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First of all I am an newbie to this board. I may be forced into an early retirement next year, though it's not what I want it may come to pass anyway. I given some look at retirement calcuators and how much could be withdrawn for life. It seems that 3 to 4% is what's recommended. My question is, if stocks can reasonably be expected to appreciate 10% per year and inflation is roughly 3% or less why couldn't I withdraw say 7.5% per year and still have some appreciation and a margin of safety? Any comments will be greatly appreciated.

Gary
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My question is, if stocks can reasonably be expected to appreciate 10% per year and inflation is roughly 3% or less why couldn't I withdraw say 7.5% per year and still have some appreciation and a margin of safety?

The tax man cometh.

Golfwaymore
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sportfool asks,

First of all I am an newbie to this board. I may be forced into an early retirement next year, though it's not what I want it may come to pass anyway. I given some look at retirement calcuators and how much could be withdrawn for life. It seems that 3 to 4% is what's recommended. My question is, if stocks can reasonably be expected to appreciate 10% per year and inflation is roughly 3% or less why couldn't I withdraw say 7.5% per year and still have some appreciation and a margin of safety? Any comments will be greatly appreciated.

Ah, the age old question.

The reason you can't take 7% and retire happily ever after is volatility. The stock market goes up and down, and there have beem several extended down periods where a 7% withdrawal would have depleted your retirement portfolio past the point of no return.

If you haven't see it already, check of the Retire Early Study on Safe Withdrawal Rates, http://www.geocities.com/WallStreet/8257/restud1.html

Your not the first person that thought he could withdraw 7% from a retirement portfolio. No less a light than Fidelity's Peter Lynch thought so as recently as 1995 (Lynch, Peter, “Fear of Crashing” Worth Magazine, September 1995), but quickly withdrew the article after being presented with evidence to the contrary.

intercst


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y question is, if stocks can reasonably be expected to appreciate 10% per year and inflation is roughly 3% or less why couldn't I withdraw say 7.5% per year and still have some appreciation and a margin of safety?

This might be true if your portfolio returned 10% consistently every single year. Unfortunately, you'll never be able to get this kind of consistency. By having forced withdrawals at too high a rate, you wind up damaging your portfolio during the down years. Too many down years and your portfolio is destroyed.

Also, you should hopefully have some holdings outside of stocks, such as bonds, which will give you a lower yield.
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First of all I am an newbie to this board. I may be forced into an early retirement next year, though it's not what I want it may come to pass anyway. I given some look at retirement calcuators and how much could be withdrawn for life. It seems that 3 to 4% is what's recommended. My question is, if stocks can reasonably be expected to appreciate 10% per year and inflation is roughly 3% or less why couldn't I withdraw say 7.5% per year and still have some appreciation and a margin of safety? Any comments will be greatly appreciated.

Because the 40 year survival rate (using over 125 years of historical data) of a 7.5% withdrawal rate is only 36.2%. This means that in 64 out of 100 40-year periods you would have run out of money.

Had you retired in 1937, you would have run out of money in 1946.

Had you retired in 1973, you would have run out of money in 1980.

If you retire in 2001, you may run out of money eventually as well.

See http://capn-bill.com/fire/ for an easy to use web based calculator. (and where I got the above numbers from)
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Author: sportfool     Date: 10/16/01 11:57 PM    Number: 53436  
I given some look at retirement calcuators and how much could be 
withdrawn for life. It seems that 3 to 4% is what's recommended. My 
question is, if stocks can reasonably be expected to appreciate 10% per 
year and inflation is roughly 3% or less why couldn't I withdraw say 
7.5% per year and still have some appreciation and a margin of safety?


I agree with Intercst that volatility is the main reason you 
can't withdraw a higher amount, and I thought I would add a couple of 
comments.

The problem is that if the market declines the first year or two you 
withdraw your living expenses, your withdrawal becomes a much bigger 
percentage than you originally planned.  If the market happens to 
increase the first year, then your yearly withdrawal percentage becomes 
smaller, and you can take a bigger withdrawal and still survive.

Here is an actual historical example of what can happen if you retired 
at the beginning of 1973 with a $500,000 portfolio and used a 7.5% 
withdrawal rate (increased annually by 3% for inflation):

                         Port Value    Withdrawal    S*P500 Growth
-------------------------------------------------------------------
                      	 $500,000 	 $37,500
End of year 1973	 $394,698 	 $38,625 	-14.66%
            1974	 $261,820 	 $39,784 	-26.47%
            1975	 $304,634 	 $40,977 	37.20%
            1976	 $326,512 	 $42,207 	23.84%
            1977	 $263,893 	 $43,473 	-7.18%
            1978	 $234,879 	 $44,777 	6.56%
            1979	 $225,157 	 $46,120 	18.44%
            1980	 $237,081 	 $47,504 	32.42%
            1981	 $180,269 	 $48,929 	-4.91%
            1982	 $159,460 	 $50,397 	21.41%
            1983	 $133,613 	 $51,909 	22.51%
            1984	 $86,827 	 $53,466 	6.27%
            1985	 $44,090 	 $55,070 	32.16%
            1986	 $(13,008)	 $56,722 	18.47%

In this example, the arithmetic average growth of the market over the 
period from 1973 - 1986, as measured by the S&P500, was 11.9%.  Yet the 
portfolio was exhausted after only 14 years by taking a 7.5% yearly 
withdrawal (adjusted by 3% per year for inflation).

If the above example is repeated starting in 1975 instead of 1973, the 
portfolio would have survived.  But, there is no way to tell what will 
happen in the future, so the best we can do is to use worst case 
historical examples to guide us.

The historical maximum safe withdrawal rate for long-term portfolio 
survival is approximately 4% (adjusted for inflation).

Russ
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I appreciate all the comments and am taking them to heart, however I never envisioned the payout amount would be static. I planned on taking 7.5% of the balance per year. (Actually .00625 per month).If the portfolio declined in value, I would be taking less cash though the percentage would remain constant. For instance if the portfolio is worth $500k the first month I would take $3125. If in that month the S&P declined by 5% my portfolio would be worth $472k. (500000-3125 x .95) The next month I would take $2950. (.00625 of 472000). And so on. This portfolio is only stocks and does not include real estate which of course could be sold to raise cash.

Gary
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sportfool,

I appreciate all the comments and am taking them to heart, however I never envisioned the payout amount would be static. I planned on taking 7.5% of the balance per year. (Actually .00625 per month).If the portfolio declined in value, I would be taking less cash though the percentage would remain constant. For instance if the portfolio is worth $500k the first month I would take $3125. If in that month the S&P declined by 5% my portfolio would be worth $472k. (500000-3125 x .95) The next month I would take $2950. (.00625 of 472000). And so on. This portfolio is only stocks and does not include real estate which of course could be sold to raise cash.


That's fine as long as you have enough flexibiity in your spending to accomodate a 50% drop in your monthly income. Most retirees don't and seek inflation-adjusted withdrawals to maintain their spending power.

intercst
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<<<<Here is an actual historical example of what can happen if you retired at the beginning of 1973 with a $500,000 portfolio and used a 7.5% withdrawal rate (increased annually by 3% for inflation):

Port Value Withdrawal S*P500 Growth
-------------------------------------------------------------------
$500,000 $37,500
End of year 1973 $394,698 $38,625 -14.66%
1974 $261,820 $39,784 -26.47%
1975 $304,634 $40,977 37.20%
1976 $326,512 $42,207 23.84%
1977 $263,893 $43,473 -7.18%
1978 $234,879 $44,777 6.56%
1979 $225,157 $46,120 18.44%
1980 $237,081 $47,504 32.42%
1981 $180,269 $48,929 -4.91%
1982 $159,460 $50,397 21.41%
1983 $133,613 $51,909 22.51%
1984 $86,827 $53,466 6.27%
1985 $44,090 $55,070 32.16%
1986 $(13,008) $56,722 18.47%

In this example, the arithmetic average growth of the market over the
period from 1973 - 1986, as measured by the S&P500, was 11.9%. Yet the
portfolio was exhausted after only 14 years by taking a 7.5% yearly
withdrawal (adjusted by 3% per year for inflation).>>>>

And actual inflation was much higher than 3% during those years, so actual results would have been worse.

CPI - data
Original Data Value
Series Id: MUUR0000AA0Not Seasonally AdjustedArea: U.S. City AverageItem: All itemsBase Period: 1967=100

Year Ann Avg
1967 100.0
1968 104.2
1969 109.8
1970 116.3
1971 121.3
1972 125.3
1973 133.1
1974 147.7
1975 161.2
1976 170.5
1977 181.5
1978 195.4
1979 217.4
1980 246.8
1981 272.4
1982 289.1
1983 298.4
1984 311.1
1985 322.2
1986 328.4
1987 340.4
1988 354.3
1989 371.3
1990 391.4

And Year over Year CPI Data:

12 Months Percent Change
Series Id: MUUR0000AA0Not Seasonally AdjustedArea: U.S. City AverageItem: All itemsBase Period: 1967=100

Year Ann Avg
1967 2.9
1968 4.2
1969 5.4
1970 5.9
1971 4.3
1972 3.3
1973 6.2
1974 11.0
1975 9.1
1976 5.8
1977 6.5
1978 7.7
1979 11.3
1980 13.5
1981 10.4
1982 6.1
1983 3.2
1984 4.3
1985 3.6
1986 1.9
1987 3.7

1988 4.1
1989 4.8
1990 5.4

From http://www.bls.gov/cpi/

Thus, in the relevant time frame only one year (1986) was less than 3% and only two more years were less than 4% (1983 and 1985); for the first nine years the arithmetic mean average inflation rate was slightly in excess of 9%. I would suggest that russ was being very conservative using a fixed 3% inflation number; reality would have been much worse.

Regards, JAFO


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As long as you just take a fixed percentage withdrawal of the total amount invested you will never run out of money, but the value of the total amount invested may decline in both absolute and inflation adjusted value over time, and likewise your fixed percentage withdrawal will decline in both absolute and inflation adjusted value,---if you have other investment sources to make up for the potential shortfall you may be OK as long as you take into account this likely scenario. Real estate, although inflation protected,is not very liquid, so you may need to consider more liquid reserves to accomodate the likely volitilty of your stock portfolio assets.
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Author: sportfool Date: 10/17/01 3:08 PM Number: 53474

Gary wrote:
I appreciate all the comments and am taking them to heart, however I never envisioned the payout amount would be static. I planned on taking 7.5% of the balance per year. (Actually .00625 per month).If the portfolio declined in value, I would be taking less cash though the percentage would remain constant. For instance if the portfolio is worth $500k the first month I would take $3125. If in that month the S&P declined by 5% my portfolio would be worth $472k. (500000-3125 x .95) The next month I would take $2950. (.00625 of 472000). And so on. This portfolio is only stocks and does not include real estate which of course could be sold to raise cash.

Gary,

I hear what you are saying, and of course it looks good on paper.

However, one thing I found out after I retired is that your monthly living expenses are extremely hard to reduce. I had thought that I would have money left over at the end of each month after paying all my essential living expenses, but I was wrong. I had underestimated the number of unexpected things that would pop up. The end result is that since I retired at the end of April, my monthly expenses have averaged 20% higher than I had planned. My recommendation to you is to first determine the minimum you think you'll need each month, and then add 20% to it. That number should come close to the real minimum.

And, if this amount is higher than 4% of your portfolio, then I would not count on being able to make your portfolio last. If you sell some real estate to add to your portfolio, then you should add that amount to your portfolio now and see if your expenses are going to exceed 4%.

My point for saying all this is that before you actually retire, it seems like it would be easy to cut back on expenses, but after you actually retire, expenses seem nearly impossible to reduce. In fact, the only way I can see to do it is to move to a less expensive house (or less expensive area of the country).

Lastly, most economists are forecasting a long period of less than average growth in the economy. In the latest issue of the 'AAII Journal' Fama and French (two of the most respected economists) say that they expect 2.9% - 5.2% real growth for the foreseeable future (add inflation to get expected market growth).

Assuming average inflation of 3%, that indicates a stock market growth of 5.9% - 8.2%, well below the historical market returns of just over 11%. This just further reinforces the sentiment that you shouldn't fudge on the 4% max withdrawal, or you will very likely exhaust your portfolio.

Russ
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However, one thing I found out after I retired is that your monthly living expenses are extremely hard to reduce. I had thought that I would have money left over at the end of each month after paying all my essential living expenses, but I was wrong. I had underestimated the number of unexpected things that would pop up. The end result is that since I retired at the end of April, my monthly expenses have averaged 20% higher than I had planned. My recommendation to you is to first determine the minimum you think you'll need each month, and then add 20% to it. That number should come close to the real minimum.

Russ,

Just curious, can you say how your actual after-retirement expenses compare to your actual before-retirement expenses?

The reason I ask is that the assumption in my plan (read, my Excel spreadsheet) is that my after-retirement expenses will be equal to my before-retirement expenses. The other big assumption I have in this area is that my increased health care costs will be offset by a reduction in my income/FICA/Medicare taxes. I think this will be a fair assumption since I save a large portion of my income; thus my AGI in retirement should drop dramatically.

--malakito.
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I'd like to support Russ' statements in some recent posts he's made about post-retirement spending.

rkmacdonald: one thing I found out after I retired is that your monthly living expenses are extremely hard to reduce. I had thought that I would have money left over at the end of each month after paying all my essential living expenses, but I was wrong. I had underestimated the number of unexpected things that would pop up. The end result is that since I retired at the end of April, my monthly expenses have averaged 20% higher than I had planned. My recommendation to you is to first determine the minimum you think you'll need each month, and then add 20% to it. That number should come close to the real minimum.

Having ER'd on August 1st of this year, I've tried to get a handle on what we're actually spending. Even using Quicken, that can be difficult to do. After all, there are things that are recurring, non-discretionary expenses, and we're pretty good about budgeting for these, but there's also the unexpected, non-discretionary things that happen, and the discretionary but "gee-we-really-want-this" items that are competing for funds, too.

In spite of a lot of analysis, I definitely underestimated how much these all total up to be, and now we have to figure out how we're going to deal with it. (Perhaps I'll do some consulting or something to help make up the difference, or maybe we'll move to a less expensive place near ariechert, but I made sure we had our five year ladder in place before taking ER, so we're not desperate. <grin>)

But if you don't figure this out ahead of time, and allow a safety margin of some sort, you could find yourself with a number of unpalatable choices.

bill2975
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Perhaps I'll do some consulting or something to help make up the difference, or maybe we'll move to a less expensive place near ariechert, but I made sure we had our five year ladder in place before taking ER, so we're not desperate. <grin>)- bill2975

Yeah Bill, just come up here and live near us hillbillys! Whooo Heee!
One of the neighbor kids just got married and bought a little white frame house and 10 acres of land for $52,000. He's painted it and fixed it up nice. We bought an extra five acres of land right next to us in 1986 for $8,000 and it is now worth $20,000. We're rich! - Art

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Yeah Bill, just come up here and live near us hillbillys! Whooo Heee!
One of the neighbor kids just got married and bought a little white frame house and 10 acres of land for $52,000. He's painted it and fixed it up nice. We bought an extra five acres of land right next to us in 1986 for $8,000 and it is now worth $20,000. We're rich! - Art


Art, I suppose it's all relative. My family in Boston all think I've turned into a hick living out here in Colorado. When I visit them, it's always fun saying "Howdy" to everyone, and pretending to gawk at all the funny lookin' people in the big city. The air smells funny too.

randyy
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Author: malakito Date: 10/18/01 6:39 PM Number: 53570
...can you say how your actual after-retirement expenses compare to your actual before-retirement expenses?

The reason I ask is that the assumption in my plan (read, my Excel spreadsheet) is that my after-retirement expenses will be equal to my before-retirement expenses. The other big assumption I have in this area is that my increased health care costs will be offset by a reduction in my income/FICA/Medicare taxes. I think this will be a fair assumption since I save a large portion of my income; thus my AGI in retirement should drop dramatically.


I think you are right on.

I'm still analyzing the details, but it looks like my post-retirement expenses are just slightly lower than my pre-retirement expenses (maybe 5%). I'm living in the same house, so there is no change in the the mortgage payment, utilities, school/property taxes, cable, internet, telephone, cellular phone, etc. I still have my two cars, but I'm driving them a little less. My lunch expenses are a little less because I'm eating lunch at home now. However, I have more time to travel, so that expense has gone up some. As you mentioned, FICA/Medicare goes away but health insurance virtually replaces it. My federal income tax will be considerably lower, because my AGI will be much less, and I will use long term capital gains for replenishing my cash buffer as much as possible.

Russ
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Yeah Bill, just come up here and live near us hillbillys! Whooo Heee!
One of the neighbor kids just got married and bought a little white frame house and 10 acres of land for $52,000. He's painted it and fixed it up nice. We bought an extra five acres of land right next to us in 1986 for $8,000 and it is now worth $20,000. We're rich! - Art


Kind of similar to the year I spent in Smyth County Va. I bought a 3br house on one acre that bordered a national park and had a creek running throug the front yard. I bought it in 1993 for 30K. I sold it in 1998 for 40K. I bought 5 1/2 acres in Wythe County Va in 1988 when I was just a mere lad for about $3500. I sold it in 1999 for either 11 or 12K.

I'll still stick with where I'm at. Houses are a tad more and land is a bit more, but it's a happier area. Once you get south of Abingdon, southwest Virginia seems so depressed. Just my opinion of course.

Mark

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