Author Topic: 4% Rule - A Tale of 3 Retirees  (Read 8364 times)

SnackDog

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4% Rule - A Tale of 3 Retirees
« on: September 07, 2014, 06:14:37 AM »
The 4% is interesting in the context of big market swings around retirement time, when the capital for the 4% is set and first year withdrawal established.  Consider the following scenario.

Bill, Mary and Pat all have a target retirement age of 60.  They and their spouses have had long and enriching careers and they have saved a lot and are nearly ready to retire.  At the beginning of 2007, each had saved a $5MM and had it invested in a total stock market index fund (let's suppose they and work in California where such a sum is fairly modest given 30 or so working years and high COL). Each saves $100,000 per year by being frugal, using Republic Wireless and biking to Costco for dinners out.

Bill turns 60 in 2007. He retires Jan 1 2008 with savings of 5.37MM (S&P 500 appreciated 5% in 2007, plus he saved another 100K that year).  He lives the rest of his life on $215,000/year (4%).

Mary turns 60 in 2008.   Her $5.3MM Jan 1 2008 fell to $3.3MM by the end of the year (just like Bill's 'cuz the S&P 500 tanked 37% that year). She retired Jan 1 2009 on $140,000 per year even though she worked a year extra while Bill saved nothing, blew $215,000 on vacations and fine dining,  worked on his blog and caught up on daytime tv.

Pat retired Jan 1 2010 with $4.52MM (S&P surged 25% during 2009).  Pat will live on $181,000 annually, even having worked and saved two more years than Bill.

Hardly seems fair or sensible, does it?   Should we ignore big swings in the market near retirement time and just assume a 10% annual appreciation the last year or two to smooth out any wild gyrations which would give us a crazy high or low starting value from 4%?    Doing so (using 10% in each case instead of the actual) would put Bill at $224K, Mary at $250K and Pat $280K.  Great for everyone, especially Mary!  What would you do?
« Last Edit: September 07, 2014, 06:16:33 AM by SnackDog »

bluebell

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Re: 4% Rule - A Tale of 3 Retirees
« Reply #1 on: September 07, 2014, 06:45:06 AM »
SnackDog, does this assume that all 3 investors sell and get out of the stock market entirely when they retire? If Mary stayed invested she might have had a few lean first years, but her portfolio would have rebounded by now, right?

kyleaaa

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Re: 4% Rule - A Tale of 3 Retirees
« Reply #2 on: September 07, 2014, 07:12:22 AM »
Sequence of returns risk is among the biggest risks retirees face. A few bad years in the beginning will have SERIOUS negative consequences. That's why I think the whole "retire with 80% in bonds and increase equity exposure as you age" movement probably has legs.

SnackDog

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Re: 4% Rule - A Tale of 3 Retirees
« Reply #3 on: September 07, 2014, 08:31:52 AM »
Sequence of returns is no issue for any of these three people, based on historical simulations.   All cases will reach 30 years without running out of money.  Seem like Mary will finish with a lot leftover.  This suggests one should retire in a year when one's portfolio is at a maximum.

Bonds did a lot worse than stocks in the years shown.  Bill, Mary and Pat would start out with $194k, $88k, and $125K, respectively with a portfolio of 100% bonds (80% bonds would be slightly better).

Bonds appear particularly risky now.  Good luck reading tea leaves but if you think both bonds and stocks look risky now, just dial back your starting withdrawal.

not_a_trex

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Re: 4% Rule - A Tale of 3 Retirees
« Reply #4 on: September 07, 2014, 11:56:41 AM »
I don't understand how Bill is not affected by swings in the market after he retires. If he's running on the 4% rule I assume he still has a large part of his portfolio in stocks.

My understanding of the rule was that 4% was a SWR of your current portfolio net worth. As you show in your example, this will change over time with withdrawals and market swings.

notsofast

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Re: 4% Rule - A Tale of 3 Retirees
« Reply #5 on: September 07, 2014, 03:47:13 PM »
snackdog, why does Pat have to adjust her withdrawal amount based on portfolio size and bill does not?   I am pretty new to this site (been lurking for awhile) but I thought the premise of the 4% rule was that the market will rebound in a few years with returns in excess of 4% so that you won't run out of money even when your 4% SWD rate may be greater than 4% due to market dips.

marty998

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Re: 4% Rule - A Tale of 3 Retirees
« Reply #6 on: September 07, 2014, 04:41:50 PM »
I think you've made a big boo boo there Snackdog too.

My gut feel is that the 4% needs to rise as fall in absolute dollar terms depending where the stash is at that point in time.

Honestly though I think there's a tendency for most people gunning for FI to over-save. People who are FI just seem to earn more in retirement and die with a gigantic pot of gold. Anecdotally speaking of course.

RichMoose

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Re: 4% Rule - A Tale of 3 Retirees
« Reply #7 on: September 07, 2014, 10:09:08 PM »
I think the 4% SWR has nothing really to do with the market at any particular time.

It works more like this: (Projected annual expenses net of benefits [pension + SS] x 25) = The minimum value of your portfolio when retiring

Then you can draw the money for your annual expenses (about 4%) for the rest of your life with a 90%+ chance you'll never run out of money even accounting for inflation.

Bottom line, its not the end all be all, its just a number to help you figure out if you can retire or not based on the value of your invested assets.

CanuckExpat

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Re: 4% Rule - A Tale of 3 Retirees
« Reply #8 on: September 08, 2014, 04:33:17 AM »
From Bogleheads Wiki:
Quote
The authors of the paper, however, did not mean for their scenarios to be applied rigidly or uncritically. The article makes this very important statement:

The word planning is emphasized because of the great uncertainties in the stock and bond markets. Mid-course corrections likely will be required, with the actual dollar amounts withdrawn adjusted downward or upward relative to the plan. The investor needs to keep in mind that selection of a withdrawal rate is not a matter of contract but rather a matter of planning.

Clarification from Professor Philip L. Cooley, senior author of the Trinity study:
What the "4% SWR" means is not that you can treat a portfolio as if it were a guaranteed annuity. I think all the [Trinity] authors meant is that if it is late 2008 and your stocks halve in value, you don't need to halve your spending instantly. It's OK to cross your fingers and continue spending according to the 4%-then-COLAed plan, even though it means dipping into capital, and it's OK to go on doing that for a while.

Professor Cooley's response:
You have hit the nail on the head! I've tried to explain that thought to journalists but they don't seem to get it. You've got it. Stay flexible my friend!, which is the advice we should give to retirees.

Aphalite

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Re: 4% Rule - A Tale of 3 Retirees
« Reply #9 on: September 08, 2014, 08:49:46 AM »
Nothing that hasn't already been said, but you'd have 3-5 years worth of withdrawl of your portfolio in cash/equivalents so you can ride out any downturns as you get close to retirement age. Mary wouldn't be withdrawing from the stock portion of the portfolio because she would have planned ahead and had cash ready before the crash hit

arebelspy

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Re: 4% Rule - A Tale of 3 Retirees
« Reply #10 on: September 08, 2014, 04:15:00 PM »
All this tells us is that you should be flexible with your retirement spending.

If Mary wants to spend more, looks at her portfolio after the post-2009 market run up, and decides she can, she should.

If we have another crash, she may want to reevaluate (ditto the other two).

Rigid retirement spending is not the way to go.
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tj

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Re: 4% Rule - A Tale of 3 Retirees
« Reply #11 on: September 09, 2014, 10:11:51 PM »
5,000,000 saved up is a MODEST savings for retirement? Really?

Scandium

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Re: 4% Rule - A Tale of 3 Retirees
« Reply #12 on: September 10, 2014, 11:03:36 AM »
Retire = cash out whole portfolio?

They are 100% in the S&P500 until the day they retire?! Ouch. I'm decades away, but was planning on more like 50-50 stock bonds, with couple years in cash..

arebelspy

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Re: 4% Rule - A Tale of 3 Retirees
« Reply #13 on: September 10, 2014, 07:03:36 PM »
To the last two posts: I think the point of this hypothetical wasn't to talk about AA, or how much one needs to FIRE, but to point out the vast differences in the amount one can spend based on sequence of returns risk, even if they don't run out of money (which is the typical concern with SOR).
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Scandium

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Re: 4% Rule - A Tale of 3 Retirees
« Reply #14 on: September 10, 2014, 09:27:58 PM »
To the last two posts: I think the point of this hypothetical wasn't to talk about AA, or how much one needs to FIRE, but to point out the vast differences in the amount one can spend based on sequence of returns risk, even if they don't run out of money (which is the typical concern with SOR).
Sure, I guess it's interesting to see the numbers. Just not really actionable because of the points I mention above..

arebelspy

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Re: 4% Rule - A Tale of 3 Retirees
« Reply #15 on: September 10, 2014, 10:34:29 PM »
To the last two posts: I think the point of this hypothetical wasn't to talk about AA, or how much one needs to FIRE, but to point out the vast differences in the amount one can spend based on sequence of returns risk, even if they don't run out of money (which is the typical concern with SOR).
Sure, I guess it's interesting to see the numbers. Just not really actionable because of the points I mention above..

Maybe.  Keep in mind that everyone has their own preferences.

I like a 100% (or 90/10 maybe) AA.  50-50 is way too conservative for me.
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Scandium

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Re: 4% Rule - A Tale of 3 Retirees
« Reply #16 on: September 11, 2014, 06:44:09 AM »
To the last two posts: I think the point of this hypothetical wasn't to talk about AA, or how much one needs to FIRE, but to point out the vast differences in the amount one can spend based on sequence of returns risk, even if they don't run out of money (which is the typical concern with SOR).
Sure, I guess it's interesting to see the numbers. Just not really actionable because of the points I mention above..

Maybe.  Keep in mind that everyone has their own preferences.

I like a 100% (or 90/10 maybe) AA.  50-50 is way too conservative for me.

Yes I'm 100% stocks now, at age 30 (retire ~50..). But would you do that the day you retire as well? Sounds a bit too risky again. 50-50 may be a little much, but I was thinking I'd go 20-40% bonds as I get closer. Although haven't given it much thought yet.

arebelspy

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Re: 4% Rule - A Tale of 3 Retirees
« Reply #17 on: September 11, 2014, 08:04:12 AM »
Yes I'm 100% stocks now, at age 30 (retire ~50..). But would you do that the day you retire as well? Sounds a bit too risky again. 50-50 may be a little much, but I was thinking I'd go 20-40% bonds as I get closer. Although haven't given it much thought yet.

Possibly.  It depends on a number of factors (such as what the rest of my portfolio looks like, if I have a pension or SS, what my WR is, etc.)

It's a good question, for sure.

But I can think of a number of scenarios where I'd want to be 100% equities, and a number where I wouldn't.  It depends on the person and the situation.

I try not to be too quick to judge someone's AA.

(Unless they're planning a long ER and it's way too conservative, like mostly cash on a 4% SWR.)
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SnackDog

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Re: 4% Rule - A Tale of 3 Retirees
« Reply #18 on: September 11, 2014, 08:13:19 AM »
To the last two posts: I think the point of this hypothetical wasn't to talk about AA, or how much one needs to FIRE, but to point out the vast differences in the amount one can spend based on sequence of returns risk, even if they don't run out of money (which is the typical concern with SOR).

The point is that people following the 4% rule, sensu stricto, in the real years provided in the example would have vastly different living standards for the rest of their lives, despite having saved the same amount up to the start of 2008.  And all, according to the rule, would have a high chance of NOT outliving their savings according to available history.  4% rule also says they do not need to make any changes to their spending or withdrawal based on market behavior after they retire and begin to spend.   It is akin to three persons leaping off a cliff to hang-glide to the beach below.  They will all make it to the beach.  The one who takes off from the cliff with a huge gust of updraft wind may have a wonderful, long flight and enjoy herself.  The one who is hit with a downdraft at the start, will have a scary rush straight to the landing spot.   This suggests one may wish to wait on the cliff for the updraft before taking off!!

arebelspy

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Re: 4% Rule - A Tale of 3 Retirees
« Reply #19 on: September 11, 2014, 08:19:08 AM »
This suggests one may wish to wait on the cliff for the updraft before taking off!!

I'm as bad at predicting wind patterns as I am stock market moves, so I'm not sure how much this helps...   ;)
We are two former teachers who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and are now settled with three kids.
If you want to know more about us, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
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foobar

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Re: 4% Rule - A Tale of 3 Retirees
« Reply #20 on: September 11, 2014, 01:21:56 PM »
I think you've made a big boo boo there Snackdog too.

My gut feel is that the 4% needs to rise as fall in absolute dollar terms depending where the stash is at that point in time.

Honestly though I think there's a tendency for most people gunning for FI to over-save. People who are FI just seem to earn more in retirement and die with a gigantic pot of gold. Anecdotally speaking of course.

Here is the thing: Bill can take out 4%,  Mary can take out 6% and Pat can do 5%. Why? Because valuations matter. It isn't 1994 anymore and we have 20 more years of research since trinity was published.  In the worst case (market crashes), you can take 4% out. In the best case (market soars after retirement), you can take out 6 or 7%. And in the average case you get to take out 5%. When you retire, you don't really know what case you in. 5 years into retirement you have a much better idea.  You can try and use current PE10s/interest rates when you retire but that adds in yet another lever.

The side effect of not knowing your SWR is that you pretty much have to oversave. Odds are you can take out around 5% but that only gives you 80% security. If you want to but up north of 95% you need to get down to 4%.

And finally nobody really suggests that you take 4% inflation adjusted from your start portfolio for the next 30 years. They suggest that is a reasonable estimate and that you should adjust along the way. Have a 15 year bull market when stocks return 14%? Spend away. Have 15 years of 5% return, you might want to think about dropping a bit cause you might be in the 2% failure range.