More Draw Down Dilemma

Develop A Contingency Plan For Retirement – Features

Here is a quick read about the draw down dilemma retirees face. it cites the 4% number as a good starting point but points out how the number could go up to 6% in a very bad case scenario for equities.

My answer to this has always been; whatever you got, 4%.

My answer probably means you don’t run out of money but does mean that a meaningful pay cut is in the offing after a bad year or three. That scenario would also have to be mitigated of course but part of that solution is behavioral–depending on your specific situation it could all be behavioral or none of it but mostly likely somewhere in between.

14 Comments

  1. The problem is the “fat tails.” The actual likelihood of a serious drawdown is far higher than most statistical analysis will show. That means that committing a high proportion of one’s assets to stocks, at this point anyway, is probably economically suicidal. The 10 year return on stocks is no better than Treasuries, anyway, and risk and volatility are much higher both retrospectively and prospectively. Retirees who are not actively timing should put their money in TIPS and withdraw accordingly.

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  2. “The 10 year return on stocks is no better than Treasuries”

    Over what period? A particularly bad one? Reference, please.

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  3. hippodrome, Hussman has shown several times that over the last decade (give or take) equities have not beaten tbills–he has chronicled this for several months actually.

    anon, i am not making a declarative statement right here but will ask a question to challenge your thesis; when is it better to buy equities right after a ten year period where equities have not beaten treasuries or after a several decade period where they have beaten treasuries?

    Looked at in a vacuum, now would be the time to buy equities. Obviously i am less gung ho than that rihgt now but I would submit this is not the worst time in history to have equitiy exposure; below your target? yes, but zero weight(which I don’t think you are saying) no.

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  4. Please forgive an off topic noob question: When buying a foreign country ETF like EEM, what is the effect on my returns when the dollar exchange rate fluctuates?

    Thanks for your help!

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  5. you own a foreign stock or etf; dollar down creates a tailwind for you, dollar up creates a headwind.

    when you buy a foreign stock you are also investing in that currency so when that currency goes up v the greenback you benefit

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  6. One question/issue I am currently wrestling with is whether for a retirement portfolio that is taking regular annual withdrawals versus a pure growth/accumulation portfolio (where year to year volatility may not matter as much) is if it makes more sense to tilt the retirement portfolio more towards low volatility, absolute return type investments.

    For example, my Dad just retired with a roughly 200K 401(k) that is being rolled into a IRA. He is an extremely conservative investor with a low threshold for volatility. He is taking 100k and putting it into money market and CDs, and giving me the other 100K to manage.

    Now in my model portfolio, I own Hussman Strategic Growth but in a relatively small allocation. I am contemplating whether a much larger allocation makes sense for a retirement account where bigger drawdowns may be unacceptable.

    This problem is compounded by the current low interest rates in the fixed income world and low dividend yields provided by most stocks.

    A bit of a vent here, but it is tough for savers and those living on fixed incomes and their investment portfolios. The Fed taking interest rates continually lower and overall low for most of the past 7 years, may be good for debtors and juicing/stimulating the economy, but it is horrible for savers/investors looking for decent returns with little to no risk.

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  9. I thought you were advocating 4.4% a while back not 4%?

    Economists find that people continue to spend at a high level even if there income is reduced significantly for quite a while. I think people will not reduce spending if a few bad years come a long until the math starts looking really bad.

    I think people need to take less to start or work longer. Working full time for 6 to 12 months longer at $40/hr is equivalent to many years of part time work at $8/hr in retirement.

    There is really no nice way to correct things once the math starts looking bad. Saying spend 4% no matter what is easy to say but not very realistic for most people.

    I do think the 4% is much more realistic than the 4.4%. Unfortunately I think the next 10+/- years will be less than optimal and even lower numbers will be required to start.

    BTW if engineers designed products with only a 96% success rate and a 4% catastrophe potential they would either take the engineering license away from them or throw them in jail.

    seg

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  10. BTW if engineers designed products with only a 96% success rate and a 4% catastrophe potential they would either take the engineering license away from them or throw them in jail.

    FWIW, as a former electrical engineer who switched to the investment world, here is the problem with the parallel.

    The physical world of bridges, circuits, wiring, etc. obey certain laws of physics that NEVER change and are known with ABSOLUTE CERTAINTY. You can calculate what size cable is needed to carry a certain current and there are no uncertainties with that.

    Unfortunately, the investment world doesn’t work that way. There is no way to know anything with absolute certainty. The market has returned 10-11% the last 50-100 years. Does that mean with 100% certainty the U.S. market will return 10-11% for the next 20 or 50 years. Nope.

    Ultimately, in the investment world you are dealing with probabilities whereas in engineering you are dealing with certainties. That makes it alot easier to design for 100% reliability.

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  11. Seg, 4.4% gives a 96% chance for success. I think I have, without thinking about it, gravitated to 4 point O as a function of being somewhat conservative.

    Mike C, this may be difficult to take in from a stranger but doing something different for a relative is probably a horrible idea.

    I would say do the same as you do for people for whom you have no emotional interest in.

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  12. Mike C,

    Point taken for engineering vs. finance, but the world of finance is full of it.

    There are constant Rosie scenarios provided to the public that are simply unrealistic. Either they are not honest or idiots following the heard IMO.

    Then they simply use a 4% probability of failure as there excuse as opposed to proper planning.

    seg

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  13. The 4% withdrawal rate quoted by almost everyone, assumes one leaves his principal intact at his death.

    What guideance is there for those who wish to leave zero principal at death?

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  14. i think that in order to leave none you either need to knwo when you will die or you could put it all in an annuity.

    not being a wise ass–i just don’t know.

    Reply

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More Draw Down Dilemma

Develop A Contingency Plan For Retirement – Features

Here is a quick read about the draw down dilemma retirees face. it cites the 4% number as a good starting point but points out how the number could go up to 6% in a very bad case scenario for equities.

My answer to this has always been; whatever you got, 4%.

My answer probably means you don’t run out of money but does mean that a meaningful pay cut is in the offing after a bad year or three. That scenario would also have to be mitigated of course but part of that solution is behavioral–depending on your specific situation it could all be behavioral or none of it but mostly likely somewhere in between.

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