute requirement.