**A Year's Safe Withdrawal Rate**

Now that we are beginning to design retirement portfolio strategies, it makes sense to define a special term, a

**Year's Safe Withdrawal Rate**. It is an exceedingly powerful concept. Failure to differentiate between a

**Year's Safe Withdrawal Rate**and the traditional uses of the term Safe Withdrawal Rate has caused us no end of troubles. IMHO, if we were to substitute the term, a

**Year's Safe Withdrawal Rate**, for

**hocus's**use of the words Safe Withdrawal Rate, we would have a whole lot better idea of what he has been saying all along.

I will start with the traditional historical sequence method of calculating a Safe Withdrawal Rate. Using that method, you can calculate a separate Safe Withdrawal Rate for every start year in the database. I know. I did it for the years 1921-1980 using Captain Bill's (

**dory36's**) FIRECalc calculator. I have reported those results. It is meaningful to identify a Safe Withdrawal Rate for 1959, for example. It would be a Year's Safe Withdrawal Rate. It would be the one for 1959.

In the traditional study that uses the historical sequence method, only one number is identified. It is the lowest of all of the Safe Withdrawal Rates examined. It is not even necessary to calculate a Safe Withdrawal Rate for each and every year. It is only necessary to increase the withdrawal rate until you encounter a one failure, and then to back off minimally until there are no failures. That final rate is reported. It is the lowest from among the Safe Withdrawal Rates for individual years. It is a lower bound.

If one assumes that there is no relationship whatsoever between stock prices and Safe Withdrawal Rates, that single reported number would be sufficient. But there are ways to relate portfolio safety and valuations. That means that a Year's Safe Withdrawal Rate is meaningfully defined in terms of valuations. It is not necessary to confine yourself to using the lower bound. In a very real sense, the traditional Safe Withdrawal Rates based on historical sequences are

**for estimating any individual Year's Safe Withdrawal Rate. And since we normally associate such calculations with financial projections, the results of traditional Safe Withdrawal Rate studies have minimal utility going forward. In a very real sense, traditional Safe Withdrawal Rate studies have**

*not*valid**. They have looked at a collection of years and there is a range of valuations associated with those years. They have not extracted the relationship between the valuation and the Safe Withdrawal Rate of each individual year. We can do that now.**

*not*incorporated valuationsIt has been possible all along to incorporate valuations into Monte Carlo calculators. One specifies the mean and standard deviation (or standard deviations) of his investments as inputs. The Gordon equation translates a measure of valuation into an estimate of the mean. It can be modified for use with several measures of valuation.

The Monte Carlo approach will always allow for a continuous range of probabilities, whereas the historical sequence method is limited by having a discrete number of years. It is common to set a failure rate a 5% (or 95% probability of success) when extracting Safe Withdrawal Rates from a Monte Carlo model. It is best to form a similar estimate when using the historical sequence method. It is seldom done, but it is applicable. The general idea is to estimate the probability distribution in the 5% to 10% region by curve fitting, weighted heavily in favor of the 20% to 25% of the years that failed at the lowest withdrawal rates. When something of this nature is done, it can be meaningful to talk about a Safe Withdrawal Rate (at the 95% level of safety) that can increase as well as decrease as the number of years vary. With this variation, which always occurs at levels of safety other than 100%, it is meaningful to talk about an average of Safe Withdrawal Rates as the number of years vary.

Being able to estimate each Year's Safe Withdrawal Rate gives us a powerful tool for designing strategies for retirement portfolios. We can do that now. When we exclude the 1881-1920 anomaly, we can relate P/E10 closely to a Year's Safe Withdrawal Rate. We can use the Gordon Model with inputs based on stock market valuations to produce a complementary estimate of a Year's Safe Withdrawal Rate. We have already identified the mechanism for failure at times of high valuations. We are entering an era when we will Specify and Design retirement portfolio strategies.

Have fun.

John R.