A long time ago I came to realize that it is easy to specify the right actions required to manage a retirement portfolio. Unfortunately, it is apparently not as easy to understand why it is the right thing. You actually have to analyze studies and learn something.The 4% rule is a good example of that. This is typical of so many articles written about it. The studies that derive the 4% rule are worst case studies. But inevitably, someone like hocus or Pfau asks the question, "What if today is worse than average? Shouldn't we change the rule to account for that?" So they go in search of a new rule or a new formula . . . on in the case of hocus, a new lifelong uninformed rant.In this article, the author looks at an analysis done by T. Rowe Price. They start with a 55/45 portfolio, retire on 1 Jan 2000, rebalance monthly, withdraw 4% inflation adjusted per year, assume 3% inflation a year, and observe that at the end of 2010, the portfolio is down 33% from it's peak. I notice a number of things about this. 1- rebalance monthly? That might sound like a good idea, but it is not likely to improve your chance of portfolio survival. Rebalancing helps keep your portfolio risk approximately constant, but it actually tends to reduce the long-term expectation of value. More frequent rebalancing can actually weaken your speed to recovery after a down time. 2- why assume 3% inflation which happens to be higher than reality for this period? 3- Why stop at the end of 2010. Keep on looking and following the plan and things look quite a bit better by now.So based on this volatility in the equity portion of the investment portfolio, Pfau suggest nothing related to the equity portion of the investment portfolio. Instead, he suggests going to an annuity in place of bonds??? How does he propose to rebalance monthly - or ever - now? . . . 200 Monte Carlo simulations for each product allocation, and assuming returns based on current market conditions, the winning combination turns out to be a 50/50 mix of stocks and fixed annuities . . .So many questions: 1- How did he keep the mix 50/50??? Does he have access to some kind of new annuity that allows him to rebalance? 2- What do you mean "based on current market conditions"? Does that mean he assumed the market would always perform exactly as it is today? That seems like a pretty brain-dead assumption. 3- How much survivability did he really gain over bonds using this mix? 4- And of course there is the question of using Monte Carlo. There is a lot of underlying assumption built into any Monte Carlo analysis.All of these guys miss the point. The 4% rule gives you a guideline to use in computing how much you have to save to retire. The rule was actually developed as much because it provided a spending model and investment model that could be rationalized/justified and be simulated. I doubt very many people actually live by a 4% withdrawal rule. Things happen. You need a new car one year. You have to paint the house one year. You have to replace the roofing one year . . . You spend what you need to spend to be comfortable. If you planned wisely, that amount typically falls around 4% or less. But you don't let it rain in your living room if fixing the roof puts you at 4.05% this year and you don't blow money just to get your spending up to 4%.So, yes, you can add more rules to backtest against the past history and increment the 4% rule up to 4.1% maybe, but that's pretty naive.
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