Interim Withdrawal Rates

Research on Safe Withdrawal Rates

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JWR1945
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Joined: Tue Nov 26, 2002 3:59 am
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Interim Withdrawal Rates

Post by JWR1945 »

Overview

I have been holding back my latest research until the activity on this board improves. However, I have never held back, nor do I intend to hold back, any information that people need right away. Some of the numbers in this post are from the research that I am withholding.

It is quite clear what my research to date has shown. Current retirees should be out of stocks (as represented by the S&P500). Today's valuations are much too high.

In terms of selecting investments, I have restricted myself to looking at what is available in the calculators. That suggests that 2.2% TIPS (available on the secondary market) is the best choice. Alternatives that focus upon dividends and/or low valuations make sense. It is just that they are not characterized by the tools that I have at hand. I believe that carefully selected equities can do at least as well as TIPS even in today's market. Real estate can do even better.

What I have not calculated in the past is the withdrawal rate that retirees should use. That is what I present here.

These results are sketchy. An alternative choice would be to take advantage of our research into switching. It shows that the 30-year Historical Database Rate with switching is 5% as opposed to 4% without switching when dividends and valuations are inside of the historical range. The historical range for dividends extends down to 3% as opposed to less than 2% today. The historical range for valuations as measured by P/E10 extended up to 24 or 27 before the bubble. You would make adjustments to bring today's numbers into the historical range. For example, you might adjust the 30-year withdrawal rate to be 5% times the ratio of 24 (or 27) and today's P/E10. Without switching, you would use 4% times the same ratio.

Interim Actions

The appropriate withdrawal rate is 4.25% over 40 years. The initial allocation would be 100% TIPS at 2.2%. That allocation could last for ten years. Afterwards, a combination of 80% stocks and 20% commercial paper would be adequate. Other choices, especially using stocks and TIPS with switching, would be superior, but I have not quantified them. You would be waiting for P/E10 to drop to 16.7 before investing in stocks.

The Remaining Fraction

Refer to the equations in this thread and post:
http://nofeeboards.com/boards/viewtopic.php?t=1541
http://nofeeboards.com/boards/viewtopic ... 536#p12536

After ten years, TIPS at 2.2% (real) interest will retain 79.59% of their initial principal at a withdrawal rate of 4.25%. [It is 80.09% at 4.20%.]

The 30-year Safe Withdrawal Rate of an 80% stock / 20% commercial paper portfolio is 5.41% when the initial P/E10 is 12.5. Its most likely 30-year zero balance rate is 6.99%. [The confidence limits are plus and minus 1.58%.]

Divide 4.25% by 5.41%. That tells us that we need a balance after ten years equal to 78.56% of the portfolio's initial balance (at zero years) when we switch over to 80% stocks. If P/E10 falls to 12.5 within ten years, we can safely continue withdrawing 4.25%.

The 30-year Safe Withdrawal Rate of an 80% stock / 20% commercial paper portfolio is 4.07% when the initial P/E10 is 16.7. Its most likely 30-year zero balance rate is 5.65%. [The confidence limits are plus and minus 1.58%.]

If P/E10 fails to fall to 12.5 within ten years, we may decide to decrease withdrawals. P/E10 is highly likely to fall back to 16.7 (or less) within ten years. To get full safety, we would drop them to 4.07% of the balance after ten years (or 3.25% of the initial balance). The odds remain better than 50% that we could continue to withdraw the same amount (in real dollars) for another 30 years. [The odds would be 50% if the zero balance withdrawal rate were 5.41%. When P/E10 is less than 16.7, the zero balance withdrawal rate is 5.65%.]

Design by using Withdrawal Rates

What I have engaged in is a method of design. I have broken one's retirement period into two parts and made them compatible. Throughout the process, you can monitor how well your assumptions are holding up in order to make corrections as needed.

This is not exactly a Safe Withdrawal Rate calculation, but it is closely related. This kind of design is made possible by having Safe Withdrawal Rates and their confidence limits available. In this case we used a TIPS-only portfolio to get us back into the historical range.

I have previously set forth a design method based on dividends.

Have fun.

John R.
JWR1945
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Posts: 1697
Joined: Tue Nov 26, 2002 3:59 am
Location: Crestview, Florida

Post by JWR1945 »

Just in case it has not become obvious: I used my discoveries about Safe Withdrawal Rates versus the percentage Earnings Yield 100E10/P (or 100%/[P/E10]) to come up with some of my numbers.

The confidence levels (at the confidence limits) are close to 86% (but no worse than 75%). Previously, I had estimated the confidence limits as having a 90% level of confidence.

Today's TIPS long-term are yielding 2.4%. The rate had briefly dipped below 2%. It briefly exceeded 2.5% very recently.

Have fun.

John R.
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