Author Topic: Adjustments to the 4% safe withdrawal rate  (Read 2042 times)

centwise

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Adjustments to the 4% safe withdrawal rate
« on: November 25, 2019, 09:17:31 AM »
Hi all,

I'm a believer in the 4% rule, having read some of the original studies long ago, along with the excellent MMM articles. But I haven't thought in depth about the finer nuances, the way many of you have. I would love to have your comments on the scenario below.

Suppose I were to retire (not particularly early, say at least age 60 ish) and start taking out 4% of my stash, to be followed by an annual inflation adjustment. I assume that I am unlikely to run out of money before age 95.

Now suppose a really good investment year comes along, during which my stash increases by an amount much greater than the inflation rate. Could I "reset" my retirement, and say: "OK! I declare this year to be my new retirement year!" ... and start over with 4% of the new amount?

For example: I retire with $1 million. First year I take out $40k. The next year there is 3% inflation so I should increase my withdrawal by 3% to $41,200. BUT my stash is now at $1.1 million. So I "restart" my retirement at 4% of the new amount and withdraw $44,000 instead... to be adjusted annually by the inflation rate.

Is there something wrong with this logic? I would be ratcheting up my withdrawals during "great years" but not adjusting downward during bad years (unless inflation is negative). Is this a recipe for trouble? Thanks in advance for your insights. Sorry if this has been addressed before; if it has, a link would be great.

Edit: on the other hand, if I had chosen Year 2 as my retirement year in the first place, I wouldn't even worry about it. I would simply start with 4% of $1.1M and assume that everything would be fine from there. So... would this work?
« Last Edit: November 25, 2019, 09:34:12 AM by centwise »

RWD

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Re: Adjustments to the 4% safe withdrawal rate
« Reply #1 on: November 25, 2019, 10:08:25 AM »
Is there something wrong with this logic? I would be ratcheting up my withdrawals during "great years" but not adjusting downward during bad years (unless inflation is negative). Is this a recipe for trouble? Thanks in advance for your insights. Sorry if this has been addressed before; if it has, a link would be great.

Yes, the 4% rule assumes you only increase your spending with inflation. That way the good years build a buffer for the bad years. If you keep ratcheting it up then when a crash/recession comes you may run out of money. You would be effectively changing your starting year until you found one right before a crash, which would be the worst time to start.

But you have hit on one of the weird parts of the 4% rules. Not all starting years are equal. But we won't know what was too safe vs too risky until it is already in the past.

RWD

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Re: Adjustments to the 4% safe withdrawal rate
« Reply #2 on: November 25, 2019, 10:16:57 AM »
I meant to leave you this link as well. There has been a metric ton of discussion on the 4% rule:
https://forum.mrmoneymustache.com/investor-alley/stop-worrying-about-the-4-rule/

Boofinator

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Re: Adjustments to the 4% safe withdrawal rate
« Reply #3 on: November 25, 2019, 10:21:25 AM »
The 4% rule relies on a past success rate in the U.S. of something like 95%. So if you keep ratcheting up to 4% withdrawal rate every year, the odds are at some point you are going to land on the 5% of failures and then proceed to watch your stash continually diminish over the following 30-year span of time.

If you want to use the strategy of ratcheting up in the good years with a similar probability of success as the traditional 4% rule, you'll want to pick a withdrawal rate that has historically had a 100% success rate. Running simulations on cFIREsim.com, it seems like a 3.5% withdrawal rate would allow for the strategy you're suggesting without (historically) having to worry about running out of money.

Malcat

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Re: Adjustments to the 4% safe withdrawal rate
« Reply #4 on: November 25, 2019, 10:54:34 AM »
Well, sure, you can do that, but then it's not following the 4% rule. 

If you want to spend more when up and less when down, then take a look at some variable WR simulations.

That said, it's always important to keep in mind that no simulation actually represents reality, so they're all more guidelines than anything.

centwise

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Re: Adjustments to the 4% safe withdrawal rate
« Reply #5 on: November 26, 2019, 07:43:39 AM »
Is there something wrong with this logic?

Yes, the 4% rule assumes you only increase your spending with inflation. That way the good years build a buffer for the bad years. If you keep ratcheting it up then when a crash/recession comes you may run out of money. You would be effectively changing your starting year until you found one right before a crash, which would be the worst time to start.



The 4% rule relies on a past success rate in the U.S. of something like 95%. So if you keep ratcheting up to 4% withdrawal rate every year, the odds are at some point you are going to land on the 5% of failures and then proceed to watch your stash continually diminish over the following 30-year span of time.


Thank you so much! -- this is the exact bit of logic that I was missing! Thanks also for the link to all the many useful discussions about the 4% rule and variations thereof. I will definitely follow some type of variable withdrawal rate when the time comes.

Fortunately, I have a pension so I won't have to rely entirely on my stash, therefore it should be very easy for me to dial back on the spending during lean years.

secondcor521

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Re: Adjustments to the 4% safe withdrawal rate
« Reply #6 on: November 26, 2019, 12:13:32 PM »
If one is using a <100% safe WR (*), then it is a bit like playing Russian roulette over and over again - eventually the odds will be bad for you.

If one is using a 100% safe WR (*), then it is a way to increase spending and decrease ending portfolio value.

Here is an old article on the subject:

https://retireearlyhomepage.com/popr.html

I think it's also called the "retire again and again" model; googling that term might yield relevant comments.

(*) Adopting the premise that the future will not be worse than the worst in the past, which is a separate discussion.

wellactually

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Re: Adjustments to the 4% safe withdrawal rate
« Reply #7 on: November 26, 2019, 01:08:26 PM »
I fundraise for an endowment and we basically operate a revolving version of the 4% rule for distributions. We take an average of the past three years' balances and allow a distribution of up to 4% of that amount. Some endowment distribution policies are more modest and give a 3% cap.

Anyway, this works because the endowment is supplemental to additional annual budgeted funds available for our project, so down periods are disappointing but won't ruin us. The three year average helps to mitigate the effects of a single good or bad year end. Basing calculations on a new number each year means the safe distribution fluctuates, but it also makes sense in this situation because we are still actively fundraising principle.

I'm sure if one wanted, an averaged calculation could mitigate effects of starting in what ended up being a high year (even some kind of average of market performance from past 3 years to create a multiplier number). But you can't adjust up if you won't adjust down.

mistymoney

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Re: Adjustments to the 4% safe withdrawal rate
« Reply #8 on: November 28, 2019, 10:26:00 AM »
Is there something wrong with this logic? I would be ratcheting up my withdrawals during "great years" but not adjusting downward during bad years (unless inflation is negative). Is this a recipe for trouble? Thanks in advance for your insights. Sorry if this has been addressed before; if it has, a link would be great.

Yes, the 4% rule assumes you only increase your spending with inflation. That way the good years build a buffer for the bad years. If you keep ratcheting it up then when a crash/recession comes you may run out of money. You would be effectively changing your starting year until you found one right before a crash, which would be the worst time to start.

But you have hit on one of the weird parts of the 4% rules. Not all starting years are equal. But we won't know what was too safe vs too risky until it is already in the past.

hmmm - I always thought is was 4% of what you had in the kitty each year - not that you did your own adjustments at 3% from the starting point - makes it a lot more calculating!

mistymoney

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Re: Adjustments to the 4% safe withdrawal rate
« Reply #9 on: November 28, 2019, 10:30:57 AM »
I fundraise for an endowment and we basically operate a revolving version of the 4% rule for distributions. We take an average of the past three years' balances and allow a distribution of up to 4% of that amount. Some endowment distribution policies are more modest and give a 3% cap.

Anyway, this works because the endowment is supplemental to additional annual budgeted funds available for our project, so down periods are disappointing but won't ruin us. The three year average helps to mitigate the effects of a single good or bad year end. Basing calculations on a new number each year means the safe distribution fluctuates, but it also makes sense in this situation because we are still actively fundraising principle.

I'm sure if one wanted, an averaged calculation could mitigate effects of starting in what ended up being a high year (even some kind of average of market performance from past 3 years to create a multiplier number). But you can't adjust up if you won't adjust down.

Yes - I had thought that if you just do 4% on whatever - that your draw would go down in a bad market, and then that would work out in the end.

so if you take 40k on 1m, and next year it is 875k, then you would take 35k.....and that is how it would work out long term.

RWD

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Re: Adjustments to the 4% safe withdrawal rate
« Reply #10 on: November 28, 2019, 10:35:58 AM »
Is there something wrong with this logic? I would be ratcheting up my withdrawals during "great years" but not adjusting downward during bad years (unless inflation is negative). Is this a recipe for trouble? Thanks in advance for your insights. Sorry if this has been addressed before; if it has, a link would be great.

Yes, the 4% rule assumes you only increase your spending with inflation. That way the good years build a buffer for the bad years. If you keep ratcheting it up then when a crash/recession comes you may run out of money. You would be effectively changing your starting year until you found one right before a crash, which would be the worst time to start.

But you have hit on one of the weird parts of the 4% rules. Not all starting years are equal. But we won't know what was too safe vs too risky until it is already in the past.

hmmm - I always thought is was 4% of what you had in the kitty each year - not that you did your own adjustments at 3% from the starting point - makes it a lot more calculating!
so if you take 40k on 1m, and next year it is 875k, then you would take 35k.....and that is how it would work out long term.

4% of current stash each year will often result in years where you can't meet your expenses. Sure it's fine if the market only drops ~15% but if it drops 40% then you'll either not be able to sustain 4% of current stash while still paying the bills or it means you had a ton of fat in your budget. In addition, if you are ratcheting it up then that means your stash won't grow as much so when there is a big drop there will be less to draw from in the low years.

In theory you spend the same amount each year (plus inflation) but in practice you'll have some years where you spend more and some where you spend less so it isn't an exact science.

pecunia

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Re: Adjustments to the 4% safe withdrawal rate
« Reply #11 on: November 28, 2019, 10:54:26 AM »
I've read if you are over 60, since the money need not last as long, a 5 percent withdrawal rate may be considered.

Malcat

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Re: Adjustments to the 4% safe withdrawal rate
« Reply #12 on: November 28, 2019, 11:41:41 AM »
I've read if you are over 60, since the money need not last as long, a 5 percent withdrawal rate may be considered.

It all depends on individual factors and risk tolerance.

Malcat

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Re: Adjustments to the 4% safe withdrawal rate
« Reply #13 on: November 28, 2019, 11:42:26 AM »
I fundraise for an endowment and we basically operate a revolving version of the 4% rule for distributions. We take an average of the past three years' balances and allow a distribution of up to 4% of that amount. Some endowment distribution policies are more modest and give a 3% cap.

Anyway, this works because the endowment is supplemental to additional annual budgeted funds available for our project, so down periods are disappointing but won't ruin us. The three year average helps to mitigate the effects of a single good or bad year end. Basing calculations on a new number each year means the safe distribution fluctuates, but it also makes sense in this situation because we are still actively fundraising principle.

I'm sure if one wanted, an averaged calculation could mitigate effects of starting in what ended up being a high year (even some kind of average of market performance from past 3 years to create a multiplier number). But you can't adjust up if you won't adjust down.

Yes - I had thought that if you just do 4% on whatever - that your draw would go down in a bad market, and then that would work out in the end.

so if you take 40k on 1m, and next year it is 875k, then you would take 35k.....and that is how it would work out long term.

That's a reasonable model, but it's not at all what the 4% rule is.

Buffaloski Boris

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Re: Adjustments to the 4% safe withdrawal rate
« Reply #14 on: November 28, 2019, 05:42:53 PM »
Iím not a believer in the 4% rule. Itís a rule of thumb at best. For folks retiring in their 30s and 40s I think itís too optimistic. For older folks in their 60s itís perhaps too pessimistic. Everyone is different. In the end, this is a Sequence of Return Risk issue. The best stuff Iíve seen on SoRR hands-down is at the Early Retirement Now website. Iíd go through the series there before making any decisions.

RWD

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Re: Adjustments to the 4% safe withdrawal rate
« Reply #15 on: November 28, 2019, 07:38:22 PM »
Iím not a believer in the 4% rule. Itís a rule of thumb at best. For folks retiring in their 30s and 40s I think itís too optimistic. For older folks in their 60s itís perhaps too pessimistic. Everyone is different. In the end, this is a Sequence of Return Risk issue. The best stuff Iíve seen on SoRR hands-down is at the Early Retirement Now website. Iíd go through the series there before making any decisions.

Well technically the 4% rule in the Trinity Study was specifically investigating 30 year time frames. So it obviously needs custom adjustment for anyone looking at more or less years than 30 (see cFIREsim).

maizefolk

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Re: Adjustments to the 4% safe withdrawal rate
« Reply #16 on: November 28, 2019, 07:44:02 PM »
so if you take 40k on 1m, and next year it is 875k, then you would take 35k.....and that is how it would work out long term.

If you do that you will absolutely, positively, never run out of money. As others have said, in a really bad recession you may have to cut your spending by 50% or more. But your total balance with never go to zero.

If you're able to sustain the lifestyle you want while accepting that level of volatility of spending from year to year, spending 4% of your current balance each year is a lot safer than the spending plan proposed by the 4% rule.

Malcat

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Re: Adjustments to the 4% safe withdrawal rate
« Reply #17 on: November 28, 2019, 07:46:23 PM »
so if you take 40k on 1m, and next year it is 875k, then you would take 35k.....and that is how it would work out long term.

If you do that you will absolutely, positively, never run out of money. As others have said, in a really bad recession you may have to cut your spending by 50% or more. But your total balance with never go to zero.

If you're able to sustain the lifestyle you want while accepting that level of volatility of spending from year to year, spending 4% of your current balance each year is a lot safer than the spending plan proposed by the 4% rule.

Yes, which is why a variable WR is important to look at, but it is absolutely NOT the 4% rule.

jojoguy

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Re: Adjustments to the 4% safe withdrawal rate
« Reply #18 on: November 29, 2019, 06:41:15 AM »
I like to read threads like this. Even though our 4% safe withdrawal rate will be when we hit the 500K at the basic necessity level(our yearly expenses right now), our comfortable level is 750K-850K for that nice extra buffer zone. Perhaps we are being too cautious, but it wouldn't hurt us to work a couple of more years in our current jobs to reach our desired level. We still have a while to reach 500K though.

norajean

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Re: Adjustments to the 4% safe withdrawal rate
« Reply #19 on: November 29, 2019, 07:06:19 AM »
It goes without saying that the more you spend the higher your chance of running out of money.  In reality, people don't keep spending into oblivion but cut back their spending when they see their nest egg vanishing. 

Many people also spend more in their early retirement years than at the end, unless late life health care or long term care bills mount.  Once you are age 75 or so you typically no longer need to buy crap and travel as much as you once did.  House is paid for, etc.  So, spending more than 4% the first ten years may be ok and is recommended by some.

If the market craps out in the early years, you will be in trouble no matter where you started your 4%, and will need to cut back.  The important thing is to be able to cut back (have plenty of discretionary spending in that 4% figure), be able to go back to work, or find other ways to make ends meet.

This is all about withdrawal strategies, which is very different from how much is needed to stop accumulating.  Most people who are frugal and like saving have a tough time spending down their nest egg.

mistymoney

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Re: Adjustments to the 4% safe withdrawal rate
« Reply #20 on: November 29, 2019, 07:44:56 AM »
Is there something wrong with this logic? I would be ratcheting up my withdrawals during "great years" but not adjusting downward during bad years (unless inflation is negative). Is this a recipe for trouble? Thanks in advance for your insights. Sorry if this has been addressed before; if it has, a link would be great.

Yes, the 4% rule assumes you only increase your spending with inflation. That way the good years build a buffer for the bad years. If you keep ratcheting it up then when a crash/recession comes you may run out of money. You would be effectively changing your starting year until you found one right before a crash, which would be the worst time to start.

But you have hit on one of the weird parts of the 4% rules. Not all starting years are equal. But we won't know what was too safe vs too risky until it is already in the past.

hmmm - I always thought is was 4% of what you had in the kitty each year - not that you did your own adjustments at 3% from the starting point - makes it a lot more calculating!
so if you take 40k on 1m, and next year it is 875k, then you would take 35k.....and that is how it would work out long term.

4% of current stash each year will often result in years where you can't meet your expenses. Sure it's fine if the market only drops ~15% but if it drops 40% then you'll either not be able to sustain 4% of current stash while still paying the bills or it means you had a ton of fat in your budget. In addition, if you are ratcheting it up then that means your stash won't grow as much so when there is a big drop there will be less to draw from in the low years.

In theory you spend the same amount each year (plus inflation) but in practice you'll have some years where you spend more and some where you spend less so it isn't an exact science.

yes - the 40% drop would be difficult - nearly halving the draw. But regardless, I would try to cut back to bone in that scenario! As would most I think. But you're right that making the bills on the regular is important.

Something to think about more! Especially if that is the underlying method for all the simulations!