Tad Borek wrote:
- quote -

Tad I entirely agree with what you say. A couple of additional
thoughts:

- inflation tends to run faster in services than it does in goods. For
a retired person, therefore, inflation probably runs faster than
reported because property taxes, healthcare, nursing home costs, energy
etc. run up faster than inflation in general

- at 3% inflation, purchasing power halves every 24 years, roughly. So
it is easy to see how one (or one's spouse, if one is male) could have
a difficult time in their late 80s or early 90s, and well live to that
age (although housing wealth is tappable). Hence the danger of fixed
annuities.

- here in the UK we also have inflation linked annuities (typically up
to 5% inflation). However the payment per month (starting) will be
typically be 1/3rd less (ie a fixed annuity pays 50% more).

All annuity rates are driven by life expectancies (and the buyers of
annuities tend to live longer than average, making the rates worse) and
by long term bond rates. Long term bonds now seem to me to be too low
in yield. This is entirely a macroeconomic judgement call and is worth
what you paid for it as a forecast! I think the US has been able to
borrow money, despite skyrocketing deficits, at low rates because the
Chinese and other countries have artificially depressed their
currencies relative to the US.

This gives them massive trade surpluses, which their central banks
invest in US dollar securities, particularly very safe ones (mortgage
backed and govt bonds). This lowers interest rates (raises bond
prices).

So at some point I expect to see somewhat higher US 10 and 30 year bond
rates, and higher annuity rates.

Tradeoff is that life expectancies keep moving up as medicine improves.
I don't see any change to that pattern *except* that natural
catastrophe (eg the current heat wave) and periodic pandemics are
likely to be more of a feature of life in the future than in the past
40 years or so (on the former because of global warming, on the latter
because bugs adapt quite rapidly, more rapidly than we have been able
to innovate new drugs, and because any health issue is now a global one
due to air travel and other factors*, and public health infrastructure
has deteriorated in many countries).

* SARS spread out of Vietnam, but became an issue in a Hong Kong
apartment complex with a sewage back up, and this led to Toronto
virtually being shut down.

Bucky wrote:
- quote -

Bucky, just to make that a fair comparison -- the studies that suggest a
~4% withdrawal rate (25X rule of thumb) assume that your withdrawals
increase with inflation every year. If you maintain a fixed withdrawal
rate (same dollar amount, as with a fixed annuity) you can take out
quite a bit more. If your investments earn more than 4% annually the
account should last "forever" - if you fix the withdrawal at 4% of the
starting amount.

A principal benefit of a fixed annuity is that it acts as "longevity
insurance" - if you live to age 99 Vanguard is obligated to continue
making those payments. Another is that you don't need to bother with, as
you put it, managing the risk yourself - figuring out whether a 6%
withdrawal rate is the right rate, or 5.82%, etc...and either way, how
to invest the money in the meantime.

-Tad

BreadWithSpam[at]fractious.net wrote:
- quote -

I'm a mathematician. I make simplifying assumptions. It's what I do.
:-)

Now, assume a spherical cow...

All joking aside, I wouldn't say that I assumed away volitaility.
Instead, I think it's more fair to say that I "compressed" it in to a
worst case scenario. In reality, there are a lot worse scenarios than
losing half your money and then having the market resume as normal
(like losing ALL your money). But that seems to be the worst thing
that's happened to the S&P 500 thus far.

And that's a diversified portfolio! Heck, I invested in 500 different
companies. That's not diverse enough for you? ;-)

--Bill

BreadWithSpam[at]fractious.net wrote:
- quote -

I thought the 4% drawdown rule was using fixed withdrawals of 4% the
initial amount (which means it excludes inflation).

In article <yobodv44ugz.fsf[at]panix2.panix.com> ,
BreadWithSpam[at]fractious.net wrote:

- quote -

The Vanguard site allows obtaining a quote for inflation-adjusted
annuities. The return in that case is about 5.4% (and if the
capital is 1,000,000 or more, they ask you to call for a quote,
so the rate may be a bit higher for bigger bucks).

"Bucky" <uw_badgers[at]email.com> writes:

- quote -

A pair of 67 year olds has something like a 50+% chance that
one of them will live another 25 years. Look into an annuity
with inflation adjustments - in 25 years, with typical inflation,
that 6% will look like 3% of today's spendable amount.

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Thanks, those were good reads. After reading those, that really draws
me towards fixed annuities for retirement. I got some quotes for
Vanguard for a person that was born on 1/1/1940 and retiring now,
starting to receive payments 1/1/2007. For a fixed lifetime annuity,
one could receive almost 6%, which is far higher than a 4% drawdown
rate to achieve ~100% guarantee if one wanted to manage risk themselves.

woessner[at]gmail.com wrote:
- quote -


Why does the inflation rate make any difference w/ a constant withdrawl
rate? Any size nest egg <strikeout> with a guaranteed rate of
return</strikeout> will last forever if you only withdraw the interest
every year. Inflation only determines whether, say, 5% will be enough
in future years. Or is that the point -- to make sure you have enough
left when you eventually have to increase your rate of withdrawl due to
inflation?

Best regards,
Bob

"woessner[at]gmail.com" <woessner[at]gmail.com> writes:

- quote -

Your calculation is interesting, but it's assuming away volatility
and diversification. The rule of thumb comes from (and I don't have
a source handy) various studies which run simulations of portfolios
with different asset allocations and historical average rates of
return - and volatilities of those returns.

Here's one article, published a few years ago, which shows
the likelihood of a portfolio surviving various lengts of time
with varying drawdown rates and asset allocations:

http://www.thestreet.com/funds/manag...x/1423956.html

4% survives 100% of the time (probably rounded, but awfully
close to 100%) in all mixes of stocks and bonds except for
the 100% stock portfolios. Chances are, though, that at
the end of the 30 years, one will have drawn down some
principal on some of those as well, and it doesn't say
anything about inflation. It cites an older AAII study
that I couldn't get to, but I'd like to see some more
details about inflation assumptions and ending asset values.

That table looks suspiciously similar (identical?) to
this one posted by Scott Burns:
http://www.dallasnews.com/s/dws/bus/...dy/table1.html

This one assumes inflation adjustment and makes a pretty
good case for the 75% stock/ 25% bond portfolio:
http://www.dallasnews.com/s/dws/bus/...dy/table3.html

The article which links to those two tables:
<http://www.dallasnews.com/sharedcont...l.f5a90da.html
Note that the numbers are not his - he got them from a
university study - which appears to be this one:
<http://www.findarticles.com/p/articl...07/ai_n9278657

It's also pretty interesting comparing the annualized
returns that these various asset allocation generate -
one can get a pretty decent proxy for some of them by
looking at some of the low-cost no-load index-based
asset-allocation funds (ie. Lifestyle/Lifestrategy/etc).

Anyway, bottom line is that 25x is just a rule of thumb
and really nothing more. But it wasn't completely pulled
out of thin air.

An alternative, for folks who aren't concerned with leaving
any remaining assets to their heirs but are worried about
outliving their money - immediate fixed annuities - or perhaps
a combination of some money invested 75/25 and some in annuities.
Immediate annuities make it hard to retire at 40 - but at 65-70,
the payouts are pretty healthy - and, depending on the options,
potentially quite a bit higher than 4%


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- quote -

I've often wondered about the rule of 25. I know the basic idea is
that you have a (nearly) guaranteed investment that returns 7.5%.
Subtract 3.5% for inflation and you get 4%. Invert that and you have
the rule of 25. But that begs the question... where do you find a
(nearly) guaranteed investment that returns 7.5%?

So I was playing around with some numbers and I came up with an
alternate derivation that pretty much gave me the rule of 25. It's
kinda creepy, actually.

Suppose you retire and your entire nest egg is invested in an S&P 500
index fund. Now suppose the stock market crashes the day after you
retire and you lose half your money. How much of your ORIGINAL amount
can you withdraw? The answer is given by:

W(R, I) = (exp(R - I) - 1) / 2

where W is the percentage annual withdrawal of your original amount, R
is the average annual return of the fund (compounded continuously) and
I is the average annual inflation. Let's pick 11.2% for R and 3.5% for
I:

W(11.2%, 3.5%) = 4%

And there you have the rule of 25.

You can argue about what the average return from an S&P 500 index fund
really is. I've seen estimates below 10% and above 12%. So 11.2%
seems reasonable. (Of course, I picked 11.2% knowing it would make the
result come out an even 4% :-D).

--Bill

Just saw this and noted how closely it matches how we've
discussed spend-down in retirement here:

http://money.cnn.com/2006/06/30/pf/e...ymag/index.htm

<snip> (re: someone nearing 62 with $320,000 in an IRA)

As a rule, if you want your nest egg to last at least 30 years, you
should limit your draw in your first year of retirement to about 4%
of your portfolio's value, or about $13,000 in your case.

<snip
In addition to the $13,000 from your portfolio, you'll also have
Social Security coming in. Since I don't know your current salary
(let alone your salary history, which is instrumental in figuring
your benefit), let's generously estimate that your Social Security
payment comes in around $15,000 a year, which would be a decent
estimate for someone earning $70,000 today. (You can get a more
accurate estimate of your Social Security benefit by going to the
Social Security benefit calculator.

So with both your Social Security and draws from your portfolio,
you're probably talking pre-tax annual income of less than $30,000
a year.

<snip
Yikes. All I can say is that (a) this person is probably way
better off than most folks nearing that age and a lot of folks
who will be getting there in the next decade or two - that's
a nice sized IRA, but it's clearly not a lot to retire on; and
(b) well, it's a very incomplete analysis - we don't know anything
about things like this person's actual income or the value of
her home or if it's paid off, etc.

Nevertheless, it's not a bad little column that a lot of people
out there might do well to read. (not so much the folks who
hang out here - we talk about this all the time - but folks
out there who don't talk about it or think about it - they
might benefit from reading a simple, reasonably well written
column explaining a specific situation).




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