Author Topic: Help with 4% SWR rule  (Read 5848 times)

Rocketman

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Help with 4% SWR rule
« on: June 06, 2014, 08:20:51 PM »
I basically understand the 4% rule and I am trying to project retirement funds for the next 50 years in a spreadsheet - I am between 6 to 10 years away from FIRE.

I have made some simplifying assumptions to help me with my spreadsheet - I am trying to figure out the ramifications.

For my withdrawal amount I have multiplied 4% by the investment balance as of 1/1/20xx (Jan 1st of that year).

Thus if the market falls I will have to make due with a little less, or if the Market SCREAMS next year I can/will take out a bit more.

That is a bit different from the standard 4% SWR of 4% + inflation adjustment each year - always increasing each year.

Also, how do you plan on the Market Gain/Loss Rate - currently I am using 6% even - but the market is more like 2%, 10%, -10% 12% -2% ...

Thanks

Rocketman


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Re: Help with 4% SWR rule
« Reply #1 on: June 06, 2014, 09:13:45 PM »
The general idea is a 4% withdrawal rate will produce a fairly successful income stream for a long time without depleting the principal. You just have to be flexible as you pointed out here:

Thus if the market falls I will have to make due with a little less, or if the Market SCREAMS next year I can/will take out a bit more.

So the general idea is on average you can take out 4%, but if you have 3-4 bad years in a row this will kill your plans for the long-term so you will have to take out less if market returns dictate. The sequence of returns is extremely important. If the market tanks for 3 years immediately after you retire, it will hurt you a lot more than if it tanks for 4-5 years 15 years into your retirement.

Also, how do you plan on the Market Gain/Loss Rate - currently I am using 6% even - but the market is more like 2%, 10%, -10% 12% -2% ...

You don't. Average those numbers you quoted (12%/5=2.4%). That's either pessimistic, or a bad 5 year run, but the point is whatever your average anticipated market returns are should dictate your SWR after adjusting for inflation. The trinity study concluded 4% is a safe rule of thumb. Some people are more comfortable with 3%. Stick with one of them, and forget about the market dips unless they are really severe.

When you hit that -10% year, spend less and/or try to pick up a bit of income (you know, from a job, GASP) if necessary.

rmendpara

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Re: Help with 4% SWR rule
« Reply #2 on: June 06, 2014, 09:32:58 PM »
I basically understand the 4% rule and I am trying to project retirement funds for the next 50 years in a spreadsheet - I am between 6 to 10 years away from FIRE.

I have made some simplifying assumptions to help me with my spreadsheet - I am trying to figure out the ramifications.

For my withdrawal amount I have multiplied 4% by the investment balance as of 1/1/20xx (Jan 1st of that year).

Thus if the market falls I will have to make due with a little less, or if the Market SCREAMS next year I can/will take out a bit more.

That is a bit different from the standard 4% SWR of 4% + inflation adjustment each year - always increasing each year.

Also, how do you plan on the Market Gain/Loss Rate - currently I am using 6% even - but the market is more like 2%, 10%, -10% 12% -2% ...

Thanks

Rocketman

The 4% rule was based on backtested scenarios that includes all market gain/loss scenarios over the past several decades. Of course, the next 50 years may not work out the same as the last 50 years (in terms of market returns), but the idea is that it shouldn't be way different. Again, we are "managing" risk, not "eliminating" risk.

If you lower the SWR to 3-3.5%, you'll have a MUCH larger buffer and your funds should last forever. If you are retiring early, I would recommend using a slightly lower SWR than 4% (which is usually given as advice for "traditional" retirees at age 60+ based on a 20 year or so retirement... we may live much longer).

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warfreak2

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Re: Help with 4% SWR rule
« Reply #4 on: June 07, 2014, 04:29:02 AM »
Thus if the market falls I will have to make due with a little less, or if the Market SCREAMS next year I can/will take out a bit more.
The point is that you don't do this. You make the same withdrawal, adjusted for inflation, every year, whatever happened in the market. The Trinity study showed that if you invest in 75% stocks/25% bonds, this is 100% safe for 30 years (based on historical data).

Now, you could withdraw 4% of your balance every year, and actually this is guaranteed to be 100% "safe" forever! You will never go broke so long as your withdrawal is never 100% of your balance... you're even guaranteed to be 100% "safe" forever if you withdraw 50%, or 90% of your balance every year! The problem is, if your balance takes a hit, your withdrawal goes down and you might have to live on half of your usual expenses that year... risking a 50% pay cut is not "safe".

boarder42

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Re: Help with 4% SWR rule
« Reply #5 on: June 07, 2014, 05:18:36 AM »
http://www.cfiresim.com/input.php

use this to get comfy with it 4% SWR is only safe 72% of the time throughout history.   3% never fails and 3.5% is 95% successful i believe.  if i'm remembering the last time i ran it correctly

warfreak2

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Re: Help with 4% SWR rule
« Reply #6 on: June 07, 2014, 05:47:52 AM »
http://www.cfiresim.com/input.php

use this to get comfy with it 4% SWR is only safe 72% of the time throughout history.   3% never fails and 3.5% is 95% successful i believe.  if i'm remembering the last time i ran it correctly
If you use a 75% stocks/25% bonds allocation, over 30 years, and set the fees to 0% (the fee should be included when you make your 4% withdrawal) then the success rate is 106/113 or 93.8%. For 3.5% withdrawal, it's 112/113 or 99.1%.

boarder42

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Re: Help with 4% SWR rule
« Reply #7 on: June 07, 2014, 06:02:55 AM »
yes over 30 years ... OP stated 50 in original Post.  personally i run it at 80 b/c who knows how long i'll live... and i plan to be done mid to late 30s ... and if it lasts 80 it will probably last forever

i know you were running based on the trinity study.  but that doesnt apply to mustashians who retire very early and typically keep a larger stock to bond ratio than 75%

warfreak2

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Re: Help with 4% SWR rule
« Reply #8 on: June 07, 2014, 06:17:20 AM »
yes over 30 years ... OP stated 50 in original Post.
Oh, right.

Quote
i know you were running based on the trinity study.  but that doesnt apply to mustashians who retire very early and typically keep a larger stock to bond ratio than 75%
It may not apply based on the length of the withdrawal period, but you should choose the safest asset allocation (which, over 50 years, should be pretty close to the safest allocation over 30 years) and then determine the withdrawal rate based on the level of safety you are comfortable with. I.e. it should apply to your decision about what allocation to use. To be fair, the Trinity study didn't look at allocations between 100%/0% and 75%/25%, but it did find that 75%/25% is a lot safer than 100%/0%.

Ziggurat

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Re: Help with 4% SWR rule
« Reply #9 on: June 07, 2014, 09:35:38 AM »
..
Also, how do you plan on the Market Gain/Loss Rate - currently I am using 6% even - but the market is more like 2%, 10%, -10% 12% -2% ...


This just came into my inbox this morning: How to Estimate Stock and Bond Returns. It's a Canadian blog, but the examples they give are based on a portfolio of 1/3 Cdn, 1/3 US, 1/3 International, so I think it should be translatable to U.S. investors.  I quickly looked at the white paper and in that, they break down expected U.S. returns separately from Cdn.

Quote
There are two main approaches one can use when estimating future returns. The first is to rely on history ... The second approach uses valuation metrics to estimate future stock returns based on current market conditions. ... both methods are flawed. But as we argue in the white paper, it is likely that when one methodology overestimates expected returns, the other will underestimate it. Therefore, using a simple average of the two methodologies may produce a more accurate estimate, as the errors tend to offset one another.

They give some expected returns for different stock/bond mixes and include a standard deviation estimate.

George_PA

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Re: Help with 4% SWR rule
« Reply #10 on: June 07, 2014, 10:07:18 AM »
Also, how do you plan on the Market Gain/Loss Rate - currently I am using 6% even - but the market is more like 2%, 10%, -10% 12% -2% ...
Thanks

Rocketman

Based upon our known historical data, a 100% stock portfolio will return 11% over a long period of time. Given that inflation long term runs about 4%, the "real" rate of return is 7% (11% returns - 4% inflation). 

Thus, it is a bit complicated.   For my spreadsheet I have everything in today's dollar amounts (2014).  Thus, I use 7% future returns to know what the future amounts will be in terms of today's dollars.  As long as you factor all your living expenses and all other money amounts in your spreadsheet in today's dollars amounts as well, your spreadsheet will be as accurate as can be reasonable predicted.  This is because what is ultimately important in FI is your ratio of investment income to living expenses.

Alternatively in your spreadsheet, you could use 11% as your return but then you have to increase your living expenses by 4% each year as you project into the future.

source: http://www.mrmoneymustache.com/2011/06/06/dude-wheres-my-7-investment-return/