The problem was that the methodology used in the intercst study is an invalid methodlogy for purposes of determination of the SWR, as defined in the study. It ignores a critical factor in the analysis, and thus always generates the wrong answer to the question posed.
your use of the term invalid requires explanation since it does not correspone to the usual use of the word, sorry to drag this over to town center but since the usual invalidity claim is being made here............
Historical swr studies and inflation adjusted safe withdrawal rates
The rate is expressed relative to initial portfolio value. Withdrawals in subsequent years are adjusted upward for inflation.
There are two general approaches to estimating "safe" withdrawal rates from retirement portfolios.
Studies based on historical sequences of returns have looked at various portfolio compositions and based on the amount initially withdrawn have reported the probability of portfolio survival. (Example Trinity) or the maximum "100% Safe" withdrawal rate. (REHP) These studies have limitations. If planned withdrawals start at a period of overvaluation more extreme than occurring during the course of the study questions arise about the applicability of the historical swr. Interesting attempts to test the historical swr have included rearranging the yearly data, increasing the expense ratio to simulate possible lower future investment returns, and simply reducing "swr" in a linear fashion according to degree of overvaluation/ historical extremes.
Monte Carlo analysis allows computer simulation of safe withdrawal rates based on estimates of portfolio return and variability. One limitation of this type of study is that future portfolio returns and volatility are unknown.
Using a particular definition of "safe withdrawal rates" (swr) some people (mainly hocus) have argued that historically based swr analysis is invalid. Most people seem to use the term "safe withdrawal rates" as if it meant withdrawal rates which are safe. Hocus has a specialized meaning in mind: Please explain how the Trinity study is invalid.
The Trinity study methodology does not take into account how the SWR changes with changes in valuation levels.
And here by failure to account for changes in valuation, he means failure to explicitly include valuation in some sort of calculation.. Many of us, using the conventional meanings of words have disagreed.
I don't agree with this claim. In science of all sorts, researchers frequently chose to study one part of a problem and basically ignore everything else. I see it all the time in food and health studies. Just because a study doesn't present the whole picture doesn't mean it is invalid. Just that it is limited. Authors usually include some wiggle words to indicate that they haven't presented the entire picture. The REHP study does that. Bensolar 7/20/03
Further hocus on this matter:
The reason why I say that the 2.0 percent number is valid and the 2.3 percent number is valid, but the 4.0 percent number is invalid, is that the first two numbers both are the product of methodologies which consider the effect of changes in valuation, while the latter is not.
Some of us wasted effort trying to tell hocus that changes in valuation occurred during the historical period and were implicit in the study. A waste of effort since he has defined valid studies as those that make explicitly use of valuation in some sort of calculation.
Some of us wanted to say that perhaps a study could be valid but less applicable to current circumstances. For example at the peak of the market bubble the market's p/e ratio was above the range that existed in the 1870-1970 period studied. Monte Carlo analysis using expected future returns suggested a lower swr. Wasted words since for hocus the "invalidity" of the study is definitional and does not depend in any way on the study actually giving a wrong or unreliable swr estimate. The study is invalid even for the 1870-1970 period where the withdrawal rate is know to have been safe. Hocus has also criticized the study for giving too high a withdrawal estimate and for causing "busted retirements" but I think it is important to understand that the invalidity claim if definitional and is not subject to disproof.
Until 7/21 I had assumed that hocus understood the Trinity/REHP approach and simply rejected the embedded inclusion of valuation preferring a calculation based on an explicit valuation factor. Then hocus revealed that he completely misunderstood the studies:
What the conventional analysis tells you, I believe, is the average SWR over a long period of time. If you properly calculated all the SWRs for each of the past 100 years, added them together, and then divideded by 100, I believe that the number you would get would be something close to 4. I guess it's good to know that number. But that number is not the SWR as defiined for purposes of SWR analysis.
and then look at this:
The one thing that distinguishes me from all others in this matter is that I am the only one who understood the realities of SWRs from the first day.
hocus Sun Aug 17
There may be some who do not possess a clear understanding of exactly how a SWR is defined in the studies ......... If there are genuine points of confusion, I am happy to help out.
hocus Sat July 26
Hocus prefers to call studies based on sequential historical data the "traditional method."
I thought this was an interesting scattergram of maximal withdrawal rates vs. P/e ratio:
Apparently even devoted followers of the historical approach are aware that there is an association between valuation, investment results, and safe withdrawal rates.
(Thanks to Intercst and BenSolar)
Alternatives to this type of withdrawal include:
Annual withdrawal of a fixed proportion of the portfolio
Preservation of capital with spending dividends/ income
Multiple sub-portfolios/ dynamic asset allocation
sensible withdrawal rates
There is an "official" swr definition on the NFB FIRE board but hocus defines swr in a somewhat different manner.