Add to that our series on safe withdrawal rates where we found that over a long retirement horizon bonds become much less attractive. In the Trinity Study with retirement horizons of 15-30 years, you can get away with a bond share as high as 50%. But over long horizons of 40-60 years in the FIRE community, the low expected returns of bonds can jeopardize the sustainability of the portfolio as we showed in part 2 of our series.
Has anything changed since last year? Are we now a bit more optimistic about bonds? After all, yields have risen. The 10-Year Treasury yield reached 2.6% earlier this year but has since fallen again to about 2.2-2.3% just last week.
Welcome back to the Safe Withdrawal Rate series. 13 installments already! As requested by many readers, both in the comments section and via email, I wanted to look into one intriguing method, called “Prime Harvesting” (PH) to dynamically shift the stock vs. bond allocation during retirement. Where does this post fit into the big picture? Recall that parts 1-8 of our series dealt with fixed withdrawals and fixed asset allocation (same % stocks and bonds throughout retirement). Make sure you check out our SSRN working paper, now downloaded over 1,000 times!
Parts 9-11 dealt with how to adjust the withdrawal amounts while keeping the asset allocation fixed (Guyton-Klinger, VPW, CAPE-based rules, etc.). Prime Harvesting does something completely different: Keep the withdrawal amount constant, but use a dynamic stock/bond asset allocation to (hopefully) squeeze out some extra withdrawal wiggle room; the Northwest corner in the diagram below. Almost uncharted territory in our series!
Eventually, of course, we like to move to that Northeast corner: Dynamic withdrawals and Dynamic Asset Allocation. But let’s take it one step at a time! Let’s see what this Prime Harvesting is all about.
We were surprised by how many personal finance bloggers publish their net worth numbers. J. Money over at RockstarFinance maintains the world’s first and only (to our knowledge) blogger directory and out of almost 1,000 bloggers, over 250 publish their net worth. So, should we publish ours? What good is all that stealth wealth business (see the excellent posts from Physician on FIRE and The Retirement Manifesto) if I post our net worth on the blog? Well, if someone were to find out who we actually are then with or without the precise number it would be pretty obvious that we’re well off. Whether our net worth is $500,000 or $5 million, what’s the difference, then? People get mugged on the street every day for much less. So we might as well show our numbers, right?
When we read about withdrawal strategies in early retirement, the cash cushion is often one crucial ingredient. Simply keep a little bit of cash sitting around on the sidelines, dig into that cash during an equity market drawdown and avoid selling equities until the next recovery. How much cash? Well, the Global Financial Crisis raged for “only” 18 months and the average garden-variety recession should last a year or even less. Thus, even if we assume that the equity market takes a little bit longer to recover it will take only very little cash and very little opportunity cost to achieve this. The whole issue of Sequence of Return Risk is solved! Who knew this was so easy? This is almost too good to be true! Well, unfortunately, it might be just that; too good to be true.
Here are our top six concerns about the cash cushion:Read More »
In last week’s post on dynamic withdrawal rates, one of the withdrawal rules we actually liked quite a bit was based on the Shiller CAPE ratio. One disadvantage of any such rule: The CAPE is at a high level by historical standards, 29.30 to be precise as of this morning (March 22, 2017). Today’s CAPE-based withdrawal rates will be very stingy, only around 3% per annum.
So, what to do about our CAPE Fear? One reader recently made an interesting observation: The CAPE uses ten-year rolling S&P500 earnings. So, once we roll out the low earnings from the Global Financial Crisis (GFC) in 2008/9, average earnings should move up again and the CAPE should come down. But by how much? Probably not below 20. Still, how much of a decline in the CAPE can we realistically expect: 10%? 20%? We have to start a new Excel Spreadsheet for that. Let’s get cranking!
After a three week hiatus from our safe withdrawal rate research, welcome back to the next installment! If you liked our work so far make sure you head over to SSRN (Social Science Research Network) and download a pdf version. It’s a free 47-page (!) pdf working paper covering parts 1 through 8:
But let’s move on to part 11. In our previous posts (Part 9 and Part 10), we wrote about the Guyton-Klinger dynamic withdrawal rule and why we’re not great fans. Add to that our two-month-long bashing of the static 4% rule and people may wonder:
What withdrawal rule do we like?
True, we proposed a lower initial withdrawal rate (3.25-3.50% depending on future Social Security income), but that’s just the starting point. We have written here and elsewhere that this withdrawal rate is not set in stone. How do we go about adjusting the withdrawals in the future? How did different dynamic withdrawal rules perform in the past? How do we even measure how much we like a withdrawal rate rule? Today, we like to take a step back and gather a list of criteria by which we like to evaluate different (dynamic) withdrawal rules. Then simulate a bunch of withdrawal rules and assign grades.Read More »
If you’re waiting for part 11 of the Safe Withdrawal Rate series, please be patient. It’s scheduled for next week and will dive deeper into variable withdrawal rate rules! For this week we have some other pressing business because tomorrow will be the eighth birthday of a very good friend of ours:
The Bull Market that started on March 9, 2009.
Almost eight years ago to the day we saw the trough of the stock market during the Global Financial Crisis when the S&P500 index closed at 676.53 and the Dow Jones Industrial at 6,547.05. The intra-day low on March 6 was even a bit lower – the very ominous 666 points in the S&P500. Everyone pretty much thought the world would end soon!
How bad was the March 2009 trough?
From its previous high in October 2007, the S&P 500 index fell by almost 57% and even with dividends reinvested the drop was a still staggering 55%.
This drop was even more severe and at a faster pace than the Dot-Com bust in the early 2000s, which was “only” a 49% drop over 2.5 years!
In March 2009, the S&P500 fell all the way back to its September 1996 (!) level, so it wiped out 12 years worth of equity gains.
Last year in December we noticed that one of our Municipal Bond mutual funds had short-term losses. That’s not a huge surprise after the post-election bond yield surge and hence it was time to harvest those losses. If you’re not familiar with Tax Loss Harvesting, we wrote two earlier posts on the topic, one dealing with the general concept and one dealing with the implementation. In any case, after we sold the underwater tax lots, where do we put the money? For 30 days we can’t invest in the same fund (or different fund with identical benchmark) or we’d run afoul with the IRS wash-sale rule. There was one asset class that we had never owned but had definitely been on our radar screen for a while. Finally, we took the plunge and invested in… drumroll …
Last week’s post about the Guyton-Klinger Dynamic Withdrawal Rule only scratched the surface and we ran out of time and space. So, today we like to present some additional and detailed simulation data to present at least four areas where Guyton and Klinger are quite confusing and misleading:
The ambiguity between withdrawal rates and withdrawal amounts. A casual reader might overlook the fact that the withdrawal amounts may very well fall outside a guardrail range. Inexplicably, Guyton and Klinger are very stingy with providing information on withdrawal amounts over time. There aren’t any time series charts of actual withdrawals in their paper.
True, Klinger shows time series charts in this paper, but they are only for the median retiree. Does anyone else see a problem with that? The good old 4% rule did splendidly for the median retiree since 1871 so I haven’t really learned anything by looking at the median. Wade Pfau showed (with a Monte-Carlo study) that the GK rule has a 10% chance of cutting withdrawals by 84% after 30 years. It’s very suspicious that the inventors of the rule don’t show more details about the distribution of withdrawals. You could call this either deception or invoke Hanlon’s Razor and blame it on sloppiness and incompetence, and both options are not very flattering.
The Guyton-Klinger rule (even with a 4% initial withdrawal rate) is very susceptible to equity valuations. Results look much worse if you look at the average past retiree with an elevated CAPE ratio (20-30).
Guyton-Klinger doesn’t afford you to miraculously increase your withdrawal amount without any drawback. The higher the initial withdrawal amount the higher the risk of massive spending cuts in the future.
So, let’s get cranking! We present another case study, the dreaded January 2000 retirement cohort, and also subject the Guyton-Klinger Rule to the whole ERN retirement withdrawal simulation engine to see how all the different retirement cohorts going back to 1871 would have fared. That’s over 1,700 cohorts because we insist on doing our simulations monthly, not annually. Read More »
The number one suggestion from readers for future projects in our Safe Withdrawal Rate Series: look into dynamic withdrawal rates, especially the Guyton-Klinger (GK) withdrawal rate rules. The interest in dynamic rate rules is understandable. Setting one initial withdrawal amount and then stubbornly adjusting it for CPI inflation regardless of what the portfolio does over the next 50-60 years seems wrong (despite the extremely simple and beautiful withdrawal rate arithmetic we pointed out last week).
So, here we go, our take on the dynamic withdrawal rates. Jonathan Guyton and William Klinger proposed a dynamic strategy that starts out just like the good old static withdrawal rate strategies, namely, setting one initial withdrawal amount and adjusting it for inflation. However, once the withdrawal rate (expressed as current withdrawal rate divided by the current portfolio value) wanders off too far from the target, the investor makes adjustments. Also, notice that this works both ways: You increase your withdrawals if the portfolio appreciated by a certain amount relative to your withdrawals and you decrease your withdrawals if the portfolio is lagging behind significantly. Think of this as guardrails on a road; you let the observed withdrawal rates wander off in either direction, for a while at least, but the guardrails prevent the withdrawal rate from wandering off too far, see chart below. It’s all pretty intuitive stuff, though, as we will see later, the devil is in the details.
The Wall Street Journal calls this methodology “A Better Way to Tap Your Retirement Savings” because it allows higher (!) withdrawal rates than the traditional 4% rule. As you probably know by now, we’re no fans of the 4% rule and if people claim that we can push the envelope even further by just applying some “magic dynamic” we are very suspicious. Specifically, we believe that the GK methodology has (at least) one flaw and we like to showcase it here.Read More »