Author Topic: Are You Sure About the 4 percent SWR?  (Read 13519 times)

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Are You Sure About the 4 percent SWR?
« on: January 18, 2013, 10:42:59 PM »
Here is a new article from Wade Pfau, suggesting our current low rate environment might be making the 4 percent SWR not so safe.

http://wpfau.blogspot.com/2013/01/new-research-article-4-rule-is-not-safe.html

sol

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Re: Are You Sure About the 4 percent SWR?
« Reply #1 on: January 18, 2013, 11:05:38 PM »
This is the worst kind of crystal ball gazing.

The market has a relatively small history of returns than can be modeled exhaustively, even without resorting to Monte Carlo simulations.  This is exactly what firecalc does, because the number of years of returns just isn't that big.  What else could you possible base your assumptions about the future on, if not all of the relevant history ever recorded?  Maybe all of the stock market returns for all stock markets that ever existed?  (hmmmm, not a bad idea, actually).

But while I do support the assumption that stationarity isn't permanently justifiable, I'm not ready to jump ship on it.  The future may not look like the past, but the immediate future is pretty likely to look like the immediate past.  Just because the stock market has never collapsed to zero and erased everyone's paper wealth doesn't mean it will never happen, e.g. eventually the sun will explode and wipe out all life on earth and the market will go to zero.  But trying to make the prediction that today, this moment, is the turning point of all of history is a tough call to make.  I don't buy it.

Besides, the 4% swr rate number is oft quoted but rarely understood in context.  The original publication (the famous Trinity Study) to throw out that number also said that if you stay the course in the stock market and use less than 4%, your biggest risk is underspending and leaving an enormous inheritance (oh noes!).  And that you can typically double that 4% rate for periods of 15 years or less, so your time period is more relevant than your swr.

If you think the US economy is headed down the shitter, you should probably plan for less than a 4% withdrawal rate, or invest overseas.  If you think the future will look like the past, 4% is still valid.

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Re: Are You Sure About the 4 percent SWR?
« Reply #2 on: January 19, 2013, 01:33:08 AM »
What else could you possible base your assumptions about the future on, if not all of the relevant history ever recorded?
Basically agreed. While I do think that it's possible to look at the world and predict a sea-change, I don't have the wisdom to do it and I don't have the wisdom to know who to trust to predict it. Certainly a Ph.D. or a professorship isn't enough, because plenty of doctors and professors disagree with each other.

I do think that the article raises a good question: what do we do in the face of potential instability. Part of the answer is explored in this site: learn to lower your cost of living without lowering your quality of life. And I guess we can look for other ways to hedge against a major market recession.

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Re: Are You Sure About the 4 percent SWR?
« Reply #3 on: January 19, 2013, 07:13:32 AM »
There's another thread around here that referenced an article comparing today's investors to the historical "landed gentry" and pointed out that they used a 0% SWR (i.e., they lived off the income their land produced, but never sold any of the land itself).

It may not be necessary (or even practical for most people), but I think it would be a fun goal to get to a 0% SWR.  Besides, it isn't impossible: MMM has mentioned in some of his articles that his net worth is still going up, even in (pseudo-)retirement.

arebelspy

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Re: Are You Sure About the 4 percent SWR?
« Reply #4 on: January 19, 2013, 08:19:06 AM »
I like Wade Pfau, he has a lot of good stuff to say.

He does seem to be getting more conservative lately. Or maybe it's me that's changed and am reading him differently.

0% SWR is feasible with dividends, rental income, etc. (I'm planning on rental income covering expenses, so I suppose that's a 0% SWR, but I'll have a lot of risk by not being properly diversified).  But in general, the lower you get your SWR, the longer you need to work.  To go from a 4% to a 2% SWR, you have to double your stache.  That can take awhile.

I might prefer to have a higher SWR and drop spending in lean years.  I don't know yet, because I'm not at the FIRE point.  But it's a question every early retiree must ask (besides pensioners, but they have their own set of questions).

It's all about what tradeoffs you are willing to accept, and what lets you sleep at night.
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Re: Are You Sure About the 4 percent SWR?
« Reply #5 on: January 19, 2013, 11:20:31 AM »
I think Wade is reporting that math is still math.

The 4% rule is a great place to start a retirement forecast, but using it to achieve 100% safety might come at the cost of a very long working career or a very high portfolio. 

Annuities (like Social Security or a small SPIA) and variable spending can take care of that last few percentage points.  That's still very hard to simulate on a computer statistical model, but Wade has moved the research closer to simulating it than anyone else.

Another Reader

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Re: Are You Sure About the 4 percent SWR?
« Reply #6 on: January 19, 2013, 11:54:46 AM »
I think Wade is getting more conservative because the recent market performance has made him and his colleagues less confident in their original numbers.  They now see that sequence of returns can have a major impact and it appears that their original assumptions about yields may have been overly optimistic.  Because so many people have paper-only portfolios and rely on the research to decide what their acceptable withdrawal rate will be, these folks decided to redo their research and publish their findings.

Application of the SWR is easiest to follow with paper assets.  The procedure most often suggested is to take the SWR the first year and increase the dollar amount of withdrawals every year by the rate of inflation.  If you have a $1M portfolio, the first year you withdraw $40,000 if you rely on the 4% SWR.  If inflation is 2 percent that year, the next year you withdraw $40,800.  If inflation is 3 percent in that year, you withdraw $42,024 the following year, and so on. 

If you have a $1M portfolio, earn $50,000 in dividends and withdraw $40,000, what's your withdrawal rate?  4 percent, leaving you with $1,010,000.  You don't withdraw 4 percent of the portfolio the next year, you withdraw $40,000 plus the inflation percentage of that $40,000.  You withdraw the $40,800, not the $40,400 that is 4 percent of the year-end portfolio.  If the portfolio earns $20,000 in net dividends and declines by 20 percent over the first year, you still withdraw the $40,800 the second year.  Oops, you are now over 5 percent.  A few bad years (sequence of returns) will put you in a tailspin.  If you can't supplement this paper portfolio with earned income or some other source of income, you had better cut your spending dramatically. 

I don't agree that dividends and rental income equal a 0 percent SWR.  The SWR is used to take a snapshot.  You multiply the initial value of the portfolio, whatever comprises that portfolio, by the selected SWR to get your first year's spendable income from that portfolio.  However, spending only the net dividend and rental income insures you do not decumulate and that every piece of a business or real estate asset that was there for you on Day 1 is producing income for you until you sell it.  Spend LESS than that, and you will be able to buy more pieces of businesses and real estate assets to insure you have a prosperous retirement and you won't be holding your breath waiting for the next round of SWR research.

MMM relies on earned income and "withdrawal" of the net income from his rental property.  If he reinvested all of the net rental income and relied only on earned income, his withdrawal rate would be zero.  Not decumulating and allowing the stash to grow (even adding to it when rent plus earnings exceed expenses) is the key to his success.

Make sense?

« Last Edit: January 19, 2013, 02:08:59 PM by Another Reader »

happy

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Re: Are You Sure About the 4 percent SWR?
« Reply #7 on: January 20, 2013, 03:23:49 AM »
Yes, if you have a few bad years right at the beginning of your retirement, it makes a big hole that is very difficult to catch up ever after: bad years at the end are less significant.  Also for some of us non- US citizens, in my case Australia, SafeMax is<4%. http://wpfau.blogspot.com.au/2010/09/for-my-first-blog-post-i-would-like-to.html#.UPu9bqUij8s.

When I first read MMM, I was excited to learn retirement could be done on shares, index funds will do it, without too much complexity, mainly because real estate here is so expensive and good deals on positively geared RE are hard to find.  After pondering this for a year, I think the accumulation phase is requires  different strategies to when you actually retire. I'm thinking more and more of having some positive cash flow rental , even just 1 or 2 (well as many as I can get, but probably that won't be more than 2 LOL!) in addition, to buffer such effects. Even if the rental stream doesn't cover living expenses and even if there is no capital gain on the property, as long as it will keep producing rent, then this should offset some of the  ups and downs of the shares.

Another piece of advice I read somewhere was to have 2-3 years of expenses saved to live off without starting to withdraw, so that it the market drops as soon as you resign, you can wait it out hoping for recovery before you have to start withdrawing.

At the end of the day the safest habit seems to be to always, always live on less than you earn ie try to keep that net worth going up even in retirement.
« Last Edit: January 21, 2013, 12:14:47 AM by happy »

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Re: Are You Sure About the 4 percent SWR?
« Reply #8 on: January 20, 2013, 05:37:26 AM »
The advantages for real estate in the US as an investment are the favorable tax treatment and leverage.  As long as you understand the math of leverage and use it wisely, you can use it to accumulate a much larger income producing portfolio than most people can with unleveraged paper assets.  Along the way, you get to deduct all of your expenses, including interest, and your net income may be sheltered to a large extent by depreciation.  As I understand the Australian system, you don't have the same advantages.   I would be more hesitant to take on the work and the risk of real estate without those advantages.

My impression is that it is very difficult for an individual to accumulate significant wealth in a place like Australia unless you can build a business that generates a lot of income.  Is that accurate?


happy

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Re: Are You Sure About the 4 percent SWR?
« Reply #9 on: January 20, 2013, 06:45:43 AM »
The details may different, but we can still claim mortgage interest and expenses. If you are negatively geared ie losing money, you can claim this loss against your income, reducing tax. However its still a loss. If you come out making money from the rent after expenses,  it adds to your income and you will be taxed. There are ways to minimise some of this and tax law here is very complex, but thats essentially how it works. In previous decades people here did what you are doing now. The problem with real estate now, is that it is very expensive, mortgage rates are much higher than US, there is much less capital gain than in previous decades (and if you are lucky enough to make a capital gain when/if you sell you will be taxed), and rents sound about the same as US. So poor ROI. There have been substantial changes in landlord/tenant agreements, generally favouring tenants much more, so if you get a bad tenant it can be tricky to sort out.. Renovating and flipping was once profitable, but building costs/labour has risen and the margins are now slim.

Australia has a much more "socialist" system in the same way Canada does...and tax rates are also substantially higher than US. All that leads to it sounding like its a lot harder than US to get ahead ( I don't really know since I've never lived in US). And yes if you build a very successful business thats probably the best way to be very wealthy from a zero start at present.

That being said, Mustachianism still works, sure does....just some of the variables are weighted differently...  and of course "the shockingly simple math" works just the same.

My comment about a rental or two, was more in line with, once having build the stache, trying to balance,  diversify and stabilise so as to optimise the "withdrawal" phase. Possibly there are some ideas like "cash ladders" that could also be used to stabilise some share volatility also. Still thinking about all this.

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Re: Are You Sure About the 4 percent SWR?
« Reply #10 on: January 20, 2013, 04:30:19 PM »
Yes, if you have a few bad years right at the beginning of your retirement, it makes a big hole that is very difficult to catch up ever after: bad years at the end are less significant. 

I have heard things like this before and maybe someone can help me understand the math because I'm not getting it.

If you have a set amount, the order the years come in doesn't matter.  $10,000 x -7% x -75% x 9% x 20% is $3041 and so is $10,000 x 20% x 9% x -75% x -7%.  That whole transitive power thing.

If you make ongoing contributions, say, $100 a year, the order starts to make a difference.  -7%, -75%, 9% and 20% leaves you with $3324 while the reverse leaves you with less, $3182.  Big swings either way affect later years more because that's when you have more money which is why the typical advice is to be more conservative with investments in later life--or at least, I'm guessing there's a mathematical explanation and that's it.  It would also be good advice psychologically speaking since you're making certain long-term decisions (where to live, etc.) with less opportunity for flexibility when you're older. 

I'm just plugging in the numbers here, though, not getting at the abstract principal, so maybe someone can tell me where/if I'm going astray.

sol

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Re: Are You Sure About the 4 percent SWR?
« Reply #11 on: January 20, 2013, 04:51:45 PM »
It's not so much the transitive nature of fractional multiplication as it is the historic frequency of the worst down years and it's impact on crossing the 0% threshold.

If you retire right before a big decline, your balance drops too low to support the SWR based on that higher amount.  If you retire right after a big decline, your SWR is a relatively smalller dollar number and you are more likely to see decades of growth before the next big crash.

This is a good point, though, for people who worry about their SWR.  If you don't see a big crash in the first five or ten years of your retirement, you're almost certainly golden.

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Re: Are You Sure About the 4 percent SWR?
« Reply #12 on: January 20, 2013, 06:10:59 PM »
And that's exactly why sequence of returns matter.  If you retire and hit a few really positive years, your portfolio swells to the point where the annual subtractions, indexed for inflation from the first year, are a much smaller percentage of the portfolio at that point.  Although the portfolio compounds (or declines) over time at the market rates for the various assets in it, the amount you take out (subtract) and spend each year compounds at the rate of inflation.  If your portfolio of assets doubles in value over 7 to 10 years the amount you take out is closer to 2 percent if inflation is low over the same period.

I think it helps to look at the projected withdrawal rate at the beginning of every year.  Take the snapshot again using the projected withdrawal amount indexed for inflation and the value of your asset portfolio at the beginning of the year.  For example, using the same $1M starting portfolio and the 4 percent SWR amount for year one of $40,000 and a 2 percent inflation rate, the withdrawal in year two should be $40,800.  If the total value of your assets drops to $700,000, your withdrawal rate is around 5.8 percent.  The "snapshot" for someone with $700,000 in assets that retires at the 4 percent SWR that year, says he or she can only take $28,000 and index it up for inflation in the future.  Unless your portfolio can "catch up" fairly quickly, you are going to have to cut withdrawals or run a high risk of running out of money.

This is why I concluded long ago that the maximum "safe" rate of withdrawal is the whatever the net income from your assets is.  Once you start liquidating capital assets, you become more subject to sequence of returns risk.  A few down years, and you are sliding down a very slippery slope.  Safer yet is to spend less than your net income and continue to invest.  For example, Uncle Sam requires minimum distributions from tax deferred retirement accounts - forced decumulation.  I will respond by using some of the net distributions to pay down rental mortgages and invest in more assets.  It's a matter of draining one bucket and filling another.

MMM is taking "withdrawals" from only the real estate portion of his total portfolio.  He spends a portion of his total income, comprised of earned income and net rental income.  I would only be hazarding a guess, but my bet is his "withdrawal" rate is between 1 and 2 percent of his total portfolio.  There is no decumulation.  He continues to fill the his portfolio buckets with excess income, hedging until he tires of working.  A very wise man with a very sensible plan in my view.

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Re: Are You Sure About the 4 percent SWR?
« Reply #13 on: January 20, 2013, 06:16:13 PM »
If you have a set amount, the order the years come in doesn't matter.  $10,000 x -7% x -75% x 9% x 20% is $3041 and so is $10,000 x 20% x 9% x -75% x -7%.  That whole transitive power thing.

That's true, in a vacuum portfolio with a spherical investment.

What you are missing is that you are taking withdrawals from it. So in a down year, you then withdraw, and have less money in the portfolio and need an even BIGGER up year to make up for it.

You noticed in your post that it makes a difference when you get what returns when you are adding to a portfolio:
Quote
If you make ongoing contributions, say, $100 a year, the order starts to make a difference.

The same is true in reverse. 

Taking money out when it's down depletes the potential future earning power.
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Re: Are You Sure About the 4 percent SWR?
« Reply #14 on: January 21, 2013, 07:27:02 AM »
There is some evidence that we've crossed/are crossing the threshold to permanent low interest rates and returns.  This seems to be a mix of limits of growth in a world of finite resources, increasing prices of commodities and extraction of them becoming more difficult, etc.  Jeremy Grantham is of this view and has a lengthy track record of correctly predicting major market trends:

http://www.nature.com/news/be-persuasive-be-brave-be-arrested-if-necessary-1.11796?nc=1353050343717

http://www.gmo.com/websitecontent/JG_LetterALL_11-12.pdf

Being optimistic, we can hope that he is incorrect or that new growth comes from other sources, as it often has in the past.  But the premise which began this thread - limited market history as the basis for the 4% SWR - raises the quesiton of whether that entire period, i.e. 1880 - 2008 was itself somewhat of an outlier.

I prefer the crazy optimism of MMM and sources like The Rational Optimist, but I feel it's important to have an understanding of different views and sources of info.  Since I'm some way from FI, I feel I can have optimistic and pessimistic plans with my numbers.  Also have kids to think about and not just my own lifetime.

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Re: Are You Sure About the 4 percent SWR?
« Reply #15 on: January 21, 2013, 07:59:35 AM »
There is some evidence that we've crossed/are crossing the threshold to permanent low interest rates and returns.   

I don't fear that it is permanent but I do mildly fear a scenario like Japan - two plus decades of 0% rates and 0% growth and 50%+ decline in stock market and still have some inflation. 

I think the possible outcome for all of these is low, but not impossible, as the US has a far more dynamic and diversified economy than Japan. A diversified global investment portfolio helps to mitigate this too.   

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Re: Are You Sure About the 4 percent SWR?
« Reply #16 on: January 21, 2013, 09:50:04 AM »
Ooookay, thanks everyone, I was totally missing the fact that Happy said in the beginning "of your retirement."  For some reason I thought we were talking about the acquisition phase.  In which case, I sort of answered my own question as it's the reverse of the contributions of $100 series.  And that's an interesting point too about the historic frequency.

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Re: Are You Sure About the 4 percent SWR?
« Reply #17 on: January 21, 2013, 11:16:30 AM »
TBut the premise which began this thread - limited market history as the basis for the 4% SWR - raises the quesiton of whether that entire period, i.e. 1880 - 2008 was itself somewhat of an outlier.

4% as a reasonable return isn't limited to this period.  If you've ever read Jane Austin, for instance, you'll notice that many of the characters have their money invested in "the four-percents", government bonds returning a 4% interest rate.

Perhaps we should stop thinking about growth entirely, and consider dividends instead.  Some company - Acme Products, say - makes widgets and sells them at a profit to Wile E. Coyote and his friends.  Widgets are consumable, and so there is a steady market, Acme makes a profit, and pays 4% dividends to its stockholders.  Shouldn't that continue to hold true as long as there are coyotes trying to catch roadrunners with Acme products?
« Last Edit: January 21, 2013, 02:57:57 PM by Jamesqf »

Togoshiman

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Re: Are You Sure About the 4 percent SWR?
« Reply #18 on: January 22, 2013, 07:23:54 AM »
The 4% withdrawal rate assumes a certain growth rate in equities and other investments.  If that growth rate is not met, then the previously safe withdrawal rate is no longer safe, i.e. you'll run out of funds before your likely demise.  If you follow the 4% rule, you have baked in assumptions - there is some compelling thought to support the idea that some of those assumptions may no longer hold true and will be even less likely to do so over time.

While I'm no economist, I would also hazard that income in the form of rents, whether that is property or capital investment, relies to a significant degree on net growth of the economy.  Or put another way, Mr. Darcy's 12,000 per year might not stay at 12,000 per year in a 20-year Japan-like deflationary spiral.

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Re: Are You Sure About the 4 percent SWR?
« Reply #19 on: January 22, 2013, 07:52:31 AM »
While I'm no economist, I would also hazard that income in the form of rents, whether that is property or capital investment, relies to a significant degree on net growth of the economy.

Rents are tied to wages.  If wages stagnate, so do rents.

If there's inflation, both should rise, in theory.  If there isn't (and no economic growth either), they may stay flat.
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Re: Are You Sure About the 4 percent SWR?
« Reply #20 on: January 22, 2013, 08:03:49 AM »
And as the consumer, you should be able to adjust your spending accordingly.  If your rents are flat and your net income is flat or declining, everyone's cost of living should be flat as well.  The capital assets are not decumulated and survive to produce income the following year.

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Re: Are You Sure About the 4 percent SWR?
« Reply #21 on: January 22, 2013, 08:07:25 AM »
While I'm no economist, I would also hazard that income in the form of rents, whether that is property or capital investment, relies to a significant degree on net growth of the economy.

Rents are tied to wages.  If wages stagnate, so do rents.

If there's inflation, both should rise, in theory.  If there isn't (and no economic growth either), they may stay flat.

This is generally true except in "Stagflation" environment - this is the worst possible scenario and even with sluggish wages rents might rise because underlying expenses and interest rate will be rising and landlords will need to offset this or risk being cash flow negative (let alone ROI negative).  This may be a low probability scenario (although I think it is greater than the deflationary risk that most are worried about) but it is possible that the relation of rents to income can disconnect.   




Jack

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Re: Are You Sure About the 4 percent SWR?
« Reply #22 on: January 22, 2013, 08:15:43 AM »
Here's a stupid question: given that the situation we're discussing keeps getting compared to Japan, why don't we just look at what Japanese investors are doing about it?

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Re: Are You Sure About the 4 percent SWR?
« Reply #23 on: January 22, 2013, 08:52:15 AM »
What landlords get in rents depends on the market for rentals, not their costs.  If rents rise in a stagflationary environment, it's likely operating expenses will rise faster, because wages control rents.  Fewer rentals will be purchased and some will be sold if the returns don't justify holding the properties.  The supply of rentals will decline, and eventually an equilibrium will be found. 

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Re: Are You Sure About the 4 percent SWR?
« Reply #24 on: January 22, 2013, 08:56:53 AM »
Rents are tied to wages.  If wages stagnate, so do rents.

If there's inflation, both should rise, in theory.  If there isn't (and no economic growth either), they may stay flat.

This is generally true except in "Stagflation" environment - this is the worst possible scenario and even with sluggish wages rents might rise because underlying expenses and interest rate will be rising and landlords will need to offset this or risk being cash flow negative (let alone ROI negative).  This may be a low probability scenario (although I think it is greater than the deflationary risk that most are worried about) but it is possible that the relation of rents to income can disconnect.

Okay, but as the landlord in that scenario, your rents are rising.  And if you have fixed interest rates loans, or free and clear properties, rising interest rates don't matter to you.  Expenses rising does, but, as you point out, in that situation rents may still be rising.

In most economic situations, having rentals is a good scenario, be it inflationary, stagflation, flat (no growth - as AR points out, if your rents aren't rising because there is no inflation, then your costs are the same and you don't need rents to rise), etc.

In a strongly deflationary environment would you not want them, as the prices of the assets (houses) themselves would be dropping as well as wages (and thus rents).  But what investments are good in deflation?  Not much, besides cash or equivalent.  But in most other scenarios, rentals are so tied to wages that they have natural protections against inflation.
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Re: Are You Sure About the 4 percent SWR?
« Reply #25 on: January 22, 2013, 09:18:10 AM »
Another piece of advice I read somewhere was to have 2-3 years of expenses saved to live off without starting to withdraw, so that it the market drops as soon as you resign, you can wait it out hoping for recovery before you have to start withdrawing.

Unless the recovery takes much longer than your cash buffer.  Perhaps this is an argument for a portfolio heavily weighted (maybe more than 50%) in TIPS?

At the end of the day the safest habit seems to be to always, always live on less than you earn ie try to keep that net worth going up even in retirement.

Agreed.  And for my own situation, I've decided that it may not be enough to just save a lot as a percentage of your income: you truly need to get your absolute costs down to near-MMM levels to have a worry free and fun early retirement.  That is, we can argue about SWR all day, and since no one can predict the future, there really is no way to derive the right answer.  So the safest approach is to "work" just enough to cover expenses, and let the investment portfolio continue to grow.  As mentioned, this is basically what MMM does.

The thing with getting your absolute costs down is this: presumably, you want to retire from the corporate grind or working for The Man or get away from full-time or something along those lines.  Basically, you want what I call a "hobby job": for MMM, this is carpentry and blogging.  It's different for everyone.  But I believe that the total income in a hobby job is fairly low.  That is, if your expenses are maybe $40k/year or higher, your "retirement job" will be less like a hobby, and look a lot more like the average guy's full-time gig.  But if you get your expenses down to MMM levels, then it's much easier to cover expenses... two people earning minimum wage could just about cover it.

There are exceptions, of course, your hobby job could become a runaway success (as MMM has suggested his blog is).  But I wouldn't plan on that happening.  Perhaps, what you do once you are FI is best described as a continuum, with pure hobby on one end and full time work for The Man on the other end.  Generally speaking, pay scales proportionally to where you land on the continuum.  The strategy after FI is to land as close to "pure hobby" as possible, while still covering living expenses.  The lower your expenses, the easier this will be.

tooqk4u22

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Re: Are You Sure About the 4 percent SWR?
« Reply #26 on: January 22, 2013, 09:18:28 AM »
What landlords get in rents depends on the market for rentals, not their costs.  If rents rise in a stagflationary environment, it's likely operating expenses will rise faster, because wages control rents.  Fewer rentals will be purchased and some will be sold if the returns don't justify holding the properties.  The supply of rentals will decline, and eventually an equilibrium will be found. 

Typically this is true that wages drive rents in both inflationary and deflationary times - but this becomes disconnected during stagflation.  People still need a place to live and expenses will rise for all property owners, not just rentals. Rental profitability will wane initially, then supply will be slowed or reduced as it the ROI will not justify the cost to build, and rents will rise to minimally keep pace with the inflating expenses - meanwhile incomes have either stayed the same or declined during this period. 

As you say, it will balance out because as the supply subsides people will migrate to doubling up or multigenerational households......hmmmm that is kind of going on now....rents are rising fairly fast, underlying operating expenses are growing, incomes aren't growing, and economic activity is growing slowly, BUT we are not stagnating currently.  Also there is an abundant supply of homes nationally that is keeping rents in check (rents would be rising faster if not for this) as they are turned to rentals or sold cheaply (so owners equivelant rent is decling while rents are rising) and there is more supply being added in the multifamily space. The supply issue is creating deflationary pressures on real estate right now which is being offset by monetary easing by the fed to create inflationary pressures - as such housing prices have stabilized for now.



tooqk4u22

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Re: Are You Sure About the 4 percent SWR?
« Reply #27 on: January 22, 2013, 09:31:38 AM »
Okay, but as the landlord in that scenario, your rents are rising.  And if you have fixed interest rates loans, or free and clear properties, rising interest rates don't matter to you.  Expenses rising does, but, as you point out, in that situation rents may still be rising.

This is true - during stagflation your expenses will rise faster than your rents (the link to wages is not completely disconnected) but if you have held your real estate for a while and have long term fixed rate debt that is conservatively leveraged then you will be able to withstand this period recognizing that your net cash flow from your property is probably flat but the inflation part is eroding the value of that net cash flow but should be increasing the value of the property itself.

Stagflation would be disasterouse if it happens within a short time of buying, use of high leverage, and/or variable rates. 


[/quote]
In most economic situations, having rentals is a good scenario, be it inflationary, stagflation, flat (no growth - as AR points out, if your rents aren't rising because there is no inflation, then your costs are the same and you don't need rents to rise), etc.

In a strongly deflationary environment would you not want them, as the prices of the assets (houses) themselves would be dropping as well as wages (and thus rents).  But what investments are good in deflation?  Not much, besides cash or equivalent.  But in most other scenarios, rentals are so tied to wages that they have natural protections against inflation.
[/quote]

Agree with this too - defalation is bad for rentals and inflation is good, the issue is the inbetween. 

Keep in mind that Stagflation, in any economy, is a relatively rare occurence - but it has and can happen and I can see the possibility for the US (again low).

chucklesmcgee

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Re: Are You Sure About the 4 percent SWR?
« Reply #28 on: January 22, 2013, 11:00:29 AM »
It may not be necessary (or even practical for most people), but I think it would be a fun goal to get to a 0% SWR.  Besides, it isn't impossible: MMM has mentioned in some of his articles that his net worth is still going up, even in (pseudo-)retirement.

I believe Jacob from ERE hit this- what was his figure, 15 times annual expenses? That required some aggressive return estimations I believe.

Honestly that's my goal. Hit 0% SWR, do whatever's fun and inflate my lifestyle if needed.

DoubleDown

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Re: Are You Sure About the 4 percent SWR?
« Reply #29 on: January 22, 2013, 12:51:27 PM »
That is, we can argue about SWR all day, and since no one can predict the future, there really is no way to derive the right answer.  So the safest approach is to "work" just enough to cover expenses, and let the investment portfolio continue to grow.  As mentioned, this is basically what MMM does.

The thing with getting your absolute costs down is this: presumably, you want to retire from the corporate grind or working for The Man or get away from full-time or something along those lines.  Basically, you want what I call a "hobby job"

This is huge, I completely agree. Of course, you will get lots of argument that you are not "retired" because now you are having to work to meet your income needs.

If one is retiring early (i.e, at a fairly young age), then earning some income on the side seems pretty natural for most. It doesn't have to be a lot of money. Earning just a small amount on the side could nearly or completely offset the marginal amount you would have to deplete your capital during a string of bad years, and would just add a larger safety margin in good years. I imagine few of us are doing or contemplating doing absolutely nothing to earn a little extra money, post-working for the man.

I'll add one thing: the practically idiot-free approach (barring large scale economic collapse) in order to avoid bad sequencing up front, is NOT to be heavily allocated in investments that are subject to large downward (or upward) swings, and continue to add to the stash through what you've called hobby work the first couple of years. I have no intention of having the majority of my portfolio in stocks when I ER, especially given the volatility of recent years. I'll keep it to a fairly small percentage overall (say, 20-30% of portfolio) to help combat inflation, but the majority will be in investments that are (near-)guaranteed NOT to lose money and will likely rise only modestly (bonds, govt. securities, real estate...). Then, in later years, one could decide if they want to become a little riskier with their investments when the horizon for the rest of your life is shorter, and bad sequencing cannot devastate the long term picture.

That way, I can accurately gauge each year what my SWR is, without having to worry about cutting my expenses in order to weather a shitty 10- or 20-year period of flat or even negative stock market returns, or finding I'm broke in old age because of bad sequencing up front. The biggest "threat" will be whether investments are adequately keeping up with inflation over the very long term. But get this: Inflation will be a non-issue to me 20 or 30 years from now, when I will be completely comfortable with starting to deplete capital, knowing that I won't have many more years to have to make it last! Depleting capital radically in the first 5 or 10 years through bad investment returns?? Yeah, not such a fan of that...

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Re: Are You Sure About the 4 percent SWR?
« Reply #30 on: January 28, 2013, 05:15:58 AM »
I think those who focus solely on SWR miss the point - you need to be flexible.  I can't imagine too many people continuing to increase their drawdowns by the rate equaling whatever the last year's CPI was even if their investments tanked.  The obvious response to such a situation would be to reduce expenses as much as possible and / or put in some work generating some $$$ to offset the cost of living.  It's still far better than *having* to go to work 40 hours a week doing something you don't like at all, isn't it?

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Re: Are You Sure About the 4 percent SWR?
« Reply #31 on: January 30, 2013, 11:54:33 AM »
Couldn't you get around bad times in the market by having a portion of your stash in Cash investments?  That way, if the markets go down a lot, you could use the Cash investments and not take money out of those investments that had decreased a lot.

tooqk4u22

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Re: Are You Sure About the 4 percent SWR?
« Reply #32 on: January 30, 2013, 12:11:12 PM »
Couldn't you get around bad times in the market by having a portion of your stash in Cash investments?  That way, if the markets go down a lot, you could use the Cash investments and not take money out of those investments that had decreased a lot.

You could but then you would be depressing your overall returns and subjecting it inflation - bonds, reits, metals/commodities, are better for this.

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Re: Are You Sure About the 4 percent SWR?
« Reply #33 on: January 30, 2013, 12:31:30 PM »
Couldn't you get around bad times in the market by having a portion of your stash in Cash investments?  That way, if the markets go down a lot, you could use the Cash investments and not take money out of those investments that had decreased a lot.

There have been studies of using a "cash buffer" in retirement, yes.

In general it's an inferior strategy numerically, but many retirees have 2-5 years expenses in cash so they don't have to sell when the market's down as more of a psychological thing than a math thing.
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Re: Are You Sure About the 4 percent SWR?
« Reply #34 on: January 30, 2013, 01:00:02 PM »
Quote
There have been studies of using a "cash buffer" in retirement, yes.

Can you point me to any of these?
See, I've often vaguely wondered about the value of having a cash buffer combined with market timing.  That is, you take a cash buffer for say 2-5 years, but if the market goes down  x percentage, you plow a portion of it back in the market (or into another investment opportunity that seems particularly promising) then and live off the remainder without drawing down until you have to.  When the market goes goes back up you slowly replenish your 2-5 year buffer.  This is sort of my current version of an emergency fund.  I keep one, but I'm equally willing to consider it an opportunity fund if there's a good investment opportunity and then I just slowly replenish the emergency fund with gains from investments later figuring I could get by with a LOC or other e-fund option in the interim.  It's sort of both a psychological net for me for both wanting to have some extra cash in case of emergencies OR a really good investment opportunity.  But I don't really know if it's just what keeps me happy or if there's a real benefit to it.

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Re: Are You Sure About the 4 percent SWR?
« Reply #36 on: January 30, 2013, 02:17:05 PM »
I do keep cash reserves in an account that is subject to RMD's.  The cash reserve is flexible, but is at least one year's worth of RMD's.  If the market tanks 50 percent, I'm not forced to sell to take the RMD.  The worst scenario is a high value on December 31 that sets the RMD for the following year with a crash in January.  Usually there is more cash there because I'm looking to buy on sale or I'm not confident there won't be a major pullback.  It's an insurance policy priced at the opportunity cost.

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Re: Are You Sure About the 4 percent SWR?
« Reply #37 on: February 03, 2013, 07:38:11 AM »
Can you point me to any of these?
See, I've often vaguely wondered about the value of having a cash buffer combined with market timing.  That is, you take a cash buffer for say 2-5 years, but if the market goes down  x percentage, you plow a portion of it back in the market (or into another investment opportunity that seems particularly promising) then and live off the remainder without drawing down until you have to.
You're describing the technique of value investing.

twinge

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Re: Are You Sure About the 4 percent SWR?
« Reply #38 on: February 03, 2013, 08:17:41 AM »
Quote
You're describing the technique of value investing.

Do you know of any evidence about the effectiveness of this approach to value investing? It seems different to me than just market timing or just holding a cash buffer-- as I would be varying my consumption patterns and adjusting my psychological need for security of having an emergency fund (that is those things that I can control) based on a pre-set definition of how far the market is varying from the point at which I started living off my investments instead of earned income.  But maybe that's just semantics and my own way of trying to justify that my particular brand of  market timing works?


AR--I like that idea of a cash buffer equivalent to RMD (not that I'm anywhere near the age where that matters yet but I like to worry as far in advance as I can :) ).

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Re: Are You Sure About the 4 percent SWR?
« Reply #39 on: February 03, 2013, 07:51:47 PM »
Do you know of any evidence about the effectiveness of this approach to value investing?
Yeah:  Berkshire Hathaway.  It'd work great if you're willing to keep up with the reading & research, and if you have nerves of steel to invest that "spare" cash in times like March 2009... or in late 2008 when nobody expected that things could possibly get worse.  Nothing quite like the feeling of buying a dollar for 80 cents, only to watch the price drop to 60 cents a few months later.  Or so I've heard.  But then I didn't have Lehman, GE, BofA, and Goldman Sachs calling me up to pitch preferred shares with warrants.

Most humans can't act as rationally as Bogle, let alone Buffett.  For the rest of the human race it's probably best to invest regularly for retirement in low-cost index funds according to an asset allocation (including value assets).  In retirement it's probably best to annuitize a portion of the portfolio, to keep the rest of the portfolio within a tolerant band of asset allocation, to spend less during down markets (Bob Clyatt's 4%/95% plan), and to have a separate emergency fund for... emergency use only.  We keep two years' expenses of our ER portfolio in cash because that's the average length of a bear market.  But then I can also slam my wallet shut pretty quickly when sentiment turns negative.

I've read quite a bit about investor behavioral psychology, and it makes you extraordinarily pessimistic about the future of the human race.  I'm highly skeptical that most retirees would coolly assess the economy in March 2009, rationally project the survivability of the remaining four years of their cash stash, and invest half of that into anything other than a coffee can buried in the back yard... or MREs & shotgun shells.

But, hey, the more you read about Graham & Buffett, the more capable you may be of rising above the performance of the average investor.

Tyler

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Re: Are You Sure About the 4 percent SWR?
« Reply #40 on: February 03, 2013, 09:28:36 PM »
But what investments are good in deflation? 

Long-term treasury bonds.

Much of this discussion reminds me of why I like the Permanent Portfolio. 
« Last Edit: February 03, 2013, 09:32:11 PM by Tyler »

arebelspy

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Re: Are You Sure About the 4 percent SWR?
« Reply #41 on: February 03, 2013, 10:44:37 PM »
But what investments are good in deflation? 

Long-term treasury bonds.

Much of this discussion reminds me of why I like the Permanent Portfolio.

Wouldn't you categorize that as "cash or equivalent"?  I find the PP intriguing, tempting even, especially for a "safe" long term ER. I wouldn't use it during a growth/acquisition phase though, personally.
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Re: Are You Sure About the 4 percent SWR?
« Reply #42 on: February 03, 2013, 11:06:42 PM »
In the PP, short-term treasury bonds serve as cash.  Long-term bonds are a different animal -- they're just as volatile as stocks (but often rise when stocks fall).  They're a critical part of the non-correlated modern portfolio theory rebalancing strategy that makes the PP tick.

The PP isn't for everyone, but I've personally found it to be very beneficial to my investing sanity as it really does smooth out the peaks and valleys while providing decent real returns.  I'm sure I could earn more with other strategies (along with higher risk of losing more) but for me the concept of "enough" investment returns falls right in line with the Mustachian concept of "enough" spending and savings.  And the smoother ride should make ER a bit less stressful.



« Last Edit: February 03, 2013, 11:26:42 PM by Tyler »

tooqk4u22

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Re: Are You Sure About the 4 percent SWR?
« Reply #43 on: February 04, 2013, 09:10:05 AM »
I am extremely bearish on the PP given the enormous tailwinds that have benefited gold and treasuries over the last 20 years - and there is more downside to this portfolio than people think.

Furthermore, even with those tailwinds the PP has lost out to a portfolio 100% invested in equities and one invested 60/40 equities/bonds (although I still would have issues with the bonds in this environment when forecasting future returns).  But was a smoother ride with PP.


Your money, your choice but the PP will significantly underperform going forward.

Tyler

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Re: Are You Sure About the 4 percent SWR?
« Reply #44 on: February 04, 2013, 10:13:43 AM »
It's easy to predict the winning investment in retrospect. I'm less confident in my ability to see the future.

You're right - to each his own.  How to invest is always controversial -  if there was one clear-cut winner everyone would be doing it.  I just bring up the PP as an option for those in this thread concerned about volatility.  I've been pleased not only with results but also with the rationale behind the portfolio in general.