SWR

Research on Safe Withdrawal Rates

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mannfm11
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SWR

Post by mannfm11 »

Rob here posted a reply to a post I put up on the Prudent Bear fund board. In it he directed the people to this board, which I find covers a very interesting topic.

For several years, I have been trying to find a reasonable way to liquidate a portfolio in retirement. My career is in doing next to nothing besides studying markets and financial matters and being a life insurance agent. Being financially educated at a major university in the 1970's, it has taken me years to understand insurance on a financial basis. Some of it is very cut and dried, like term insurance, which statistically says the company is almost never going to pay a claim because they can find most of the people that are going to die young (fewer people die young, by that I mean under 60 than you would think).

There is a simple way to figure out how much money you can take out of an asset or group of assets and figure you are going to be fairly solid. Take the current yield of the group and put the average in a finacial calculator and amortize it over a period of 10 years longer than life expectancy. That will give you an answer that will work over 90% of the time. The higher the yield in such a calculation, the less principal is deducted. An example is $1 million at 6% and at 9% for 25 years. 6% generates a payment of $78,226. 9% generates a payment of $101,806. the 6% payment includes principal of $18,226 ,while the 9% payment has a principal payment of 11,806. This $6800 difference helps offset the error for overstating the return. 25 years would take a 65 year old man to 90 years of age. If one wanted to stretch their retirment to lets say 100 or retire earlier, they would just add the difference to the 25 years and amortize.

I think the idea in here is pretty solid. If one wanted a system to re-evaluate, they would take an annual rebalancing into account. Should their stocks decline 25%, then amortize the new figure by 24 years. Use the same yield as you used before. So, a portfolio made up of 50% stocks and 50% bonds with the bonds yielding 6.5% and the stocks yielding 5.5% (more on this later), they could take money at 6% on an equal basis or take more money out of stocks or out of bonds, but next year the stocks would be down to $375,000 less 75% of the amount withdrawn. Running a $1 million amortization against $865,000 or so is starting to move over into the realm of risk.

What is the return to be associated with stocks? It appears the work of Robert Schiller is popular here and for those of you that don't know, Shiller is using a version of the formula P=D/k-g. P=price, D=dividend, k=capitalization rate and g=growth rate. In short, we are talking about dividends plus growth rate either before or after inflation being the return. Without having a price, if one can deduce that the dividend is $20,000 a year and the trend in growth is 3% annually, then the return is $20,000 plus 3%. Where we are lost today is the market has lost track of this formula and has no clue as to what stocks are to return to be a legitimate portfolio investment. Should the portfolio be valued at $1 million and people accept this is the norm, then the return associated with this portfolio would be 5%. But, as some of you well know, once people realize they are paying management fees to manage portfolios of risky assets that yield no better than treasuries, then there is going to be a flight from stocks and the 5% return, though in some ways, valid will go out the window. Being that nothing over time is going to take the growth rate above 1% over inflation, the only thing that can get the yield on stocks to the 5% or so above inflation is an adjustment in price to raise the dividend to 4% or no growth in price over a long period of time. In either case, then the return has to be based on dividends and dividends alone. Currently, that is 1.61% on the SPX, trailing.

What am I saying in the previous paragraph? In part, I am saying that to present a 7% return going forward, stocks are going to have to lose 60% of their value. If one would like to have a means of withdrawing money out of a stock portfolio, take the dividend and divide it by 4% if you are liberal and 4.5% if you are conservative. Add inflation plus 1% to that figure and that should produce a fairly safe withdrawal rate. Thus, a $1 million portfolio in the SPX would be valued at $402,500 on a liberal basis and $357,777 on a conservative basis. Taking 7% out of this type portfolio on anything but an extremely abnormal basis will likely preserve it for decades. In a depression type market, one would have to adjust downward.

So, the problem you guys are debating isn't about prices, but values. A retireee needs a portfolio that generates income, not gains and losses and he needs to understand the financial value of what he owns on a conservative basis. The problem, which i will relate in another post is the financial education system has lost sight of finance and gotten involved in historical statistics. Every statistic but the most important one, what will the stream of income be worth.
Mike
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Post by Mike »

...once people realize they are paying management fees to manage portfolios of risky assets that yield no better than treasuries, then there is going to be a flight from stocks...
What would make people realize this?
JWR1945
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Post by JWR1945 »

Mike wrote:
...once people realize they are paying management fees to manage portfolios of risky assets that yield no better than treasuries, then there is going to be a flight from stocks...
What would make people realize this?
Experience. Several years of uninspiring returns.

Have fun.

John R.
Mike
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Post by Mike »

That would do it.
mannfm11
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Post by mannfm11 »

Good response John. The thing about stock markets is people get in on the top, suffer, then get out, never to get in again. What I am writing about isn't common knowledge and Wall Street isn't going tell you or me about it. Dr. Shiller has the data and the right idea, though I think he is using a little to high a risk premium for a portfolio. At the same point, I doubt 125% of dividends is a good figure to use to reflect stock buybacks. Over history, stock buybacks have been a tool of mania markets and are rarely employed in normal markets. You may have read Mania's, Panics and Crashes by Kiddleberger, the former Ford chair at MIT. This is required reading for high level Wall Streeters. He talks about the different panics and how the key companies of the time were making markets in their own stock. Much of the buybacks today are to mop up stock issued to employees. No stock and the company would have to cough up cash on exercise of options. Instead, they take a writeoff of what is a noncash expense.
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