The continued viability of the 4% rule in the US in the 21st century

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jacob
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The continued viability of the 4% rule in the US in the 21st century

Post by jacob »

http://www.ft.com/cms/s/0/ab4d28c4-3872 ... 6126f.html (FIRE trajectory not starting out well)
http://retirementresearcher.com/the-sho ... he-4-rule/ (not representative anyway)
viewtopic.php?f=3&t=7829 (underlying issues)

And of course the generally ignored fact that the Trinity study only covered 30 years even if it's widely assumed to last forever in much of the FIRE community.

enigmaT120
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Re: The continued viability of the 4% rule in the US in the 21st century

Post by enigmaT120 »

Oh well. Fir trees return something like 6% per year. That's actual growth, not necessarily more money.

cmonkey
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Re: The continued viability of the 4% rule in the US in the 21st century

Post by cmonkey »

Any way to read ft without paying?

jacob
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Re: The continued viability of the 4% rule in the US in the 21st century

Post by jacob »

Googling the title and entering via google often works: us risks future of low growth says imf

IlliniDave
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Re: The continued viability of the 4% rule in the US in the 21st century

Post by IlliniDave »

I've got plenty of fir trees...

I abandoned 4% almost immediately after I first heard of it because I was looking at potentially up to 40 years, and I've believed for quite some time that future US market returns will be muted relative to history. There have been updates to the Trinity Study that show 3% is pretty robust out to 40 years, but they rely on historical data, which, if not fatal, is a noteworthy flaw. I made up my own Monte Carlo sim and decided 2.5% or lower suits my disposition. I project now that I'll average that if I ER today, but the problem is I'm front-loaded (~4.5% for 15-17 years then <0.5% forever after). Makes me more vulnerable to sequence of return risk.

One adaptive strategy is just not to be robotic about the withdrawal rate/use of Trinity method, and be willing/able to lower spending in response to circumstances (so-called VWR strategies). That's not terribly different than my approach of supersizing a little, just a matter of building in margin.

One can also take on more risk by investing in lower-priced markets to attempt to recoup some of what the US may not produce in returns.

cmonkey
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Re: The continued viability of the 4% rule in the US in the 21st century

Post by cmonkey »

IlliniDave wrote:One adaptive strategy is just not to be robotic about the withdrawal rate/use of Trinity method, and be willing/able to lower spending in response to circumstances (so-called VWR strategies). That's not terribly different than my approach of supersizing a little, just a matter of building in margin.
I think this 4% rule is geared entirely toward people that outsource all their financial planning, since that is the majority audience. Get the bulk of them through. There is no substitute for frugality, flexibility and simply paying attention.

For example - Lending Club loan demand has absolutely tanked and there are only a few hundred loans available at any given moment. My filters didn't pick anything up for the past couple weeks and I was building up cash. Since I was paying attention I just adjusted my filter to include lower rate loans (B). Slightly lower return is better than cash sitting around.

I like the long term graph in that retirement researcher article. Based on that 4% looks pretty good if you don't outsource.

IlliniDave
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Re: The continued viability of the 4% rule in the US in the 21st century

Post by IlliniDave »

cmonkey wrote: I think this 4% rule is geared entirely toward people that outsource all their financial planning, since that is the majority audience. Get the bulk of them through. There is no substitute for frugality, flexibility and simply paying attention.
I think the withdrawal strategy that underlies the Trinity Study was chosen just because it is simple to implement for the purposes of the study's number-crunching and easy to understand. Mostly it seems like a planning tool for intermediate-/long-range planning. I don't think anyone actually uses it prescriptively unless, like you say, they pay for some sort of automated financial service.

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Re: The continued viability of the 4% rule in the US in the 21st century

Post by jacob »

@iDave - The 4% rule combined with Vanguard all stock market (domestic and international respectively, 50/50 or 75/25) is taken by many readers as prescriptive fire-and-forget gospel in much of the blogging world. Many don't care to look deeper than "but famous blogger said so ... " when it comes to investing. They just want a simple how-to prescription based on authority. Many really are that "unconsciously incompetent" when it comes to investing.

There are two strategies one can pursue as a blogger facing this: Either give a simple (and inaccurate but precise) prescription or give a complex (and accurate but imprecise) prescription hoping that people might be forced to learn enough for an informed implementation.

Each backfire in their own way but in case of the former, risk is pushed away from the blogger and into the person's future. In the latter, risk is pushed towards the blogger as some readers don't understand enough to implement it correctly in the present thus blame their personal ignorance on the blogger complaining it's too vague, yadda yadda.

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Re: The continued viability of the 4% rule in the US in the 21st century

Post by IlliniDave »

jacob, yeah, I understand that it is seen that way, and the difficulties of trying to speak to ears looking for an easy solution, preferably via an app on their smart phone. :) I just wonder how many people actually put it into practice rigorously. Most people seem to use it to size the nest egg, then spend what they need/want (within reason) on an ongoing basis and keep an eye on things, adjusting as a function of the financial environment. That's tricky for a bare bones ERE-er because there isn't much downside, but for the person whose 4% is part of a $50K-$60K or higher total income, there's wiggle room.

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Re: The continued viability of the 4% rule in the US in the 21st century

Post by jacob »

@iDave - I think that using the 4% rule as a sizing-gauge holds for the ERE community, but it's not the impression I get from e.g. reddit or most of the comments on other blogs where people are willing to pull the plug at 4% at current valuations, future prospects, and so on...

In particular, it seems that the assumption is that optimism will save them whereas in reality, it will be wiggle room. However, there's a fairly big step between 4% and 3% and a much bigger step between 4% and 2%. Can someone spending $25k a year go to $19k (3%) or $13k (2%) if things turn out less than exceptional? Yes, in principle ... but would they want to if they weren't FIRE'ing based on naive assumptions?

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Re: The continued viability of the 4% rule in the US in the 21st century

Post by BRUTE »

brute thinks most normal humans would probably fail this flexibility test. they seem to like having maxed-out mortgages, 2 cars on credit, and so on. brute thinks the more ERE-inclined a human, the more flexible he/she probably is in the down times. therefore, with limits, someone who's looking into EREish things could probably go from 4% to 3%. going to 2% is tough, but would probably be doable for a while, think great depression.

brute thinks increasing one's flexibility is quite important here.

IlliniDave
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Re: The continued viability of the 4% rule in the US in the 21st century

Post by IlliniDave »

jacob, I have to admit most of my anecdotal data comes from the group over on bogleheads.org, who are in general more financially conservative than average, and wealthier than average. 25X to 33X has rule-of-thumb status over there as a planning tool for accumulation targets to support "normal" retirement. Many plan on more elaborate detailed strategies in retirement (so-called "liability matching" being one of the more popular, along with various bucket approaches and conservative allocations with multiples up to 50X). So I'll definitely admit that I don't have a good cross section of data and my perception is thereby warped. Many of the authors/bloggers favored over there are also advising sub 4% SWR targets. In general it's not a FIRE crowd, though there are a few of us mixed in. I agree that at sub median spending levels wiggle room is tough to come by, and I'd say the ER/FIRE crowd should be cautious of 4%.

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Re: The continued viability of the 4% rule in the US in the 21st century

Post by Dragline »

This sounds more like an argument to purchase a single premium immediate annuity. If you make it to your early 40s as a male, you can purchase a single premium annuity that will yield over 4% annually right now (without an inflation escalator). The longer you wait to buy it, the more it will yield.

Of course, there is counterparty risk . . . But if you believe that your actually returns from investments will be closer to 2-3% CAGR, an annuity for a good chunk of the stash would be a relative bargain and a no-brainer for most people.

I agree that the 4% rule is just a rule of thumb and one could easily make adjustments going forward. But a good plan would be to make "necessary" expenses like food and shelter account for only 2% to give you room to easily cut back.

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Re: The continued viability of the 4% rule in the US in the 21st century

Post by BlueNote »

There's going to be an absolute floor WR (withdrawal rate), which will vary by individual. The WR floor will largely be determined by how much a persons skill can be substituted for money. Generally the more skill the lower the withdrawal rate and the safer the principal. Now if we categorize FIRE people into those who prefer using money to solve problems and those with a bias for using a wider variety of life skills I think the latter can obviously sustain a variable WR much easier than the former. When you go on the boglehead forums there's a large number of people who seem to be playing the FIRE game using only a narrow specialization in traditional personal finance skills. Therefore they're savings goals are enourmous in order to support the desired lifestyle. The Trinity study is useful as a rule of thumb but I think it's a major weakness in ones FIRE game if they're relying on that alone. These people tend to make fun of people like me , HE RIDES HIS BIKE TO WORK, What a weirdo! I feel bad that they miss the joy of knowing that you're getting exercise, doing something fun, saving money and having less of an impact on the environment (web of goals and tensegrity).

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Re: The continued viability of the 4% rule in the US in the 21st century

Post by jennypenny »

If you're talking about the average 65yo retiree, the 4% rule isn't bad advice if the money is invested very conservatively. It gives them 25 years' worth of expenses. They just have to make sure the die by the time they reach 90. ;)

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Re: The continued viability of the 4% rule in the US in the 21st century

Post by JamesR »

The trinity studies are super conservative and didn't test a wider range of portfolio allocations. A safemax approaching 4% is already pretty conservative. The country based thing is interesting, but it's still probably on the low side due to poor methodology.

If we look at portfoliocharts, we can see that opening up the portfolio allocation can potentially bring up the SWR to 7-8%.

So if we take these both in hand, and do some more research, I wouldn't be surprised if we can feel very secure at 5% SWR. Diversification & not keeping everything in US-based stocks, bonds, cash would probably help too.

Also if we're retiring between the ages of 20-45, then like MMM says "First retire, then get rich". There's endless opportunities to produce value from your hobbies or create some side income or go back into a new career that you're curious about, etc.
Last edited by JamesR on Wed Jun 22, 2016 8:49 pm, edited 3 times in total.

BRUTE
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Re: The continued viability of the 4% rule in the US in the 21st century

Post by BRUTE »

brute will retire at 13, by buying apple stock in 1983 (*)

* yes, both of these will require a time machine

The Old Man
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Re: The continued viability of the 4% rule in the US in the 21st century

Post by The Old Man »

The 4% rule failed about 5% of the time. It is more important to understand the reasons for failure than to develop a more precise % rule. The 4% rule portfolio was stocks and bonds. It failed due to inflation, since neither stocks nor bonds provide inflation protection. A more robust rule would develop a better portfolio.

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Re: The continued viability of the 4% rule in the US in the 21st century

Post by Tyler9000 »

Dragline wrote:This sounds more like an argument to purchase a single premium immediate annuity.
That's probably not an accident. Wade Pfau promotes annuities pretty often.

Yeah, I think the Trinity Study is both followed too religiously by some and dismissed too quickly by others.

As JamesR points out, its definition of what a retirement portfolio looks like (a simple S&P 500 fund and a broad corporate bond fund) actually does not resemble many people's real-life portfolios so the conclusions are already thrown out the window. Not all stocks and bonds are created equal, and different portfolios have different withdrawal rates.

But I personally don't relate to criticism of the assumed withdrawal methodology. It's based on the idea that one's standard of living is relatively fixed and is simply inflation-adjusted, which I find meshes quite well with an ERE mindset. The biggest critics tend to be "traditional" retirees more concerned about spending as much as possible or eager ERE hopefuls looking for every angle to retire sooner. I personally like how it forces people to focus on that "happy" expense level as a reasonable reality check.

In any case, I think the general methodology is a sound way to quantify the relative risk and sustainability of certain portfolios and spending habits. As long as one looks to it for guidance rather than guarantees, you can learn a lot.

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Re: The continued viability of the 4% rule in the US in the 21st century

Post by IlliniDave »

What I've found as the most difficult aspect is not knowing how well the future will rhyme with the past when it comes to investment returns and inflation. Those projections are what any scoring of any strategy depend on. The robustness in any plan is only as good as the assumptions that go into it.

The withdrawal methodology of Trinity is fine in concept, is good for framing the problem, provides a trajectory from a bird's eye view, etc. I don't think the Trinity study intended to put forth a prescription for retirement portfolio draw down. This isn't intended as a criticism of it, but I don't think very many people make it through multiple decades with spending that is that smooth and consistent, even starting at traditional retirement age. Fortunately, the tendency is for spending to decline later in retirement. That (irregularity of spending profile) might be more true for people who try to exercise FI in their mid-forties or earlier as compared to the traditional mid-sixties retiree (or it could be less true).

Partial annuitization is sometimes the cornerstone of the liability matching strategies. For those unfamiliar with the term, the concept is to figure out your no-kidding spending floor (possibly less any pension/SS) then fund it (enough to last the rest of your life) in some super conservative way (cash, s-t and/or inflation protected gov't bonds, annuity, etc.). Then the remaining assets (the fun money and/or legacy money) can be invested more aggressively and/or used more freely.

Bucket strategies are similar but they sort of take a sliding window approach (and generally don't use annuities) rather than a single deployment of capital apriori.

Add via edit: One thing I'll add is that I believe anyone that approaches "retirement" with a plan, even imperfect, is ahead of the game compared to many of their contemporaries. Most people follow a "Fire! Ready! Aim!" recipe, often not by choice.
Last edited by IlliniDave on Thu Jun 23, 2016 6:54 am, edited 3 times in total.

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