Author Topic: Follow up to "how do you know when you can increase your withdrawal rate"  (Read 620 times)

Ladychips

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Some months ago, I asked when one would know you could increase your withdrawal rate (thread here: https://forum.mrmoneymustache.com/ask-a-mustachian/when-do-you-know-you-can-adjust-your-withdrawal-rate

@maizeman responded on that thread :"If you're interesting in optional/discretionary spending, the simulations I've run* suggest that once your withdrawals are down to 3.2% of your portfolio you can spend 3-3.2% of your current balance each year, as long as you're willing to cut your spending back to the original level when and if the market drops."

Would you be willing to expand on that?  If they are 3.2% at any point or after a set amount of time?  And when you say 'original level' is that the original 4% from the beginning or something else?

Also, the other day I read on the bogleheads forum a poster who said "I have noticed that when running simulations of the times that the 4% rule failed, or came close to failing, you can tell within the first 5-10 years. If the portfolio balance in years 5-10 is equal to or lower than the starting balance, then you have to be cautious and reduce expenses or take steps to add money/income (get a job, downsize the home to replenish the portfolio, annuitize the bond portion, etc). From https://www.bogleheads.org/forum/viewtopic.php?t=241773

We all know the part about the first 5-10 years.  But I'm curious to hear your thoughts on the bolded part of the post. 

maizefolk

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That is confusingly worded isn't it? Sorry about that.

So let's start with the 4% rule. You have 25x your annual expenses saved up. The first year you withdraw 4% of your portfolio (25 years expenses * 0.04 = 1 year's expenses). The next year, regardless of how much your portfolio grew or shrank, you withdraw the same amount (adjusted for inflation) and so on. The vast majority of the time you never run out of money.

The first question a lot of people ask is whether they could just spend 4% of their current portfolio balance every year. The answer is yes that's completely safe, you just have to be willing to cut expenses dramatically when the market drops 50% and 4% of your current portfolio balance is a much smaller number. Often people don't like that so they ask a second question:

Since it is safe to retire with 25x expenses, can I just "reset" my withdrawal rate each year the market rises so that I spend either the same amount of as I did last year (adjusted for inflation) OR 4% of my current net worth, whichever is greater. The answer to this is no, it increases the risk of a retirement failure (running out of money before you die) significantly. If you do this you're essentially filtering through all the possible start dates for a retirement until you find one that will result in failure.

However, in most scenarios your portfolio will grow significantly more than 4% per year so your net worth will increase and your withdrawals will decrease as a percentage of your total net worth. In the simulations I've run, once your annual spending is down to 3.2% of your current portfolio, it is okay to spend up to 3.2% of your current portfolio each year while still treating your original annual spending (4% at year 0 adjusted for inflation each year) as a floor if/when portfolio declines in value. Doing this doesn't seem to have a noticeable impact on the risk of running out of money before death.

Ladychips

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@maizeman ...So...I totally get what you are saying about not resetting the 4% every year.  That makes sense to me.  But are you saying you COULD reset to 3.2% every year?  I think you are...

Also, do you have any thoughts on the post on Bogleheads?  I'd really enjoy hearing them...

maizefolk

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I haven't tried resetting/locking in the greater of 3.2% or 3.2% last year adjusted for inflation.

My guess is that the numbers might work our, but the only scenario I actually ran was starting at 4% and then either spending that 4% adjusted for inflation each year or 3.2% of current year net worth, whichever was greater.

Resetting your baseline/floor to 3.2% each year* is conceptually a bit more risky, because you risk locking in a too-high withdrawal rate in bubbles like 2000 (or 1929) where the stock market temporary shoots up in value a lot and then drops back to something more normal.

It depends on what your end goal is. For me it was figuring out when I could safely start deploying "fun money" for either temporary experiences or charitable giving without risking my own long term solvency. If a person were instead making decisions like when they could afford to move to a higher cost of living area (something where they are not just spending money once but locking in a higher base line expense rate for the long term), then it probably makes sense to simulate with different parameters.

I skimmed the bogleheads thread a little but not in depth. Yes it is certainly true that using a regular 4% withdrawal rate, failures or close calls are almost always obvious in the first 5-10 years. If nothing bad happens to you by then, the long term CGAR of the stock market (6.8%) has almost certainly grown your wealth to a point where you're spending well less than 3%/year and it would take an event outside the range of the US historical record for you to even come close to running out of money.

Living in a country that loses a world war/experiences a civil war is a good example of the type of event that is outside the range of the US historical investment return record and which is a recipe for a bad time regardless of your withdrawal rate (or for that matter regardless of whether you are FIREd or working).

*I think I've heard some people call this the retire and retire again strategy.

secondcor521

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*I think I've heard some people call this the retire and retire again strategy.

It was initially called the POPR method:

https://retireearlyhomepage.com/popr.html

FireLane

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I skimmed the bogleheads thread a little but not in depth. Yes it is certainly true that using a regular 4% withdrawal rate, failures or close calls are almost always obvious in the first 5-10 years. If nothing bad happens to you by then, the long term CGAR of the stock market (6.8%) has almost certainly grown your wealth to a point where you're spending well less than 3%/year and it would take an event outside the range of the US historical record for you to even come close to running out of money.

Thanks for this analysis! The strategy of treating a 3.2% WR as a floor sounds like a good one. I'm bookmarking this thread to refer back to.

JGS1980

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@Ladychips, how about Variable Percentage Withdrawal?

https://www.bogleheads.org/forum/viewtopic.php?f=10&t=120430&p=1761580#p1761563

https://www.bogleheads.org/wiki/Variable_percentage_withdrawal

The way I see it, if your stick to a VPW model, it will be mathematically impossible to run out of money, but will allow for "fun money" spending above your baseline when the market has been generous. When the market is down, VPW does what many folks would do naturally anyway -> it tells you to spend less money until the market recovers.

Also, I'd add that this allows you to enjoy your money while still relatively young. I personally don't really expect to be living the high life at age 87, you know? Note the recommendation for SPIA for "floor spending" at age 80.