4% vs 8%

[Freda]

I was listening to a Dave Ramsey podcast while baking yesterday (yum, muffins for breakfast all week), and he recommended having a nest egg sizeable enough so you can live off an 8% draw.

That's quite a jump from the Moustachian 4%.

Thoughts?

[Jack]

That sounds more like an emergency fund, drawing 8% per month (which would last about 12 months). The phrasing "sizable enough [for] an 8% draw" reinforces that interpretation, since the assets required for an 8% withdrawal rate are smaller, not larger, than the assets required for a 4% withdrawal rate of of the same amount.

The idea of an 8% per year withdrawal rate for a normal 30-year retirement makes no sense to me, let alone for a longer Mustachian early retirement.

[the fixer]

He might also be making some assumptions about social security income...?

[Freda]

That sounds more like an emergency fund, drawing 8% per month (which would last about 12 months). The phrasing "sizable enough [for] an 8% draw" reinforces that interpretation, since the assets required for an 8% withdrawal rate are smaller, not larger, than the assets required for a 4% withdrawal rate of of the same amount.

The idea of an 8% per year withdrawal rate for a normal 30-year retirement makes no sense to me, let alone for a longer Mustachian early retirement.

For emergency fund he just said six months expenses was all. 

Seems to me the emergency fund was too small and the retirement need too big?

[Bigote]

He gets heavily criticized for this, his inflated estimates of what average market returns are, his love for actively managed funds, and his love for investment advisors that kick back to him.

Lots of info about him on Bogleheads.  Basically the skinny is he's great to help people get out of debt (especially a certain type of person), but his investment advice is to be avoided at all costs.

[shaunr]

Usually if you hear someone talk about a withdrawal percentage that high, they're talking about a different withdrawal strategy.   (Another possibility: they are really dumb and should be ignored)

The method touted by MMM (SWR) works by starting out with a dollar value equal to 4% of your stash, and then increasing the amount each year to keep up with inflation.  For example if you start with 1 million, you might withdraw $40,000 the first year, $41,200 the second year, 42,436 the third year, and so on.  This amount would be independent of what was happening in the market / your nest egg.  The advantage is that you are planning on a reliable fixed income.

The other way to do it is to use a flat percentage and withdraw that amount of your stash each year.   If you decide to use 8%, you might withdraw 0.66% per month, every month.   If your portfolio grows at a rate > 8%, you will get a pay raise the next month.  If your portfolio is going down in value, you may receive a significant pay cut the next month.  (8% is a pretty ridiculous  / risky amount in my opinion, so something in the 5-7% range would probably be more realistic with this method.)   An advantage with this approach is that your nest egg will never go to zero.  Since you take a flat percentage each time, your income will drop accordingly when the market tanks.

So in short, the 4% method gives you a moderate stable income.  The "8%" method gives you more income when times are good, and less income when times are not-so-good.  And both are are probably highly optimistic given the current environment, so I would recommend lowering both if you're planning to retire in the next decade :)

[No Name Guy]

Or it could be the standard financial planner way of doing things.  Instead of NEVER touching the principal, one could plan to burn through the nest egg over a certain time period.

Doing the math on Excel, I come up with:

At 3% earnings, with an 8% withdrawal rate, the next egg will be gone in 15.7 years.
At 4% earnings, with an 8% withdrawal rate, the next egg will be gone in 17.4 years.
At 5% earnings, with an 8% withdrawal rate, the next egg will be gone in 19.7 years.

If you take the standard 65 retirement age, you'd be out of money at 80.7, 82.4 and 84.7 years of age, respectively. 

Per the wikipedia page on life expectancy, US overall is just shy of 78 years, women is 80.5, men 75.4.

Given that Ramsey is gearing his pitch to the masses (e.g. non-ER / FI / IW in their 30's, 40's), this wouldn't be unreasonable advice.

[Bigote]

It would be horrible advice.  Sequence of returns matters.

[shaunr]

No Name Guy,

What Bigote said is key:

It would be horrible advice.  Sequence of returns matters.

A 4% SWR is designed to keep you safe in the event of a bear market early in retirement.  An 8% SWR has a huge chance of wiping you out immediately in this case.   Your excel sheet probably doesn't account for this :)

[frugalman]

I'm 63 YO and work out daily.  Figure I need to plan for 25 to 30 years, not forever.  I plan to retire at age 66, full social security age for me.  With just social security and a small pension, and a very Mustachian $1,550/mo in expenses, we will have $1,650/mo in "savings" beyond our basic expenses (including groceries, healthcare, insurance, utilities, gasoline, taxes etc).  This is without touching the stash.  In fact, this grows to $2,800/mo when DW starts drawing social security just 4 years later.

I may very well draw 8 percent every year I can for a few years, so we can do some of the major travelling we want to do.  We want to see Monet's gardens, and the art treasures of Europe, at a leisurely pace.  Then, we want to tour the US and Canada, do an Alaskan cruise etc.  While we still have our health.  At some point, we will just be done and mostly just stay home and enjoy our life, with maybe a cruise or Florida stay to break up the winter monotony.  So I'm thinking 8 percent for five or six years, and maybe zero percent thereafter, as $2,800/mo surplus should be more than enough unless we get into hyperinflation.  If we become Zimbabwe, not much I'll be able to do but grow my own vegetables and heat my home with free wood from the acres around us.

[mpbaker22]

It would be horrible advice.  Sequence of returns matters.

Yes, to make this clear for everyone.  A 12% withdrawal rate, could potentially work if you started at 12%, then increased the withdrawal value, in dollars, for inflation, AND you just happened to start the year  before the markets go up 30%.
But if you start the year before markets go down 30%, you're screwed.

I always assume the x% withdrawal rate meant you would take out x% of whatever is in your portfolio each year (or plan to do that at a maximum), but that doesn't seem to be what people are talking about in this thread.

[No Name Guy]

You're missing the fact that Ramsey is gearing his pitch to the masses - the work to 65, count on social security, might even have a pension crowd and plan on SPENDING IT ALL / burning the principal by about the time you'll die bunch.  And for that crowd, chances are Ramsey et al would recommend a pretty damn conservative mix - lots of bonds, cash, CD's and only a bit in high volatility shit like stocks.  If you're planning on spending principal, then return of capital becomes equally if not more important that return on capital. 

If your money is invested in a not very volatile manner, one can plan out how to spend it pretty well, sequence of returns be damned. Think if you had $100 cash laying around - I need that $100 to last for 15 years, hey, I get to spend $6.66 a year, constant dollars, or $5.37 the first year, increasing by 3% inflation / year thereafter - your choice.  Taking 8 bucks the first year, 8%, and bumping that by 3% it'll last 10 years and change.  Factor up to what ever starting amount you have.  Sequence of "returns" doesn't matter in this extreme example (which sets a boundary for the problem), since one has an absolutely non-volatile "portfolio" with zero return - cash under the mattress. 

And yes, I'm well aware of the sequence of returns issue.  Fucking duh.  My comment was addressed specifically toward WHO (Ramsey) was making the 8% comment, HIS AUDIENCE (Retire at 65+, burn principal in addition to interest / dividends out of a conservative portfolio, "traditional" retirement, etc), and how IN THOSE CIRCUMSTANCES, he could state that 8% number.  Does 8% apply to the ERE / FI / IW at 20-40 crowd?  Fuck no - and I never said it did.  Shit people, grab a fucking clue and quit making straw men.

And who the hell mentioned 12%?

[the fixer]

Financial advice does need to be geared to the masses, but you can't take a demographic look at it and say "well if someone retires at 65 and average life expectancy is 80 then they only need their money to last 15 years!" Yes, that's average, but that also means 50% of people will run out of money before they die. That's not very responsible.

The 4% SWR was based on a 30-year timeline geared at traditional retirees. And traditional retirees need to be more conservative than us, not less, because they generally have a greater risk of medical issues and a harder time re-entering the workforce.

[dragoncar]

I wanted desperately for someone to make a valid case for 8%!!

MAybe 8% is a good target for someone planning semi retirement

[Jamesqf]

I wanted desperately for someone to make a valid case for 8%!!

MAybe 8% is a good target for someone planning semi retirement

If you're retiring at 65, the average life expectancy is a bit over 19.5 years.   From the numbers No Name Guy posted, that's almost exactly how long it would take to burn through a stash with 5% earnings and an 8% withdrawal rate.

[GreenGuava]

You're missing the fact that Ramsey is gearing his pitch to the masses - the work to 65, count on social security, might even have a pension crowd and plan on SPENDING IT ALL / burning the principal by about the time you'll die bunch.  And for that crowd, chances are Ramsey et al would recommend a pretty damn conservative mix - lots of bonds, cash, CD's and only a bit in high volatility shit like stocks.  If you're planning on spending principal, then return of capital becomes equally if not more important that return on capital.

Actually... Ramsey recommends a 100% stock portfolio - he has four styles of stock funds he recommends, and tells people to split your savings among those four.  In rare cases, he'll suggest adding a fifth, balanced fund (stocks and bonds).  He says to avoid bonds (not sure if general investing ignorance or a total avoidance of debt, even on the other side;  I believe he did this when bonds had decent returns, too) entirely.

But anyway, lots of Ramsey's investing advice can be understood best by looking at who he's talking to:  people who are horrible with money and would likely make all kinds of worse decisions than the ones Ramsey is advocating, such as selling their stocks in event of a crash (exactly the wrong time to sell) or spending every dime available to them.

[GoStumpy]

Plus, anyone that knows Ramsey's personality knows that he LOVES getting a rise out of people, so he intentionally continues to do the 12% returns even though he KNOWS it gets people so riled up... He loves it.

I find it pretty entertaining, myself :)

[Another Reader]

I remember the 12 percent return claim from years ago, but not the 8 percent withdrawal rate.  My guess is if he is telling people they can withdraw 8 percent, he's doing the simple calculation of 12 percent return - 4 percent for inflation.  Ramsey is all about the simple math because it works with his audience.  People that follow Ramsey are generally not likely to read Wade Pfau or delve into the matter much beyond what they hear. 

I enjoyed listening to him years ago while stuck in commuter traffic.  How can you not enjoy comments like "I've done stupid with zero's on it" and the country preacher zeal of his debt free message?

[pianogineer]

My guess is if he is telling people they can withdraw 8 percent, he's doing the simple calculation of 12 percent return - 4 percent for inflation.

This is exactly where he gets 8%. He actually "advocates" never touching the nest egg and only spending the earnings with this logic.

[Alex in Virginia]

I wanted desperately for someone to make a valid case for 8%!!

MAybe 8% is a good target for someone planning semi retirement

Okay... I'll go ahead and throw fat on that fire. :O

I in fact am drawing 8% annually from my retirement portfolio -- and the portfolio's book value isn't going down, which means theoretically this could go on forever.  How is this?  My portfolio consists of 80% high dividend stocks, 20% high yield corporate bonds, and a token hunk of peer-to-peer lending capital.  Caution, though: to pull this off you need an ice-cold head, a steady stomach, and a reliable anti-panic mental approach. Plus the willingness to put in the time and study it takes to select and continuosuly monitor 20 to 30 "right" companies to invest in so that your portfolio can survive the inevitable down drafts and nasty surprises that come with all corporate stock and bond investing.

You don't just throw your money into a few mutual funds and get to draw an 8% annual yield.  You have to work for it. :(

Alex in Virginia