The 4% Rule – A Castle in the Air

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steveo73
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Re: The 4% Rule – A Castle in the Air

Post by steveo73 »

I'm trying to think how to explain this issue to people that are caught up in the idea of SWR's and clear delineations of what is right and wrong etc when it comes to WR's.

The idea that there is some perfect WR that can lead to 100% safety is I suppose at a level of understanding of say a 3 out of 10.

There is a massive amount of complexity in this issue and indeed in the whole picture of FIRE.

I think people should read this post. Admittedly it's from another forum but it's really good.

https://forum.mrmoneymustache.com/post- ... msg3061789

Some random points:-
This is the thing about FI, it's an arbitrary number you make up for yourself.
The person has set a largely arbitrary savings goal for themselves, met it, and chosen to leave a job that they no longer feel financially obliged to continue working.
The trick is to view the data as a guideline and your decision making based on that data-set is dependent on your specific circumstances and there are also opportunity costs.

Everyone would prefer a lower WR but you can cheat yourself by having really low expenses. This potentially can consign you to a life of misery. Your mates want to go out for a beer and you have to say no. You can't go on a date because you can't afford it. You can't see your kids because the petrol costs too much to go and see them and public transport isn't an option.
You can get to a really low WR and consider yourself safe but have worked for years in a job that you don't enjoy.

There are other factors as well such as other assets or benefits outside of your financial assets. There is also your age and health to consider.

It all comes down to looking at the data and making the best decision for you and not stating well a WR of 4% is inherently flawed and will not work ever again. It's ludicrous to state this without looking at your specific situation. I also wonder what the pay off is for stating this point. It's meaningless and it can't be proven.

The Old Man
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Re: The 4% Rule – A Castle in the Air

Post by The Old Man »

steveo73 wrote:
Fri Sep 23, 2022 8:35 pm
I'm trying to think how to explain this issue to people that are caught up in the idea of SWR's and clear delineations of what is right and wrong etc when it comes to WR's.
Remember, there is a difference between a WR for your individual PLAN versus a SWR for the expected return for a broad-market stock-bond portfolio (i.e., the 4% Rule - an ANALYSIS).

I am retired. The WR for my investment assets is zero (due to my unique circumstances and other forms of capital). My WR is independent of the expected SWR of 4% (due to the 4% Rule) of a broad-market stock-bond portfolio over a 30-year time horizon with a 95% confidence limit.

steveo73
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Re: The 4% Rule – A Castle in the Air

Post by steveo73 »

The Old Man wrote:
Fri Sep 23, 2022 9:21 pm
Remember, there is a difference between a WR for your individual PLAN versus a SWR for the expected return for a broad-market stock-bond portfolio (i.e., the 4% Rule - an ANALYSIS).
I completely understand the difference. One is a specific use case on a specific data-set with specific assumptions that is considered safe within that analysis because it passed the 95% confidence level.

The 95% confidence level is a standard success criteria in statistical analysis.

https://www.scribbr.com/statistics/confidence-interval/

It's just one use case. I think the only reason threads like this exist or people state the 4% rule isn't valid is because they don't understand what they are stating. There has been a suggestion in this thread that people have 50 year retirements. This is a completely different use case. Some people argue about stock valuations but again that misses the point. The data is the data. The 95% CI is what it is.

I'm trying to move away from discussions like this towards realistic discussions about how you utilize the data to create your own specific plan. The bigger questions are what is your specific use case and how risk averse are you. There are also catches because your assumptions can be built on quicksand. The best example of this is coming up with a figure for your estimated withdrawals. It's very hard to accurately gauge your expense and lifestyle multiple years into the future. Stock valuations may also be an issue but as we saw with Doom these are probably much less of a risk to your retirement compared to future expenses especially if retiring at a relatively young age.
The Old Man wrote:
Fri Sep 23, 2022 9:21 pm
I am retired. The WR for my investment assets is zero (due to my unique circumstances and other forms of capital). My WR is independent of the expected SWR of 4% (due to the 4% Rule) of a broad-market stock-bond portfolio over a 30-year time horizon with a 95% confidence limit.
Cool. My WR is 5% but my conditions are nothing at all like the conditions utilized within the Trinity study. I'm really comfortable with my WR including significant increases in spending at various times throughout my retirement. I couldn't handle certain lifestyle changes like divorce (the same as Doom).

My suggestion is that people planning will rarely be under the same conditions that are assumptions within the Trinity study and arguing that you have to have a WR of x% completely misses the point.

The comments I just posted (form a different forum) sum it up pretty well to me. Your retirement and life is unique to you.

xmj
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Re: The 4% Rule – A Castle in the Air

Post by xmj »

ertyu wrote:
Fri Sep 23, 2022 2:55 am
I think "because they want to" is enough of a reason. Not everyone has to measure their decisions by your metrics. You're applying your decision criteria to other people, and other people might optimize for different things.
Hah, true that. Also, I did explain my philosophy of refactoring work to become something that can be done "forever".

I've spent enough effort to answer these questions for me as part of trying to grok Wheaton levels beyond WL5. Took me a few years, too, to come up with a setup that will let me do that.

In particular, a lot of my thinking was spawned by a few Twitter conversation related to posts to the r/FIRE reddit, that describe the realization that a lot of post-FIRE stories a few years in write about their acculturation to upper-middle class status - and convergence of those early retirees' behaviors to norms that people starting with generational wealth had all along.

A further input to my thinking also has been this quote here:
nickcammarata wrote: Increasingly convinced that instead of asking “how would I act if I had Thing?” and better to ask “how do people with Thing act?”

It’s often so hard to feel Thing is really like if you don’t actually have, the behavior of those who do may be the best guide you have
So being able to see first-hand how those with private incomes live, work and play (mostly from us gathering at the same spaces in real life), what I *do* see is a more curiosity-driven lifestyle that tends to include more frequent low-cost high-reward bets, more degrees of freedom, way higher propensity to taking calculated risks, entrepreneurship and an even bigger focus on family (three or more kids as norm, not outlier).

Citing the Wheaton Levels table for WL7, "SWR is just a backup to other incomes; NW is in runaway mode" would describe this rather well, except most wouldn't know as much about any of the underpinning works and they'll still be naturals at all this.

The Old Man
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Re: The 4% Rule – A Castle in the Air

Post by The Old Man »

OK. Now I understand your position.
steveo73 wrote:
Fri Sep 23, 2022 11:06 pm
I'm trying to move away from discussions like this towards realistic discussions about how you utilize the data to create your own specific plan. The bigger questions are what is your specific use case and how risk averse are you. There are also catches because your assumptions can be built on quicksand. The best example of this is coming up with a figure for your estimated withdrawals. It's very hard to accurately gauge your expense and lifestyle multiple years into the future. Stock valuations may also be an issue but as we saw with Doom these are probably much less of a risk to your retirement compared to future expenses especially if retiring at a relatively young age.
I completely agree. Your concerns are about developing a reasonable PLAN that is practical and takes into consideration real life twists and turns. These ideas would be worthwhile for a separate thread. Plan construction tends to have received limited discussion as it gets conflated with the 4% Rule.
steveo73 wrote:
Fri Sep 23, 2022 11:06 pm
One [the 4% Rule] is a specific use case…The data is the data. The 95% CI is what it is…My suggestion is that people planning will rarely be under the same conditions that are assumptions within the Trinity study and arguing that you have to have a WR of x% completely misses the point.
My argument is that people will never be under the assumptions within the Trinity Study. The conclusions of the Trinity Study are a statistical artifact. The confidence level under real world circumstances will be less than 95%. Earlier in this thread I explained why I believe this assertion. I’ll summarize below.

(1) Inflation: The Trinity Study experienced a 5% failure rate. These failures occurred in the 1960s-70s when the USA was experiencing considerable inflation. In retrospect this is not surprising as a stock-bond portfolio offers limited protection against inflation. Inflation is not understood; thus, it cannot be predicted. The 95% confidence level of the 4% Rule (and 4% Rule Portfolio) is not warranted.
(2) During the Great Depression the economy did not return to full production in a timely manner as predicted by classical economics. Full production was only achieved with the outbreak of World War II. For World War II a state planned economy complete with wage-price controls and production targets were introduced. The failure of the economy to recover quickly was puzzling to contemporaries and is still puzzling today. The 4% Rule incorporates the impact of a world war for improving the performance of the economy. Can we and should we expect a major political event to happen just when we need it to happen? I have not assessed the impact, but I would not be surprised if the conclusions of the Trinity Study would be different if there was no World War II. Remember the Trinity Study is based on USA data, not world data.

What is the practical effect? A 4% withdrawal rate is not as safe as people believe. The failure of the 4% Rule is one of the potential failure modes for a PLAN and as steveo73 states it is more likely that plan failure would be driven by considerations other than the performance of your investment assets.

ertyu
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Re: The 4% Rule – A Castle in the Air

Post by ertyu »

It seems to me that because most people are total return investors, CEOs manage towards that. The phrase "stewards of the stock price" has been floating around a ton lately - or at least it seems so to me. So, if most investors are total return investors, CEOs might be more likely to "return capital" to investors via buybacks as opposed to dividends. Buybacks are also more aligned with the CEOs own incentives - get their own position to appreciate and then cut and run. I'm not sure that this invalidates the argument of "yield investors" but it does make FI via the "preserve principal" method harder.

steveo73
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Re: The 4% Rule – A Castle in the Air

Post by steveo73 »

The Old Man wrote:
Sat Sep 24, 2022 11:26 am
it is more likely that plan failure would be driven by considerations other than the performance of your investment assets.
This is the key point.

There are so many variables but a key one is your expenses. This here is critical. You also cannot predict your expenses perfectly 5, 10, 20 years etc into the future. Your expenses are driven by your lifestyle which includes desires. Doom is a great example. He had a 3% WR until he didn't. He couldn't control the situation that led to his 30k per year expenses no longer being sufficient to sustain his lifestyle.

--> This is actually a big topic. You should look at poverty levels, you should look at the pension available in your country, you should consider divorce if applicable or getting married or into a relationship if you aren't in a relationship. You should consider your long term health.

There are opportunity costs though all through your individual decision making on this issue.

Just say you state I can live of 10k per year and you actually hold to that limitation. That means if something comes up which costs more than $10k per year you can't do it. This is nuts to me. I've mentioned fixing my roof and paying exorbitant dollars to go surfing. These costs were not in my initial budget. What do you do ? If your expenses are really tight you are in a rough position.

Just state I have increased expenses and I give myself a lot more room to spend more. I've created a more realistic plan that has some flex. Then I look at my investment returns and I read people talking about how the 4% rule will fail and so I state well I'm getting to 2% You could be working another 10 years and you might hate your job.

The real point is and it's possibly the key economic decision that you make is how to maximize your lifetime utility.

xmj
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Re: The 4% Rule – A Castle in the Air

Post by xmj »

ertyu wrote:
Sat Sep 24, 2022 6:23 pm
It seems to me that because most people are total return investors, CEOs manage towards that. The phrase "stewards of the stock price" has been floating around a ton lately - or at least it seems so to me. So, if most investors are total return investors, CEOs might be more likely to "return capital" to investors via buybacks as opposed to dividends. Buybacks are also more aligned with the CEOs own incentives - get their own position to appreciate and then cut and run. I'm not sure that this invalidates the argument of "yield investors" but it does make FI via the "preserve principal" method harder.
Another point with buybacks is that buybacks help camouflage and sterilize stock-based compensation.

You announce a big buyback of 1'000'000 shares with the left hand, and with the right hand distribute a fresh 1'000'000 shares to executive and senior management. Who will be the wiser?

zbigi
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Re: The 4% Rule – A Castle in the Air

Post by zbigi »

Re: buybacks - I have a silly side question: what happens when the company buys back 100% of its stock and effectively owns itself? Who gets put on the board of directors? I'm guessing that, since the owner of company A is company A, the current management gets to decide who the new directors will be?

IlliniDave
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Re: The 4% Rule – A Castle in the Air

Post by IlliniDave »

zbigi wrote:
Sun Sep 25, 2022 2:24 am
Re: buybacks - I have a silly side question: what happens when the company buys back 100% of its stock and effectively owns itself? Who gets put on the board of directors? I'm guessing that, since the owner of company A is company A, the current management gets to decide who the new directors will be?
My guess ... it probably would never happen.

If a company proceeded in that direction I think the last shareholder of record would own the entire company and would have no motivation to sell his share to himself. To sell out he'd have to find a third party buyer. The exception is maybe if the company is going under and liquidating--selling off everything and dividing the proceeds between shareholders, but that's not really what's understood as share buybacks.

matchewed
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Re: The 4% Rule – A Castle in the Air

Post by matchewed »

IlliniDave wrote:
Sun Sep 25, 2022 6:45 am
My guess ... it probably would never happen.

If a company proceeded in that direction I think the last shareholder of record would own the entire company and would have no motivation to sell his share to himself. To sell out he'd have to find a third party buyer. The exception is maybe if the company is going under and liquidating--selling off everything and dividing the proceeds between shareholders, but that's not really what's understood as share buybacks.
Isn't that just the equivalent of taking a company private?

xmj
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Re: The 4% Rule – A Castle in the Air

Post by xmj »

No, that's a liquidation and corresponding return of remainder capital.

Taking a company private mostly means 1) delisting from stock exchanges 2) often squeezing out the minority shareholder for cash, which you can do if you own 50%+1 share in most jurisdictions.

zbigi
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Re: The 4% Rule – A Castle in the Air

Post by zbigi »

IlliniDave wrote:
Sun Sep 25, 2022 6:45 am
My guess ... it probably would never happen.

If a company proceeded in that direction I think the last shareholder of record would own the entire company and would have no motivation to sell his share to himself. To sell out he'd have to find a third party buyer. The exception is maybe if the company is going under and liquidating--selling off everything and dividing the proceeds between shareholders, but that's not really what's understood as share buybacks.
Yeah, I agree that it's not a practical scenario. I'm just wondering how the law would work if someone did it anyway (say, as a prank). Would we end-up with this distopian, self-perpetuating company that answers to no one but itself?

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Re: The 4% Rule – A Castle in the Air

Post by jacob »

zbigi wrote:
Sun Sep 25, 2022 8:45 am
Yeah, I agree that it's not a practical scenario. I'm just wondering how the law would work if someone did it anyway (say, as a prank). Would we end-up with this distopian, self-perpetuating company that answers to no one but itself?
No, you're thinking of the company as an entity in and of itself which is incorrect in this context. The company is owned by the remaining shareholders. If a company buys back shares on the open market, it's technically buying out some ex-shareholders on behalf of the remaining shareholders.

For example, lets say there are 10 shareholders who own 100 shares each. The company has 1000 shares outstanding. One person decides to list their 100 shares for sale and the company buys them back. Two things can happen.

1) The company cancels the shares. There are now 900 shares outstanding. These are owned by 9 shareholders with 100 shares each.

2) The company keeps the shares. These shares appear on the liability side of the balance sheet as an offset to the outstanding equity.
So before the buyback, the company's liability would look like this:
Outstanding shares: 1000.
And after it would look like this
Outstanding shares: 1000
Treasury shares: -100 (importantly, these have no voting rights and therefore do not determine the board)
Net outstanding: 900

So basically the same result. The difference is that if the shares are cancelled, the company would have to do another emission if it wanted to raise cash, whereas in the second case, it could sell them back to the market again.

Insofar this process got down to 1 remaining shareholder, this person would own 100% of the outstanding shares and effectively own the entire company.

Interestingly, companies are on average pretty bad at this game tending towards buying back shares when the price is high and selling back when it's low.

TL;DR - Just delete the idea that a company can own parts of itself from your mind. It can't. It only appears so because of an accounting gimmick. Instead of "buying back shares" think of it as "buying out shareholders". This process usually ends up with the entire company getting bought out and taken private.

zbigi
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Re: The 4% Rule – A Castle in the Air

Post by zbigi »

jacob wrote:
Sun Sep 25, 2022 9:25 am
No, you're thinking of the company as an entity in and of itself which is incorrect in this context. The company is owned by the remaining shareholders. If a company buys back shares on the open market, it's technically buying out some ex-shareholders on behalf of the remaining shareholders.

TL;DR - Just delete the idea that a company can own parts of itself from your mind. It can't. It only appears so because of an accounting gimmick. Instead of "buying back shares" think of it as "buying out shareholders". This process usually ends up with the entire company getting bought out and taken private.
Thanks for a well-elaborated clarification. I am however interested in the "glitch" aspect (theoretical and interesting for its own sake) of the whole buyback thing, so it doesn't cover the twisted scenario I had in mind.

Regarding that scenario, the key bit of information I was missing is that the treasury shares don't get to vote. So, if the last remaining owner of the company (who owns effectively 100% of it) would donate 100% of his shares to the company, they would all either get cancelled or end up as non-voting. So, I guess no one would be allowed to vote on the new board...

IlliniDave
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Re: The 4% Rule – A Castle in the Air

Post by IlliniDave »

matchewed wrote:
Sun Sep 25, 2022 7:48 am
Isn't that just the equivalent of taking a company private?
I think that's an option, not sure the technical mechanism to change its status from publicly traded to privately owned. Alternately it could probably go on as-is with the option of issuing new shares in the future to raise capital.

mathiverse
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Re: The 4% Rule – A Castle in the Air

Post by mathiverse »

xmj wrote:
Sat Sep 24, 2022 5:23 am
In particular, a lot of my thinking was spawned by a few Twitter conversation related to posts to the r/FIRE reddit, that describe the realization that a lot of post-FIRE stories a few years in write about their acculturation to upper-middle class status - and convergence of those early retirees' behaviors to norms that people starting with generational wealth had all along.
Any links to the Twitter threads that made a big impression on you? Also from your thinking what did you conclude are the "norms that people starting with generational wealth had all along"?

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Re: The 4% Rule – A Castle in the Air

Post by jacob »

zbigi wrote:
Sun Sep 25, 2022 10:44 am
Thanks for a well-elaborated clarification. I am however interested in the "glitch" aspect (theoretical and interesting for its own sake) of the whole buyback thing, so it doesn't cover the twisted scenario I had in mind.

Regarding that scenario, the key bit of information I was missing is that the treasury shares don't get to vote. So, if the last remaining owner of the company (who owns effectively 100% of it) would donate 100% of his shares to the company, they would all either get cancelled or end up as non-voting. So, I guess no one would be allowed to vote on the new board...
Alright, Mr Twist.

Lets say that the corporation keeps buying back shares until there's only one share left outstanding owned by one person. That share is worth the value of the business by definition. When that share is bought back, the seller is handed the value of the corporation. If it's handed over in cash, it's essentially the liquidation value as the business is being levered to pay the cash. If it's handed over in assets, it's basically the business itself. In either case, once the number of outstanding shares reaches zero, the corporation itself ceases to exist. That doesn't mean that the buildings and machines stop existing. These are now owned by the liquidators or the person with the last share. They're just no longer part of the structure that was the corporation. This incidentally is about how it would go when a public company is taken private.

Part of the problem is that the seller of the last share can't refuse payment in cash or in kind. If they want to donate the company itself, they'd have to sell it first, thereby eliminating the corporation, and then donate the business (or the cash) to ... whoever they want to, like the executive officers, floor workers, or the [former] board members. These would then be the owners of a private company.

So as far as I understand, the boundary case you're looking for technically [legally] can't exist. The number of outstanding shares can not go to zero without dissolving the corporation. A corporation without shareholders is not a corporation.

zbigi
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Re: The 4% Rule – A Castle in the Air

Post by zbigi »

jacob wrote:
Sun Sep 25, 2022 7:45 pm

Part of the problem is that the seller of the last share can't refuse payment in cash or in kind. If they want to donate the company itself, they'd have to sell it first, thereby eliminating the corporation, and then donate the business (or the cash) to ... whoever they want to, like the executive officers, floor workers, or the [former] board members. These would then be the owners of a private company.
Why can't the owner of the last share company donate that last share to the company itself? If the seller of the last share can't refuse payment, he can just sell the share for 1 cent . After this transaction, the company will effectively own 100% of its shares. What happens then?

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Re: The 4% Rule – A Castle in the Air

Post by jacob »

zbigi wrote:
Mon Sep 26, 2022 6:00 am
Why can't the owner of the last share company donate that last share to the company itself? If the seller of the last share can't refuse payment, he can just sell the share for 1 cent . After this transaction, the company will effectively own 100% of its shares. What happens then?
After this transaction the business (or company) will have no outstanding shares. The company/business is therefore no longer a corporation. It would have to become some other legal structure.

The reason for this is to prevent the situation you're seeking in which the board or the CEO decides to take over the company by using the company's funds (which really is the funds of the shareholders) to buy out the shareholders. There are therefore laws in place to cap the amount of treasury stock.

For example, in the example above, the company decides to borrow a gazillion dollars and buy out 6 of the 10 shareholders. It now has 60% of the shares and is an absolute majority shareholder and the board/CEO should therefore be able to do what they want, e.g. cash out and buy yachts and screw the remaining 4 shareholders. Since some people would likely do that if it was legal, it is illegal. This is also why the company distinguishes between treasury shares and common shares. What you're proposing is to turn the last treasury share into a common share in order for the corporation to own itself. But since it's still a treasury share, the corporation (which again is just a legal structure) has effectively no owners and therefore no existence.

It's a little bit like asking: Suppose there's only one shareholder and he dies. Who owns the corporation or the company? Other laws take over.

I think the "other laws" you're looking for is a trust. In that case, buy out the remaining shareholders, delist the company from the stock exchange taking it private. The private owner then sets up a trust and donates/gives the business to the trust... along with some bylaws for the board, etc.

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