Help me understand how the SWR works with market volatility?

[TopHatFox]

4% SWR = 25x annual expenses invested, yes?

So, if I were to invest $7,000 annual expenses x 25 = $175,000, and withdraw $7,000 a year, then it'd be no buffer* 4% SWR.

Now, what if, after I invest the $175,000 in, say, public equities, a day, week, or month after the market corrects down 33% to a capital change of $115,000. Should I then only withdraw $115,000 x .04 = $4,620? Or again withdraw $175,000 x .04 = $7,000?

I imagine the variable rate withdrawal portfolio would last longer, especially with a no buffer 4% SWR.

Also, the 4% SWR was researched for a 30 year portfolio, and assuming I will earn no additional money ever, should I aim for a 3% SWR if mine needs to last me from age 30 to 100?

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*No buffer meaning 7k are the lowest expenses feasible, expenses that would be difficult to cut down further barring long term back-packing, cycle touring, accepting govt. welfare, living in a cave a la Daniel Suelo (fascinating person), WOOFING, etc.

[Dragline]

The variable withdrawal scenario actually lasts forever -- think about it. But the annual amounts could be quite variable!

The "original" 4% rule was to fix it at the beginning (in your example, $7K) and only add for inflation, regardless if the total portfolio value goes up or down.

Here is a recent article about it from some people who practice what they preach: http://www.gocurrycracker.com/what-is-y ... he-4-rule/

As they note, the original rule implies zero adaptation or additional income for the rest of your life. Most people can be a little more flexible if they try.

[Hankaroundtheworld]

@dragline heads-off, I must say, you explain it very elegantly

@Zalo, I doubt the 4% rule could apply nowadays, as it seems we are heading for a lower growth scenario in the world with too much instabilities. I would use some variation in SWR following common sense (like how the market is performing and how much risk you are willing to take in your investment portfolio, and do not forget to diversify, as the 4% rule is focused on only a certain asset class). Even better, create some passive income streams, multiple, so you can balance between them (read the book ERE )

[bradley]

Dragline, thanks for sharing that. It definitely gave me more insight into the whole idea of investing, and lessened my obsession a little bit with having the "perfect" portfolio. Of course (and I'm saying this to myself), we adapt as we see fit, and it would be a shame to spend extra years toiling away just to achieve a 3% or 2% withdrawal rate, when 4% can be just fine, especially with other things considered.

[steveo73]

it would be a shame to spend extra years toiling away just to achieve a 3% or 2% withdrawal rate, when 4% can be just fine, especially with other things considered.

This is a key point for me personally. I don't see the point of getting to a really low WR especially because I have 3 kids. I'd expect my expenses to go down rather than up.

[vexed87]

I agree with HATW, If you don't plan on quitting work once your reach FI, there's no real reason to worry whether the 4% rule will work or not. Once you have your nest egg, you can takes risks with your career without worry of immediately about generating massive income. Even a few dollars an hour flipping burger at mcdonalds (part time) could make up for a slow market/dividend cuts.

If you follow the ERE principles correctly, you should have multiple income streams which can negate the effects of a market that isn't growing as well as it has historically.

Personally I plan or taking on some trade work when I hit FI so I can so I can learn more DIY skills, i.e. joinery, plumbing etc.

[IlliniDave]

The conventional wisdom is that for retirement periods that could last up to on the order of 50 years or more, 3% or even 2% might be more prudent than 4%.

The original Trinity study method is to compute the 4% based on the first year's balance and adjust it upwards each year based on inflation with no future consideration of how the balance changes over time. So if you go "by the book" then you would not adjust downward in year 2, rather you'd adjust upward for inflation.

What you are illustrating is something known as "sequence of returns risk". An underlying assumption of the Trinity Study is that equities/bonds will behave roughly within the parameters they have exhibited in the past, meaning they will provide positive returns more frequently than negative returns, and have a tendency to mean-revert. The retiree would typically expect to see his assets grow over time even after the annual withdrawal (the Trinity Study looked at a whole range of stock/bond allocations but my observations are taken from my recollection of the more stock-heavy end of the continuum). A worst-case scenario for a by-the-book SWR retiree is to hit a severe bear market immediately out of the gate in retirement before he has experienced any real growth of his original asset pool. Such timing misfortunes are the cause of most of the failures when back-testing against historical data.

There are any number of so-called variable withdrawal strategies out there that can alleviate the sequence of returns risk so long as the retiree has flexibility in his spending needs. This is often coupled with an amount of oversizing of the nest egg so that if withdrawals must be reduced in the future, there is a good chance they will still cover the minimum requirements.

The "downside" is that median outcomes typically show the retiree gaining wealth throughout retirement. A 4% WR strategy is designed to weather all but the very worst of historical outcomes, meaning that for a more typical outcome in the economic/financial world, the 4% is quite conservative. The same is even more true for 3% or 2% strategies.

I do think Hank AW is right, that going forward returns might fall short of what was observed in the 20th century, so a combination of more conservative initial positioning (i.e., lower initial withdrawal rate) and ability to be flexible seems prudent.

I used the so-called SWR only for the purpose of calculating a target value for my asset hoard. I do not intend to use that family of strategies in retirement. For the most part I simply plan to spend what I need to spend to feel content.

[Dragline]

I would use some variation in SWR following common sense (like how the market is performing and how much risk you are willing to take in your investment portfolio, and do not forget to diversify, as the 4% rule is focused on only a certain asset class). Even better, create some passive income streams, multiple, so you can balance between them (read the book ERE )

This is a very good point -- the Trinity study and many other such analyses are essentially limited to investments and income drawn from traditional stock and bond portfolios, and therefore are implicitly assuming that those are the only investments/sources of income available.

If you are also relying on "other things" that are uncorrelated with financial markets, which might include side income, pensions, rental property, private lending, or annuities, to name a few, your personal SWR could be higher or lower. But these things are mostly difficult to model over decades-long periods -- we don't have easily available data.

So we myopically fixate on things that we have numbers for, which we can dutifully crunch.

[TopHatFox]

@Dragline, IlliniDave, Vexed: Useful points. I think I will aim to save more than I need for essential expenses, act out all the relatively inexpensive life goals of mine when I hit my FI capital target (all the long term, slow-travel hiking, camping, cycling, WOOFing, etc.), possibly reduce my withdrawal rate when the market is lower than usual for the year, maintain my withdrawal rate to average levels when the market is up greater than average for the year, and learn more and more skills--as I like to do--so I have options in doing activities I like for casual money! Perfect.

It further seems that bare-bones 4% SWR can be only a step to developing wealth, almost like creating my own essential expenses stipend so I may explore my own interests and income streams from there. It's a starting point.

Cool thing is, I can save my bare-bones requirement of 175k in only a few years after college, especially with an income of 50k+, and what I hope to be a starting point of 30k. If I can combine that with some work I like for those years (working on a research sailboat by leveraging my two sail boat study away adventures, then I'll be externally fulfilled for those years and externally wealthy).

Wow!

[Tyler9000]

This is a very good point -- the Trinity study and many other such analyses are essentially limited to investments and income drawn from traditional stock and bond portfolios, and therefore are implicitly assuming that those are the only investments/sources of income available.

If you are also relying on "other things" that are uncorrelated with financial markets, which might include side income, pensions, rental property, private lending, or annuities, to name a few, your personal SWR could be higher or lower. But these things are mostly difficult to model over decades-long periods -- we don't have easily available data.

So we myopically fixate on things that we have numbers for, which we can dutifully crunch.

+1000! I'll add that the list of "other things" includes any stock or fund that is not an S&P500 index fund. Too many people have the false idea that if they invest in things like small cap value stocks, emerging markets, specific industries, and actively managed mutual funds that the Trinity study conclusions still apply because they're still all stocks. But in reality, "stocks" mean something very specific in the study, and ignoring the assumptions invalidates the conclusions.

FWIW, this issue was my main motivator for creating this calculator: http://portfoliocharts.com/portfolio/hurricane/ You can see for yourself how changing the asset allocation alters the results. You won't find mention of "success rates", but it uses the same methodology as FireCalc with a lot more asset classes. Just be warned -- the data only goes back to 1972, and there are times before that where something that looks good since then would have failed. Use it as a guide to compare portfolios, not as any guarantee of success.

[jacob]

So where do I go to buy these 1972 funds today?

[Tyler9000]

1972 funds are for amateurs. Looking at the mess of historic outcomes, if you stumble across a time machine I'd much prefer to go back to the 80's.

IMHO, learning from the range of outcomes in the past can be helpful provided you also prepare yourself to adjust to an uncertain future. They go hand in hand. It's when people put too much faith in either the stats of the past or their own ability to outsmart the future that they get themselves into trouble.

[IlliniDave]

This is a very good point -- the Trinity study and many other such analyses are essentially limited to investments and income drawn from traditional stock and bond portfolios, and therefore are implicitly assuming that those are the only investments/sources of income available.

If you are also relying on "other things" that are uncorrelated with financial markets, which might include side income, pensions, rental property, private lending, or annuities, to name a few, your personal SWR could be higher or lower. But these things are mostly difficult to model over decades-long periods -- we don't have easily available data.

So we myopically fixate on things that we have numbers for, which we can dutifully crunch.

That's a good point.

All of that should be taken care of in the definition of what withdrawals need to be. People often loosely use the term "expenses" while they generally mean residual expenses after other income sources outside the portfolio are considered. The typical math for a mainstream retiree might be that $50K/yr gross income is desired and $30K from SS is expected, so they would accumulate a nest egg to provide the residual $20K/yr ($500K if the target is based on 4%).

The same approach can be applied to a broad range of other income sources.

There are some woe and doom folks out there who are convinced pensions and SS will evaporate, and they might try to pile up the $1.25M+ required to totally fund their desired $50K just from a portfolio. It's fine if someone wants to do that but not everyone has a financial sledgehammer or the desire to work well into their 60s or beyond to accumulate so much. In this mindset SS and pensions as considered "gravy". When I was younger I was like-minded, but as I aged I realized the cost of that approach in years was more than I cared to pay. Arguably it's a greater degree of financial independence.

[SimpleLife]

I rely first and foremost on rental income. Index funds will cover my expenses alone, and so will rentals. I like to have options, but the plan is to let the funds grow while I live off rental income, unless I need to dip in. Also plan on getting a gov job again (turned last few down) so I can get a pension with only 5 years put in, not to mention group health insurance rates even in retirement.

That should put me right at the cusp of my planned retirement at 40. Pension is only 1k a month with minimum time put in, and it's only that high due to a high salary, but it's an additional stream of income.

[Tyler9000]

I like that plan. Multiple paths to success. A robust plan like that will outmaneuver SWRs every time.