Author Topic: Portfolio Draw Down Approaches?  (Read 10712 times)

Dawg Fan

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Portfolio Draw Down Approaches?
« on: June 17, 2015, 04:43:11 PM »
I have been absorbing allot of info here recently from the seasoned FIRE-ed folks, other web sites, cFireism, and my running my own simple math and am still struggling with the ideal withdrawal/rebalance model assuming some form of SWR. Here is the question followed by some general assumptions and a basic example...

What securities or % of those securities (stocks/bonds/CDs/cash) in my portfolio should I be pulling from to cover my planned annual expenses?

Assumptions (simplified somewhat generically to hopefully help answer the question)...
- SWR 4%, 30 yr horizon, 25 X in portfolio at time of FIRE
- 75/25 split (75% Stocks/25% includes CDs, Bonds, Cash)
- $1M portfolio looking for $40K Yr1
- Actual expenses are the 4% yr 1 and no other income sources (i.e. pensions, SS)
- Rebalance 1 time/yr

Eg 1 Portfolio (75% returns 10%/25% returns 1%)
- End of yr 75% worth $825K/25% worth $252.5K
- Withdraw $40K from 25%, balance now $212.5K
- Portfolio balance after yr withdrawal $1.0375M 
- Rebalance says now be $778,125 (75%)/$259,375 (25%)... sell more stock while up, reload 25%

Eg 2 Portfolio (75% returns <10%>/25% 1%)
- End of yr 75% worth $675K/25% worth $252.5K
- Withdraw $40K from 25%, balance now $212.5K
- Portfolio balance after yr withdrawal $887.5K
- Rebalance says now be $665,625 (75%)/$221,875 (25%)... sell more stock while down, reload 25%

So here lies the question. If we pull only from the 25% first and let the stocks ride, but rebalance, we are selling possibly in a down market. I suppose the strategy would be NOT to rebalance in a down market and continue to draw from the 25%? Our 25% gives us 6+ yrs of padding for the market to come back so is this the right strategy? Or, do we leave our 25% alone in the good stock yrs and harvest stock gains over a certain % (something over our portfolio blended overall return of 4%)??

For now, I am ignoring the fact that we could have saved something over 25X, built a 100% expense covered dividend portfolio (which would probably be over 25X), have other income generating assets like real estate, got a part time job, lowered our expenses, maintained an additional 1 - 2 yrs in a liquid account (again, more than 25X), etc.. I realize these are all good backup/protection options and am still interested to hear how you use them if that is the case, but I am hopeful some of you have discovered the optimal way to draw down/rebalance your portfolios in both good and bad markets and discovered a formula that works.

My sense is the stock harvesting approach makes the most sense when returns hit over a certain threshold as this also has you selling on higher returns and at least not selling on negative returns, but I can be convinced otherwise.

Show me your wisdom!





forummm

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Re: Portfolio Draw Down Approaches?
« Reply #1 on: June 17, 2015, 05:08:49 PM »
Generally people recommend withdrawing funds in the proportion that keeps your asset allocation in balance. If your goal is to be 75/25, and you're 76/24 as you to go pull some funds, then sell some of the stocks to bring it into balance again. This maintains your desired asset allocation, and forces you to sell high. If you're trying to decide when to sell stocks or bonds based on some other market information, you're engaging in market timing. It's easy to guess wrong when trying to time the market. That could cost you a lot.
« Last Edit: June 17, 2015, 05:10:53 PM by forummm »

fb132

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Re: Portfolio Draw Down Approaches?
« Reply #2 on: June 17, 2015, 05:11:10 PM »
Out of curiosity, what is your age?

Dawg Fan

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Re: Portfolio Draw Down Approaches?
« Reply #3 on: June 17, 2015, 05:42:09 PM »
Real answer is I am 51 and plan to FIRE at 55. My portfolio/assets are significantly higher as are my planned RE expenses, but I was mainly trying to reconcile strategies for withdrawals. I would also be curious as to how people are doing their living expense withdrawals... monthly? at the beginning of the yr into a cash acct?

Dawg Fan

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Re: Portfolio Draw Down Approaches?
« Reply #4 on: June 17, 2015, 05:53:00 PM »
Generally people recommend withdrawing funds in the proportion that keeps your asset allocation in balance. If your goal is to be 75/25, and you're 76/24 as you to go pull some funds, then sell some of the stocks to bring it into balance again. This maintains your desired asset allocation, and forces you to sell high. If you're trying to decide when to sell stocks or bonds based on some other market information, you're engaging in market timing. It's easy to guess wrong when trying to time the market. That could cost you a lot.

I am struggling with this approach if you have 1, 2, or more down yrs in the 75% (stock portion). Remember, you need to withdrawal the $40K somewhere and at sometime? What am I missing?

clifp

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Re: Portfolio Draw Down Approaches?
« Reply #5 on: June 17, 2015, 06:22:21 PM »
Generally people recommend withdrawing funds in the proportion that keeps your asset allocation in balance. If your goal is to be 75/25, and you're 76/24 as you to go pull some funds, then sell some of the stocks to bring it into balance again. This maintains your desired asset allocation, and forces you to sell high. If you're trying to decide when to sell stocks or bonds based on some other market information, you're engaging in market timing. It's easy to guess wrong when trying to time the market. That could cost you a lot.

I am struggling with this approach if you have 1, 2, or more down yrs in the 75% (stock portion). Remember, you need to withdrawal the $40K somewhere and at sometime? What am I missing?

The theory is you keep selling bonds and buying stocks.  The first 3 years of my retirement the S&P was down -9%, -12%, and -22%. The NASDAQ was far worse. It wasn't too hard for me to keep buying cause I was focused on the income the stocks were producing.  But psychologically I imagine it was for many people.

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Re: Portfolio Draw Down Approaches?
« Reply #6 on: June 17, 2015, 06:41:40 PM »
... For now, I am ignoring the fact that we could have saved something over 25X, built a 100% expense covered dividend portfolio (which would probably be over 25X), have other income generating assets like real estate, got a part time job, lowered our expenses, maintained an additional 1 - 2 yrs in a liquid account (again, more than 25X), etc...

I guess I've done just about all of the above, except for the income-generating real estate.  (I'm not counting my REIT investments.)  So I say to you: don't ignore those strategies.  They can give you the peace of mind not to overagonize how you draw down your investment principal.  But I guess that's easy for me to say, because I would consider drawing down principal as only a last-resort emergency backup.

Dawg Fan

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Re: Portfolio Draw Down Approaches?
« Reply #7 on: June 17, 2015, 06:59:01 PM »
@Clifp I hear you and I know you use a heavy dividend approach to covering your expenses, but that probably means your SWR is less than 4%, your stash is greater than 25x, or your expenses are less? If you need to maximize your 25x based on 4%, in the case of any growth oriented portfolio over 60% stock, there needs to be a draw down strategy that plays the law of averages the best. Like you, my research says burn thru my 25% first and bet stocks will come back before 6 yrs (in the case of 75/25). Will I have the balls to buy more stocks?? I doubt it, and I doubt others would risk giving up the security of the remaining 25% to fund their $40k in this example unless you have alternative income coming in (I.e. In your case, significant dividend income). I know there is no perfect answer and the final answer may be you just need to have more than 25x in some mixture to make it all work.

Eric

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Re: Portfolio Draw Down Approaches?
« Reply #8 on: June 17, 2015, 07:09:27 PM »
Generally people recommend withdrawing funds in the proportion that keeps your asset allocation in balance. If your goal is to be 75/25, and you're 76/24 as you to go pull some funds, then sell some of the stocks to bring it into balance again. This maintains your desired asset allocation, and forces you to sell high. If you're trying to decide when to sell stocks or bonds based on some other market information, you're engaging in market timing. It's easy to guess wrong when trying to time the market. That could cost you a lot.

I am struggling with this approach if you have 1, 2, or more down yrs in the 75% (stock portion). Remember, you need to withdrawal the $40K somewhere and at sometime? What am I missing?

So if you have 1, 2, or more down years of stocks, that will automatically mean that your AA is tilted more towards bonds.  So sell bonds first.  If you can sell $40k worth of bonds and are still underweight stocks, then keep selling and buy stocks until your AA is in balance.  The sale of bonds over and above your $40k should be done in a tax sheltered account (usually a t-IRA) to avoid tax issues.  If $40k is too many bonds to sell (puts you overweight stocks), then figure out the correct mixture of stocks and bonds to sell to maintain your desired 75/25 AA.

Keep in mind that your AA is comprised of all of your holdings and is not per account.  So there's no reason to make things match everywhere, only that the total of all your investments = 75/25.

Dawg Fan

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Re: Portfolio Draw Down Approaches?
« Reply #9 on: June 17, 2015, 07:31:41 PM »
@Eric this begs the question of when/how/where is your frequency of withdrawals for you annual expenses? In my eg 2 I show the effects of 1 yr of a down market, withdrawal from 25%, yet rebalance says still sell some stock? It seems to me you always want to have some measurable amount of annual expenses in your bond/CD/cash portion of your portfolio relative to your risk profile to tap into before you hit your stocks as a precaution to a multi-year down cycle, otherwise, you are selling stocks when they are down to eat. Maybe that's a reasonable risk? Just doesn't feel prudent statistically? Again, any alternative income sources or larger than 25x initial portfolios change the whole argument.

clifp

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Re: Portfolio Draw Down Approaches?
« Reply #10 on: June 18, 2015, 12:26:45 AM »
@Eric this begs the question of when/how/where is your frequency of withdrawals for you annual expenses? In my eg 2 I show the effects of 1 yr of a down market, withdrawal from 25%, yet rebalance says still sell some stock? It seems to me you always want to have some measurable amount of annual expenses in your bond/CD/cash portion of your portfolio relative to your risk profile to tap into before you hit your stocks as a precaution to a multi-year down cycle, otherwise, you are selling stocks when they are down to eat. Maybe that's a reasonable risk? Just doesn't feel prudent statistically? Again, any alternative income sources or larger than 25x initial portfolios change the whole argument.

The reality is if you have 3 bad years in the stock market in a row in the beginning than you are probably headed for a failed retirement, and you are in the 5-10% of retirements that fail the 4% 30 year not always safe withdrawal strategy.  Your options at this point are pretty limited, cut expense, go back to work, or take even more risk. Although with a 75/25 portfolio there isn't much more risk you can take slightly higher AA with an emphasis on small cap and emerging markets.


It is worth looking at this ongoing thread on the fate of my fellow Y2K retirees. After 14 years their 75/25 portfolio is down to $391K (in real terms).  http://www.raddr-pages.com/forums/viewtopic.php?f=2&t=1208&start=390  Odds are very good the Y2K retiree runs out of money in 8-12 years. Unfortunately I'm not sure that a clueless Y2K retire blinding withdrawing 4%and rebalance would have know something was wrong before the 2008/9 crash.


Now having said all the doom and gloom, let me point out something many early retiree, sort of forget about or dismiss as something "I'll never see" Social Security.  Now there is some wisdom in a 35 or 40 years, pretty much  ignoring SS. However for a 50 year old it isn't that far away.  If we take the case of the poor Y2K retiree after 14 years into retirement they have ~$400K and need to withdraw 40K/year or 10% ugh for the next 16 year. However lets assume that retired at 50. They are now 65 and eligible for Social Security odds are for somebody who manage to accumulate $1 million by age 50, they probably maxed or nearly maxed SS as such they are eligible for at least $15,000 and likely closer to 20K with an additional 20K a year coming in their withdraw drops to 20K per or 5% and has a very high probability of last 20 or 25 years.
« Last Edit: June 18, 2015, 01:02:47 AM by clifp »

Dawg Fan

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Re: Portfolio Draw Down Approaches?
« Reply #11 on: June 18, 2015, 04:12:41 AM »
@Clifp Conclusion... A combination of having more than 25x, additional income sources (i.e. SS, real estate), design a more dividend/interest producing portfolio (similar to Clifp), lower SWR, have an emergency plan to reduce expenses/withdrawals in down yrs, and be prepared to cut someone's lawn if necessary... Set a plan and then modify as needed. In my case, and I suppose most that are in my position, I am looking for a sound plan/foundation to launch with that is not too aggressive, but also not so conservative that I get stuck in the OMY syndrome. All that being said, I know there is no one size fits all here, but hearing the different approaches/styles helps us pre FIRE-ees start to meld together a plan that may work best before launch.

Thanks all for the insight.

forummm

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Re: Portfolio Draw Down Approaches?
« Reply #12 on: June 18, 2015, 05:51:40 AM »
Generally people recommend withdrawing funds in the proportion that keeps your asset allocation in balance. If your goal is to be 75/25, and you're 76/24 as you to go pull some funds, then sell some of the stocks to bring it into balance again. This maintains your desired asset allocation, and forces you to sell high. If you're trying to decide when to sell stocks or bonds based on some other market information, you're engaging in market timing. It's easy to guess wrong when trying to time the market. That could cost you a lot.

I am struggling with this approach if you have 1, 2, or more down yrs in the 75% (stock portion). Remember, you need to withdrawal the $40K somewhere and at sometime? What am I missing?

I echo what Eric said. By selling your bonds instead of your stocks that have dropped, you are avoiding selling your stocks low. You might even find that you need to sell even more bonds to buy more stocks to get back to 75/25. That means you're buying low. That's exactly what you want your asset allocation to do--help you to buy low and sell high.

Dawg Fan

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Re: Portfolio Draw Down Approaches?
« Reply #13 on: June 18, 2015, 06:54:51 AM »
First, I understand the concept of AA and practice rebalancing presently, but am not FIRE yet, so no withdrawals, just accumulation. Let me try and provide a simple illustration to show you where I am struggling with the "sell more bonds and buy more stocks when stocks are down " in a post FIRE world. The premise is you are drawing down $40K/yr 1 from somewhere and based on what I am hearing from most folks, you generally hit your bond-ish investments first, particularly in down yrs of the stock market. Let's assume the following...

- Yr 1 I have $1M + $40K cash so I don't make my first withdrawal until end of first yr
- Withdrawals thereafter once/yr for next yrs expenses, following 4% SWR
- 75% Stock/25% Bond-ish
- My annual withdrawals typically from my 25% first in most cases... isn't that the conventional wisdom here???
- Assume no inflation
- 2 Yr analysis assumes Portfolio performs -10% yr1, +10% yr 2, all losses come form stocks, bonds return 0

Eg
End Yr1: 75% = $675,000
              25% = $250,000 - $40,000 = $210,000
             New balance = $885,000
             Rebalance = $663,750/$221,250 (selling stocks low/buying bonds)

End Yr2: 75% = $730,125
              25% = $221,250 - $40,000 = $181,250
              New balance = $911,375
              Rebalance = $683,531/$227,844 (selling stocks high/buying bonds)

What I am hearing you all say is in yr 1 to sell more bonds and buy stocks because they are down, and while I get the concept, you are working against the rebalance approach and further depleting your bonds should we hit an extended down cycle in the stock market. I am just trying to point out that I don't see how you can do both in this example of a down cycle (rebalance and buy when down). My common sense tells me at the end of yr 1 in this example to NOT rebalance at a min, and if I am bullish, consider buying stocks while down and selling some bonds (knowing this can risk my number of safe yrs if we have an extended negative cycle). If I am not bullish on the stock market coming back and the market continues to crap out yrs 2 & 3, continue to tap my 25% which will make me look further out of balance for the current term, but keep me from selling stocks low. Alternatively, my thought was there could be value in harvesting the 75% when returns hit a certain threshold as opposed to always tapping the 25% first?

Not trying to beat this horse to death, but IF all of our $$ to cover our expenses are coming from our portfolio, we have to draw them from somewhere which further affects the balances at the end of the yr.




forummm

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Re: Portfolio Draw Down Approaches?
« Reply #14 on: June 18, 2015, 07:05:21 AM »
"if I am bullish" is a market timing statement. The point of having an asset allocation is that you are sticking with it and letting yourself receive the market return. If you just stick to your asset allocation (which your examples appear to have done--I didn't check the math), you will be making the right moves from the standpoint of your risk tolerance (as IDed by your AA) and the market performance. You do not know what the market will do next year or the year after.

forummm

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Re: Portfolio Draw Down Approaches?
« Reply #15 on: June 18, 2015, 07:07:59 AM »
Here's another idea. Run cFIREsim calculations using your 75/25 AA and having it rebalance. And have it provide one year of data for you to download and review. You can put it in Excel and see how real data provided real outcomes and how that rebalancing happened in a real scenario. You can pick any real past retirement year you like.

Dawg Fan

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Re: Portfolio Draw Down Approaches?
« Reply #16 on: June 18, 2015, 07:14:10 AM »
@forummm All I would suggest to you is if you are going to blindly follow the rebalance of your portfolio every year to match your AA then you would need to assume you are withdrawing proportionately from your 75%/25% mix every year to cover your $40K. The only problem with this is you are selling 75% of your stock portfolio in a down market to cover your expenses which seems to be contrary to the MMM wisdom. I will look at cFireism and see how it models out, but I am not sure if you can designate what part of the portfolio you are making your withdrawals from??

morning owl

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Re: Portfolio Draw Down Approaches?
« Reply #17 on: June 18, 2015, 07:43:30 AM »
Question from an interested and curious noob...

Why do you assume that you always draw down the 4% withdrawal from your 25% bond-like allocation? Wouldn't you draw the 40k from your stock allocation when stocks are high?

Eta referring to this comment from Dawg Fan above:

Quote
75% Stock/25% Bond-ish
- My annual withdrawals typically from my 25% first in most cases... isn't that the conventional wisdom here???
« Last Edit: June 18, 2015, 07:45:40 AM by morning owl »

forummm

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Re: Portfolio Draw Down Approaches?
« Reply #18 on: June 18, 2015, 07:50:56 AM »
@forummm All I would suggest to you is if you are going to blindly follow the rebalance of your portfolio every year to match your AA then you would need to assume you are withdrawing proportionately from your 75%/25% mix every year to cover your $40K. The only problem with this is you are selling 75% of your stock portfolio in a down market to cover your expenses which seems to be contrary to the MMM wisdom. I will look at cFireism and see how it models out, but I am not sure if you can designate what part of the portfolio you are making your withdrawals from??

cFIREsim actually models the approach you have used in your examples. It withdraws once per year (I forget if it's at the beginning or end of the year) and rebalances at that time.

If you are withdrawing and rebalancing blindly each year, it doesn't matter what fraction of your withdrawal came from stocks or bonds. The AA takes care of that for you. In the very scenarios you typed up, you saw that a big drop in stocks would cause you to not sell stocks--it would actually cause you to buy them. I'm not sure where the disconnect is here. That's why I suggested looking at some real life scenarios to see if it makes more sense to you.

forummm

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Re: Portfolio Draw Down Approaches?
« Reply #19 on: June 18, 2015, 07:53:09 AM »
Question from an interested and curious noob...

Why do you assume that you always draw down the 4% withdrawal from your 25% bond-like allocation? Wouldn't you draw the 40k from your stock allocation when stocks are high?

Eta referring to this comment from Dawg Fan above:

Quote
75% Stock/25% Bond-ish
- My annual withdrawals typically from my 25% first in most cases... isn't that the conventional wisdom here???

I don't agree with the OP's assumption. The way people normally use an AA, if stocks are way up, they would take their withdrawal either primarily from or completely from stocks in order to bring their AA back into balance--as you say, owl.

morning owl

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Re: Portfolio Draw Down Approaches?
« Reply #20 on: June 18, 2015, 07:54:42 AM »
DF, in your OP you withdraw from your bonds in the first portfolio example even though stocks are higher than 75% of your AA. If you were to withdraw 40k from your stocks, they would still be above 75% AA, which means you should withdraw more than the 40k and replenish your bonds until both are at a 75/25 level again. No? Is my math wrong here? This would prevent your bonds from being diminished, if you sell stocks in the 'high' years and keep to your AA.

ETA OK I did the math -- I see that is basically what you are doing. I'm just not sure why you need to sell the bonds first at all. It seems like an extra step that overcomplicates things, because you are selling them and then buying them all back again, plus some extra.

« Last Edit: June 18, 2015, 08:15:55 AM by morning owl »

skyrefuge

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Re: Portfolio Draw Down Approaches?
« Reply #21 on: June 18, 2015, 08:44:00 AM »
If you need to maximize your 25x based on 4%, in the case of any growth oriented portfolio over 60% stock, there needs to be a draw down strategy that plays the law of averages the best.

If you believe in a 4% SWR, then you're totally overthinking all of this.

The research that created the 4% SWR assumed the same withdrawal strategy that forummm is describing: simply withdraw your 4%, and rebalance to your original AA (or withdraw your 4% in a manner that maintains the original AA; that's a mathematically identical way of saying the same thing).

A "down market" doesn't require any different approach. The existence of "down markets" and the simple withdrawal method are baked into the 4% SWR number, and any attempts at fancy withdrawal gymnastics are more likely to hurt your portfolio survival than help.

brooklynguy

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Re: Portfolio Draw Down Approaches?
« Reply #22 on: June 18, 2015, 09:03:46 AM »
Dawg Fan, I believe you are conflating together different ideas from the different advice you are getting around the forum.  The idea of drawing down on fixed income investments first and/or holding cash buffers (consistent with the advice Nords is giving in your thread in the Post-FIRE subforum) is one approach, but not necessarily the optimal approach and definitely not the approach reflected in the research that revealed a 4% WR to be "safe" even under historical worst case scenarios.  Now, Nords definitely knows what he's talking about (which is one hell of an understatement), and, after taking behavioral/psychological factors into account, that type of approach may be best.  But, for someone with the disposition to stick to their desired allocation through thick and thin, following the simple constant-allocation-maintaining withdrawal plan described by forummm (which is consistent with the withdrawal plans underlying the SWR research, which do not distinguish between up markets and down markets) makes more sense and (historically) has been optimal.

amberfocus

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Re: Portfolio Draw Down Approaches?
« Reply #23 on: June 18, 2015, 09:39:11 AM »
First, I understand the concept of AA and practice rebalancing presently, but am not FIRE yet, so no withdrawals, just accumulation. Let me try and provide a simple illustration to show you where I am struggling with the "sell more bonds and buy more stocks when stocks are down " in a post FIRE world. The premise is you are drawing down $40K/yr 1 from somewhere and based on what I am hearing from most folks, you generally hit your bond-ish investments first, particularly in down yrs of the stock market. Let's assume the following...

- Yr 1 I have $1M + $40K cash so I don't make my first withdrawal until end of first yr
- Withdrawals thereafter once/yr for next yrs expenses, following 4% SWR
- 75% Stock/25% Bond-ish
- My annual withdrawals typically from my 25% first in most cases... isn't that the conventional wisdom here???
- Assume no inflation
- 2 Yr analysis assumes Portfolio performs -10% yr1, +10% yr 2, all losses come form stocks, bonds return 0

Eg
End Yr1: 75% = $675,000
              25% = $250,000 - $40,000 = $210,000
             New balance = $885,000
             Rebalance = $663,750/$221,250 (selling stocks low/buying bonds)

End Yr2: 75% = $730,125
              25% = $221,250 - $40,000 = $181,250
              New balance = $911,375
              Rebalance = $683,531/$227,844 (selling stocks high/buying bonds)

What I am hearing you all say is in yr 1 to sell more bonds and buy stocks because they are down, and while I get the concept, you are working against the rebalance approach and further depleting your bonds should we hit an extended down cycle in the stock market. I am just trying to point out that I don't see how you can do both in this example of a down cycle (rebalance and buy when down). My common sense tells me at the end of yr 1 in this example to NOT rebalance at a min, and if I am bullish, consider buying stocks while down and selling some bonds (knowing this can risk my number of safe yrs if we have an extended negative cycle). If I am not bullish on the stock market coming back and the market continues to crap out yrs 2 & 3, continue to tap my 25% which will make me look further out of balance for the current term, but keep me from selling stocks low. Alternatively, my thought was there could be value in harvesting the 75% when returns hit a certain threshold as opposed to always tapping the 25% first?

Not trying to beat this horse to death, but IF all of our $$ to cover our expenses are coming from our portfolio, we have to draw them from somewhere which further affects the balances at the end of the yr.

Okay, I see the problem that the OP is having here. Essentially, at the end of year 1, stocks are down and bonds are flat, so NOTHING is up. In order to withdraw living expenses, you have to either:

1. Let your allocation drift by ONLY selling bonds, or
2. Rebalance properly and take a hit by selling stocks

Now, both stocks and bonds actually throw off dividends (even without a dividend-focused approach), so you can just take those distributions for expenses regardless of where they came from. I ran the numbers, and assuming current yields for VTSAX and VBTLX, you actually don't have to sell stocks in order to keep your allocation. You have the space to sell enough bonds to cover your remaining expenses AND buy a tiny bit of stock (~$1800 worth), to boot.

https://docs.google.com/spreadsheets/d/1azrHYDp5QiIbjFJMARvJY6F-dg10LR0KNZsGQTMixTM/edit#gid=0

However, if you can't make up the your remaining expenses by selling bonds until they return to 25% allocation, then you're still stuck with the above two choices.

I'm not FIRE yet either, so this is all a hypothetical exercise for me, but thinking through this, because I wouldn't want to sell stocks in a down market either, this is where I'd employ my cash reserves. If I can't weasel my way out by cutting expenses, etc., I'd sell enough bonds to reallocate to 25%, and then take the rest from my cash reserves.

To the seasoned FIREes -- would this be a theoretically sound approach?

Eric

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Re: Portfolio Draw Down Approaches?
« Reply #24 on: June 18, 2015, 10:37:13 AM »
DawgFan, have you ever heard of the concept of price anchoring?  Let me outline a scenario for you:

You're currently retired (congrats!) and you are drawing off your portfolio for living expenses.

You bought $40K worth of VTSAX in 2009.  In two years from now, it's worth $100K.  You need to sell $40K for expenses.  I'm assuming you're okay with selling shares that appreciated 150%.  Right?  Cool.  Done and done.

Now what if I told you that between now and 2017, it was worth $150K at one point, but now has dropped 33% from the high water mark to be worth only $100k.  Now you're selling when the market is down.  But is there really a difference?  You're still selling the same stock that still vastly increased in value.  The only difference is your perception of the value.

So the point of having an AA as part of a larger Investor Policy Statement is to remove the emotion and the natural human observation biases from your plan.  As you mentioned above, you should "blindly follow" your AA, sort of the same way you blindly go to the dentist every 6 months or blindly change your car's oil after 7000^ miles.  In this way, you have a plan to follow and are not tempted (to continue the analogy) to continue driving on the same oil well past 7000 miles just because the car is running fine, or start changing the oil every 1000 miles just because the car needed a few repairs. 


^Or whatever mileage.  It's an example, let's not actually talk about cars and oil changes people, thanks!

forummm

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Re: Portfolio Draw Down Approaches?
« Reply #25 on: June 18, 2015, 11:03:30 AM »
Okay, I see the problem that the OP is having here. Essentially, at the end of year 1, stocks are down and bonds are flat, so NOTHING is up. In order to withdraw living expenses, you have to either:

1. Let your allocation drift by ONLY selling bonds, or
2. Rebalance properly and take a hit by selling stocks

Now, both stocks and bonds actually throw off dividends (even without a dividend-focused approach), so you can just take those distributions for expenses regardless of where they came from. I ran the numbers, and assuming current yields for VTSAX and VBTLX, you actually don't have to sell stocks in order to keep your allocation. You have the space to sell enough bonds to cover your remaining expenses AND buy a tiny bit of stock (~$1800 worth), to boot.

https://docs.google.com/spreadsheets/d/1azrHYDp5QiIbjFJMARvJY6F-dg10LR0KNZsGQTMixTM/edit#gid=0

However, if you can't make up the your remaining expenses by selling bonds until they return to 25% allocation, then you're still stuck with the above two choices.

I'm not FIRE yet either, so this is all a hypothetical exercise for me, but thinking through this, because I wouldn't want to sell stocks in a down market either, this is where I'd employ my cash reserves. If I can't weasel my way out by cutting expenses, etc., I'd sell enough bonds to reallocate to 25%, and then take the rest from my cash reserves.

To the seasoned FIREes -- would this be a theoretically sound approach?

Dividends don't matter here. The OP's scenario could still exist if the price of the bonds just happened to go down the same amount as the dividends they spit off (say because of a small interest rate increase). It doesn't matter whether you 1) spend the dividends or 2) have the dividends automatically reinvested and then just sell stocks and/or bonds when you take your withdrawals.

With an AA and 4%SWR, the whole task of paying for your expenses from your portfolio is as simple as:
1) Pull out your 4% (inflation adjusted) for the year
2) Move money between stocks and bonds to get your AA back into alignment.

That's it. You can pull out money more frequently. You can preferentially reallocate in a tax-advantaged account to avoid CG taxes. Or you can do the inverse if your income is low enough that CG taxes are $0. But anything more complicated is unnecessary.

amberfocus

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Re: Portfolio Draw Down Approaches?
« Reply #26 on: June 18, 2015, 02:07:52 PM »
Okay, I see the problem that the OP is having here. Essentially, at the end of year 1, stocks are down and bonds are flat, so NOTHING is up. In order to withdraw living expenses, you have to either:

1. Let your allocation drift by ONLY selling bonds, or
2. Rebalance properly and take a hit by selling stocks

Now, both stocks and bonds actually throw off dividends (even without a dividend-focused approach), so you can just take those distributions for expenses regardless of where they came from. I ran the numbers, and assuming current yields for VTSAX and VBTLX, you actually don't have to sell stocks in order to keep your allocation. You have the space to sell enough bonds to cover your remaining expenses AND buy a tiny bit of stock (~$1800 worth), to boot.

https://docs.google.com/spreadsheets/d/1azrHYDp5QiIbjFJMARvJY6F-dg10LR0KNZsGQTMixTM/edit#gid=0

However, if you can't make up the your remaining expenses by selling bonds until they return to 25% allocation, then you're still stuck with the above two choices.

I'm not FIRE yet either, so this is all a hypothetical exercise for me, but thinking through this, because I wouldn't want to sell stocks in a down market either, this is where I'd employ my cash reserves. If I can't weasel my way out by cutting expenses, etc., I'd sell enough bonds to reallocate to 25%, and then take the rest from my cash reserves.

To the seasoned FIREes -- would this be a theoretically sound approach?

Dividends don't matter here. The OP's scenario could still exist if the price of the bonds just happened to go down the same amount as the dividends they spit off (say because of a small interest rate increase). It doesn't matter whether you 1) spend the dividends or 2) have the dividends automatically reinvested and then just sell stocks and/or bonds when you take your withdrawals.

With an AA and 4%SWR, the whole task of paying for your expenses from your portfolio is as simple as:
1) Pull out your 4% (inflation adjusted) for the year
2) Move money between stocks and bonds to get your AA back into alignment.

That's it. You can pull out money more frequently. You can preferentially reallocate in a tax-advantaged account to avoid CG taxes. Or you can do the inverse if your income is low enough that CG taxes are $0. But anything more complicated is unnecessary.

I understand how a straight-up 4% SWR works. You sell 4% and rebalance to your AA regardless of what the market's doing. Boom, done. Simple.

I guess the reason I complicated matters a little and went slightly beyond the OP's original proposed scenario is because I'm trying to employ a more adaptive/nuanced strategy that brings in other contingencies such as tapping cash reserves, in case a straight-up 4% SWR doesn't feel comfortable enough. I'm personally planning on having cash reserves, so I was just trying to see if the OP's scenario is one in which it'd be appropriate to tap into those.

As for the dividends - I brought them up because they're cashflow that's already pre-determined. You can definitely ignore them and reinvest, but they're a passive way to "draw down" your equities without outright selling shares.

Ultimately, I'm too conservative for a straight-up 4% SWR, which is why I'm working other contingencies into my FIRE plan, but I realize that's just my own personal (lack of) tolerance for longevity and market risk. YMMV.

forummm

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Re: Portfolio Draw Down Approaches?
« Reply #27 on: June 18, 2015, 02:22:02 PM »
You can add a separate cash component if that buys you less anxiety. But holding a year in cash has been shown to negatively impact returns. It's incredibly difficult to know when to market time--which is what you're doing if you're selectively drawing down the cash you have instead of selling stock, and then selectively adding back to the cash instead of buying stock. Studies show people make the wrong timing decisions and it negatively impacts their returns. If you want to be more conservative than 75/25, a better idea might be 70/30 or 60/40. See how those scenarios play out for you in cFIREsim.

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Re: Portfolio Draw Down Approaches?
« Reply #28 on: June 18, 2015, 04:38:20 PM »
I have been out of touch for a while doing pre-FIRE activities aka work. Perhaps I am mixing/matching some advice from those of you who are applying this. There is no question as to how rebalancing one's AA works as I mentioned, I do it now in my pre-FiRE world. What I am hearing most of you say is proportionately withdraw from your portfolio each year the $40K (Forummm I believe you are implying cFireism will do just that?). So, in the case of my eg 1, you would be selling stocks ($30K), Bond/CD/Cash ($10K) which represents the 75/25 portfolio mix, and then rebalance the remaining. Or, as I was just suggesting/asking, you could sell from your 25% since stocks are down. Conversely, in eg 2, you could do the proportionate split and rebalance or pull your $40k from stocks and rebalance. Again, there is no argument here, I am just proposing different ideas. The main thought is the stock market historically offers the best returns (compared to bonds/CDs/cash), however, that is generally over "time" (could be 1 yr, 3 yrs, 10 yrs). So, if we believe that, then the thought is using the 25% during those periods gives you some margin to see your stocks recover since that is what you always banked on in the first place by holding stocks. Just checking to see if there is a better mouse trap out there.

forummm

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Re: Portfolio Draw Down Approaches?
« Reply #29 on: June 18, 2015, 06:50:48 PM »
I'm still confused about what the confusion is. And I'm not understanding what your "other ideas" are.

cFIREsim does operate as I've described. As long as you are withdrawing in such a way that keep the AA roughly in balance, and then rebalancing annually, you're following the program. Don't worry about other stuff.

amberfocus

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Re: Portfolio Draw Down Approaches?
« Reply #30 on: June 18, 2015, 09:31:46 PM »
You can add a separate cash component if that buys you less anxiety. But holding a year in cash has been shown to negatively impact returns. It's incredibly difficult to know when to market time--which is what you're doing if you're selectively drawing down the cash you have instead of selling stock, and then selectively adding back to the cash instead of buying stock. Studies show people make the wrong timing decisions and it negatively impacts their returns. If you want to be more conservative than 75/25, a better idea might be 70/30 or 60/40. See how those scenarios play out for you in cFIREsim.

Is it really so outlandish to hold cash reserves to hedge against short-term market risk? I actually thought it was common practice to have some liquidity -- and a few years of expenses doesn't seem all that unreasonable, not when one's dealing with a Mustachian spend rate. The cash is not meant to enable market timing; it's operating more like rebalancing -- you draw it down when investments are down, and build it back up (to some sort of cap) when investments perform well. If 2008 were to repeat, wouldn't it be better to hang tight and ride out the downturn by spending down cash instead of selling?

I'm interested in seeing the studies that examine the impact of cash reserves on returns, if you can share them. At the very least, I'd like to understand the argument and what exactly is going on there. Is it just the opportunity cost of not investing the cash and earning returns, or does it have to do with people "market timing", which I don't quite understand the mechanics there, and don't think it's what I'm describing, but maybe I'm misunderstanding?

As for using a higher bond allocation, the problem with that approach is that while it mitigates short-term portfolio volatility, it increases longevity risk, so that's not a perfect solution either. In my current line of thinking, I'd rather mitigate short-term volatility via cash reserves than with more bonds, specifically because I need the higher equity allocation for longevity. When I say I'm conservative, I don't mean it in terms of AA (I have no qualms with 75/25); I  mean it in terms of SWRs, in that I'd rather brute force the hell out of my stash. I know, I know, this is OMY syndrome, but it's a bit different to OMY at age 30 than at age 60, IMO.

At the end of the day, I'm not quite grokking the argument against cash reserves, which I would have thought would be an acceptable alternative to the OP's dilemma.

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Re: Portfolio Draw Down Approaches?
« Reply #31 on: June 19, 2015, 09:42:22 AM »
You can add a separate cash component if that buys you less anxiety. But holding a year in cash has been shown to negatively impact returns. It's incredibly difficult to know when to market time--which is what you're doing if you're selectively drawing down the cash you have instead of selling stock, and then selectively adding back to the cash instead of buying stock. Studies show people make the wrong timing decisions and it negatively impacts their returns. If you want to be more conservative than 75/25, a better idea might be 70/30 or 60/40. See how those scenarios play out for you in cFIREsim.

Is it really so outlandish to hold cash reserves to hedge against short-term market risk? I actually thought it was common practice to have some liquidity -- and a few years of expenses doesn't seem all that unreasonable, not when one's dealing with a Mustachian spend rate. The cash is not meant to enable market timing; it's operating more like rebalancing -- you draw it down when investments are down, and build it back up (to some sort of cap) when investments perform well. If 2008 were to repeat, wouldn't it be better to hang tight and ride out the downturn by spending down cash instead of selling?

I'm interested in seeing the studies that examine the impact of cash reserves on returns, if you can share them. At the very least, I'd like to understand the argument and what exactly is going on there. Is it just the opportunity cost of not investing the cash and earning returns, or does it have to do with people "market timing", which I don't quite understand the mechanics there, and don't think it's what I'm describing, but maybe I'm misunderstanding?
here
https://www.kitces.com/blog/research-reveals-cash-reserve-strategies-dont-work-unless-youre-a-good-market-timer/

Yes you would be market timing. You say "spending down cash instead of selling?" which imply you know where the bottom is. What if you spend down cash, and then the market drop another 20%? Now you're selling even more stocks, at even lower prices. Instead of rebalancing your bonds into cheaper stocks. But hte article expla

As for using a higher bond allocation, the problem with that approach is that while it mitigates short-term portfolio volatility, it increases longevity risk, so that's not a perfect solution either. In my current line of thinking, I'd rather mitigate short-term volatility via cash reserves than with more bonds, specifically because I need the higher equity allocation for longevity.
But then cash reserves is even worse! The return on bonds is (usually) greater than that on cash. Your AA calculation doesn't seem quite right. If you reduce bond allocation, but increase your cash holdings the same amount you have not actually increased equity allocation. Cash is part of your AA. With 25x spending, and one year in cash you have 4% of your AA in cash. So really a 72/24/4 allocation of stocks/bonds/cash. Not 75/25. You can test this is cFiresim by setting a cash allocation.

At the end of the day, I'm not quite grokking the argument against cash reserves, which I would have thought would be an acceptable alternative to the OP's dilemma.

forummm

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Re: Portfolio Draw Down Approaches?
« Reply #32 on: June 19, 2015, 11:16:41 AM »
Amberfocus, play around with a cash allocation in cFIREsim and see what you get. It won't let you do market timing, but it will show you what effect cash has on a portfolio for many historical scenarios. The market timing you are proposing is very hard to do. And will most likely be done to your detriment. If someone without much financial knowledge knew when the best times to buy and sell were, then the pros would know too, and would have already done the buying or selling, driving the price to the point where you gain nothing from your knowledge. If you can't know better than a pro, then you're doing something risky. The simple 4% SWR and a consistently rebalanced AA takes care of all of this for you automatically.

amberfocus

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Re: Portfolio Draw Down Approaches?
« Reply #33 on: June 19, 2015, 11:27:31 AM »
You can add a separate cash component if that buys you less anxiety. But holding a year in cash has been shown to negatively impact returns. It's incredibly difficult to know when to market time--which is what you're doing if you're selectively drawing down the cash you have instead of selling stock, and then selectively adding back to the cash instead of buying stock. Studies show people make the wrong timing decisions and it negatively impacts their returns. If you want to be more conservative than 75/25, a better idea might be 70/30 or 60/40. See how those scenarios play out for you in cFIREsim.

Is it really so outlandish to hold cash reserves to hedge against short-term market risk? I actually thought it was common practice to have some liquidity -- and a few years of expenses doesn't seem all that unreasonable, not when one's dealing with a Mustachian spend rate. The cash is not meant to enable market timing; it's operating more like rebalancing -- you draw it down when investments are down, and build it back up (to some sort of cap) when investments perform well. If 2008 were to repeat, wouldn't it be better to hang tight and ride out the downturn by spending down cash instead of selling?

I'm interested in seeing the studies that examine the impact of cash reserves on returns, if you can share them. At the very least, I'd like to understand the argument and what exactly is going on there. Is it just the opportunity cost of not investing the cash and earning returns, or does it have to do with people "market timing", which I don't quite understand the mechanics there, and don't think it's what I'm describing, but maybe I'm misunderstanding?
here
https://www.kitces.com/blog/research-reveals-cash-reserve-strategies-dont-work-unless-youre-a-good-market-timer/

Yes you would be market timing. You say "spending down cash instead of selling?" which imply you know where the bottom is. What if you spend down cash, and then the market drop another 20%? Now you're selling even more stocks, at even lower prices. Instead of rebalancing your bonds into cheaper stocks. But hte article expla

As for using a higher bond allocation, the problem with that approach is that while it mitigates short-term portfolio volatility, it increases longevity risk, so that's not a perfect solution either. In my current line of thinking, I'd rather mitigate short-term volatility via cash reserves than with more bonds, specifically because I need the higher equity allocation for longevity.
But then cash reserves is even worse! The return on bonds is (usually) greater than that on cash. Your AA calculation doesn't seem quite right. If you reduce bond allocation, but increase your cash holdings the same amount you have not actually increased equity allocation. Cash is part of your AA. With 25x spending, and one year in cash you have 4% of your AA in cash. So really a 72/24/4 allocation of stocks/bonds/cash. Not 75/25. You can test this is cFiresim by setting a cash allocation.

At the end of the day, I'm not quite grokking the argument against cash reserves, which I would have thought would be an acceptable alternative to the OP's dilemma.

Ah, thank you so much for the link! Okay, I think I see the argument now. And in the case of the OP's scenario, you're absolutely right -- cash would be detrimental. Data is data, I'm a scientist, and it's the best way to sway me.

However, the reason why I wanted to read the article is because I wanted to check the context and assumptions of the study. The article assumes a 4% SWR, which means that a 2 year reserve would comprise 8% of the portfolio, which is really significant. That is absolutely a drag on total portfolio allocation and returns, and I would never, ever do that.

What I was envisioning in my own plan is more like $50K in cash, which is about 3 to 4 years of (extremely Mustachian ;)) expenses. Against a $2MM goal portfolio being drawn down at 1% (yes, we're *that* batshit :P), that's an AA rounding error. I think $50K would be what a normal person would consider a healthy-sized emergency fund -- in case the car, roof, furnace, and some important bodily organ all go at once. I suspect you wouldn't make the same arguments against holding this level of liquidity. I think it'll all come out in the wash.

But actually, now I understand your and forummm's the earlier comments a lot more, especially the part about increasing bond allocation instead of holding cash. I agree that Team Just Reallocate makes the best sense for the OP's scenario. This discussion has been very illuminating, and I really appreciate everyone's comments.

brooklynguy

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Re: Portfolio Draw Down Approaches?
« Reply #34 on: June 19, 2015, 12:05:01 PM »
What I was envisioning in my own plan is more like $50K in cash, which is about 3 to 4 years of (extremely Mustachian ;)) expenses. Against a $2MM goal portfolio being drawn down at 1% (yes, we're *that* batshit :P), that's an AA rounding error.

Yes, if you're using a 1% withdrawal rate, then you've already "won the game" (and then some!) and you can afford to dial back the risk, even way beyond holding merely 3-4 years of expenses in cash.  You could probably go 100% cash and still be okay (but, on the other hand, you'd also surely be fine with 100% equities and zero cash reserve -- a full three-quarters of your portfolio would have to go up in smoke before you enter the 4% Rule territory that most of us are comfortable retiring on!).  If you grossly oversave to that extent, the risks of using a cash reserve strategy no longer apply.  And, as I mentioned earlier in this thread (and as discussed in the Kitces article), it's important to keep behavioral/psychological factors in mind -- even if holding a cash buffer isn't optimal, if it will prevent you from panic-selling in a down market, the drag on returns is a price worth paying (just think of it as the premium on a portfolio-self-sabotage insurance policy).

forummm

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Re: Portfolio Draw Down Approaches?
« Reply #35 on: June 19, 2015, 12:47:39 PM »
What I was envisioning in my own plan is more like $50K in cash, which is about 3 to 4 years of (extremely Mustachian ;)) expenses. Against a $2MM goal portfolio being drawn down at 1% (yes, we're *that* batshit :P), that's an AA rounding error. I think $50K would be what a normal person would consider a healthy-sized emergency fund -- in case the car, roof, furnace, and some important bodily organ all go at once. I suspect you wouldn't make the same arguments against holding this level of liquidity. I think it'll all come out in the wash.

Uhhh, a 1% withdrawal rate? Seriously? That's cool and all, but why are you at all worried about holding any cash or what stocks to sell? You can be 100% stocks and live off of the dividends and never sell a share. In fact, you'll be continually buying them. If I had 100x my expenses, I wouldn't have any emergency fund beyond a few grand in checking. Why would you possibly need it? You could have six figures moved from your investments to your checking account in 2 days. There's almost no expense I can think of where you don't have at least 2 days of notice before you need cold hard cash. Maybe for bail or for ransom. But even then you have options.

forummm

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Re: Portfolio Draw Down Approaches?
« Reply #36 on: June 19, 2015, 12:59:17 PM »
For fun I put a 1% WR into cFIREsim with 100% stocks. After a 50 year retirement where you simply forget to even file for SS (i.e. you don't take it), you end up on average with $40 million in today's dollars (probably around a half billion dollars in 2075 dollars).

In the worst cast scenario you end up with $12.8 million in today's dollars.

Keep in mind that with a 50 year retirement, you're only spending an inflation-adjusted half of your initial portfolio--$1 million total spend of the $2 million initial portfolio.

So yeah. It's a very conservative approach.
« Last Edit: June 19, 2015, 01:04:51 PM by forummm »

Financial.Velociraptor

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Re: Portfolio Draw Down Approaches?
« Reply #37 on: June 19, 2015, 05:06:11 PM »
U Cray-Cray.  Do it right and have a 0.10% WR.  A thousand times expenses.  *Now* you can lay claim to the title "Mustachian."

forummm

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Re: Portfolio Draw Down Approaches?
« Reply #38 on: June 19, 2015, 05:29:17 PM »
U Cray-Cray.  Do it right and have a 0.10% WR.  A thousand times expenses.  *Now* you can lay claim to the title "Mustachian."

<chuckles>

amberfocus

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Re: Portfolio Draw Down Approaches?
« Reply #39 on: June 19, 2015, 05:35:45 PM »
U Cray-Cray.  Do it right and have a 0.10% WR.  A thousand times expenses.  *Now* you can lay claim to the title "Mustachian."

Ha, no kidding. Don't even get me started -- that's an entirely separate discussion and I don't want to derail the thread. :P But the short version is -- I'm already more conservative than most in that I prefer 2% to 4%. But the SO -- he doesn't even want to ER at 1%, so maybe we'll actually be at 0.1% WR for realz by the time he feels comfortable. We're actually at 2% *now*, so I'm hoping he'll mellow out and relent by the time the stash size hits 1% in a few years (markets allowing). >.<

forummm

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Re: Portfolio Draw Down Approaches?
« Reply #40 on: June 19, 2015, 05:41:33 PM »
U Cray-Cray.  Do it right and have a 0.10% WR.  A thousand times expenses.  *Now* you can lay claim to the title "Mustachian."

Ha, no kidding. Don't even get me started -- that's an entirely separate discussion and I don't want to derail the thread. :P But the short version is -- I'm already more conservative than most in that I prefer 2% to 4%. But the SO -- he doesn't even want to ER at 1%, so maybe we'll actually be at 0.1% WR for realz by the time he feels comfortable. We're actually at 2% *now*, so I'm hoping he'll mellow out and relent by the time the stash size hits 1% in a few years (markets allowing). >.<

You're already at 2%? Do you like your job? If not, you should get to do what you want with your life even if he decides to keep working. 2% is hella conservative already. You're legit FI. You can FIRE yourself whenever you want.

Scandium

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Re: Portfolio Draw Down Approaches?
« Reply #41 on: June 19, 2015, 08:25:13 PM »
Eh yeah. What everyone else said..  You could have 8 years of expenses invested  in penny stocks and baseball cards and still be ok!
FIRE! do it nauuw!

amberfocus

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Re: Portfolio Draw Down Approaches?
« Reply #42 on: June 19, 2015, 10:26:58 PM »
U Cray-Cray.  Do it right and have a 0.10% WR.  A thousand times expenses.  *Now* you can lay claim to the title "Mustachian."

Ha, no kidding. Don't even get me started -- that's an entirely separate discussion and I don't want to derail the thread. :P But the short version is -- I'm already more conservative than most in that I prefer 2% to 4%. But the SO -- he doesn't even want to ER at 1%, so maybe we'll actually be at 0.1% WR for realz by the time he feels comfortable. We're actually at 2% *now*, so I'm hoping he'll mellow out and relent by the time the stash size hits 1% in a few years (markets allowing). >.<

You're already at 2%? Do you like your job? If not, you should get to do what you want with your life even if he decides to keep working. 2% is hella conservative already. You're legit FI. You can FIRE yourself whenever you want.

Heh, if you guys would like to pile on/talk me off the ledge, why don't we head over to my journal thread? I just made it yesterday and it's still quite lonely. :)

Nords

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Re: Portfolio Draw Down Approaches?
« Reply #43 on: June 21, 2015, 02:37:05 PM »
Dawg, speaking as a nuclear-trained submarine engineer, if I were to assemble all of your posts into one gigantic quote then I think it'd be apparent that you have one of the worst cases of over-nuking it that I've ever seen.

You may also wish to reconsider your math.  The numbers are correct but your perception of what's happening to the numbers is not.

Let's take your latest example and work it a little differently.
First, I understand the concept of AA and practice rebalancing presently, but am not FIRE yet, so no withdrawals, just accumulation. Let me try and provide a simple illustration to show you where I am struggling with the "sell more bonds and buy more stocks when stocks are down " in a post FIRE world. The premise is you are drawing down $40K/yr 1 from somewhere and based on what I am hearing from most folks, you generally hit your bond-ish investments first, particularly in down yrs of the stock market. Let's assume the following...

- Yr 1 I have $1M + $40K cash so I don't make my first withdrawal until end of first yr
- Withdrawals thereafter once/yr for next yrs expenses, following 4% SWR
- 75% Stock/25% Bond-ish
- My annual withdrawals typically from my 25% first in most cases... isn't that the conventional wisdom here???
- Assume no inflation
- 2 Yr analysis assumes Portfolio performs -10% yr1, +10% yr 2, all losses come form stocks, bonds return 0

Eg
End Yr1: 75% = $675,000
              25% = $250,000 - $40,000 = $210,000
             New balance = $885,000
             Rebalance = $663,750/$221,250 (selling stocks low/buying bonds)

End Yr2: 75% = $730,125
              25% = $221,250 - $40,000 = $181,250
              New balance = $911,375
              Rebalance = $683,531/$227,844 (selling stocks high/buying bonds)

What I am hearing you all say is in yr 1 to sell more bonds and buy stocks because they are down, and while I get the concept, you are working against the rebalance approach and further depleting your bonds should we hit an extended down cycle in the stock market. I am just trying to point out that I don't see how you can do both in this example of a down cycle (rebalance and buy when down). My common sense tells me at the end of yr 1 in this example to NOT rebalance at a min, and if I am bullish, consider buying stocks while down and selling some bonds (knowing this can risk my number of safe yrs if we have an extended negative cycle). If I am not bullish on the stock market coming back and the market continues to crap out yrs 2 & 3, continue to tap my 25% which will make me look further out of balance for the current term, but keep me from selling stocks low. Alternatively, my thought was there could be value in harvesting the 75% when returns hit a certain threshold as opposed to always tapping the 25% first?

Not trying to beat this horse to death, but IF all of our $$ to cover our expenses are coming from our portfolio, we have to draw them from somewhere which further affects the balances at the end of the yr.
Let's go back to the end of Year #1, where stocks have returned -10% and bonds have returned 0% and your cash balance is zero.  Don't sell anything yet, but instead take another look at the asset allocation.

At that point the numbers would be:
Stocks = $675K (= 90% of $750K)
Bonds = $250K.
Total Stocks + Bonds = $925K. 

Before you sell anything, you want to end up with $40K in your checking account for the start of Year #2.  Technically, you actually want a bit more than $40K because there might have been some inflation during that terrible year for the stock market, but let's ignore that for now.  Or let's decide that it's a recession and you're going to cut back on your spending a little.  Either way the number is $40K.

Total S+B = $925K
Cash needed = $40K
New Total S+B = $885K.

Now rebalance as you've done:
Rebalancing stocks would be $885K x 75% = $663,750.
Rebalancing bonds would be $885K x 25% = $221,250.

Now here's what's happening to get you to those numbers:
Sell off stocks $675K-$663,750 = $11,250.
and sell bonds $250K -$221,250 = $28,750.

Conclusion:
Yeah, you sold some of your stocks in a down market.  But as others have pointed out, the stocks you sold (at year-end prices) are still worth more than what you paid for them (your average cost basis).  You've been buying stocks for years, maybe even decades, and during two-thirds of that time the market has gone up way more than it's dropped.  Although the stock market was down at the end of Year #1, you did not sell stocks at a loss.  You would be keenly aware of this as soon as you got your 1099 from your brokerage and saw that you had taxable capital gains.

If the market had been flat during Year #1 then you would've sold $30K of stocks (75% of $40K) and only $10K of bonds (25% of $40K).  But because stock performance sucked last year, you're taking far less from your stock shares. You're easing up on the stock harvest and taking most of next year's $40K from your bond portfolio.

You're actually leaving nearly $20K of your stocks in the market (to recover) instead of selling.  By leaving money in your stock AA, you essentially bought more stocks.  You're actually taking more of your bonds because they didn't lose as much as the stock market lost. 

It's just asset allocation.  Do the math and don't over-think it.

MidWestLove

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Re: Portfolio Draw Down Approaches?
« Reply #44 on: June 21, 2015, 03:59:45 PM »
"It's just asset allocation.  Do the math and don't over-think it."

what Nords said, not over-thinking it is a key as it may get to analysis paralysis vs enjoying your life. if you want to be more specific, usually it make sense to set up 'sweep' account, 'pre-fund' such account with cash 'reserve' (2,3,5 years - whatever you feel comfortable), write down exact rules (what, when, how, if this then that) which would be simply math based and ignore anchoring and then follow the rules you agreed with yourself on. 

Now is this pure 75/25 ? no, there is cash balance involved providing cushion. does it work for real people I know (including my family)? yes. does it allow them not to care about balances at will and only look at them at "cash refill" time? yes.