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Author: BassAttack Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 74759  
Subject: Burn Rate Date: 8/20/1999 4:37 PM
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I have followed with great interest the discussions on this board concerning retirement investing.
I am impressed with the idea of 1 years expenses in a MMF and another 3-5 years of expenses in laddered CD's/T Bills,notes.
However,all of the scenarios discussed assume leaving a hefty estate to heirs.My situation is somewhat different and I am asking for advice from this board and it's excellant contributors.If I start with 1million and follow the above for the MMF and CD's/T Bills,notes,what burn rate can I use as a percentage for annual withdrawals so that all but about 40-50K is used up in 35 years?
Obviously this situation is somewhat unusual.If I also assume a 4% inflation rate will this help the figsures to be more conservative?What rate should I use for a return on port?9% given the stats re the S&P?
In discussing adjusting the withdrawal percentagesfor inflation,would I add or subtract the inflation percentage number from the annual withdrawal percentage?
My health/physical condition is not all that great so I am obviously concerned about this topic and the results since my primary concern is with my wife and not myself.Any help is greatly appreciated.Bassattack/wayne
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Author: TMFPixy Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 13301 of 74759
Subject: Re: Burn Rate Date: 8/20/1999 4:55 PM
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Greetings, Wayne, and welcome. You wrote:

<<I am impressed with the idea of 1 years expenses in a MMF and another 3-5 years of expenses in laddered CD's/T Bills,notes.
However,all of the scenarios discussed assume leaving a hefty estate to heirs.My situation is somewhat different and I am asking for advice from this board and it's excellant contributors.If I start with 1million and follow the above for the MMF and CD's/T Bills,notes,what burn rate can I use as a percentage for annual withdrawals so that all but about 40-50K is used up in 35 years?
Obviously this situation is somewhat unusual.If I also assume a 4% inflation rate will this help the figsures to be more conservative?What rate should I use for a return on port?9% given the stats re the S&P?
In discussing adjusting the withdrawal percentagesfor inflation,would I add or subtract the inflation percentage number from the annual withdrawal percentage?
My health/physical condition is not all that great so I am obviously concerned about this topic and the results since my primary concern is with my wife and not myself.>>


Well, there are a lotta "ifs" in your questions. IF you average 9% per year return, IF inflation averages 4% per year, IF you want the portfolio to last 35 years, and IF you want $50K left at that time, THEN you may take $56,313 dollars the first year, and then increase each succeeding year's withdrawal by 4%. At the end of 35 years there will be $50K left. BUT -- An average rate of return is far different than actual rates from year to year, so your results may vary. For that reason, you must look at your results on an annual basis to ensure you don't hit a bad patch of returns that will deplete that portfolio far faster than planned. Increasing withdrawals in times of declining returns are a sure prescription for disaster.

Regards..Pixy

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Author: BassAttack Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 13310 of 74759
Subject: Re: Burn Rate Date: 8/20/1999 10:10 PM
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TMFPixy:
Probably the better question should have been:Assuming a 1 million investment and a 35 year time period what would be a good burn rate leaving only about 50K at the end?What rate of return,inflation rate,etc is being used to arrive at this pre tax figure?How much(%) should be taken off the top for 1-5 years of expenses?Your help is greatly appreciated.I am impressed by the promptness of your reply.BTW I also participate on the Mechanical investing and foolish workshop boards.Bassattack/wayne

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Author: ZBar Two stars, 250 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 13366 of 74759
Subject: Re: Burn Rate Date: 8/23/1999 2:35 PM
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The easy answer to your question is the formula witdrawal = (balance - 50k) / life expectancy. If your life expectancy is now 35 years, then decrease that number each year by 1. If your life expectancy changes, then use your current life expectancy for that year.

If this money is an IRA then you must follow the IRA rules for early withdrawals if before age 59 1/2 (or 55 in some cases), unless you are willing to pay 10% penalty.

The formula above is close to the minimum distribution method for IRA's.

Z

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Author: JAFO31 Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 13372 of 74759
Subject: Re: Burn Rate Date: 8/23/1999 6:15 PM
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ZBar: "The easy answer to your question is the formula witdrawal = (balance - 50k) / life expectancy. If your life expectancy is now 35 years, then decrease that number each year by 1. If your life expectancy changes, then use your current life expectancy for that year."

I am sure when JABoa appears, he will have a few thoughts, becasue he seems to be the resident expert with respect to mortality tables (among other things). One obvious comment though, is that remaining life expectancy typically does not decline by 1 year for each year lived.

Just my $0.02. Regards, JAFO

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Author: telegraph Big funky green star, 20000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 13373 of 74759
Subject: Re: Burn Rate Date: 8/23/1999 6:19 PM
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The Trinity Study and others referenced on the www.scottburns.com site will show that if you really intend to havea 30+ year withdrawal period, depending upon your asset allocation (with about 60-70% equities and 30-40% bonds optimum for that period) will give you around a 4% inflation adjusted withdrawal rate with 99% probability of your money outliving you. If you are willing to accept a 95% probability, you can take more, slightly. No 6,7,8,9%. This has the probability of 50% of being bankrupt in 30 years.

Alternatively, you can take 5% of the value of the portofio out each yea, say, based upon Jan 1 value- This gives you a non-guaranteed variable income (could be up or down) but if you are willing to live with this, you can take 5% vs 4% fixed.

There is a lot of work done on withdrawal rates, and anything over 4% withddrawal shows you have reasonable probability of running out of money!

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Author: OldOne Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 13555 of 74759
Subject: Re: Burn Rate Date: 8/31/1999 11:36 AM
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One of the problems I have with the Trinity study is that it assumes an average market rate of return. What happens if we instead put our money in the Foolish Four or RP4 or whatever we call it these days? It seems to me that if the average rate of return goes up, the acceptable withdrawal rate should also increase. I don't think it is the same percentage increase because the standard deviation of the FF is higher than the market, so the computation is complicated.

I personally like the constant % of the value of the portfolio method. Most people will also get some Social Security, so there is a fixed "floor" income and the % variation in total income is dampened by this. The other rerason I like it is that the idea of projecting a constant inflation rate over 35 years has a large chance of giving a result which does not at all correspond to reality.

The other issue I have with studies like Trinity is that they do not consider the chances for a "mid-course correction". I for one, do not intend to retire, set up my portfolio, and then never have another financial thought for the rest of my life. I will monitor my investments and make minor changes as necessary.



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Author: rjm1 Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 13558 of 74759
Subject: Re: Burn Rate Date: 8/31/1999 1:08 PM
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One of the problems I have with the Trinity study is that it assumes an average
market rate of return. What happens if we instead put our money in the Foolish
Four or RP4 or whatever we call it these days? It seems to me that if the
average rate of return goes up, the acceptable withdrawal rate should also
increase. I don't think it is the same percentage increase because the standard
deviation of the FF is higher than the market, so the computation is complicated.

I personally like the constant % of the value of the portfolio method. Most
people will also get some Social Security, so there is a fixed "floor" income and
the % variation in total income is dampened by this. The other rerason I like it is
that the idea of projecting a constant inflation rate over 35 years has a large
chance of giving a result which does not at all correspond to reality.

The other issue I have with studies like Trinity is that they do not consider the
chances for a "mid-course correction". I for one, do not intend to retire, set up
my portfolio, and then never have another financial thought for the rest of my life.
I will monitor my investments and make minor changes as necessary.


The problem is with all studies. You have to make assumptions about the market which may not match your results. The studies also assume the same pattern of stockmarket returns as in the past. The costs of investing is also missing in some cases. If I did a study to be published mine would have the same problems.

But when I figure out my retirement plan I want it to work. I have used Quicken for years and can get my actual before tax return on my investments. About 10 to 11%. (guess you can tell I am not in my 20's). What I can not do is project the actual returns that will be achieved in the future. Therefore I took 10 year patterns from investment indexes and mixed them to see how my future growth would be affected. I also adjusted the first year or two for large market declines as I think this is the bigest risk. This helps give you insite into what the proper withdrawl rate is but no one will know until it is over.

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Author: WilliamLipp Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 13563 of 74759
Subject: Re: Burn Rate Date: 8/31/1999 1:45 PM
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OldOne Date: 8/31/99 11:36 AM Number: 13555
I personally like the constant % of the value of the portfolio method. Most people will also get some Social Security, so there is a fixed "floor" income and the % variation in total income is dampened by this

I like the damping effect. It's even stronger in the the variation that moves the constant % into a cash-equivalent portfolio and then divides by 60 for the new year's expenditure rate. I would even be willing to consider to temporarily adjust the cash window to 3 years to further damp a downward fluctuation.

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Author: TMFPixy Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 13571 of 74759
Subject: Re: Burn Rate Date: 8/31/1999 3:27 PM
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OldOne sez:

<<One of the problems I have with the Trinity study is that it assumes an average market rate of return.>>

No, it does no such thing. The study compiled by three Trinity University professors, Philip Cooley, Carl Hubbard, and Daniel Walz, examined this issue by looking at historical annual returns for stocks and bonds from 1926 through 1995. Their results were published in the February 1998 issue of the AAII Journal in an article entitled Retirement Savings: Choosing a Withdrawal Rate That is Sustainable. Using historical data published by Ibbotson Associates, the study looks at the impact of withdrawal rates ranging from 3% to 12% on five portfolios ranging from 100% stocks to 100% bonds over all rolling withdrawal periods of 15, 20, 25 and 30 years from 1926 through 1995. A successful portfolio was one which ended a particular withdrawal period with a positive value. The probability of success was measured based on the ratio of positive-value ending portfolios for a specific withdrawal period to the number of possible rolling periods for that category in the years studied. As an example, there were 56 possible 15-year withdrawal periods between 1926 and 1995. If in 31 of those periods a portfolio had a positive value after a final withdrawal of 12%, then a portfolio using that withdrawal rate for 15 years had a success rate of 55% (31 divided by 56 rounded to the nearest whole percentage). The study looked at both a fixed annual withdrawal based on the rate applied to the initial portfolio and at an inflation-adjusted annual withdrawal of that initial amount.

Not surprisingly, the study revealed withdrawal periods longer than 15 years dramatically reduced the probability of success at withdrawal rates exceeding 5%. The authors reached five general conclusions:
a. Younger retires who anticipate longer payout periods should plan on lower withdrawal rates.
b. Bonds increase the success rate for lower to midlevel withdrawal rates, but most retirees would benefit with at least a 50% allocation to stocks.
c. Retirees who desire inflation-adjusted withdrawals must accept a substantially reduced withdrawal rate from the initial portfolio.
d. Stock-dominated portfolios using a 3% to 4% withdrawal rate may create rich heirs at the expense of the retiree's current consumption.
e. For 15-year or less payout periods, a withdrawal rate of 8% to 9% from a stock-dominated portfolio appears sustainable.

An excellent commentary on the study to include a link to paper itself was made by Frank Armstrong in his article Retirement Planning - Making It Last Forever. (http://www.morningstar.net/news/MS/ifk/990108farmstrong.msnhtml) Both are well worth the interested reader's review. Additional commentary may be found in The Trinity Study (http://www.scottburns.com/wwtrinity.htm) by Scott Burns and The Retire Early website's article What's the "Safe" Withdrawal Rate in Retirement? [(http://www.geocities.com/WallStreet/8257/safewith.html] The Retire Early website recently conducted a similar study using an alternative data base spanning the years 1871 through 1998. Found in The Retire Early Study on Safe Withdrawal Rates, [http://www.geocities.com/WallStreet/8257/restud1.html] it generally confirms the Trinity Study results.

All of these references agree that a "safe" withdrawal rate ranges between 4% to 6% of a retiree's starting portfolio. Withdrawal rates above 5% increase the probability that a retiree will go broke in her lifetime. All also agree that the presence of bonds in the portfolio provides a measure of stability absent in an all stock portfolio. And all agree that inflation-adjusted withdrawals fare best at lower to midlevel withdrawal rates.

<< What happens if we instead put our money in the Foolish Four or RP4 or whatever we call it these days? It seems to me that if the average rate of return goes up, the acceptable withdrawal rate should also increase. I don't think it is the same percentage increase because the standard deviation of the FF is higher than the market, so the computation is complicated.>>

I did a study on that for the period 1961 through 1998. I looked at the FF and the S&P using the same premises as The Trinity Study except that I adjusted withdrawals for actual inflation. The results will be published on TMF soon, but they revealed that the FF enjoyed a 100% success rate for inflation-adjusted 6% withdrawals in all periods for a 100% or 75% FF portfolio. The S&P 500 did so only at a 3% rate.

Look for the results to be published in coming weeks.

Regards..Pixy


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Author: OldOne Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 13574 of 74759
Subject: Re: Burn Rate Date: 8/31/1999 4:57 PM
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<< <<One of the problems I have with the Trinity study is that it assumes an average market rate of return.>> >>

<< No, it does no such thing. The study compiled by three Trinity University professors, Philip Cooley, Carl Hubbard, and Daniel Walz, examined this issue by looking at historical annual returns for stocks and bonds from 1926 through 1995.>>

What I should have said, and meant to say, is that for the stock component of the tested portfolios the Trinity study uses the average market rate of return.

I am looking forward to reading your study.

I actually think that we are in substantial agreement. I have read the references you cite, and have done some of my own analysis for a time period similar to yours.

Essentially, the FF must be balanced with at least one other, preferably non-correlated, asset in order to obtain the the highest possible indefinitely sustainable rate of withdrawal. The computations necessary for balancing with two other assets are much more numerous than for one, so most studies limit themselvs to stocks plus one other asset, typically bonds. It is not as obvious to me as it is to the authors of the cited works that the best other asset is bonds, especially if we substitute the FF for the market as a whole. There are mainstream US-based assets other than bonds which are less correlated with the FF and seem to improve the sustainable withdrawal rates to something on the order of 7%. Not an inflation-adjusted 7% of the initial portfolio, but 7% of the current value of the portfolio each year. Unfortunately, I have only tested this against historical data.

While it is easy to test against historical data, if we truely believe that market performance is a continuing upward trend with superimposed random fluctuations, we should use a more sophisticated analysis technique. For instance, we can use the historical data to estimate the statistical parameters and then use these parameters to generate a large number of equally-probable scenarios. Testing against all of these scenarios would give a much higher level of confidence than just looking at the single historical data set.




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