[pro-player width=’530′ height=’253′ type=’video’]http://www.youtube.com/watch?v=MdmbkeJe6zo[/pro-player]
Late last year we had some discussion about so-called “safe withdrawal rates” i.e. what is the ‘magic percentage’ that you can withdraw from your bank account (or other investments) each year, once you are retired, so that you don’t risk running out of money?
Jacob from Early Retirement Extreme said:
It’s fairly well-established (by the original Monte Carlo paper) that the 4% rule is only good for 30 years. Also it only pertains to a broad market total return portfolio. For shorter periods I’ve seen people quoting up to 7%. For longer periods, 3% or less seems to be in order.
He also suggested for a “more extensive discussions see Bob Clyatt’s book”, which we started discussing last week.
Bob undertakes a reasonably good strawman-analysis of some of the existing thinking on Safe Withdrawal Rates then uses some of his own analysis to come up with three rules:
1. It’s OK to withdraw between 4% and 4.5% of your portfolio each year, but
2. You only need reduce the $ figure of the previous year by 5% to cushion the effects of a down-market, as long as you
3. Follow his recommendations for a highly diversified portfolio of stocks, bonds, bicycles, and sausages.
[AJC: OK, I made up the bicycles and sausages bit ;)]
If you follow these rules, here’s your chances of NOT running out of money, depending on your time horizon:
Now, a few things bother me about this, indeed most discussions on this and other so-called Safe Withdrawal Strategies:
1. Here’s a bunch of people who generally advocate NOT to try and time the stock market, yet, in most cases (including Bob’s strategy, if you take the 5% option) you are trying to TIME the worst possible market of all: how long you expect to live!
2. There’s always a chance that your money will run out before you do – including in 7 of Bob’s 8 (recommended as ‘safe’ and ‘sustainable’) categories; and, in the one ‘safe’category, you still have to run the gauntlet of a nearly 20% chance of perhaps losing your money for 2 whole decades.
3. Even if you wind down your % to Jacob’s suggested 3% withdrawal strategy, Bob’s numbers [AJC: you’ll have to see the book for this one] still show an almost 15% chance of losing your money in the first decade.
Now, there are other Monte Carlo studies that show that withdrawal rates on 3% to 3.5% are pretty damn ‘safe’ … BUT:
a) Personally, I expect to live forever and expect my money to do the same, and
b) How close to ZERO (but never quite reaching it, according to the statistical analysis of 3% – 3.5% withdrawal rates) do I allow myself to get before I panic?
I can’t help thinking that you need to substitute the words “safe withdrawal %” for “the right length and strength of vines” in the video, above, to really understand what it would mean to suffer a prolonged market downturn in retirement 😉