Sequence of Return Risk

I had a private message where I had confused the person by presenting the charts in multiples.

I have assigned each multiple to be worth 80K and have changed the chart for my final choice of 5% or minimum 1.25x to display in dollar amounts, hopefully that will make a bit more sense in understanding what I was on about.

Also changed the Y scale from log to nominal so the range of paths is a bit more obvious.

safe withdrawal amount ranges between 100K and approx 1.2M depending on return sequence.



Lowest Capital is about 500K at the last point (44 years after retirement) best is about 24M. every thing is calculated on real returns ie todays purchasing power terms. so that 24M might actually be 50M in the future but equivalent to 24M today. The big dives that roll through the charts are the early seventies stagflation - it was by far the worst time for equities in Aus but the run up in the 60's prior would have been pretty sweet and created the greatest peaks. The real problem would have been if you missed the run up but caught the fall.

I couldn’t post the charts on a private reply – hope you see the response here.
Sorry for any confusion caused, I’m not the greatest at explaining what's going through my head.

 

I can't help but think that those charts would look like my brain function after too much home brew.

 

To add to your light reading list

Philip L. Cooley, Carl M. Hubbard and Daniel T. Walz back tested a variety of portfolio allocations and withdrawal rates between 1926 and 2009, they published Portfolio Success Rates: Where To Draw The Line in the Journal of Financial Planning

Guyton and William J. Klinger published Decision Rules and Maximum Initial Withdrawal Rates. in a 2006 research paper, essentially you take more off the table in bull markets and a little less in bear markets, it’s supposed to provide retirees with greater overall income

What's it all mean to me, not much in the accumulation phase, but it is interesting

 

Cooley article looks at how much risk is acceptable so above 75% = the portfolio doesn't run out of money 3 out of 4 times. I suppose this depends on the risk profile of the retiree, but if you want 100% certainty you might be working a lot longer. And then the risk of dying young and your money outliving you....

 

Beyond the Financial Planner's advice of 75% of your final income, I've also been reading about the rule of 300 as a guideline

Take the amount you spend each month and multiply it by 300, the answer is a rough figure of what you'll need in retirement to keep up with your current lifestyle (sans federal and local government fees and changes, medical expense/insurance increases and a 100 other items that increase above the oft touted CPI, you also need to consider a correction or crash over that timeframe as well as an extended bear market).

Example..you currently spend around $5,000 per month (or $60,000 per annum), then under the rule of 300 you need $1,500,000.00 in savings to ease back and still pay the bills.

You throw in inflation to increase your drawdown each year i.e if inflation is 3% the next year you withdraw $61,800 over the year ($60,000 x 103%). The assumption here is also that your portfolio is growing every year to help compensate for withdrawals

That amount should last you for the next 25 years, if you retire at 65, your retirement funds will last until you are 90, if our portfolio grows by more than 4% a year, then your funds will last longer than the 25 years.

The rule of 300 is based on the SWR of 4%

Some great links here

jlcollinsnh – Stocks — Part XIII: Withdrawal rates, how much can I spend anyway???

MMM – The 4% Rule: The Easy Answer to “How Much Do I Need for Retirement?”

Investopedia – Four Percent Rule Definition

If you think 4% is too high and you prefer a 3% SWR, try the rule of 400

Then again, I like the retirement strategy by @austing in which you have more income/dividends coming in than you can spend, along with a cash buffer for any dark ages ahead

 

Howard Marks in His Oaktree Memo's also has a great article called getting lucky

Buffett called his luck winning the “Ovarian Lottery”

The Fool also has an article The Hard Truth: Successful Investing Involves a Lot of Luck
Timing is everything.

 

Speaking of jlcollinsnh I purchased his book (The Simple Path to Wealth) based on the recommendation of Taylor Larrimore of Boglehead fame. This is what caught my attention in the book:

"the smooth ride most mistake for safety" is typically Bonds as a volatility dampener. In reality which is the smoother ride: Stocks + Bonds attempting to smooth capital volatility Vs Dividend Income? I choose Dividend Income.

Of course the quote above is based on US dividends where taxation penalises dividends. In Australia the yield is higher and further boosted by franking.

But as usual there's no perfect solution, it depends on each individual's circumstances both financially and psychologically.

 

On Bonds & Stocks and a 4% Withdrawal rate

Just had a quick look at Portfolio Visualizer (US based), worth a look for interests sake

60% US Stocks, 40% US Bonds allocation, $100,000 invested as at 2001.

4% Withdrawn annually and Portfolio Re-Balanced Annually

As at 2017 the Portfolio is worth $254,770.

Initial Balance $100,000
Final Balance $254,770
CAGR 5.77%
IRR 6.01%
Stdev 8.60%
Best Year 20.37%
Worst Year -20.20%
Max. Drawdown -30.72%
Sharpe Ratio 0.58
Sortino Ratio 0.85
US Mkt Correlation 0.98​

Then Inflation Adjusted



And Logarithmic Scale



Annual Returns


And Withdrawals


This online portfolio back-testing tool allows you to construct one or more portfolios based on the selected mutual funds, ETFs and stocks to analyze and back test portfolio returns, risk characteristics, standard deviation, annual returns and rolling returns.
The results include a visualization of the portfolio growth chart and rolling returns, CAGR, standard deviation, Sharpe ratio, Sortino ratio, annual returns and inflation adjusted returns. A periodic contribution or withdrawal can also be specified together with the preferred portfolio rebalancing strategy.
You can also analyze and compare asset class based lazy portfolios with a longer time horizon starting from 1972.

 

The Ultimate Guide to Safe Withdrawal Rates

We just calculated over 6.5 million safe withdrawal rates. Well, not by hand, of course, but by writing a computer program that loops over all possible combinations of retirement dates, and other model parameters.

 

Portfolio Success Rates: Where to Draw the Line

Executive Summary

• Portfolio success rate analysis provides the information needed to plan withdrawals from a retirement portfolio. Because financial markets and other matters of life change unexpectedly, those plans are likely to change.
  
• This updated analysis reports portfolio success rates net of monthly withdrawals through a range of payout periods. The data we rely on are total returns to large-company common stocks and high-grade corporate bonds as well as Consumer Price Index values and inflation rates from January 1926 through December 2009.
  
• We conclude that if 75 percent success is where to draw the line on portfolio success rates, a client can plan to withdraw a fixed amount of 7 percent of the initial value of portfolios composed of at least 50 percent large-company common stocks.
• The sample data suggest that clients who plan to make annual inflation adjustments to withdrawals should plan lower initial withdrawal rates in the 4 percent to 5 percent range, again from portfolios of 50 percent or more large-company common stocks, in order to accommodate future increases in withdrawals.
• Changes in withdrawal rates or amounts can be made in response to unexpected changes in financial market conditions using the basic tables we provide.

 

Does International Diversification Improve Safe Withdrawal Rates?

by Wade Pfau

 

A great write up below

Where’d the 4% rule come from, anyway? (Hint: it wasn’t the Trinity Study.)

Interestingly also was that William (Bill) Bengen made an update to the rule to increase to 4.5% if looking at 30 years of retirement - I'm Bill Bengen, and I first proposed the 4% safe withdrawal rate in 1994. Ask me anything!

 

A two page primer from Blackrock

Sequence of returns

 

@Redwing given a lot of interest in this subject are you considering early retirement?

 

@Nodrog

Should that be No Grog

 

I think a lesson from a lot of this stuff is that the danger zone is close to retirement and the early stage of retirement. Having enough cash / bonds to avoid having to draw on equities if the market tanks during these dangerous times seems wise.

 

Or just even... work a little.

 

Yes, that is a message I am hearing loud and clear through all these threads is to always have eyes open and be measured in the approach. And as @Gockie mentions, always be ready to pick up an alternate income stream to help smooth the transition.

 

Sequencing risk and ways to manage it - Cuffelinks

Interesting article on ways to manage or minimise sequence of return risk when approaching retirement.

 

YOUR HOME COUNTRY IS INSEPARABLE FROM YOUR WITHDRAWAL RATE