Author Topic: Challenge to the 4% rule  (Read 2573 times)

Running_the_jewels

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Challenge to the 4% rule
« on: September 23, 2015, 09:44:31 AM »
http://www.fa-mag.com/news/new-research-challenges-4-withdrawal-rule-8674.html

The financial adviser magazine wrote about some new research that suggests a more appropriate withdrawal rate of under 2%!  Unsurprisingly, a portion of that was to take care of the 1-2% fees that an adviser should charge, but some of the other data was interesting.  Anyone have solid arguments against the analysis made in the article?

Dalmuti

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Re: Challenge to the 4% rule
« Reply #1 on: September 23, 2015, 11:09:16 AM »
I think you linked the wrong article, since the one you linked is from 2011 and mostly suggests withdrawal rates higher than 4%.

I saw the article I think you were referring to, and its link is below.

http://www.fa-mag.com/news/why-4--could-fail-22881.html?section=47

In response to your question, I think you correctly point out that the inclusion of management fees is kind of silly.  Since each person's management fees may vary, I would say that rather than trying to include an "average" it's better if people just lump their management fees in as an expense so if you have 2% fees you can only withdraw 2% while if you are fully in VTSAX, you can withdraw 3.95%.  I also don't think the arguments about current market conditions are very good.  They make arguments for why returns in the immediate future may not be good, but the whole point of using Monte Carlo analysis and such is that we don't know what is coming in the future.  The 4% rule works for the worst retirement dates in US history, so the only way it doesn't work for current retirees is if this year is a worse year to retire than the worst in US history.  That is possible of course, but they certainly don't prove it (or even really try to argue it). 

The best argument they make (and the one that does make me nervous) is that the 145 years of US history is too short to use for this and is an outlier compared to global results.  If I use a 4% withdrawal rate, I'm betting that the next 30 years will be as good as the last 145 have been for the US (assuming I'm investing in US markets), rather than being like the last 145 have been for Japan or France.  I do think that early retirees have a big advantage because of how much of the risk of a 4% withdrawal rate is sequence of return risk.  If you are a 40-year-old retiree and get a bad early sequence of returns, you can go back to work or make other large changes to the plan more easily than a 70-year-old retiree who probably needs his SWR to pan out to avoid poverty.


Running_the_jewels

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Re: Challenge to the 4% rule
« Reply #2 on: September 23, 2015, 12:13:13 PM »
Thanks, and you were correct that I linked the wrong article - I had read it earlier and assumed my google search surfaced the correct one.  Your analysis makes sense - one of the most interesting things was the comparison of various countries and whether the 4% rule would work in those locations - US has had a better run than most countries.

nereo

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Re: Challenge to the 4% rule
« Reply #3 on: September 23, 2015, 12:22:30 PM »
... how about we look at the forest instead of all the trees?

If one were to use a 2% withdraw rate (let's say $30,000/year on $1.5MM) he/she would be able to withdraw the same amount of 50 years if the portfolio does nothing more than match inflation (i.e. 0% real growth).  Even at -1% real growth (about what you'd get putting all $1.5MM into today's dismal savings accounts) it would still last you 41 years.

Essentially, using a 2% WR you are betting that real-adjusted returns will be 0 (or worse) for decades.

a 2% withdraw rate seems pretty stupid, doesn't it?

Dalmuti

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Re: Challenge to the 4% rule
« Reply #4 on: September 28, 2015, 04:01:44 PM »
... how about we look at the forest instead of all the trees?

If one were to use a 2% withdraw rate (let's say $30,000/year on $1.5MM) he/she would be able to withdraw the same amount of 50 years if the portfolio does nothing more than match inflation (i.e. 0% real growth).  Even at -1% real growth (about what you'd get putting all $1.5MM into today's dismal savings accounts) it would still last you 41 years.

Essentially, using a 2% WR you are betting that real-adjusted returns will be 0 (or worse) for decades.

a 2% withdraw rate seems pretty stupid, doesn't it?

Your argument makes sense, but it oversimplifies the situation by ignoring sequence of returns risk.  The problem with arguments like this is that whether someone runs out of money or not isn't purely determined by their starting money, spending, and average real growth.  The order that the individual returns come in matters, not just the average.  Every investment with real growth on average also has years with losses and those portfolio losses hurt much worse in the early years after your retirement.  For instance, if you withdraw at 2.5%, your money lasts 40 years if you get 0% real growth every year.  If instead you lose 60% of your portfolio in the first year and then have 5% real growth for every year after that, you have around a 1% annualized real growth rate for a 28 year period, so you might think your money would last longer than 40 years.  But in fact, this sequence of returns will leave you penniless at the end of those 28 years.  The high returns in the successive years of retirement aren't enough to make up for the one terrible loss.  In case you think that by using the first year, I'm just reducing the starting investment, you do just as poorly if the drop is in the 3rd year if it is a 65% loss with all other years getting 5%.   

Of course, big drops in the US stock market have typically been followed by spectacular rebounds, so you won't find a year in US history where someone would have lost 60% of their investment in a single year (at least not if they are diversified).  But the authors of this paper make the point that in other countries, the rebound hasn't always been a given, so it may be worthwhile to consider how your withdrawal rate would have fared in other countries (countries that haven't been on a spectacular rise to become a superpower over the last century).  Even if someone thinks that they can avoid this risk by not investing in stocks, there have been other countries where runaway inflation would cause you to have a 60% real loss even if you were in "safe" investments like CDs.  I'm not saying that these scenarios are likely for the US, but they are certainly possible, so I don't think a 2% withdrawal rate sounds stupid.

I'm not saying everyone (or even most people) should use a rate this low, but you do reduce your risk of outliving your money by reducing your withdrawal rate.  Whether the risk reduction is worth the cost is a decision for each person to make themselves.  I will probably still target a higher rate like 3.5%, but I do that knowing that if I have catastrophic losses early in my retirement, I may need to greatly reduce spending or return to work.         

Tyler

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Re: Challenge to the 4% rule
« Reply #5 on: September 28, 2015, 05:15:34 PM »
The first thing that makes me hesitate is that the study uses a Monte Carlo simulation based on a prediction of future returns using valuation models.  While I'm sure it's well-reasoned (Mr. Pfau is a very smart guy and highly respected), the output is only as good as the assumptions going in and I don't believe anyone can predict the future. 

The second issue I have is that investing is much more sophisticated and interesting than simple stock and bond funds that make for easy analysis, and the specific funds you choose affect the results.  Your personal portfolio probably doesn't look or behave exactly like the one studied.  You can read more about that here: http://forum.mrmoneymustache.com/investor-alley/asset-allocation-and-safe-withdrawal-rates/
« Last Edit: September 28, 2015, 05:24:14 PM by Tyler »