Bridging the gap between expected returns and failure withdrawl rates

[Seadog]

Is there a way to do this? Perhaps I need to explain, but basically, you have an expected return on broadly invested stocks/bonds of 7-10% or so, however due to the possibility of a particularly bad run based entirely upon the year you choose to retire, we are prudent by only withdrawing 4%. While you are confident you wont run out of money, you are also expecting to have a good deal more money than you need. 

Simply stated, to insure against variability of returns, you end up saving almost twice as much as you need. Are the any products out there, almost an annuity in the sense to not only ensure you don't go bust, but allow you to pull out over 4% by spreading the risk around in a classic insurance sense?

Like home insurance, they only reason you have it is because life spans are finite, and the expected interval between losing your home is many many lifetimes. If you could live forever it would be far ore prudent to simply replace your home as it burned down, and save on the insurance.

Similarly here, the only reason we have a 4% rule, is because returns highly variable, and by nature of life, you can only pull the retirement trigger once. If you could have a hundred 30 year work-retirement cycles it wouldn't be an issue. Is there a way to get some sort of insurance to bridge the gap between expectation and variable reality?

If I retire this year (or any year), 4% for 30 years, I have a 95% chance of success, however I also *expect* to have almost twice my initial amount left over after 30 years. I like others here I'm sure hate leaving money on the table.

If however, I teamed up with 50 other people, some younger, some older, each with a million dollars and a 30 year retirement, all buying the same funds, but doing so for each of the sequential retirement years, now a 6% withdrawal rate with almost 100% success can be achieved. While 50% of individual years failed, individually isn't as important as the sum total of everyone.

This is really just another way to diversify, and basically allow you to rein in the tails of variability of your investments. Is there such a way to do this? Or am I just describing annuities/pension funds etc? If that's the case why don't any of these offer more than what we can achieve with the 4% rule?

[ixtap]

Well, to get the older and the younger to expect a 30 year retirement, you have to choose younger who expect to die relatively young. If there is a reason for them to expect that, they might be more likely to go through the funds for medical.

[RedmondStash]

Don't forget about inflation. The 4% rule is based in part on an expectation of 7% annual returns and 3% annual inflation, so 4% is what you can pull out each year and leave your principal essentially intact, with the same buying power (7 minus 3).

But you only get returns as high as 7% (on average) by taking greater risks than something like an annuity. If there's an annuity out there that gives you a guaranteed 7% return, that would be great, but I doubt there is.

The way I look at it is: high risk, high volatility = highest returns, averaged over periods of a decade or more. Low risk, low volatility = lower returns than will get me to my goals. So I'm going for the higher-risk -- or maybe just higher volatility -- option.

It just depends on how quickly you want to get where you're going, and how much volatility you can stomach.

[electriceagle]

Is there a way to do this? Perhaps I need to explain, but basically, you have an expected return on broadly invested stocks/bonds of 7-10% or so, however due to the possibility of a particularly bad run based entirely upon the year you choose to retire, we are prudent by only withdrawing 4%. While you are confident you wont run out of money, you are also expecting to have a good deal more money than you need. 

Simply stated, to insure against variability of returns, you end up saving almost twice as much as you need. Are the any products out there, almost an annuity in the sense to not only ensure you don't go bust, but allow you to pull out over 4% by spreading the risk around in a classic insurance sense?

Like home insurance, they only reason you have it is because life spans are finite, and the expected interval between losing your home is many many lifetimes. If you could live forever it would be far ore prudent to simply replace your home as it burned down, and save on the insurance.

Similarly here, the only reason we have a 4% rule, is because returns highly variable, and by nature of life, you can only pull the retirement trigger once. If you could have a hundred 30 year work-retirement cycles it wouldn't be an issue. Is there a way to get some sort of insurance to bridge the gap between expectation and variable reality?

If I retire this year (or any year), 4% for 30 years, I have a 95% chance of success, however I also *expect* to have almost twice my initial amount left over after 30 years. I like others here I'm sure hate leaving money on the table.

If however, I teamed up with 50 other people, some younger, some older, each with a million dollars and a 30 year retirement, all buying the same funds, but doing so for each of the sequential retirement years, now a 6% withdrawal rate with almost 100% success can be achieved. While 50% of individual years failed, individually isn't as important as the sum total of everyone.

This is really just another way to diversify, and basically allow you to rein in the tails of variability of your investments. Is there such a way to do this? Or am I just describing annuities/pension funds etc? If that's the case why don't any of these offer more than what we can achieve with the 4% rule?

You're all investing in total stock market and total bond market, so you all sink or swim together. You need interdimensional travel to worlds with multiple realities to achieve the kind of diversification that you are seeking.

[Eric]

Don't forget about inflation. The 4% rule is based in part on an expectation of 7% annual returns and 3% annual inflation, so 4% is what you can pull out each year and leave your principal essentially intact, with the same buying power (7 minus 3).

No part of the 4% rule is based on that.  The oft quoted 7% returns is already a real amount, so if you subtract inflation again, you're double counting it.  Not to mention that the 4% rule worked in times when inflation was way higher than 3%.  Just because 7-3 happens to equal 4 doesn't mean that it has anything to do with how the 4% rule was derived.  You should read the Updated Trinity Study to understand the methods of how 4% came about.

[rantk81]

Are the any products out there, almost an annuity in the sense to not only ensure you don't go bust, but allow you to pull out over 4% by spreading the risk around in a classic insurance sense?

Yeah I that is an annuity.  However, like market returns are never guaranteed, neither are annuities. The insurance company offering the annuity could go bankrupt.

[rantk81]

This got me thinking.... It would be an interesting exercise to compare the effective interest rates of current annuity offers with the dividend interest rates offered by a basket of insurance company stocks.

[maizefolk]

As others have said, the problem is that at any given point in time everyones FIRE outcomes are linked.

This is why it is easy to insure your home against fire (a small percentage of homes will burn down in a given year), but much more difficult to insure it against an earthquake (most years no homes are destroyed but if your house goes in an earthquake, hundreds of thousands or millions of houses will be lost at the same time), and impossible to buy effective insurance against world-ending asteroid strikes or nuclear war.

[SnackDog]

Your options -
1) Plan for 4% or less SWR and be safe.  If you have extra left over (95% probability if you manage to live 30 years), you give it away to charity or offspring.
2) Take higher than 4% withdrawals but have a backup plan if things go sour (go back to work, sell house, reduce spending, move in with relatives)
3) Annuitize.  This will let you take 6 or 7% but is not normally inflation-indexed so best to wait until age 70 or so to purchase.  Also better to wait because now interest rates are low so annuity returns are low.

[Seadog]

As others have said, the problem is that at any given point in time everyones FIRE outcomes are linked.

This is why it is easy to insure your home against fire (a small percentage of homes will burn down in a given year), but much more difficult to insure it against an earthquake (most years no homes are destroyed but if your house goes in an earthquake, hundreds of thousands or millions of houses will be lost at the same time), and impossible to buy effective insurance against world-ending asteroid strikes or nuclear war.

That's sort of exactly my point. Everyone's outcome is linked with regards to the *start date*, which unfortunately each person only gets one. At 4%, me, you and the next guy each have a 5% failure rate retiring this, next, and the year after, but each should expect to accumulate 7%, and end up with about double our 'stache after 30 years. By combining all three accounts, and successively pulling the trigger one starting this, next, and the year after, the extreme tails will get pulled in such that it's either a lower chance of failure to the point that once you have enough people that each year is represented, you approach a 7% safe withdraw rate, with 0% chance of failure (essentially mimicking the market).

What I'm suggesting is to diversify over many start dates. Presumably if everyone in the world invested all their money in the market as a FIRE exercise, your "share" of the profits would be the historical average return.

To quote your example, it would be more like an insurance company diversifying it's policies over many locations vs time. While many areas may be subject to burning down houses due to an abnormally dry summer nation wide, only some areas would be subject to earthquakes.