PSA: 2.7% is the new 4%

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Crusader
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PSA: 2.7% is the new 4%

Post by Crusader »

Sorry for the clickbait title, but I just saw this video, and considered it my duty to share:
https://www.youtube.com/watch?v=1FwgCRIS0Wg

It outlines a lot of the problems I have with the way the 4% SWR was calculated, so if you are planning your retirement on that number, you should probably watch it. (What I would recommend is a variable withdrawal rate, e.g. https://www.bogleheads.org/wiki/Variabl ... withdrawal).

basuragomi
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Re: PSA: 2.7% is the new 4%

Post by basuragomi »

I love a good WR slapfight, but it's not really relevant, you know?

1. I can get an inflation-linked guaranteed annuity that pays out 4.2%. This implies that the underlying assets minus profit and overhead have better performance than the same underlying assets in this analysis that pay out 2.7%. Why not get the annuity and forget about it?
2. 2.7% WR = 37 years of savings for 35 year life expectancy. It would suggest that hoarding durable and non-perishable goods right now, rather than owning productive assets, is the best course of action. Is this what you're doing?
3. At a 75% savings rate, the difference between 4% vs ~3% WR, and 3% vs 2.5% WR, is just one good year saving in the equities markets. There aren't many people focused on early retirement that also intend to spend the absolute maximum they can theoretically get away with. At least, not here.

2Birds1Stone
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Re: PSA: 2.7% is the new 4%

Post by 2Birds1Stone »

To add to the point basuragomi made, the risk of failure at anything <3.5% is usually irrelevant when you compare it to longevity risk.

This calculator is very rudimentary, but it shows the point I'm trying to make. Here a 4% WR has a 12% chance of failure, which seems high until you realize that your chance of being dead instead is 85%. BSoG wrote a post recently about trying to plan more than 5-10 years out which made me think....being flexible* in the future is far more valuable. If you arrived at a 3% WR then it will not be hard to figure it out if that's not enough.

https://engaging-data.com/will-money-la ... 00&mort=ss

*just a 10% spending flexibility in down years increased portfolio survival success to 99.8%, there is no equivalent for longevity risk.

Crusader
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Re: PSA: 2.7% is the new 4%

Post by Crusader »

basuragomi wrote:
Fri Dec 23, 2022 11:19 am
I can get an inflation-linked guaranteed annuity that pays out 4.2%.
Are you sure about that? If I want someone to pay me $4200, adjusted for inflation (so it will keep going up over time), that will cost me $100k? Maybe if you are old, but definitely not when you are young.
basuragomi wrote:
Fri Dec 23, 2022 11:19 am
2.7% WR = 37 years of savings
No, 2.7% WR is not equal to 37 years of savings. You have to account for inflation so it is not known how long your 37x(this year's expenses) stash will last you.
basuragomi wrote:
Fri Dec 23, 2022 11:19 am
At a 75% savings rate, the difference between 4% vs ~3% WR, and 3% vs 2.5% WR, is just one good year saving in the equities markets. There aren't many people focused on early retirement that also intend to spend the absolute maximum they can theoretically get away with. At least, not here.
Yes, this is a good point. If you can adjust your spending accordingly, then this does not apply to you. But, I've seen the 4% number as some kind of benchmark thrown around here enough that I thought people should be warned. I think it's important to realize where that number is coming from, and if you already know this, the originally posted video is not for you. But, if you think that if all you need is to save 25x(your living expenses) for that to give you enough money in retirement for life (on average), then you would be wrong.
2Birds1Stone wrote:
Fri Dec 23, 2022 12:00 pm
That's a great tool, I didn't know about it, thanks! But, what data does it use? If it uses historic US equity data, that has survivorship bias, I would be wary.

Now, to be clear, if you are implementing ERE, i.e. low living expenses, then this further removes a lot of the risk because if you need to get a job to put your portfolio on track, that probably won't be very hard to do, and you won't be able to do it for very long.
Last edited by Crusader on Sun Dec 25, 2022 5:55 am, edited 1 time in total.

ertyu
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Re: PSA: 2.7% is the new 4%

Post by ertyu »

2Birds1Stone wrote:
Fri Dec 23, 2022 12:00 pm
... a 4% WR has a 12% chance of failure, which seems high until you realize that your chance of being dead instead is 85%.
idk if the two probabilities can be assumed to be independent, in the sense that people who engage in disciplined saving are likely to also engage in other disciplined behaviors that are likely to increase longevity, but if they are independent, the probability of (portfolio failure) and (alive) = 0.12 x 0.15 = 0.018, or approx. 2%

this of course is predicated on the standard set of assumptions that we've chewed to death as a forum, which basically come down to being able to assume that there won't be a structural break in the data and that conclusions drawn on the basis of the data thus far can be extrapolated to the future.

basuragomi
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Re: PSA: 2.7% is the new 4%

Post by basuragomi »

Crusader wrote: No, 2.7% WR is not equal to 37 years of savings. You have to account for inflation so it is not known how long your 37x(this year's expenses) stash will last you.
I've never seen anyone doing WR on a NPV basis, but okay. The point is that when years of savings must exceed years of life, you are explicitly assuming that return on assets will not match inflation. So why invest in any stock market at all, compared to durable goods, when your baseline assumption is that you are guaranteed to lose value?

DutchGirl
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Re: PSA: 2.7% is the new 4%

Post by DutchGirl »

There is this group of financial advisors who insist people need to have $5 million before even considering retiring. Otherwise they might run out of money! Financial advisors of course do have a reason to be very careful, one can imagine a client suing financial advisors for telling the client they can retire and then meeting some bad luck and running out of money. Hardly ever will a financial advisor be sued for advising their client to work 2 to 10 more years and then the client realising at say age 75 that he is running out of life sooner than out of money.

I thought that people going for FI and especially going for ERE were more willing to accept risks and to be flexible. One needs some money, sure, but one can also use other talents/"assets" to provide for oneself in case of a financial storm.

Now I've seen people go from advising a 4% SWR to a 3.25% one and now a 2.7% one. Where will it stop? Would it not be better to stick with the 4% WR and rely on your flexibility and other talents/skills and also accept that there will be some remaining risk to whatever life you create for yourself?

2Birds1Stone
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Re: PSA: 2.7% is the new 4%

Post by 2Birds1Stone »

The OP was well intentioned but a PSA about the 4% rule being risky is not really threadworthy on ERE.

DutchGirl
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Re: PSA: 2.7% is the new 4%

Post by DutchGirl »

The current top post on the blog by Jacob is timely:

"First people seek a 4% withdrawal rate to cover their expenses because 4% has been shown to survive worst case scenarios over 30 years. Then they seek 3% just to be safe which is a 33% margin. Then the target changes to 2% just to be a bit safer even though this is actually a 100% improvement compared to the original case which means that in the historically worst case they’d end up with millions of dollars they can’t spend."

Source: https://earlyretirementextreme.com/one- ... mfort.html ; originally posted 2011-03-26 .

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Re: PSA: 2.7% is the new 4%

Post by jacob »

What's not new is the desire to put a number on it. To put the X%-rule in perspective, it came about because retirement planning used to be done in one of the following two ways.

1) I have constructed a portfolio that provides me with enough income to currently live on. Because of my firm belief that my portfolio is rock solid, I can put it on autopilot and retire.

2) I have accumulated some savings, say $400,000 and I spend $50,000/year. I'm tired of working and I want to retire now. Mr Financial advisor tells me I will spend 80% of my income in retirement, so to make my portfolio pay enough, I need it to return 400000/(50000*0.8)=10% per year. I therefore need to invest it in "whatever" has that risk-reward profile, e.g. "growth stocks".

This is how it was until about the mid/late 1990s. Practically the stone age, eh?

And the problem with that was the risk of inflation, lack of growth, etc. would cause some of these individual plans to fail. So enter Bengen and the Trinity study trying to put a more realistic number on it using statistics.

I suspect if an uncertainty range was published along with the 4% "answer", there might be less optimization and tuning. Because most of these threads seem to circle around not having calculated the variation on "the number".

This can be done though.

Add: Okay, so this has been done and is given as 4% in 95% of the cases or some such. Now, the question is how many understand what that means and how many go "hey 95% is so close to 100% that it's not going to happen to me!".

Would the discussion change if "the answer" was given as 6% +/- 2.5% instead? ... or would people interpret that as 3.5% being that absolute lower bound?

ertyu
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Re: PSA: 2.7% is the new 4%

Post by ertyu »

2Birds1Stone wrote:
Fri Dec 23, 2022 12:00 pm
your chance of being dead instead is 85%.
I do wonder if the chance of one being dead won't go higher given the increasing prevalence of infectious disease with global warming. Will governments be as determined to fight the next covid, and would anyone have incentive to produce and develop vaccines at scale without a guaranteed government contract?

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unemployable
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Re: PSA: 2.7% is the new 4%

Post by unemployable »

I suspect ERers have a lower chance of "premature" death, i.e., lower than the average, than the general population does. Primarily because ERers by nature have a long-term outlook and thus are more averse to behaviors that would achieve short-term fulfillment at the expense of long-term sustainability. That is, ER and longevity are correlated.

Not that the general point isn't valid. At 4% with say a 30-year time horizon at age 50 you're still way more likely to die before you run out of money. Especially if you are expecting some sort of pension or social payment stream kicking in at roughly the midpoint.

The counter-counter argument may be that once you are ER you partake in activities that are more harmful than those working mandarins expose themselves to — in my case things such as mountain climbing and more driving. I'd still say the first-order effect dominates.

prudentelo
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Re: PSA: 2.7% is the new 4%

Post by prudentelo »

People like to think the highest valuations and the highest interest rates also come with lower future return. Bad news enjoys the company, the logic not as much.


The WR% is an important and should be seen as the "fixed" quantity. What is not fixed is your outcome which always uncertain, even the 0.5% WR fails to communist revolution. The "safer" option than living on the financial wealth at any level is continuing to be employed even if you do not need the money.

WR% shows you how much you can trade this security for freedom.

Is it ever good idea to trade away all the security of employment? Maybe not. WR% shows you can minimize the security, maximize freedom at around the 2-3% mark if you want it. Also shows better to keep the employment engine running at the good power if you are more like 10%.

Keeping working giving up wanted freedom to get "security" of 0.5% rather than 3.5% (7x the more money) is also failure.

Crusader
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Re: PSA: 2.7% is the new 4%

Post by Crusader »

basuragomi wrote:
Sun Dec 25, 2022 12:19 pm
I've never seen anyone doing WR on a NPV basis, but okay. The point is that when years of savings must exceed years of life, you are explicitly assuming that return on assets will not match inflation. So why invest in any stock market at all, compared to durable goods, when your baseline assumption is that you are guaranteed to lose value?
I don't know what durable goods you are talking about. The baseline assumption is not that you will lose value, it is that you might lose value (the expected vs. realised return is different). But, even if you are assuming that you will lose value, you have to compare that to the alternatives. If you knew that the inflation was 10%, and the stock market would yield you 9%, I would still invest in the stock market over cash. (assuming I am OK with the volatility). I think that money is one of the few goods that you can pretty reliably say will be valued by others. This allows you to earn and save money today so that you don't have to in the future (e.g. in retirement)... even with inflation. If inflation is high, the utility of doing this is less valuable, of course.

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Sclass
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Re: PSA: 2.7% is the new 4%

Post by Sclass »

Durable goods aren’t durable.

When you run out of money you run out of time. Especially if you are already close to running out of time. In the bigger scheme it may not be an issue if you do 2% or 5%.

There is this uncertainty around your time of death and the lifetime of your money. It is far out there if you have a sound retirement plan. When you’re 80 crossing zero net worth is probably the least of your worries.

I have a buddy who lost his mom the same time I did in 2019. Both his mom and my mom were ~83. He had $40,000 left in her account. My mom had $300,000 left. They both died the same way. In hospice with oxygen masks under heavy sedation. I really got to think about this hard with my pal a few years ago when we discussed the deaths.

As far as I can tell they died the same way. I’m regretful that his mom died in kind of a sterile institution while mine died at home with my ad hoc rotating hourly caregivers. But really, what difference did it make?

I think we have to consider if you are close with your SWR and balance the train wreck at death isn’t really a train wreck. There are different degrees of wreck. Soft landing into your casket. Being fired out of a human cannon into your casket. Falling at terminal velocity into your casket. Or maybe just a little bump as you fall into your casket. For our two moms described above the sign out was equivalent for them.

To my buddy it was different. He had two months of run rate. I had ten. He was panicking. I on the other hand was moderately worried.

If you are smart enough to plan around 2.7% to 5% your landing won’t be catastrophic. At worst it’ll hurry you up a bit.

This reminded me of something I have come to realize recently. How much you die with will greatly influence who is by your bedside when you die. If that matters to you zero or $300,000 can make a difference. Just saying this for those who want to optimize to 100% drawdown at death.

In my own family I’ve seen a lot of heirs unhook after they learned they wouldn’t be getting anything. This is before the death but leading up to it. If your senior care is motivated by this kind of relationship you should keep it in mind. In the five most recent passings I’ve seen inheritance wildly change the senior care strategy.

Nothings perfect when you’re dead.

basuragomi
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Re: PSA: 2.7% is the new 4%

Post by basuragomi »

@crusader, I don't really understand your logic here.

Would you rather: buy a jar of jam (or socks or fertilizer or pre-paid services or whatever) for $2 now that you know you will eat two years from now,
or: invest the $2, have it turn into $3, and buy the same jar of jam in two years for $4?

What course of action delivers more value to you? What leaves you with more money in the future?

If you are saying that you expect the market to yield more than inflation so it's worth the risk, then your SWR is by definition above 2.7% in this scenario. If that's the case, then how is 2.7% relevant?

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conwy
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Re: PSA: 2.7% is the new 4%

Post by conwy »

Remember this is just an estimate and an average. It's never going to be exactly 2.7%. Some years is could be way more, some years way less, some years just sideways. The exact return of any given year will be random and unpredictable.

Best strategy IMO is some combination of flexible spending rules, fixed income allocation and occasional or part-time work.

I've invested enough in stocks so that 2% will cover my "fixed" costs such as rent and food.

For an extra safety buffer, I've saved up cash equivalent to almost half the stock portfolio and keep it in high-interest savings, CDs and inflation-linked bond ladder. This massive bucket of cash can be drawn on in dribs and drabs whenever stocks take a dive.

On top of that, planning to continue working part-time or part-year for the next 10-20 years which will reduce my time horizon. Also planning to learn some in-demand skills that would allow me to work part-time, in case my primary career goes away.

With all of the above taken into account I feel pretty safe to at least semi-retire.

WFJ
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Re: PSA: 2.7% is the new 4%

Post by WFJ »

https://www.marketwatch.com/story/forge ... 1664559109

https://papers.ssrn.com/sol3/papers.cfm ... id=4227132

IMHO, the 4% rule will leave many in a precarious position at some point in their retirement.

WFJ
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Re: PSA: 2.7% is the new 4%

Post by WFJ »

jacob wrote:
Mon Dec 26, 2022 8:32 am

Add: Okay, so this has been done and is given as 4% in 95% of the cases or some such. Now, the question is how many understand what that means and how many go "hey 95% is so close to 100% that it's not going to happen to me!".

Would the discussion change if "the answer" was given as 6% +/- 2.5% instead? ... or would people interpret that as 3.5% being that absolute lower bound?
In a sample of 100 individuals, the 99% CI of those who understand the difference between a C.I. and point estimate are 0.00001 to 0.01 and a right skewed distribution. This is why point estimates are fed to the masses even though they are meaningless.

I suspect that if one were to estimate a 99% confidence interval for an ERE WR, the lower bound would include a negative number for anyone under 50, meaning one will have to return to work and contribute to avoid failure.

prudentelo
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Re: PSA: 2.7% is the new 4%

Post by prudentelo »

1% WR gives naive (no compounding, no sequence risk) 50 year time horizon (40->90) with 50% market loss in 50 years period

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