Sequence of Return Risk

Blowed if I know what percentages apply or if they are even relevant.

I work on the concept of $xx in v $yy out and as long as $xx is larger than $yy I don't care much.

 

Dynamic is the key.

Valuation driving the dynamism is the optimization, Uber driver sentiment is close enough when the numbers aren't tight.

Forcing a fixed income stream from a volatile asset base is super inefficient.

The real risk of Inflexible and fixed withdrawal rates of 3% and below is probable excess compounding to ridiculous accumulation levels at death (hence missed opportunity to spend and enjoy when you have health, energy, and ability of younger age)


Accumulating is easy – set the asset allocation for efficiency and head down bum up on the savings rate. Its all you can sensibly do. Accept that fate will have more influence on the output of the accumulation process than any tweaks you make to the inputs.


When to stop accumulating and how much you can spend from the accumulated portfolio are the more interesting and influence-able questions. Get these judgement wrong and you can needlessly waste or at least under-utilize a lot of good years.


Not forgetting that even the 4% rule produces minimal probability of running out of cash in worst case historical scenario whilst forcing an inflation adjusted fixed income steam.


Given that you are much more likely to die with 5x your starting balance with the 4% rule than run out of money; and given that Australia has a decent pension safety net; and given dynamic models produce much more efficient spending outcomes – I think most people over accumulate/under spend capital. (I stand guilty)


A bit of spending flexibility, a dynamic withdrawal plan, Acceptance that fate can override almost anything you put in place to “ensure” a positive outcome and faith that community(government) will provide a safety net if your life span encompasses a far left tail occurrences and 3.5% (or even 4%) is most likely already trading good current years for super wealthy old years. Is that a good trade or is that a trade driven mainly by fear?

 

I just want to say that once again @dunno you have a way of making me see the issues I haven't quite grasped or thought about enough that really helps me figure out my own priorities, goals, risk tolerance, etc. Thank you.

 

JUST HOW SAFE ARE ‘SAFE WITHDRAWAL RATES’ IN RETIREMENT?
PDF

This study considers one of the cornerstone questions in the retirement income debate; namely, what’s a safe withdrawal rate for retirement? This question is of particular importance to Australia’s superannuation system, which is characterised by having compulsory contributions during the retirement saving (or accumulation) phase, but no compulsory requirement to annuitise lump sums at the commencement of the retirement income (or distribution/decumulation) phase. As a result, many retirees face a classic asset–liability mismatch, the need to fund relatively short- and medium-term retirement spending needs with a longterm investment strategy. This study tests one of the most popular heuristics that have arisen from the safe withdrawal debate, specifically the 4% rule. Our findings question the validity of this approach using historical international return data

 

still assumes just 50% allocation to equities?

 

For brevity, we only report the 50:50 results in this paper

Looks like they may have trialed various allocations, but only added in the 50:50 to the paper

 

found this also

https://asifprod.blob.core.windows....-australian-perspective.pdf?sfvrsn=2ffb874a_4

 

That was quite a poor "research" article. It added nothing of actual use and showed no critical thinking at all. I thought it might have some interesting analyses like including franking credits or internationally diversified portfolios but was just a run of the mill simple analysis of existing data with nothing new added or deeper insight. Where is the discussion on integrating the age pension, annuities etc.?

Note that the "journal" it is in is not a real journal, it's a griffith university one. Personally I would pay no attention to it. To be honest I'm becoming much more strict on what I read in the finance space as there is too much crap out there. For retirement work I stick to people like Michael Kitces who I feel has a good grasp on the middle ground between over and under spending. His recent guest spot on the rational reminder podcast was a great one.

 

Hi @Ross36

I am a bit with you on limiting width of reading now days in relation to withdrawal rates

One problem appears to be that even the academics seem to love rigid inflation adjusted withdrawal amounts. It is the assumption that allows the data to be mathematically modeled. But reality is that forcing a rigid income stream from a volatile asset is highly inefficient. You must have your straight-line set below the worst example to avoid failure. It is easy to scour history across multiple countries or imagine a future scenario to achieve a terrible data point that requires a very low line to avoid ruin at that point, problem is that for every other data point you over save/under spend.

There also seems to be a lot of people trying to create internet revenue that basically seem to have no idea and are coming up with nonsensical opinions to justify low withdrawal rates for click value. Fear seems to generate the interest they are after.

Personally, I’ll skim an article or paper but if it isn’t addressing the elephant in the room which for me is mortality probability v ruin probability, or an efficient way to address risk of running out which could be dynamic withdrawal or fixed/insured streams etc then I’m not interested.

........................................................................................

Death – The Elephant in the room.


This is a 4% withdrawal over 50 years 80/20 shares/bonds with a 21% failure rate which most people seem to jump up and down about as being unacceptable and throw 4% out with the bath water.

Thing is the biggest risk of running out occurs 30 years after retirement at age 80 and it is a 3.1% chance vs a 48.8% chance of being dead. At the same time, you have a 20.7% chance of having at least 2x your inflation adjusted starting balance.

Dynamic spending.

Introducing a simple flex spending parameter of 20% spending reduction if your starting balance in inflation adjusted terms drops below 80% of starting value. The red streak of ruin becomes not even visible. Worst case probabilities now occur at 90 when have a 0.2% chance of being broke vs a 84.1% chance of being dead, otherwise you will be old and rich.



Eliminating all chance of running out of money (as if that would even be possible) when Australia has a pension system is a stupid waste of precious time in many circumstances, mainly driven by fear. If the pension isn’t designed for a 90-year-old who prepares for 99% of possibilities but gets undone by fate, who is it for?

Engaging data.com's visualization calculators are great tools for getting the big picture feel (without crunching raw data yourself) for anybody interested.

 

Such wise words above. And great visuals.

I ended up retired last year a little earlier than planned. Explaining across the fence to my (retired) neighbour that “ideally I would have preferred another year or two in the workforce”.

his reply “ and what if you end up dying a year or two earlier than you preferred? That’s not ideal either is it?”

 

Ain’t that the truth. I’ve stopped reading near all of them.

As usual brilliant post @dunno. Cuts through much of the SORR bullsh*t out there whilst offering a very pragmatic approach to the issue.

Time is our most valuable asset. Your research, analysis and conclusions supported by data, sensible reasoning etc is of great value in helping others avoid loss of that precious resource “time” through working to accumulate more wealth than necessary based purely on fear!

 

Such good analysis with the additional dimension on probability of death and in a few charts. Thanks a lot @dunno

 

Great analysis @dunno

It begs the question. What genetic factors / lifestyle factors are most predictive of lifespan?

How do I build a lifespan probability table for me.

 

google life span calculator, maybe do 10 of them and average the results?

 

I tried this calculator today and I blamed it for my taking up drinking wine to gain an extra 1.3 healthy years.

87 years of being healthy and 97 years longevity.

True Vitality Test by Blue Zones

 

So logic would suggest that the more you drink the greater the number of extra healthy years.

 

In retirement planning I worry that at an advanced age - say 95 years old - (I’m 69 now) I would still need sufficient assets and income left to fund entry into an assisted care nursing home whilst my partner would still need income to fund her retirement without In any way selling the family home. Most financial / retirement plans I’ve seen use a “glide path” approach to the assets but never show any large lump sum requirement or significant nursing home expenditure late in the plan.

 

Hi @Ynot

We can make reasonable stab at your scenario using time value of money functions in EXCEL and the 4% guideline.

We know with the 4% guideline was tested for a 30-year period and it fail point is $0.

So, we can work out the implied inflation adjusted return which is 1.2%.




Now that we have calculated the inflation rate implied by the 4% guideline we can apply it to your situation. Lets assume you want 500K at 95.

We can work out the Present Value you need today if you want to take 40K for 26years and have 500K residual which is approx 1.25M or a SWR of 3.2%



Its well worth learning how to use the time value of money functions in EXCEL to run personal scenario's. Whilst its still a guess because the future is unknowable and therefore the years and rate values must be best guesses it is still a lot better than a non quantified guess at the SWR rate.

 

Perhaps a reverse mortgage? Wife gets to stay in home and equity funds entry into nursing home. Hence no or less additional retirement savings required to fund this potential event.

 

Thanks for the detailed reply - I'm glad others feel the same way. It's easy to forget that having a platform doesn't imply expertise, and that you have to be very careful paying attention to bloggers. I used to listen to podcasts like Choosefi and others, then realised that they have very little idea of what they are talking about but are experts on building their platform and revenue generating. Not to say the Kitces and Pfau's of the world are doing it for the love only, but at least the depth of knowledge and expertise they have guarantees you'll pick something useful up from them.

I'm similar - it's the whole mortality vs ruin argument. However for me it is more about my partners long term health as unfortunately she has a genetic condition which will result in requiring long term care at some stage in the next 20 years. I hope that I am still alive and cognisant to be able to work things out then, but need to figure out a plan now. We're well on the way, but it comes back to:

1. How much do you really need? Time is the most important asset we have.
2. Because of this - why the 5% failure rate? If someone said to you that you have 2 options

1. "I am 80% sure you could stop working now and never have to work another day in your life and still be financially comfortable"
2. "You can work another 5 years and then I'll be 95% sure you will never have to work another day in your life and still be financially comfortable"

which do you choose? For me the clock is ticking with the health situation, so is it worth giving up another 5 years to still be uncertain? I'm a scientist by training, so the small sample size of data we have on SWR, plus the arbitrary nature of the 5% threshold, are problematic for me. All these set SWR numbers are really plucked from the ether given the unknowns, and are too static for me to put much confidence in.

We often forget how lucky we are with the age pension, pension loan scheme, free healthcare etc. etc. Really what is financial ruin for a 67yr old who is good with money in Australia? I know a lot of my parents friends who are atrocious with money, rent their accomodation, smoke and drink and live on welfare and live what is for them comfortable lives. If you can make your money last to pension age, own a PPOR, and are happy to move to a low cost of living location the safety net for us is really quite fantastic. So why should I be so scared of a 5% or even 20% risk of investment "failure"? And if things go bad prior to that age, what are the odds I can't make any more money ever in my life? I can't mow lawns? If not, can I get disability pension support?

This is along the lines of Michael Kitces's recommendations, having guardrails in place makes so much sense. I've been setting up a lot of "if then" decision rules that I am confident I can stick to, and if something happens to me then my family can too. By combining shares, modest leverage and mortgage offset while younger with possible annuities, the pension loan scheme and the age pension when older there's a lot of possibilities to ensure we have a comfortable life.