Author Topic: Safe Withdrawal Rate for Australians  (Read 8740 times)

deborah

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Safe Withdrawal Rate for Australians
« on: February 09, 2016, 12:52:51 PM »
A week ago, Morningstar evidently put out this report http://www.morningstar.com.au/smsf/article/withdrawal-rates/7529/1 about safe withdrawal rates in Australia. Their conclusion (on looking at the past 100 years of Australian data) is that 2.5% is a safe withdrawal rate, even though we have had one of the best share market returns in the world over this time.

One of the reasons for it being much lower than 4% is that they include management fees, whereas other studies don't. As a result, I think this is worth reading by people who live in other countries, as well as Australians.

They also talk about longevity risk (although in little depth), and produce a graph of safe withdrawal rates for different retirement periods. Most of the studies are based upon 30 years of retirement, and certainly in Australia, even since the main studies have been produced, our longevity has increased substantially, so this value is not necessarily as reasonable as it might have been for the normal retiree 20 years ago.

maizefolk

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Re: Safe Withdrawal Rate for Australians
« Reply #1 on: February 09, 2016, 06:18:50 PM »
Interesting article. I had a couple of questions based on your post that lead me to dig into the article itself and I'm posting the answers here as I assume they may be of interest to others as well:

The math was done based on a 50/50 stocks bonds portfolio for each country. <-- to me this seems far too heavily weighted to bonds when investing for the super long term (four decades or more). The average inflation adjusted return from bonds across the 20 countries they looked at was 2.36% while for the stock markets in the same countries over the same period the average inflation adjusted return was 7.26%.

The assumed portfolio fee was 1% of assets annually. <-- this is a brutally high expense ratio and explains a lot of the pessimistic results of the article right off the bat.


deborah

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Re: Safe Withdrawal Rate for Australians
« Reply #2 on: February 09, 2016, 06:23:51 PM »
However, the original safe withdrawal rate studies were 50/50, so I thought the methodology (while in the current climate) quite heavily weighted, is what has been traditionally considered quite reasonable.

Unfortunately the expense ratios are not that unreasonable for Australia, where we dream of the US Vanguard MERs.

maizefolk

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Re: Safe Withdrawal Rate for Australians
« Reply #3 on: February 09, 2016, 06:40:47 PM »
Hmm. I thought the original trinity study looked at 100% bonds, 75/25% bonds/stocks, 50/50, 25/75, and 100% stocks. Maybe I was looking at a later follow up to the original study? Anyway, yes, apologies if my original post made it sound like I thought the 50/50 split was in bad faith on the part of the author. It's a perfectly defensible strategy, my point was that they could probably get their SWR higher across the various countries with a higher stock allocation.

Condolences on those expense ratios.

Eucalyptus

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Re: Safe Withdrawal Rate for Australians
« Reply #4 on: February 09, 2016, 07:28:40 PM »

Unfortunately the expense ratios are not that unreasonable for Australia, where we dream of the US Vanguard MERs.

But still nowhere near as high as 1%. For example, with my ten-fund etf portfolio (not yet fully implemented, but that's my plan) (very diversified like Merrimen), the weighted average MER is 0.20%. It would be less if I didn't have stuff in there like VGE (emerging markets), VAE (Asia ex Japan), VSO (Aus small cap). The MERs of ETFs of the ASX 300 (VAS) is 0.15, Aus bonds VGB) 0.20%.

The problem with compounding is its hard to extrapolate from their study now based on your MER difference... its not as simple as just adding back in the 0.825% difference in their management fee vs 50/50 VAS/VGB. Its more than that.


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Re: Safe Withdrawal Rate for Australians
« Reply #5 on: February 09, 2016, 08:45:32 PM »
Thanks for posting this article deborah. We don't intend to just rely on the SWR (defined benefit pensions for both of us), we will be drawing down on the capital. But I have still been very interested in the SWR and its applicability to Australia.

steveo

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Re: Safe Withdrawal Rate for Australians
« Reply #6 on: February 10, 2016, 12:29:13 AM »
I'm definitely not going below 4% unless I get a job that pays a fortune and I just can't quit because of how much I'm earning. I also can't see how 4% isn't safe when we have a dividend payout that is about 5% on average excluding tax imputation credits.

Thanks for the article though. I'm going to read through it in some more detail.

povertystrickenbastard

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Re: Safe Withdrawal Rate for Australians
« Reply #7 on: February 10, 2016, 01:20:55 AM »
Dividends on the ASX are over 7% with franking credits included.  I don't plan on having any withdrawal rate, except for what I'm forced to by my super once its in pension mode.

steveo

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Re: Safe Withdrawal Rate for Australians
« Reply #8 on: February 10, 2016, 02:08:56 AM »
Dividends on the ASX are over 7% with franking credits included.  I don't plan on having any withdrawal rate, except for what I'm forced to by my super once its in pension mode.

I think spending dividends has to be considered withdrawing however I get your point. If you are just using dividends you'd think you would be pretty safe.

The problem in my opinion is that its so tempting to put all your assets in the ASX and therefore you aren't as diversified.

dmn

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Re: Safe Withdrawal Rate for Australians
« Reply #9 on: February 10, 2016, 02:30:48 AM »
Spending dividends is withdrawing money from equities. The 4% SWR tells you that it is not safe to spend all the dividends if yields are above 4%.

A dividend yield of 7% can indicate that companies are paying out more money than they can make consistently so that dividends will either be cut or at least not increase with inflation.

For that reason, at such high dividend yields, you may need to reinvest some of the annual dividend to keep a constant dividend-adjusted income.

chasingthegoodlife

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Re: Safe Withdrawal Rate for Australians
« Reply #10 on: February 12, 2016, 02:53:31 PM »
Thanks for posting Deborah.

Agree with dmn that I'd think of dividends as 'withdrawing' for the purpose of SWR - historical share market return figures are generally based on reinvestment of dividends.

There may be tax advantages to spending only dividends and not selling off capital, but still at times you may need to reinvest a portion of dividends to ensure the value of your capital is not eroded by inflation? Not an expert here! But that's my take on it.

steveo

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Re: Safe Withdrawal Rate for Australians
« Reply #11 on: February 12, 2016, 03:54:53 PM »
Spending dividends is withdrawing money from equities. The 4% SWR tells you that it is not safe to spend all the dividends if yields are above 4%.

A dividend yield of 7% can indicate that companies are paying out more money than they can make consistently so that dividends will either be cut or at least not increase with inflation.

For that reason, at such high dividend yields, you may need to reinvest some of the annual dividend to keep a constant dividend-adjusted income.

I understand that simplistically you are correct however you aren't understanding the whole situation in Australia. The current dividend payout is about 5% in Australia. There are also tax benefits where you basically get given a tax rebate on the amount of tax the company pays which takes it up to about 7%.

On top of that the Australian stock market has grown over time even with such high dividend payouts.

brainfart

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Re: Safe Withdrawal Rate for Australians
« Reply #12 on: February 12, 2016, 09:23:34 PM »
Do you guys have such a huge home bias that you only invest in your home country (like many of the Americans on this board)? I hope not!
I might be wrong, but isn't the SWR for a global investor the same regardless of where s/he lives, before taxes?

> my ten-fund etf portfolio

That sounds like quite the nightmare to rebalance. You can cover the whole planet with much less funds.

deborah

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Re: Safe Withdrawal Rate for Australians
« Reply #13 on: February 12, 2016, 11:02:26 PM »
I might be wrong, but isn't the SWR for a global investor the same regardless of where s/he lives, before taxes?

No, you need to include currency swings (for instance in the last two years we have changed from being on par with the USD to being 70%). Also, taxes can make a huge difference. The franking credits that we have been discussing are part of the Australian tax regimen whereby company tax (of 30%) on dividends is returned to investors.

steveo

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Re: Safe Withdrawal Rate for Australians
« Reply #14 on: February 12, 2016, 11:07:09 PM »
Do you guys have such a huge home bias that you only invest in your home country (like many of the Americans on this board)? I hope not!
I might be wrong, but isn't the SWR for a global investor the same regardless of where s/he lives, before taxes?

The SWR is based off the trinity study and basically US stocks. If you were invested in your country and stocks performed differently the 4% rule would also probably not be the 4% rule.

Yes if Australians just invest in the Australian stock market we may not be diversified enough. Alternatively Australia may outperform the world for the next 100 years and then its a good bet isn't it. Personally I think you need to have some diversification.

dmn

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Re: Safe Withdrawal Rate for Australians
« Reply #15 on: February 13, 2016, 02:32:42 AM »
The SWR is based off the trinity study and basically US stocks. If you were invested in your country and stocks performed differently the 4% rule would also probably not be the 4% rule.

The focus on US stocks makes the trinity study overstate the SWR in general, because the US happens to be one the most successful stock market partly due to historical accidents which are unlikely to be repeated. In the considered timeframe, the US arose from a developing country to the world's leading superpower.

Reversion to the mean implies that investment returns, even in the US, will be lower in the future than during that particular time period in that particular country. Indeed, when historical returns for different countries are considered to account for a broader spectrum of possible events which never occured in the US, the SWR generally turns out to be lower (though not too dramatically for a globally diversified investor).

However, I disagree with the notion that the SWR depends on the country (apart from taxes which I prefer to count as expenses). The events that lower the historical SWR in other countries could also happen in the US and Australia, and vice versa. In that sense, taking into account all countries' historical returns is likely to give a more reliable estimate of the true SWR everywhere, which is probably lower than 4%.

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On top of that the Australian stock market has grown over time even with such high dividend payouts.

For limited amounts of time, the stock market is of course expected to grow much faster than 5-7% per year. The 4% SWR includes occasional crashes and crises during which over 50% of stock market value can evaporate very quickly. The main reason why the SWR is still 4% per year is because in a typical non-crash year, stocks grow much more than 4%.

However, when you include major recessions and crashes, taking out more than 4% as dividends is not safe any more, because you need to reinvest part of that dividend during good times to build buffers for the rare, twice-in-a-century events that can destroy a large part of your investments.

maizefolk

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Re: Safe Withdrawal Rate for Australians
« Reply #16 on: February 13, 2016, 10:14:34 AM »
In the considered timeframe, the US arose from a developing country to the world's leading superpower.

The original Trinity study considered 30 year windows using data from 1926 to 1996. The United States was hardly a developing country in 1926 and America's share of global stock market capitalization in 1996 was roughtly the same as it was in 1926.



You're right that a domestically invested US portfolio shows higher safe withdrawal rates than domestically invested portfolios in many other countries. However, there is another big explanatory factor* which is that the US population and economy are much larger than most other countries with long stock/bond histories, and "US" companies have a ridiculous number of foreign subsidiaries. Depending on the year, investing only in US stocks still gets you 35-50% of what would be in a whole-world ETF by market capitalization. This allows it to capture a little of the same benefits of diversification as international indices. For maximizing security over multi-decade timeframes:

Investing around the world > investing domestically in a big diversified country > investing domestically in a smaller or more specialized economy.

*Well two factors: The Dimson, Marsh, and Staunton dataset used in the Morningstar article goes back to 1900 and the worst countries for FIRE over that time are Austria, Belgium, Finland, France, Germany, Italy and Japan. Of those countries Japan (gray), Germany (light blue), France (purple), and Austria (orange) are in the graph above. Look at what happens to those lines in the 1940s. If, any time after you FIRE, there is a war being fought door to door outside your house, there is no investment portfolio that would allow you to continue to maintain your present lifestyle and you certainly have more pressing concerns.

steveo

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Re: Safe Withdrawal Rate for Australians
« Reply #17 on: February 13, 2016, 02:25:10 PM »
The SWR is based off the trinity study and basically US stocks. If you were invested in your country and stocks performed differently the 4% rule would also probably not be the 4% rule.

The focus on US stocks makes the trinity study overstate the SWR in general, because the US happens to be one the most successful stock market partly due to historical accidents which are unlikely to be repeated. In the considered timeframe, the US arose from a developing country to the world's leading superpower.

Reversion to the mean implies that investment returns, even in the US, will be lower in the future than during that particular time period in that particular country. Indeed, when historical returns for different countries are considered to account for a broader spectrum of possible events which never occured in the US, the SWR generally turns out to be lower (though not too dramatically for a globally diversified investor).

However, I disagree with the notion that the SWR depends on the country (apart from taxes which I prefer to count as expenses). The events that lower the historical SWR in other countries could also happen in the US and Australia, and vice versa. In that sense, taking into account all countries' historical returns is likely to give a more reliable estimate of the true SWR everywhere, which is probably lower than 4%.

Quote
On top of that the Australian stock market has grown over time even with such high dividend payouts.

For limited amounts of time, the stock market is of course expected to grow much faster than 5-7% per year. The 4% SWR includes occasional crashes and crises during which over 50% of stock market value can evaporate very quickly. The main reason why the SWR is still 4% per year is because in a typical non-crash year, stocks grow much more than 4%.

However, when you include major recessions and crashes, taking out more than 4% as dividends is not safe any more, because you need to reinvest part of that dividend during good times to build buffers for the rare, twice-in-a-century events that can destroy a large part of your investments.

I understand your point but the Australian stock market for some reason has typically had a high dividend payout rate. I'm not stating that we shouldn't use the 4% rule but I am stating that the payout rate is not a cause for concern or to believe that there is some problem that means the Australian stock market (and our retirements) is doomed to failure.

So basically I think taking out dividends in Australia is safe. The dividends might be cut at some point but it you are following the 4% rule (your stash is 25 times your expenses) I have confidence that you should be okay. If the payout rate is 5% with a 2% tax benefit then that is great.


dmn

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Re: Safe Withdrawal Rate for Australians
« Reply #18 on: February 13, 2016, 03:03:10 PM »
The original Trinity study considered 30 year windows using data from 1926 to 1996. The United States was hardly a developing country in 1926 and America's share of global stock market capitalization in 1996 was roughtly the same as it was in 1926.

My bad, I thought the trinity study started with the earliest data around 1900 when the European countries were still the major economic powers of the world.

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If, any time after you FIRE, there is a war being fought door to door outside your house, there is no investment portfolio that would allow you to continue to maintain your present lifestyle and you certainly have more pressing concerns.

With an internationally diversified portfolio, you can emigrate to a safe country, so I believe that global diversification offers partial protection from risk of war.

brainfart

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Re: Safe Withdrawal Rate for Australians
« Reply #19 on: February 14, 2016, 03:35:11 AM »
I might be wrong, but isn't the SWR for a global investor the same regardless of where s/he lives, before taxes?

No, you need to include currency swings (for instance in the last two years we have changed from being on par with the USD to being 70%).

The "last two years" are meaningless for an "eternal" retirement portfolio. That will change again in the future.
Besides, I was talking about a global portfolio. There always have been and always will be huge currency swings. They will sometimes work to your advantage, and sometimes against you. In the long run it will probably all even out.

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Also, taxes can make a huge difference. The franking credits that we have been discussing are part of the Australian tax regimen whereby company tax (of 30%) on dividends is returned to investors.
That is awesome. But still no reason to excessively overweight your home country.
Just buy the whole damn planet.

deborah

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Re: Safe Withdrawal Rate for Australians
« Reply #20 on: February 14, 2016, 04:26:15 AM »
Yes, two years are nothing in the scheme of things, but they illustrate how portfolios do not work out the same for global investors in different countries. They also explain why the SWRs are different in different countries, even though they may be based upon the global economy, although it will possibly work out in the end.

Of course you need to have an internationally diversified portfolio. How you get that can be an interesting conundrum. I suspect that most "home" stocks have quite an international exposure - in fact, it might be that US stocks have more home bias than, say, Australian stocks, simply because so much of the world market is the US. Some people I have talked to say that you can get whatever percentage international exposure you want by simply choosing the right "home" stocks.

urbanista

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Re: Safe Withdrawal Rate for Australians
« Reply #21 on: February 14, 2016, 07:52:59 PM »
Personally I think you need to have some diversification.

Aussies are diversified by definition. Our homes are valued 1M+.

(this is half irony, half serious)
« Last Edit: February 14, 2016, 07:58:09 PM by urbanista »

steveo

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Re: Safe Withdrawal Rate for Australians
« Reply #22 on: February 15, 2016, 02:43:56 AM »
Personally I think you need to have some diversification.

Aussies are diversified by definition. Our homes are valued 1M+.

(this is half irony, half serious)

Once you own your house you're a millionaire. It's freaken crazy.

I don't understand how or why anyone purchases investment properties in Australia because the property allocation in your asset allocation must be huge. Then again imagine owning one standard investment property and your own house with no debt. You can sell your home residence and have no capital gains tax and unless your spending is pretty large retire the next day.

Primm

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Re: Safe Withdrawal Rate for Australians
« Reply #23 on: February 15, 2016, 03:21:28 AM »
Personally I think you need to have some diversification.

Aussies are diversified by definition. Our homes are valued 1M+.

(this is half irony, half serious)

Once you own your house you're a millionaire. It's freaken crazy.

I don't understand how or why anyone purchases investment properties in Australia because the property allocation in your asset allocation must be huge. Then again imagine owning one standard investment property and your own house with no debt. You can sell your home residence and have no capital gains tax and unless your spending is pretty large retire the next day.

After today's talk by both sides of politics about cutting the negative gearing benefits around investment property they probably won't do this as much in the future...

Eucalyptus

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Re: Safe Withdrawal Rate for Australians
« Reply #24 on: February 15, 2016, 06:07:25 PM »

[/quote]

After today's talk by both sides of politics about cutting the negative gearing benefits around investment property they probably won't do this as much in the future...
[/quote]

Yeah this is going to be a fascinating bit of politics/debate leading up to and after the next election, that will change the investment scenario in Australia markedly, no matter what is decided (well, everything except the status quo).

Regardless of which side of politics wins, given that all are now talking about changes here, and even if they grandfather rules, its looking less and less fun to have property investment at the moment. I'll wait until after this period is over for myself (my parents and siblings are pretty exposed though).