What happens if you withdraw 25% of each year's gains?

Research on Safe Withdrawal Rates

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JWR1945
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What happens if you withdraw 25% of each year's gains?

Post by JWR1945 »

What happens if you withdraw 25% of each year's gains (but not losses)?

Here are some comparisons. These tables show the 5-year rolling averages of what you could withdraw at years 5, 10, 15, 20, 25 and 30 if you remove 25% of a portfolio's year-to-year gains (but not losses). Other tables show what the withdrawal rates are when none of the gains are removed. In addition, the TIPS Equivalent Safe Withdrawal Rate shows what a 100% TIPS portfolio can deliver with no risk at all.

Conditions
$100000 initial balance.
50% stocks and 50% TIPS at 2% interest.
0.20% expenses.
25% of year-to-year gains (but not losses) were removed.

A percentage of the initial balance (plus inflation) was withdrawn each year as well. The reported results are the highest percentages that would have survived for a full 30 years. If this percentage were increased by 0.1%, the portfolio would have failed within the first 30 years.

Other conditions were at their standard settings. Inflation adjustments were made each year in accordance with the CPI. The portfolio was rebalanced each year to maintain a fixed allocation. Withdrawal amounts (not including expenses) were determined at the beginning of each year. Half was withdrawn at the beginning of the year. The other half was withdrawn at the end of the year.

The 0.20% expenses are included in the reported withdrawal amounts. This is a limitation of the calculator. The alternative was to set expenses equal to zero.

Tables

Withdrawal amounts averaged over the preceding 5 years, starting with an initial portfolio balance of $100000 and removing 25% of all portfolio gains (but not losses) from the previous year, 50% stocks and 50% TIPS at a 2% interest rate.

Year, Percentage Earnings Yield 100E10/P, Maximum Surviving Withdrawal Rates in terms of the initial balance, Amounts at 5 years, Amounts at 10 years, Amounts at 15 years

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1921   19.61    6.4    7078    8024    7068
1922   15.87    6.7    7722    8224    7983
1923   12.20    6.4    7136    7927    7914
1924   12.35    6.4    7752    7413    8034
1925   10.31    6.2    8174    7061    7203
1926    8.85    5.6    7122    6409    6568
1927    7.58    5.5    7039    6952    5859
1928    5.32    4.9    5913    6455    5008
1929    3.69    4.2    4360    5638    4306
1930    4.48    4.2    4923    5103    4313
1931    5.99    4.5    5287    5499    4638
1932   10.75    5.5    7296    5977    5881
1933   11.49    6.4    8948    6576    6900
1934    7.69    5.6    7024    5842    5991
1935    8.70    6.0    7595    6343    6392
1936    5.85    5.2    5959    5522    5532
1937    4.63    4.7    4881    5268    4864
1938    7.41    5.5    5714    6236    5729
1939    6.41    5.3    5620    5900    5546
1940    6.10    5.5    5956    6027    5775
1941    7.19    6.6    7238    7168    7153
1942    9.90    7.2    8454    7655    7642
1943    9.80    6.9    7954    7373    7401
1944    9.01    6.6    7439    7085    7145
1945    8.33    6.4    7106    6912    7232
1946    6.41    6.7    6878    7725    7256
1947    8.70    7.4    8067    8312    7963
1948    9.62    7.3    8067    8245    7936
1949    9.80    7.1    7890    8088    7793
1950    9.35    7.4    8286    9086    7746
1951    8.40    6.8    7916    7793    7184
1952    8.00    6.3    7422    7083    6736
1953    7.69    6.1    7251    7061    6465
1954    8.33    6.1    7320    7136    6591
1955    6.25    5.3    6503    5847    5588
1956    5.46    4.9    5696    5525    5176
1957    5.99    5.0    5832    5694    5268
1958    7.25    5.2    6325    5777    5529
1959    5.56    4.6    5004    5298    4858
1960    5.46    4.5    5194    5023    4772
1961    5.41    4.4    5223    4861    4695
1962    4.72    4.2    4851    4592    4732
1963    5.18    4.4    5106    4911    4901
1964    4.63    4.1    4748    4540    4469
1965    4.29    3.9    4474    4297    4304
1966    4.15    3.9    4363    4305    4361
1967    4.90    4.1    4656    4869    4389
1968    4.65    4.0    4494    4660    4313
1969    4.72    4.1    4644    4598    4475
1970    5.85    4.4    5011    5046    4783
1971    6.06    4.4    4966    5174    4708
1972    5.78    4.4    5282    4871    4582
1973    5.35    4.5    5149    5013    4770
1974    7.41    5.2    5984    6009    5481
1975   11.24    5.9    7011    6743    6261
1976    8.93    5.3    5984    5948    5752
1977    8.77    5.4    6301    5970    5781
1978   10.87    6.0    7077    6949    6465
1979   10.75    6.2    7487    7006    6819
1980   11.24    6.1    7318    7034    6743
Year, Percentage Earnings Yield 100E10/P, Maximum Surviving Withdrawal Rates in terms of the initial balance, Amounts at 20 years, Amounts at 25 years, Amounts at 30 years

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1921   19.61    6.4    7094    6446    6403
1922   15.87    6.7    6971    6748    6702
1923   12.20    6.4    6505    6446    6402
1924   12.35    6.4    6500    6445    6401
1925   10.31    6.2    6291    6240    6201
1926    8.85    5.6    5680    5650    5600
1927    7.58    5.5    5619    5528    5500
1928    5.32    4.9    5023    4922    4900
1929    3.69    4.2    4341    4222    4200
1930    4.48    4.2    4349    4218    4200
1931    5.99    4.5    4638    4518    4500
1932   10.75    5.5    5563    5525    5500
1933   11.49    6.4    6473    6429    6400
1934    7.69    5.6    5688    5626    5600
1935    8.70    6.0    6128    6030    6000
1936    5.85    5.2    5324    5223    5200
1937    4.63    4.7    4780    4722    4700
1938    7.41    5.5    5649    5531    5500
1939    6.41    5.3    5482    5332    5300
1940    6.10    5.5    5726    5532    5500
1941    7.19    6.6    6730    6636    6600
1942    9.90    7.2    7423    7248    7201
1943    9.80    6.9    7173    6950    6902
1944    9.01    6.6    6908    6650    6602
1945    8.33    6.4    6500    6449    6402
1946    6.41    6.7    6810    6754    6703
1947    8.70    7.4    7528    7462    7405
1948    9.62    7.3    7445    7367    7306
1949    9.80    7.1    7275    7164    7104
1950    9.35    7.4    7544    7469    7405
1951    8.40    6.8    6932    6862    6805
1952    8.00    6.3    6442    6360    6305
1953    7.69    6.1    6273    6157    6105
1954    8.33    6.1    6226    6155    6105
1955    6.25    5.3    5409    5379    5303
1956    5.46    4.9    5032    5026    4904
1957    5.99    5.0    5245    5038    5002
1958    7.25    5.2    5506    5237    5202
1959    5.56    4.6    4837    4631    4667
1960    5.46    4.5    4772    4532    4502
1961    5.41    4.4    4698    4431    4402
1962    4.72    4.2    4274    4228    4202
1963    5.18    4.4    4495    4427    4401
1964    4.63    4.1    4228    4125    4101
1965    4.29    3.9    4046    3926    3901
1966    4.15    3.9    4016    3923    3900
1967    4.90    4.1    4175    4127    4101
1968    4.65    4.0    4089    4025    4001
1969    4.72    4.1    4154    4122    4100
1970    5.85    4.4    4480    4425    4400
1971    6.06    4.4    4506    4424    4400
1972    5.78    4.4    4489    4418    4400
1973    5.35    4.5    4554    4518    4500
1974    7.41    5.2    5268    5229    5201
1975   11.24    5.9    6034    5939    5903
1976    8.93    5.3    5445    5347    5306
1977    8.77    5.4    5597    5453    5406
1978   10.87    6.0    6183    6099    6009
1979   10.75    6.2    6577    6388    6211
1980   11.24    6.1    6908    6193    6113
Historical (maximum) Surviving Withdrawal Rates (HSWR) as a percentage of the initial balance, removing none of the year-to-year portfolio gains, 50% stocks and 50% TIPS at a 2% interest rate.

Year, Percentage Earnings Yield 100E10/P, Historical Surviving Withdrawal

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1921   19.61    7.1
1922   15.87    7.5
1923   12.20    7.2
1924   12.35    7.2
1925   10.31    7.0
1926    8.85    6.3
1927    7.58    6.2
1928    5.32    5.5
1929    3.69    4.6
1930    4.48    4.6
1931    5.99    4.9
1932   10.75    6.1
1933   11.49    7.2
1934    7.69    6.1
1935    8.70    6.6
1936    5.85    5.5
1937    4.63    4.9
1938    7.41    5.8
1939    6.41    5.6
1940    6.10    5.9
1941    7.19    7.0
1942    9.90    7.8
1943    9.80    7.5
1944    9.01    7.1
1945    8.33    6.9
1946    6.41    7.1
1947    8.70    7.8
1948    9.62    7.8
1949    9.80    7.6
1950    9.35    8.0
1951    8.40    7.3
1952    8.00    6.8
1953    7.69    6.6
1954    8.33    6.7
1955    6.25    5.7
1956    5.46    5.3
1957    5.99    5.4
1958    7.25    5.6
1959    5.56    4.9
1960    5.46    4.9
1961    5.41    4.8
1962    4.72    4.5
1963    5.18    4.8
1964    4.63    4.4
1965    4.29    4.2
1966    4.15    4.2
1967    4.90    4.5
1968    4.65    4.4
1969    4.72    4.4
1970    5.85    4.8
1971    6.06    4.8
1972    5.78    4.8
1973    5.35    4.8
1974    7.41    5.7
1975   11.24    6.5
1976    8.93    5.8
1977    8.77    5.9
1978   10.87    6.6
1979   10.75    6.9
1980   11.24    6.9
Comparison Table

Year, HSWR with no gains removed, Withdrawal Amounts (with 25% of gains removed) at 5 years, 10 years, 20 years and 30 years.

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1921   7.1    7078    8024    7094    6403
1922   7.5    7722    8224    6971    6702
1923   7.2    7136    7927    6505    6402
1924   7.2    7752    7413    6500    6401
1925   7.0    8174    7061    6291    6201
1926   6.3    7122    6409    5680    5600
1927   6.2    7039    6952    5619    5500
1928   5.5    5913    6455    5023    4900
1929   4.6    4360    5638    4341    4200
1930   4.6    4923    5103    4349    4200
1931   4.9    5287    5499    4638    4500
1932   6.1    7296    5977    5563    5500
1933   7.2    8948    6576    6473    6400
1934   6.1    7024    5842    5688    5600
1935   6.6    7595    6343    6128    6000
1936   5.5    5959    5522    5324    5200
1937   4.9    4881    5268    4780    4700
1938   5.8    5714    6236    5649    5500
1939   5.6    5620    5900    5482    5300
1940   5.9    5956    6027    5726    5500
1941   7.0    7238    7168    6730    6600
1942   7.8    8454    7655    7423    7201
1943   7.5    7954    7373    7173    6902
1944   7.1    7439    7085    6908    6602
1945   6.9    7106    6912    6500    6402
1946   7.1    6878    7725    6810    6703
1947   7.8    8067    8312    7528    7405
1948   7.8    8067    8245    7445    7306
1949   7.6    7890    8088    7275    7104
1950   8.0    8286    9086    7544    7405
1951   7.3    7916    7793    6932    6805
1952   6.8    7422    7083    6442    6305
1953   6.6    7251    7061    6273    6105
1954   6.7    7320    7136    6226    6105
1955   5.7    6503    5847    5409    5303
1956   5.3    5696    5525    5032    4904
1957   5.4    5832    5694    5245    5002
1958   5.6    6325    5777    5506    5202
1959   4.9    5004    5298    4837    4667
1960   4.9    5194    5023    4772    4502
1961   4.8    5223    4861    4698    4402
1962   4.5    4851    4592    4274    4202
1963   4.8    5106    4911    4495    4401
1964   4.4    4748    4540    4228    4101
1965   4.2    4474    4297    4046    3901
1966   4.2    4363    4305    4016    3900
1967   4.5    4656    4869    4175    4101
1968   4.4    4494    4660    4089    4001
1969   4.4    4644    4598    4154    4100
1970   4.8    5011    5046    4480    4400
1971   4.8    4966    5174    4506    4400
1972   4.8    5282    4871    4489    4400
1973   4.8    5149    5013    4554    4500
1974   5.7    5984    6009    5268    5201
1975   6.5    7011    6743    6034    5903
1976   5.8    5984    5948    5445    5306
1977   5.9    6301    5970    5597    5406
1978   6.6    7077    6949    6183    6009
1979   6.9    7487    7006    6577    6211
1980   6.9    7318    7034    6908    6113
TIPS Equivalent Safe Withdrawal Rate

Mathematically, owning TIPS is similar to granting a mortgage. The same formula applies.

The TIPS Equivalent Safe Withdrawal Rate (TESWR) is in terms of inflation adjusted (i.e., real) dollars. Two subtleties enter into the equations. One is the time mismatch between an inflation index report and the adjustment to the TIPS principal. I assume that you spend in accordance to coupon payments received as opposed to matching inflation as it occurs. The other subtlety is that some TIPS must be sold. I assume that there are no gains or losses from these transactions.

The TIPS Equivalent Safe Withdrawal Rate (TESWR) is the percentage of the original balance that can be withdrawn in equal (inflation adjusted, real) dollar amounts over the entire time period (of 30 years) with a final balance of zero.

The formula for the TIPS Equivalent Safe Withdrawal Rate (TESWR) is:
TESWR = r / [1 - (1 / [1+r] )^N ], where r is the interest rate as a decimal fraction and N is the number of years. In this case, r = 0.02 and N = 30.

Using these numbers, the TIPS Equivalent Safe Withdrawal Rate (TESWR) is 4.465%. If the initial balance is $100000, the annual withdrawal is $4465.

I will make an analysis of these data in the near future. I have already determined the regression equations when withdrawal amounts are plotted versus the percentage earnings yield 100E10/P (or 100% / [P/E10]).

Initial findings

Withdrawing 25% of the year-to-year gains generally results in larger withdrawals early and smaller withdrawals later. This extends to the comparisons with a conventional approach as well. Withdrawal amounts are (generally) larger than the conventional approach in the earlier years and smaller in later years.

There were some periods in which owning stocks reduced income relative to an all-TIPS portfolio (at a 2% interest rate). They seem to correspond to times of high valuations such as the 1960s. Today's valuations are very high, just a little bit above than P/E10 = 26 (using Professor Robert Shiller's P/E10 for the S&P500 index).

Have fun.

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

Post by JWR1945 »

What happens if you withdraw 25% of each year's gains (but not losses)?

These are the general conditions

$100000 initial balance.
50% stocks and 50% TIPS at 2% interest.
0.20% expenses.
25% of year-to-year gains (but not losses) were removed.

A percentage of the initial balance (plus inflation) was withdrawn each year as well. The reported results are the highest percentages that would have survived for a full 30 years. If this percentage were increased by 0.1%, the portfolio would have failed within the first 30 years.

Other conditions were at their standard settings. Inflation adjustments were made each year in accordance with the CPI. The portfolio was rebalanced each year to maintain a fixed allocation. Withdrawal amounts (not including expenses) were determined at the beginning of each year. Half was withdrawn at the beginning of the year. The other half was withdrawn at the end of the year.

The 0.20% expenses are included in the reported withdrawal amounts. This is a limitation of the calculator. The alternative was to set expenses equal to zero.

Tables

Data summary tables were posted earlier.

Formulas

These are the formulas for the Maximum Surviving Amounts Withdrawn y as a function of P/E10 using 1923-1980 data. They are based upon an initial balance of $100000, removing 25% of all year-to-year portfolio gains (but none of the losses) and surviving for 30 years using increments of $100. These are 5-year rolling averages.

From 1923-1980 data, withdrawing 25% of all portfolio gains and with 50% stocks and 50% TIPS at 2% interest, this is the formula at year 5:
y = (47149 / [P/E10] ) + 2851.3 and R-squared is 0.7481.

From 1923-1980 data, withdrawing 25% of all portfolio gains and with 50% stocks and 50% TIPS at 2% interest, this is the formula at year 10:
y = (37892 / [P/E10] ) + 3380.2 and R-squared is 0.5802.

From 1923-1980 data, withdrawing 25% of all portfolio gains and with 50% stocks and 50% TIPS at 2% interest, this is the formula at year 20:
y = (36095 / [P/E10] ) + 2937.2 and R-squared is 0.6408.

From 1923-1980 data, withdrawing 25% of all portfolio gains and with 50% stocks and 50% TIPS at 2% interest, this is the formula at year 30:
y = (34918 / [P/E10] ) + 2871.2 and R-squared is 0.6305.

This is the formula for the Historical (or Maximum) Surviving Amounts Withdrawn y as a function of P/E10 using 1923-1980 data. They are based upon an initial balance of $100000, not removing any year-to-year portfolio gains (and losses) and surviving for 30 years using increments of $100.

From 1923-1980 data, not withdrawing portfolio gains and with 50% stocks and 50% TIPS at 2% interest, this is the formula when withdrawing a constant (real) dollar amount (equal to the initial withdrawal amount plus inflation):
y = (40350 / [P/E10] ) + 2943.2 and R-squared is 0.7057.

To calculate percentages of the initial balance, simply divide these amounts by 1000. They are called Calculated Withdrawal Rates.

Confidence Limits

These are the confidence limits based upon visual estimates of how much the data varies about the best-fit straight line from 1923-1980. They should be close to the true 90% confidence limits.

With 25% of gains removed:
at year 5, plus and minus 1.1% of the initial balance.
at year 10, plus and minus 2.1% of the initial balance.
at year 20, plus and minus 1.2% of the initial balance.
at year 30, plus and minus 1.1% of the initial balance.

With none of the gains removed:
plus and minus 1.5% of the initial balance.

Special Confidence Limits

Here are special confidence limits based upon visual estimates of how much the data varies about the best-fit straight line from 1923-1980 when the earnings yield is low (and P/E10 is high, above 17). They take advantage of the fact that the scatter of the data increases with the percentage earnings yield (and is almost constant when plotted against P/E10). They should be close to the true 90% confidence limits.

These special confidence limits should only be used with caution.

Perhaps, their best application is in determining High Risk Withdrawal Rates. Any error would be on the side of caution. Safe Withdrawal Rates are likely to be estimated more accurately, but calculations based on the standard confidence limits should still be kept in mind as a matter of caution.

With 25% of gains removed:
at year 5, plus 0.6% and minus 0.5% of the initial balance.
at year 10, plus 1.1% and minus 0.6% of the initial balance.
at year 20, plus 0.3% and minus 0.4% of the initial balance.
at year 30, plus 0.3% and minus 0.6% of the initial balance.

With none of the gains removed:
plus 0.4% and minus 0.6% of the initial balance.

Calculated Withdrawal Rates at today's valuations

Today's P/E10 is in the neighborhood of 27 to 28. Putting P/E10 = 27.5 into the 1923-1980 formulas, we determine our calculated withdrawal rates.

With 25% of gains removed:
at year 5, the calculated withdrawal rate is 4.6% of the initial balance.
at year 10, the calculated withdrawal rate is 4.8% of the initial balance.
at year 20, the calculated withdrawal rate is 4.3% of the initial balance.
at year 30, the calculated withdrawal rate is 4.2% of the initial balance.

With none of the gains removed:
the calculated withdrawal rate is 4.4% of the initial balance.

Safe, Calculated and High Risk Withdrawal Rates at today's valuations

The Safe Withdrawal Rate is the lower confidence limit placed about the Calculated Withdrawal Rate. The High Risk Withdrawal Rate is the upper confidence limit placed about the Calculated Withdrawal Rate.

These are the Safe, Calculated and High Risk Withdrawal Rates when 25% of all gains are removed:
at year 5, they are 3.5%, 4.6% and 5.7%.
at year 10, they are 2.7%, 4.8% and 6.9%.
at year 20, they are 3.1%, 4.3% and 5.5%.
at year 30, they are 3.1%, 4.2% and 5.3%.

With none of the gains removed, they are 2.9%, 4.4% and 5.9%.

Safe, Calculated and High Risk Withdrawal Rates at today's valuations using the special confidence limits

The Safe Withdrawal Rate is the lower confidence limit placed about the Calculated Withdrawal Rate. The High Risk Withdrawal Rate is the upper confidence limit placed about the Calculated Withdrawal Rate. The following makes use of the narrower limits associated with lower earnings yields (and higher P/E10 levels, above 17). They should only be used with caution.

These are the Safe, Calculated and High Risk Withdrawal Rates when 25% of all gains are removed:
at year 5, they are 4.1%, 4.6% and 5.2%.
at year 10, they are 4.2%, 4.8% and 5.9%.
at year 20, they are 3.9%, 4.3% and 4.6%.
at year 30, they are 3.6%, 4.2% and 4.5%.

With none of the gains removed:
they are 3.8%, 4.4% and 4.8%.

Comparisons with previously reported Safe Withdrawal Rates

The frequently mentioned 2.5% Safe Withdrawal Rate at today's valuations is for an 80% stock portfolio with 20% in commercial paper. It has a Calculated Withdrawal Rate of 4.0% and a High Risk Withdrawal Rate of 5.6%.

Using a portfolio of 50% stocks and 50% commercial paper, the Safe Withdrawal Rate that was previously reported was 3.1%. The Calculated Withdrawal Rate was 4.1% and the High Risk Withdrawal Rate was 5.1%.

Using a portfolio of 50% stocks and 50% TIPS at a 2% interest rate, the Safe Withdrawal Rate is 2.9%. The Calculated Withdrawal Rate is 4.4% and the High Risk Withdrawal Rate is 5.9%.

The difference in Safe Withdrawal Rates between portfolios with 50% stocks and 50% commercial paper or 50% TIPS may be an artifact of how the confidence limits were determined. The confidence limits with TIPS were determined visually. Actual calculations were used with commercial paper.

If we use the special confidence limits for high valuations (P/E10 above 17) or low earnings yield, the rates for a portfolio of 50% stocks and 50% TIPS at a 2% interest rate, the Safe Withdrawal Rate would be 3.8%. The Calculated Withdrawal Rate would still be 4.4% and the High Risk Withdrawal Rate would be 4.8%.

Only the standard confidence limits were used with portfolios that included commercial paper.

Calculated Withdrawal Rates versus P/E10

With 25% of gains removed at year 5,
when P/E10 = 20, the calculated withdrawal rate is 5.209% of the initial balance.
when P/E10 = 25, the calculated withdrawal rate is 4.737% of the initial balance.
when P/E10 = 30, the calculated withdrawal rate is 4.423% of the initial balance.
when P/E10 = 35, the calculated withdrawal rate is 4.198% of the initial balance.
when P/E10 = 40, the calculated withdrawal rate is 4.030% of the initial balance.

With 25% of gains removed at year 10,
when P/E10 = 20, the calculated withdrawal rate is 5.275% of the initial balance.
when P/E10 = 25, the calculated withdrawal rate is 4.896% of the initial balance.
when P/E10 = 30, the calculated withdrawal rate is 4.643% of the initial balance.
when P/E10 = 35, the calculated withdrawal rate is 4.463% of the initial balance.
when P/E10 = 40, the calculated withdrawal rate is 4.328% of the initial balance.

With 25% of gains removed at year 20,
when P/E10 = 20, the calculated withdrawal rate is 4.742% of the initial balance.
when P/E10 = 25, the calculated withdrawal rate is 4.381% of the initial balance.
when P/E10 = 30, the calculated withdrawal rate is 4.140% of the initial balance.
when P/E10 = 35, the calculated withdrawal rate is 3.968% of the initial balance.
when P/E10 = 40, the calculated withdrawal rate is 3.840% of the initial balance.

With 25% of gains removed at year 30,
when P/E10 = 20, the calculated withdrawal rate is 4.617% of the initial balance.
when P/E10 = 25, the calculated withdrawal rate is 4.268% of the initial balance.
when P/E10 = 30, the calculated withdrawal rate is 4.035% of the initial balance.
when P/E10 = 35, the calculated withdrawal rate is 3.869% of the initial balance.
when P/E10 = 40, the calculated withdrawal rate is 3.744% of the initial balance.

With none of the gains removed,
when P/E10 = 20, the calculated withdrawal rate is 4.961% of the initial balance.
when P/E10 = 25, the calculated withdrawal rate is 4.557% of the initial balance.
when P/E10 = 30, the calculated withdrawal rate is 4.288% of the initial balance.
when P/E10 = 35, the calculated withdrawal rate is 4.096% of the initial balance.
when P/E10 = 40, the calculated withdrawal rate is 3.952% of the initial balance.

TIPS Equivalent Safe Withdrawal Rates

A portfolio consisting entirely of TIPS with an interest rate of 2% can provide an income of 4.465% of the initial balance (plus inflation) for 30 years. The final balance would be zero.

This assumes that one adjusts his withdrawals according to the interest received. There is a slight mismatch between when inflation actually happens and when it shows up later as an adjustment to the TIPS principal and interest.

This also assumes that TIPS can be sold as necessary without any capital gains or losses.

This provides a zero risk baseline for making comparisons.

An all-TIPS portfolio at a 2% interest rate is very attractive at today's valuations. At valuations of P/E10 = 20 and higher, an all-TIPS portfolio is almost always competitive in terms of Safe Withdrawal Rates. It is often competitive in terms of Calculated Withdrawal Rates. When the TIPS Equivalent Safe Withdrawal Rate is higher than a Calculated Withdrawal Rate, the odds are better than 50-50 that an all-TIPS portfolio will do better than one that includes stocks (as represented by the S&P500 index).

Conclusions

Withdrawing 25% of a portfolio's gains is likely to increase amounts that can be withdrawn in the early years of retirement. But this is at the expense of lower withdrawals in the later years.

At today's valuations (with P/E10 = 27 to 28 ) the Safe Withdrawal Rates of a 50% stock portfolio is 2.9% when it includes TIPS at a 2% interest rate (with none of the gains removed). When 25% of the gains are removed (but none of the losses), the Safe Withdrawal Rates (in terms of 5-year averages) vary from 3.5% to 2.7% to 3.1% to 3.1% at years 5, 10, 20 and 30. The Safe Withdrawal Rate for a portfolio of 50% stocks and 50% commercial paper is 3.1%.

[The relative Safe Withdrawal Rates with TIPS (SWR = 2.9%) versus commercial paper (SWR = 3.1%) may be an artifact of how the confidence limits were determined.]

One should use caution when considering withdrawals of 5.0% or more in today's market. Standard calculations indicate that there is a reasonable chance of success at 5.0% even though it is less than 50%. But if estimates using the special confidence limits are correct, a point that is arguable, the odds of success are very low, less than 5%.

Have fun.

John R.
Mike
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Post by Mike »

[The relative Safe Withdrawal Rates with TIPS (SWR = 2.9%) versus commercial paper (SWR = 3.1%) may be an artifact of how the confidence limits were determined.]
So for those who index the S&P, if they stay under about 3% they will probably be ok. One might get a a bit more by going higher equities when the P/E falls, but there is no way to tell when this might happen, so don't get carried away. Adding several other asset classes as Bernstein recommends will probably increase the number, but there is less historical data to go by. Buying the asset classes with the best valuation increases the number even more, but again, don't get carried away.

In general, it is better to save enough so that you can start with relatively modest initial withdrawal rates. Follow the best available strategies, and if the portfolio grows in size you will get a raise by taking the same modest percentage from the larger portfolio. Otherwise, only adjust for inflation in withdrawals.
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