SWR Semantics

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JWR1945
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SWR Semantics

Post by JWR1945 »

SWR Semantics

There is a minor semantics argument about the definition of the term Safe Withdrawal Rate on the How do we handle dividends? thread. It has produced some really good comments such as FMO's list of six limitations related to implementing the Retire Early Safe Withdrawal Rate study. However, I wish to move away from arguments based on semantics alone.

At one time and elsewhere, I suggested that hocus move away from his use of the words Safe Withdrawal Rate since the definition was used in arguments against him. Over time, I noticed that the definition was quite fluid. It might suggest reliable projections or it might be restricted to a historically based tautology. Whenever someone pinned one of hocus's detractors to any particular definition, there would be a retreat in some meaningless refuge. I also learned that the words Safe Withdrawal Rate were not unique to the Retire Early Safe Withdrawal Rate study. Other sources, including William Bernstein, used the term in the same way that hocus does. I finally concluded that hocus's usage was best. Distractions and disruptions were no more than that.

With time, the special phrase Historical Safe Withdrawal Rate was coined. I think BenSolar deserves the credit. The purpose of the term was to isolate the specialized definition unique to the Retire Early Safe Withdrawal Rate study. It then shrunk in applicability to the historical record alone with no predictive value whatsoever. Of course, such a calculation is essentially meaningless. It is just that the future is worse than the past argument had become meaningless as well. It was no longer a remote possibility but a demonstrated current condition.

hocus is right in saying that a Safe Withdrawal Rate study has no value except in predicting the future. He is right in stating that the Retire Early Safe Withdrawal Rate study has merit. He is also right in pointing out that its applicability has been distorted greatly. It is more than an academic effort. It is far less than a perfect course of action. We should not hide behind a term such as Historical Safe Withdrawal Rate to avoid addressing its predictive value. But we can use the term to identify the specific, unique study upon which it is based.

I favor the more general usage of the term Safe Withdrawal Rate as used in making predictions. It is important that the use of the term be described accurately. It is best when it is described entirely in objective terms, even when these terms describe subjective factors. To the extent that subjective factors are identified explicitly and handled appropriately, they can be included in the definition.

Have fun.

John R.
JWR1945
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Post by JWR1945 »

More semantics

On the How do we handle dividends? thread, hocus made an important distinction that I think is worth noting:

The study is based on the Shiller data, which does not reveal how individual stock investors fared. The Shiller data shows how the stock fared, not how investors in the stock fared. The two concepts are not the same thing. Using the Shiller data alone, you cannot say what the safe withdrawal rate is for individual investors. It's not possible for intercst or anyone else to achieve this feat without looking at the proper data.

There are several sources that back up this kind of observation. Reported recently on another thread: a study concluded that the typical mutual fund investor did poorly during the bull market. The study was far from perfect since there was no way to distinguish between new investors from those who had been around for the entire time. But the underlying conclusion was true. Investors (using the term very loosely) destroyed their own returns...buying high while chasing fads and selling low out of fear.

hocus has the right idea. How well stocks do is not the same as how well stock investors do. It is worth remembering.

Have fun.

John R.
hocus
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Post by hocus »

Investors (using the term very loosely) destroyed their own returns...buying high while chasing fads and selling low out of fear.

There is a sense in which this comment brings everything full circle. The impetus to my discussion of the safe withdrawal rate issue on the REHP board was a thread in which a poster revealed that he was lowering his stock allocation because the losses had just grown too great. Galeno mocked the poster, and I believe that intercst added some comments sympthetic to the Galeno view (at least that's my recollection). I thought that was bad form because in my view the investor who started the thread was doing the right thing.

It is not a mistake to pull money out of stocks if you determine that you went with too high a stock allocation in the first place. MHTyler has described on this board how he went with a high stock allocation in reliance on the intercst approach. After losing a good bit of money, he cut back. My guess is that he has a more realistic FIRE plan in place now than he had before. His mistake was not lowering his stock allocation, but in going with an unsustainable allocation in the first place.

A valid safe withdrawal rate analysis can provide the insight needed to make better initial allocations. Say that you determine that, for someone in your circumstances, a 4 percent withdrawal is 91 percent safe with a 50 percent stock allocation but only 32 percent safe with a 74 percent stock allocation. You might well decide to give up the extra long-term return you might get with 74 percent stocks in exchange for the greater safety available with a lower stock allocation. If you had enough extra assets, you might go the other way; you might take the risk necessary to get the higher return on the thinking that having a safe 4 percent withdrawal is not that big a deal for you.

The point is not to recommend high stock allocations or low stock allocations. The purpose is to assess what sorts of possibilities are likely for your investments, given what the historical data tells you. Not knowing the valid safe withdrawal rate can lead to two unfortunate decisions--the first is when you initiate an allocation that is not realistic for someone in your circumstances; and the second is when you realize the mistake and need to lower your stock allocation at a time when the price available for those shares is lower than when you bought them.

The second decision is unfortunate, but still the best thing to do given the circumstances you find yourself in. The best thing is to calculate the safe withdrawal rate prior to making your initital investment decisions. Failing that, however, it is not a mistake to reverse course and make the best of a bad situation. If you discover that you went with an unfortunate allocation, you need to change that even if it means realizing a loss as a result of the earlier mistake.
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