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Misjudging Safety-Part 2

 
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JWR1945
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Joined: 26 Nov 2002
Posts: 1697
Location: Crestview, Florida

PostPosted: Sat Mar 20, 2004 8:02 am    Post subject: Misjudging Safety-Part 2 Reply with quote

Overview

This continues my investigation into the effects of Misjudging Safety of one's retirement portfolio. This time, I look into the most common reaction to portfolio setbacks: reducing one's withdrawal amount. I exclude shifting portfolio allocations.

My general conclusion is that adjusting your withdrawal amount changes very little in terms of the how much time that you have to hunker down. You simply have to wait out the bad times.

Conditions

The Retire Early Safe Withdrawal Calculator (with and without my changes) does not include changes in withdrawal rates during retirement. The FIRECalc does. That is why I have posted 30-year Historical Database Rates for HDBR50 and HDBR80 using FIRECalc. They provide the starting point from which I have made this study.

HDBR50 consists of 50% stocks and 50% commercial paper. HDBR80 consists of 80% stocks and 20% paper. I all cases I have used an expense ratio of 0.20%. I have adjusted withdrawals to match inflation according to the CPI.

These are ranges of Historical Database Rates in terms of valuations (as measured by P/E10) from the FIRECalc tables.

For HDBR50:
At the lowest valuations, Historical Database Rates vary from 5.3% to 9.6%.
At middle valuations, Historical Database Rates vary from 4.6% to 7.1%.
At the highest valuations, Historical Database Rates vary from 3.9% to 5.7%.

For HDBR80:
At the lowest valuations, Historical Database Rates vary from 7.2% to 11.6%.
At middle valuations, Historical Database Rates vary from 5.0% to 9.4%.
At the highest valuations, Historical Database Rates vary from 4.0% to 5.9%.

As before (i.e., as in Misjudging Safety), I have examined what would have happened if someone had thought that he was at the highest level of safety but he was really in the middle level of safety. With a 50% stock portfolio (that is, with HDBR50), he believes that he has 100% safety when he withdraws 4.6% of his initial balance (plus inflation) annually. With an 80% stock portfolio (that is, with HDBR80), he believes that he has 100% safety when he withdraw 5.0% of his initial balance (plus inflation) annually.

This time, I have assumed that the retiree is cautious, possibly because he realizes that valuations are high. He has decided to reduce his withdrawals to 75% or 60% of the level that he thinks is safe until he is able to build up his confidence.

This leaves us with four possible conditions. Using HDBR50, the withdrawal amounts are 75% of 4.6% and 60% of 4.6%. If the initial amount is $100000, his initial withdrawal amount is 75% or $4600 or 60% of $4600. At 75%, the inputs to FIRECalc are initial Withdrawals of $3450 followed by a Withdrawal Change 1 of $1150. At 60%, the inputs to FIRECalc are initial Withdrawals of $2760 followed by a Withdrawal Change 1 of $1840.

Using HDBR80, the withdrawal amounts are 75% of 5.0% and 60% of 5.0%. If the initial amount is $100000, his initial withdrawal amount is 75% or $5000 or 60% of $5000. At 75%, the inputs to FIRECalc are initial Withdrawals of $3750 followed by a Withdrawal Change 1 of $1250. At 60%, the inputs to FIRECalc are initial Withdrawals of $3000 followed by a Withdrawal Change 1 of $2000.

I determined how many years the retiree would have had to wait before increasing his withdrawals to reach 100% survival in the entire 1921-1980 period.

In addition, I looked at all combinations. That is, I looked at HDBR80 withdrawal amounts for the 50% stock (HDBR50) portfolio and at HDBR50 amounts with the 80% stock (HDBR80) portfolio.

By looking at such a variety of conditions, we can see the nature of what happens if, in fact, we have misjudged our portfolio's safety.

Results

These are the number of failures versus the number of years before the increase in the amount withdrawn.

HDBR50 at 75% ($3450 followed by an increase of $1150).

Code:
Year   Failures
4    6
5    5
6    3
7    2
8    2
9    1
10   1
11   1
12   1
13   0


HDBR50 at 60% ($2760 followed by an increase of $1840).

Code:
Year   Failures
4   3
5   2
6   1
7   1
8   1
9   0


HDBR50 with HDBR80 amounts at 75% ($3750 followed by an increase of $1250).

Code:
Year   Failures
4   14
5   13
6   12
7    8
8    8
9    7
10   6
11   6
12   3
13   3
14   2
15   2
16   1
17   1
18   1
19   1
20   1
21   0


HDBR50 with HDBR80 amounts at 60% ($3000 followed by an increase of $2000).

Code:
Year   Failures
4   12
5    8
6    7
7    6
8    3
9    3
10   2
11   1
12   0


HDBR80 at 75% ($3750 followed by an increase of $1250).

Code:
Year   Failures
4    9
5    9
6    8
7    7
8    7
9    6
10   5
11   5
12   4
13   4
14   2
15   2
16   1
17   1
18   1
19   0


HDBR80 at 60% ($3000 followed by an increase of $2000).

Code:
Year   Failures
4    9
5    7
6    6
7    4
8    4
9    4
10   2
11   1
12   1
13   0


HDBR80 with HDBR50 amounts at 75% ($3450 followed by an increase of $1150).

Code:
Year   Failures
4    5
5    4
6    4
7    4
8    3
9    1
10   1
11   1
12   1
13   0


HDBR80 with HDBR50 amounts at 60% ($2760 followed by an increase of $1840).

Code:
Year   Failures
4   4
5   4
6   1
7   1
8   1
9   0


Summary Table

Time Needed to Reach 100% Survival

Code:
Condition              HDBR50   HDBR80
75% of HDBR50 amounts   13   13
75% of HDBR80 amounts   21   19
60% of HDBR50 amounts    9    9
60% of HDBR80 amounts   12   13


Remarks

Deeper cuts early on reduce the amount of time needed to gain safety.

It was always necessary to wait a long time before gaining safety. For these conditions, it was a minimum of 9 years.

It is difficult to reduce withdrawal amounts enough to shorten the amount of time to regain safety significantly. [The exception is when your reduction is very shallow compared to the bare minimum.] There are times to look for ways to adjust to harsh market realities. This reinforces the general idea behind shifting allocations.

Have fun.

John R.


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Mike
*** Veteran


Joined: 06 Jul 2003
Posts: 278

PostPosted: Sat Mar 20, 2004 9:51 am    Post subject: Reply with quote

Quote:
Deeper cuts early on reduce the amount of time needed to gain safety.

This is the sense that I usually get from reading the works of financial planners. The early years of retirement are the most crucial, and early losses coupled with withdrawals can devastate a portfolio. Minimizing withdrawals in the first several years reduces the risk to a portfolio's longevity under the standard fixed allocation scenarios. It is good to know that switching strategies can allow an alternative in case withdrawals need to be increased early on.


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JWR1945
***** Legend


Joined: 26 Nov 2002
Posts: 1697
Location: Crestview, Florida

PostPosted: Mon Mar 22, 2004 11:58 am    Post subject: Reply with quote

From previous investigations I have found that you know how things will work out at eleven years. Your portfolio will have grown or it will have started to show signs of danger.

Ten years is not quite enough.

Have fun.

John R.


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lostcowboy
* Rookie


Joined: 18 Mar 2004
Posts: 1
Location: Krum Texas

PostPosted: Tue Mar 23, 2004 12:31 am    Post subject: Reply with quote

Hi all, I found two web sites that may be of interest. http://www.isgplanning.com/Index.htm This web page http://www.isgplanning.com/Storm.htm talks about how you could of survived retiring in 1966.

On this web site http://www.saccocompany.com/index.htm He talks about adjusting the withdraw amount based on the price of the stock. While I think his formula has some problem in it, the idea holds some interest.


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JWR1945
***** Legend


Joined: 26 Nov 2002
Posts: 1697
Location: Crestview, Florida

PostPosted: Thu Mar 25, 2004 1:16 pm    Post subject: Reply with quote

To lostcowboy: Thanks for the links. They are helpful.

In terms of the formulas in the Sacco Company post, they are set up the way that an Electronics Engineer would typically set up a digital filter (or a feedback system). They have (relatively) simple solutions for a few well known, simple inputs (i.e., assumed stock market behaviors).

Have fun.

John R.


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