## High Risk at 4%? at 5%?

Research on Safe Withdrawal Rates

Moderator: hocus2004

JWR1945
***** Legend
Posts: 1697
Joined: Tue Nov 26, 2002 3:59 am
Location: Crestview, Florida

### High Risk at 4%? at 5%?

We normally discuss the Safe Withdrawal Rate on this board. This time, I will look at the exact opposite: the High Risk Withdrawal Rate.

More specifically, I am interested in when the High Risk Withdrawal Rate is 4% or 5% over a 30-year time frame.

I have extracted the following from the thread From Earnings Yield dated Thu, Apr 15, 2004.
http://nofeeboards.com/boards/viewtopic.php?t=2368

With the 50% stock portfolio, the Historical Database Rate (HDBR50) equation is HDBR50 = 0.3979x+2.6434%, where x = 100*(E10/P) or 100/[P/E10] = the earnings yield in percent and R squared equals 0.6975. When using this equation, the standard deviation of HDBR50 is 0.6178. The 90% confidence limits are plus and minus 1.01% of the calculated value.

With the 80% stock portfolio, the Historical Database Rate (HDBR80) equation is HDBR80 = 0.6685x+1.6424%, where x = 100*(E10/P) or 100/[P/E10] = the earnings yield in percent and R squared equals 0.7274. The standard deviation of HDBR80 using this formula is 0.9649. The 90% confidence limits are plus and minus 1.58%.

At 4%

These days, we refer to the numbers HDBR50 and HDBR80 in the equations as Calculated Rates. Previously, we had referred to them as Zero Balance Rates. In each case, I will solve for x, the earnings yield, when the upper confidence limit equals 4%.

With the 50% stock portfolio, the upper confidence limit is 1.01% above the Calculated Rate. When the upper confidence limit equals 4%, the Calculated Rate is 2.99% (which equals 4.00-1.01). Next we calculate x when HDBR50 is 2.99%. The equation becomes 2.99% = 0.3979x + 2.6434% or 0.3979x = 0.3466% and the earnings yield x = 0.8710731%. The High Risk Withdrawal Rate of a 50% stock portfolio occurs when P/E10 is 115 (or, more precisely, 114.80092).

When the Calculated Rate of the 50% stock portfolio equals 4%, we set HDBR50 = 4% in the equation and solve 4% = HDBR50 = 0.3979x + 2.6434% or 1.3566 = 0.3979x and the earnings yield x = 3.4093993%%. The Calculated Rate of the 50% stock portfolio occurs when P/E10 is 29 (or, more precisely, 29.33068).

With the 80% stock portfolio, the upper confidence limit is 1.58% above the Calculated Rate. When the upper confidence limit equals 4%, the Calculated Rate is 2.42% (which equals 4.00-1.58 ). Next we calculate x when HDBR80 is 2.42%. The equation becomes 2.42% = 0.6685x + 1.6424% or 0.6685x = 0.7776% and the earnings yield x = 1.1632012%. The High Risk Withdrawal Rate of an 80% stock portfolio occurs when P/E10 is 86 (or, more precisely, 85.96965).

When the Calculated Rate of the 80% stock portfolio equals 4%, we set HDBR80 = 4% in the equation and solve 4% = HDBR80 = 0.6685x + 1.6424% or 2.3576 = 0.6685x and the earnings yield x = 3.5267016%. The Calculated Rate of the 80% stock portfolio occurs when P/E10 is 28 (or, more precisely, 28.35511).

Bubble Valuations and 4%

P/E10 exceeded 29.0 in February 1997, May 1997 through August 2001 and November 2001 through April 2002. P/E10 peaked just above 44 in December 1999.

Those who started withdrawing 4% of their initial balances during those times still have a chance of reaching 30-years before they deplete their portfolios. In many cases, the odds are almost as good as 50%.

Even at the peak of the bubble, withdrawing 4% was still below the High Risk Withdrawal Rate, above which failure is almost certain to occur.

At 5%

Now let us see what happens for those who have started with a 5% withdrawal rate.

With the 50% stock portfolio, the upper confidence limit is 1.01% above the Calculated Rate. When the upper confidence limit equals 5%, the Calculated Rate is 3.99% (which equals 5.00-1.01). Next we calculate x when HDBR50 is 3.99%. The equation becomes 3.99% = 0.3979x + 2.6434% or 0.3979x = 1.3466% and the earnings yield x = 3.3842674%. The High Risk Withdrawal Rate of a 50% stock portfolio occurs when P/E10 is 29.5 (or, more precisely, 29.54849).

When the Calculated Rate of the 50% stock portfolio equals 5%, we set HDBR50 = 5% in the equation and solve 5% = HDBR50 = 0.3979x + 2.6434% or 2.3566 = 0.3979x and the earnings yield x = 5.9225936%. The Calculated Rate of the 50% stock portfolio occurs when P/E10 is 17 (or, more precisely, 16.8845).

With the 80% stock portfolio, the upper confidence limit is 1.58% above the Calculated Rate. When the upper confidence limit equals 5%, the Calculated Rate is 3.42% (which equals 5.00-1.58 ). Next we calculate x when HDBR80 is 3.42%. The equation becomes 3.42% = 0.6685x + 1.6424% or 0.6685x = 1.7776% and the earnings yield x = 2.6590875%. The High Risk Withdrawal Rate of an 80% stock portfolio occurs when P/E10 is 38 (or, more precisely, 37.60689).

When the Calculated Rate of the 80% stock portfolio equals 5%, we set HDBR80 = 5% in the equation and solve 5% = HDBR80 = 0.6685x + 1.6424% or 3.3576 = 0.6685x and the earnings yield x = 5.0225879%. The Calculated Rate of the 80% stock portfolio occurs when P/E10 is 20 (or, more precisely, 19.91006).

Bubble Valuations and 5%

P/E10 exceeded 29.5 in May 1997 through August 2001, November 2001 through January 2002 and March 2002.

Those who started withdrawing 5% of their initial balances from a 50% stock portfolio when P/E10 exceeded 29.5 have very little chance of making it to 30-years before they deplete their portfolios.

P/E10 exceeded 38 in July 1997 and in December 1998 through November 2000. P/E10 peaked just above 44 in December 1999.

Those who started withdrawing 5% of their initial balances from an 80% stock portfolio when P/E10 exceeded 38 have very little chance of making it to 30-years before they deplete their portfolios.

Final Remarks

This should help balance out the voices of those who have been telling us that 4% is overly conservative. Many who considered withdrawing 5% as taking on a reasonable risk are already in trouble. Taking note of valuations is critically important.

Do not be disturbed that the higher stock allocation has a greater likelihood of surviving with 5% withdrawals. It has a higher growth potential if future returns should turn out favorable. That might allow enough growth to allow for a 5% withdrawal rate.

If your preference is to guarantee safety, you would normalize your comparisons by looking at withdrawal rates in the neighborhood of 4%.

Have fun.

John R.

hocus2004
Moderator
Posts: 752
Joined: Thu Jun 10, 2004 7:33 am
"P/E10 exceeded 38 in July 1997 and in December 1998 through November 2000....Those who started withdrawing 5% of their initial balances from an 80% stock portfolio when P/E10 exceeded 38 have very little chance of making it to 30 years before they deplete their portfolios. "

Here's a Motley Fool board post from October 1999 illustrating the consequences that follow from decisions of responsible community members not to challenge those who have made it a longstanding practice to put forward misleading SWR claims.

http://boards.fool.com/Message.asp?mid=11405293

BGPenhollo: "5% is a bit more risky but is a safe level for providing inflation adjusted income. "

In the event that there are any who view it as unlikely that community members have made investment decisions in accord with such claims, here is another Motley Fool post from the same month.

http://boards.fool.com/Message.asp?mid=11377672

RKMcDonald: "4% of my portfolio will cover my basic living expenses. My mix will be 80% equities and 20% in cash or laddered treasury bonds....I have decided to draw 6% the first year and see how it goes. The next year I will give myself a raise only if I need it AND if the market has been good. If there is a bad year, and my portfolio decreases, I will cut my draw down to only what I need."

RKMcDonald was able to get by on a 4 percent withdrawal. That was not a safe take-out number at the valuation levels that applied at that time. Had he been informed of the realities of SWRs, he would have elected either to: (1) move a portion of his money into non-stock investment classes (TIPS were providing an SWR far in excess of 4 percent at the time); (2) stayed 80 percent in stocks and delayed his retirement until he had the savings needed to support a low-SWR retirement; or (3) reduced his spending so that he could get by on less than a 4 percent take-out number.

What he did instead was to make his retirement even more risky than it would have been with a 4 percent withdrawal by electing to start off with a 6 percent withdrawal that was not even required for him to enjoy a comfortable lifestyle. Why did he make this insanely self-destructive money decision? Because he didn't know what the data really says re SWRs. The community's irresponsibility did real harm to this poster's dream of early financial independence.

The community's irresponsibility has hurt lots of posters over the years, and there are new ones being done real harm every month in which the various Smear Campaigns continue. There are scores of similar posts sitting in the same Post Archives where these two came from. Prior to May 13, 2002, it was conventional wisdom at the Motley Fool board community that a 4 percent withdrawal from a high-stock-percentage portfolio was "100 percent safe" regardless of the valuation levels that applied, and that a 5 percent withdrawal was reasonably safe.

It wasn't my May 13, 2002, post that was a "mistake." It was that long-unchallenged conventional wisdom that was a mistake. That was a mistake that in all likelihood is going to cause serious life setbacks for a whole bunch of people who came to these boards expecting to be able to use them to obtain honest and informed insights on the question of how best to achieve financial independence early in life.

These boards thrive when honest and informed on-topic posting is permitted. They die when honest and informed on-topic posting is prohibited. I have worked like the dickens for 25 months now to save these boards, and I will work like the dickens for 25 more if that is what it takes to get the job done. I can do no more and I can do no less.

I am one poster. There is but so much that one poster can do. I need help.

Please help.

JWR1945
***** Legend
Posts: 1697
Joined: Tue Nov 26, 2002 3:59 am
Location: Crestview, Florida
JWR1945:

Would you be able to provide a list of the three numbers (Calculated Rate, Safe Withdrawal Rate, and High-Risk Withdrawal Rate) that applied on January 1 of each of the years from 1995 through 2004?

No. I do not have January 1 data for 2004.

Yes. I have just posted the information that you are after as a separate thread:
Calculated Rates of the Last Decade dated Wed Jun 23, 2004.
http://nofeeboards.com/boards/viewtopic.php?t=2657

Have fun.

John R.

JWR1945
***** Legend
Posts: 1697
Joined: Tue Nov 26, 2002 3:59 am
Location: Crestview, Florida
For more about rkmacdonald's plight and what he did, see this early thread posted at the FIRE board:

How things change dated Fri Dec 06, 2002.
http://nofeeboards.com/boards/viewtopic ... highlight=

Have fun.

John R.