Author Topic: Why do people even care about SWR - does this concept even make sense for FIRE?  (Read 6348 times)

ender

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In reading the stop worrying about the 4% rule thread, I was playing with cFIREsim trying to understand why $100 portfolio with a $6 inflation adjusted withdrawal was getting such relatively high success rates for 50+ year runs.

This was rather confusing to me initially, since I was assuming that $6 withdrawal was corresponding to a 6% withdrawal rate and expected not such a high success rate with a minimum withdrawal. But it's not. The $6 default is your inflation adjusted spending. And this corresponds to how your FIRE experience would actually be rather than some arbitrary percentage withdrawal rate.

It is often repeated that a "4% SWR is what you should aim for!" but it occurs to me that the concept of a SWR doesn't actually make much sense at all. Nearly everyone on this board is going to have more fixed expenses spend - rather than fixed portfolio spending - in ER.

Consider that if your portfolio is 1M and you spend $40k/year, if your portfolio doubles, a SWR FIRE plan implies you will withdraw $80 -- rather than the more likely $40k. The SWR also implies that it drops to $500k, you will only withdraw $20k. Neither of these scenarios is likely to really occur nor do they make sense from a planning perspective. It is far more likely you would still spend close to $40k (regardless of your portfolio balance).

Any meaningful retirement analysis should therefore not consider a SWR, but rather an expense multiplier (so 15x or 25x expenses etc). Then, use constant or inflation adjusted spending until SS/pensions, at which point that constant drawdown decreases. Or keep expenses constant and ignore future incomes. Either way retire the concept of a SWR entirely.

Am I missing something about why a SWR is so commonly used for ER and retirement planning?

Sure it's easy to conceptualize, but just because it's easy to conceptualize doesn't mean it's actually meaningful.

The takeaways I see are similar to what sol discusses here except more focused on a paradigm shift from "need 25x expenses" to "need 15x (or whatever) expenses with a modest income stream and future SS" perspective. Supplemental income streams, such as SS, pensions, rentals, hobby income, or whatever allow you to drop your expense multiplier significantly.

Additionally, using a SWR focus seems to roll the importance of surviving the first 5 years of ER into the entire time. Whereas if you focus on the inflation adjusted expense side you can much more easily address the time periods where FIRE fails. An example might be covering 50% of your expenses via part-time work and being 1/2 FIRE'd for those 5 years instead of drawing down your portfolio. Or working halftime to cover 100% expenses (but not saving anything).

ie perhaps a hypothetical "a 60k withdrawal on a 1M portfolio with 30k part-time additional income during years 1-5" scenario would seemingly reduce your working time significantly while allowing you near the same success that a 4% scenario might be if you had worked another 5 years FT.


.... this makes me want to program my own FIRE calculator to account for the scenarios which, while perhaps more complicated than "SWR!" scenarios, would allow you to build protections against risk in when comparing to historical periods for analysis.

tyir

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Consider that if your portfolio is 1M and you spend $40k/year, if your portfolio doubles, a SWR FIRE plan implies you will withdraw $80 -- rather than the more likely $40k. The SWR also implies that it drops to $500k, you will only withdraw $20k. Neither of these scenarios is likely to really occur nor do they make sense from a planning perspective. It is far more likely you would still spend close to $40k (regardless of your portfolio balance).

This is incorrect and a misunderstand for how the Trinity study determined the 4% SWR.
The way it works is you pick 4% of your starting portfolio as the amount you can withdraw. You then withdraw that as a fixed amount every year, but inflation adjusted.
In your example, year 1, you withdraw 40k. In year two the portfolio goes to 2M, but you check the inflation level (say 2%) and you withdraw a maximum of 40800. You don't change how much you withdraw based on what happened to your portfolio in the Trinity study.
They found, using this system, picking 4% was safe in 95% of situations.

If you did as you suggested and picked a flat 4% every year (i.e. 80K in year 2), that would likely be unsafe and have a much higher failure rate.

You can read more about it here: https://en.wikipedia.org/wiki/Trinity_study.

I should add: no one subscribes to this "pure" Trinity-style withdrawal, I suspect. I think people plan on spending a bit less when portfolio is down, and potentially a bit more if it does better than expected. Being flexible adds to safety.
« Last Edit: July 03, 2015, 08:12:31 PM by tyir »

clifp

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I am afraid you've missed one of the basic points of a SWR studies.  The amount you withdrawal is based on the size of your portfolio the day retired.  The value of your withdrawal is independent of the size of your portfolio in future years. The importance of the research is if you start 1,000, 000 withdraw 40K,  adjust for inflation, it doesn't matter ~90% of the time of what happens next to your portfolio. It could double or drop by 30% and you still be able to last 30 years still spending 40,000 in real dollars.

You are absolutely correct for most people their expense are relatively fixed and that's why the study is important.  For most people withdrawing say 4% of their current portfolio each year introduced too much variability.  If the portfolio goes to $2 million, 80K is more than you need if drops to $500K 20K is not enough.  That's the real benefit of the SWR studies a relative fixed withdrawal each year is better fit for most people spending needs.

You have also identified some of the problems with the 4% SWR.

I think the 4% rule is fine for planning purpose but only for people who are looking at a fairly traditional retirement, i.e. late 50s early 60 and being able to collect social security in a few years and Medicare at age 65. 

I think it is of limited use to people retiring early  say 50, and of almost no use for those looking at retiring before 40.

In reality I have yet to find any real retiree who is withdrawal is solely a function of the size of their retirement portfolio.  The longer your retirement the more value of your current portfolio should reflect your spending.

ender

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Ooh.  Oops... :)


I don't know how I didn't know that after being here so long.... pretty depressing honestly... ahhaha.
« Last Edit: July 03, 2015, 10:13:21 PM by ender »

johnny847

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Also recall that the trinity study was done many years ago before computing power was super cheap. Modeling a constant 4% inflation adjusted withdrawal rate is easy. Modelling some form of variable withdrawal rate is more difficult and quite possibly impossible with the computing power available at the time.
Today cfiresim can simulate various different variable spending models. I believe everybody should do so - sticking your head in the sand and always drawing an inflation adjusted 4% every year is just stupid.

deborah

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In Australia, the rules state that you MUST withdraw at least 4% of your superannuation from the time you retire (say 60) until you are 65, then it increases - 5% for 65-74, 6% if you are 75-79, 7% if you are 80-84, 9% for 85-89 year olds, 11% for those 90-94 and a minimum of 14% a year if you are any older.

The Australian MoneySmart web site can deal with that, but I can't see anything else that can. You get a virtually tax free environment if it is inside superannuation, and a heavily taxed one outside, so the difference is significant. I am not sure that a variable withdrawal rate like this can be modeled in cFireSim.

marty998

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In Australia, the rules state that you MUST withdraw at least 4% of your superannuation from the time you retire (say 60) until you are 65, then it increases - 5% for 65-74, 6% if you are 75-79, 7% if you are 80-84, 9% for 85-89 year olds, 11% for those 90-94 and a minimum of 14% a year if you are any older.

The rules are that you have to withdraw it. It doesn't mandate that you have to spend it.


deborah

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Yes, but a) I would like to see the cFireSim results of SPENDING it, and b) because it is in a much worse environment, I could then take the outputs of cFireSim (or whatever) and put the unspent part through it with the tax implications to see what the actual result could be.

forummm

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If you did as you suggested and picked a flat 4% every year (i.e. 80K in year 2), that would likely be unsafe and have a much higher failure rate.

No. You would have a 0% failure rate (unless the market goes to zero). 4% of any number still leaves you with 96% left in the account. The problem is that the amount you spent would sometimes be too low and would generally be too volatile for the way people tend to live. So let's say the market goes up 50% then down 50%. You'd spend $40k, account goes up to $1.44M so you spend $57.6k. Then account goes down to $691k so you spend $27.6k. Etc. That's not the way most people want to live.

desk_jockey

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No. You would have a 0% failure rate (unless the market goes to zero). 4% of any number still leaves you with 96% left in the account. The problem is that the amount you spent would sometimes be too low and would generally be too volatile for the way people tend to live. So let's say the market goes up 50% then down 50%. You'd spend $40k, account goes up to $1.44M so you spend $57.6k. Then account goes down to $691k so you spend $27.6k. Etc. That's not the way most people want to live.

Exactly.  Paraphrasing the intro to one of William Bengen's papers: even a 99% withdraw rate is safe if you reset on portfolio value annually.  You'll never run out, though practically it will be increasingly difficult to divide a fraction of one cent.   

nobodyspecial

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How do you decide the inflation rate to use for your pay rise?
There are a bunch of official/political inflation rates, there is also the rate that you see the cost of things you buy increasing.
Neither of these is directly linked to the rising value of your investments.


johnny847

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How do you decide the inflation rate to use for your pay rise?
There are a bunch of official/political inflation rates, there is also the rate that you see the cost of things you buy increasing.
Neither of these is directly linked to the rising value of your investments.

I assume by "pay rise" you actually mean increase in withdrawal amount.

But the Trinity study used some source for inflation data. If you go look at the study, they computed it based on CPI.

tyir

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If you did as you suggested and picked a flat 4% every year (i.e. 80K in year 2), that would likely be unsafe and have a much higher failure rate.

No. You would have a 0% failure rate (unless the market goes to zero). 4% of any number still leaves you with 96% left in the account. The problem is that the amount you spent would sometimes be too low and would generally be too volatile for the way people tend to live. So let's say the market goes up 50% then down 50%. You'd spend $40k, account goes up to $1.44M so you spend $57.6k. Then account goes down to $691k so you spend $27.6k. Etc. That's not the way most people want to live.

True. I meant failure in the sense it will not give you enough money to live on comfortably at some point, but I should have made this a bit more clear.

tj

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If you did as you suggested and picked a flat 4% every year (i.e. 80K in year 2), that would likely be unsafe and have a much higher failure rate.

No. You would have a 0% failure rate (unless the market goes to zero). 4% of any number still leaves you with 96% left in the account. The problem is that the amount you spent would sometimes be too low and would generally be too volatile for the way people tend to live. So let's say the market goes up 50% then down 50%. You'd spend $40k, account goes up to $1.44M so you spend $57.6k. Then account goes down to $691k so you spend $27.6k. Etc. That's not the way most people want to live.

That is actually the way a lot of people do live though. They spend more when time are good and less when times are bad, Taylor Larimore, the 90-something boglehead is a great example of this.

arebelspy

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That is actually the way a lot of people do live though. They spend more when time are good and less when times are bad, Taylor Larimore, the 90-something boglehead is a great example of this.

Sure, less and more, but not necessarily 100% correlated--e.g. the market falls 50%, they may not cut their spending 50%.  There could be a floor (and ceiling).
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tj

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That is actually the way a lot of people do live though. They spend more when time are good and less when times are bad, Taylor Larimore, the 90-something boglehead is a great example of this.

Sure, less and more, but not necessarily 100% correlated--e.g. the market falls 50%, they may not cut their spending 50%.  There could be a floor (and ceiling).

Absolutely. There's no need to be so rigid about it. We all plan for some target withdrawal rate, but in reality, life is pretty flexible based on Mr. Market or whatever other circumstances one may have.

Scandium

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How do you decide the inflation rate to use for your pay rise?
There are a bunch of official/political inflation rates, there is also the rate that you see the cost of things you buy increasing.
Neither of these is directly linked to the rising value of your investments.

I've never retired so haven't thought much about it, but one simple way I image is to just take out what you need to pay for about the same stuff you usually bought to live in the previous years (i.e the same groceries, same amount of gas etc). If it goes up 1% you'd need a little more, if it went up 5% you'd take out that much more.

Now maybe this would be dangerous if you convince yourself you "need" more and more other things, so maybe you need an upper ceiling (CPI-U?). If you're even more irresponsible maybe you do actually need to calculate a "salary" for yourself.

nobodyspecial

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That was my concern, if the 4% is based on an official inflation rate = RPI/CPI/etc. But as a mustacian you buy more staple foods that rise in price and fewer electronic toys that drop in price - you can find that your personal inflation rate is a lot higher than the official 1%.


deborah

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One problem I have with a personal inflation rate is that I have yet to see it. We are gradually lowering what we spend - even in retirement. This could be that we are still optimising our lives. Obviously, some things must be costing more with inflation, but if we are buying cheaper versions, or deciding that a product is not necessary for our lives, how can we decide on a consistent personal basket of goods?

Telecaster

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That was my concern, if the 4% is based on an official inflation rate = RPI/CPI/etc. But as a mustacian you buy more staple foods that rise in price and fewer electronic toys that drop in price - you can find that your personal inflation rate is a lot higher than the official 1%.

Food prices tend to be pretty stable over time.  But there are other measures of inflation, for example:

http://bpp.mit.edu/

They tend to track the CPI closely, which indicates the CPI is pretty good measure of actual inflation.   

I think people  make this too hard.  If after say, five or 10 years, you find that your personal inflation rate is wildly higher than the CPI, you can make some adjustments.