Switching and Sensitivity to Withdrawal Rates

Research on Safe Withdrawal Rates

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JWR1945
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Switching and Sensitivity to Withdrawal Rates

Post by JWR1945 » Thu Sep 25, 2003 10:16 am

Switching and Sensitivity to Withdrawal Rates

This is a brief study of the sensitivity of portfolio lifespans to withdrawal rates when there is switching. The older Historical Database Rates were extremely sensitive. A increase of 0.2% reduced the portfolio duration by a decade (or worse) at high levels of safety (95% and above). This sensitivity disappears when we use portfolio switching.

Study Conditions

I looked at switching between 80% stocks and 20% stocks based on P/E10 with a threshold of 12. The higher stock allocation (80%) applied whenever the P/E10 was less than 12. The lower stock allocation (20%) applied when P/E10 was equal to or greater than 12. The alternative investment was TIPS with a 3% interest rate. The expense ratio was 0.20%, which is reasonable for an S&P 500 index fund, but which is high for the TIPS. I used a modified version of the Retire Early Safe Withdrawal [Rate] Calculator (Version 1.61, November 7, 2002). My modification makes TIPS the alternative asset class when switching. The original version used commercial paper.

Otherwise, I used default values.

I restricted my analysis to the years 1921-1980 to avoid a data anomaly.

Results

These are the number of failures on or before the number of years indicated for various withdrawal rates. Switching is between 80% stocks (below threshold) and 20% stocks (at or above the threshold). The P/E10 threshold is 12. The alternative investment is TIPS at a yield of 3%.

Code: Select all

Rate          20          25          30           35          40
4.0%           0            0            0             0            0
4.2%           0            0            0             0            0
4.4%           0            0            0             0            0
4.6%           0            0            0             0            0
4.8%           0            0            0             0            1
5.0%           0            0            0             2           10
5.2%           0            0            0            11           15
5.4%           0            0            7            14           16
5.6%           0            0           13            17           17
5.8%           0            5           16            18           19
6.0%           0            8           18            19           20


Conclusion

The combination of switching and TIPS eliminates the extreme sensitivity of portfolio duration to the withdrawal rate.

Have fun.

John R.

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