Effect of Buffer on Withdrawal Rates

withdrawal strategy?

I remember reading an article a while ago about how pension funds use bonds as a buffer for fluctuating stock prices. The basic idea was that the fund moves more toward stocks when the market is down and more toward bonds when the market is up. A nice side effect was that it provided automatic balancing between stocks and bonds. I wish I had a link for you, but this was a while ago. However, I got the impression that it was at least somewhat common, so maybe if you do some research in to pension funds, you might be able to come across something like this.

My personal take is that your idea seems dangerously close to market timing. Perhaps it would be just as effective to use dollar cost averaging on your withdrawals. That way, you'll sell some stocks low, some stocks medium and some stocks high. This will provide some of the protection you're looking for.

As an aside, the 5% withdrawal rate is, IMO, entirely reasonable. The (admittedly convservative) Rule of 25 suggests a rate of 4% can be sustained indefinitely. Depending on your age, you may want to factor Social Security in to your planning. I'm 27, so I disregard Social Security when doing any retirement planning. But if you're 57, it might be a different story.

--Bill

This doesn't sound in the least like a good idea. I wouldn't think selling stocks for income is practical at all. I have monies invested for income, like Bonds or a Money Market, and that's where I'll be getting my withdrawals.

I don't understand. Are you saying you don't have any equities at all? If you do have equities, when do you rebalance?

What's wrong with selling stocks for income as long as you have enough non-stock assets to ride through bad markets? If you don't sell stocks at some point, why own them?

Thanks, Doug

I think withdrawal strategies which ignore a cash allocation are misleading... and withdrawal strategies which involve "just in time" withdrawals are living on the edge to begin with. I suggest withdrawing 8 years before you "need" the money and leave this allocation in cash or inflation indexed securities.

If the example you gave above, consider taking 8*60k and putting it in CASH the day you retire. Regardless what the market does the next 8 years, you are OK. 60k in money market, 60k in a 1 year CD, 60k in a two year CD, 60k in a 3 year CD, then 4*60k into some type of inflation security. Roll one index bond into a 3 year CD, and replenish the indexed securities from the equity investments each year (in up markets).

The remaining 580k of the portfolio needs to sustain 60k annual withdraws, but only withdraw when the market is UP. If market goes down and stays down for 8 straight years (or even 4 of the 8), everyone will have bigger problems.

I do consider this market timing... but if a big risk to porfolio is a down year or two early in retirement, I would hedge against this risk with cash. 4 years into this system, the inflation indexed securities should help portfolio do quite well generating the income needed. Takes more cash up front, though (than traditional withdrawal models).

FranksPlace2 wrote:

The way the studies are worded you are offered a 90% success rate of not outliving your money at the suggested 4% withdrawal rate. You need to keep in mind a few things. The Monte Carlo simulations that generated these numbers are based on the past 70 or so years which I believed averaged 10.5% for the simulation. Given the 10.5% average, along with its standard deviation (somewhere around 18%) the 4% number includes a 3% inflation factor, i.e. it includes raising the withdrawal by about 3% per year from the initial amount. Consider that if you could invest at 7% fixed, in perpetuity, you'd be able to take the 4% and leave the 3% to grow your principal (yes, I've ignored taxes for sake of simplicity). So the reason that the Monte Carlo gives you this based on 10.5% average is the volatility. You don't know which year will be up or down. Given all of this, there has been discussion here suggesting that the next 30 years are likely to under perform the historical numbers. That 7-8% is the more likely growth rate to expect. Next, commentary along with these studies suggests different tweaks or adjustment rules to help bump the percentage up. One rule is that you don't take the inflation bump after a down year. Since on average 1 in 3 years or so are down, you may object, that you will trail long term inflation by 1/3. I understand. Back to your original question, though. The studies do assume the withdrawals are based on the same mix within the portfolio, that at the end of each year you are rebalanced to the original plan. This matches just what you plan. If the market is up, then to rebalance you would need to sell stock. If the market has dropped, well, then the bond portion is too high and you'd buy stocks when down. To call this 'timing' is a matter of semantics. Rebalancing causes one to buy stocks when low and sell when high. Lastly, if you choose stocks with high dividends, (I'm thinking the DVY, iShares Dow Select Dividend) your stock portion will yield 3%, this is a good chunk of what you need, if 80% of your funds are in such high yield stocks, there's 2.4% of the 4% (or 5% as you desire) and the rest will take a smaller bite from your cash position. You question is straightforward, the answer is not. JOE

See jLMs response for clarification. I don't necessarily advocate the ultra-conservative 7-8 years in cash/cash-like, but neither would I subscribe to something as risky as selling equities for income.

Elizabeth Richardson

jIM - 8*60H0K

This leaves 720K for 8 years worth of growth. With the warning about "past performance, yada,yada" since 1920 the 8-yr annualized returns average 10.9% with STD Dev of 6.0%.

To start will 40% sounds a bit high, I'm with Elizabeth on this, but these conversations need to include a 'sleep factor' and your suggestion would get one through most bad periods with little risk.

JOE

If a large risk to assetts lasting for duration of retirement is a down year early, I think hedging against this risk with cash is a wise strategy. Maybe the assets do not get replaced until year 6 or 7 (so withdraw 8 years income in cash to start, but overall plan might be only 5-7 years of cash).

I am sure other strategies exist... maybe 8 years of income in bonds... maybe 8 years of income in cash or inflation bonds, the rest in equities...

The way I suggested above is the strategy I am looking to implement. 8 years cash the day I retire, with an equity/bond portfolio designed to replace this one year at a time.

Thank you all for your comments.

There seems to be a consensus that "selling stocks for income" is not a good idea. If the FPA article and Fidelity include this in their models, it does not represent good practice.

One alternative is to sell only bonds and rebalance once a year, say on a fixed date. The results for this case may be better or worse than the first case depending on whether the price on that day is higher or lower than the average for the prior sales.

My alternative is to rebalance "when the market is up" sometime over a

Going to 8 years cash is the opposite of my goal. I want more return, not less risk. My strategy could result in a 100% stock portfolio in the extreme case and I can live with that risk. (I wish I had been in

Dollar averaging is also the opposite of my goal. I don't want to sell more shares at a low price, only less shares at a higher price.

I'll retire in about a year and see how this works out.

Frank

Frank one of the concerns I've had about these withdrawal and rebalancing strategies has to do with increasing age. I've been involved in investments for some time and don't recall any age 75+ investors who could do what's required - monitoring and making decisions on the withdrawals, keeping current with tax rules, tracking basis, following the markets, etc.

Since I frequently miss the obvious , I'd be interested in comments from you and others on this subject.

-HW "Skip" Weldon Columbia, SC

I certainly expect be able to do this at 75 -- my dad is 81, mom is 80 and neither has any problem with this level of complexity. Grandma could whip me at bridge into her late 90's. However, this is another reason immediate annuities get interesting about this age.

My tentative plan (still 20 years away) is to buy an immediate annuity in my mid

The equities (probably more passively invested than now), along with social security adjustments, would cover the inflation risk.

-- Doug

Frank,

Whether you like the answer or not, $1.2MM is pretty close to the "risk-free" answer. Given 3% inflation and a 4% "risk free" investment (i.e. gov't bonds) your principle would be gone be the end of the 23rd year.

Obviously, the amount of risk you are willing to take on is entirely based on your risk tolerance. If you opted for riskier investments (for ex: 8% return) you could accomplish the same financial goals with only $850k.

Many of the answers given here could be correct. they are the proper answer given the level of acceptable risk they assumed into the situation.

As you stated it is a good idea to hold a percentage of bonds in your portfolio to hedge against a market downturn. 25% is a common allocation to be found in a moderately aggressive to conservative portfolio.

As for the selling stocks or bonds comments. Ideally you should be taking income from the bonds in your portfolio as they generate interest and never divest your principle. However, if by sell you mean to liquidate principle (whether stocks or bonds) then why would you only want to sell bonds and never equities as was mentioned here earlier? Furthermore, if the 5% withdrawal rule you mentioned earlier does not sit well with you, then I am assuming that you will be forced to liquidate principle.

By selling only bonds, you are selling at a discount in an upmarket and premium in a bear. Even if you replace the bonds in a bull (like now) as long as the market continues to rise, the value of the bonds will decline (bonds and equities inversely related blah blah blah). Given that the market has had almost twice as many up years as down, you are almost certainly asking for trouble.

Look into fee based accounts (non commission based) that use an asset allocation strategy and allow free trades and automatic rebalancing. ETFs are also more tax advantageous and usually lower in fees than mutual funds.

I think this is more what I had in mind. When Frank said selling stocks for income, I pictured a monthly (or maybe quarterly) selling to provide that monthly (or maybe quarterly) necessary income. When you allocate your assets among different classes - at least some stocks and some bonds/cash - then in order to keep the bonds/cash component providing sufficient income you probably have to sell some equities. This doesn't feel to me like selling stocks for income. I will have to sell equities, of course, but I don't anticipate it feeling like I'm selling them for income, and it certainly won't be as often as monthly or quarterly.

Elizabeth Richardson

Our family accountant, a CPA, was not only doing this at age 75, but was still teaching accounting at the university level (as an adjunct).

I'm not saying that this may be common, but certainly possible.

Mark Freeland snipped-for-privacy@sbcglobal.net

A couple of Clarifications...

When I said "sell stocks for income" I meant what Elizabeth meant, periodically selling stocks and bonds in porportion to my portfolio, e.g. 75/25, without regard to market conditions. I think that's what some of the models do. The alternative I plan to use is sell bonds periodically and sell stocks to rebalance "when the market is up."

I plan to "live rich and die broke," frittering away my principal and earnings on travel and entertainment with my wife. That is probably an overstatement of reality but it's a guide.

Skip, when I' m too old to manage my portfolio, I'll probably be too old to fritter any more so my income needs will be down.

Most of the models I have seen tend to be pass or fail, either you have plenty money at the end or you go broke in 15 years. Reality is you adjust your lifestyle based on where you are.

I'd like to have as much income when I retire as I have now. I will have more time to spend money when I am retired.

I may start at 6% and see what happens.

Frank

Here is my current favorite article on the subject. It is not short nor light, but quite readable.

-- Doug

Well, a couple of clarifications . . . Without regard to market conditions is not exactly what I meant. I have several years income in lower-risk income producing bond mutual funds and cash. However, the income they produce isn't enough to satisfy my income needs and I will have to sell some bit by bit. I am one of the lucky ones for whom the market isn't tanking the first year of retirement. Still, I have enough to disregard market conditions if necessary and replenish my bond/cash position when prices are attractive to do so.

Elizabeth Richardson