Click on "The Kitces Report" link within this article to access the May report Bob Veres is discussing.

Thanks Mike for letting us read the May issue free.

The link is posted in Bob Veres's report here:

Market-Based Withdrawals
Industry Insight
By Bob Veres
July 1, 2008

See Bob's report here:
http://www.financial-planning.com/asset/article/613331/market-based-withdrawals.html?pg=


Direct link to Mike 's report:
Available free only for a limited time
http://www.kitces.com/assets/pdfs/Kitces_Report_May_2008.pdf

what does that mean?  What link? 

Going over Mike 's report I got the following questions:

Under "Applying The Rules Today ", Mike wrote:

"As a result, planners in this environment would continue to use the more conservative end of safe withdrawal rate spectrum ( a base rate of 4.5%, or whatever is preferred in your practice), in recognition of the overvalued market environment by these measures."

Question #1: does this apply only to those retirees who are starting their retirements at this time, and if not, how to adjust the withdrawal rates of retirees who are in the withdrawal stage already?

Example:

Assume a retiree started, at the end of 1972, to withdraw 5% real annual withdrawal from the Wellington fund (VWELX, a balanced fund allocated 60% to equity). At the end of 1994 the retiree suddenly realized that the account had dropped to 23.5% of it 's original nominal value, or to 6.5% in real value. At the end of that year 1994 the withdrawal rate reached 17.65% of the original investment (in dollars), and in 1996 the account was exhausted. My question is if the retiree should have adjusted the withdrawal rate, at that time or before, and if yes, how?

As I understand it, planners could follow the current P/E 10 and keep adjusting withdrawals per Fig. 9 in Mike  's report, no matter what the previous WR has been.

The following fellow (who posts at the Diehards forums) provides a calculator for SWR -30 years and SWR-15 years, depending on the P/E 10, here:

http://www.early-retirement-planning-insights.com/year-30-retirement-risk-evaluator.html

See here a post by this poster:

http://socialize.morningstar.com/NewSocialize/forums/thread/2533853.aspx

Question # 2: How should the " Investment Implications " in Mike ' s report be applied to Monte Carlo simulations for future portfolio distributions?

p.s. Someone has deleted a post of my answering John Olsen 's above question.

Vig,
The research as I developed it in the newsletter was specifically framed for 30-year retirement periods, and thus would ostensibly only apply for people who have a 30-year time horizon (e.g., either they're starting their retirement now and want to plan for 30 years, or they started younger but currently have a 30-year time window remaining). However, there's no reason you couldn't use the same safe withdrawal rate methodology for any particular time period - i.e., for a retiree at any particular point along the retirement timeline - I simply didn't create and publish all of the different possible permutations in my initial article on this. It's also worth noting that changing the time horizon will likely adjust not only the safe withdrawal rate for that time period, but also the optimal portfolio for the time period (e.g., shorter time periods tend to support not only higher withdrawal rates, but also tend to optimize with more conservative portfolios).

Regarding your second question, the initial implication is simply that return assumptions should be adjusted for future Monte Carlo modeling (and likely standard deviation volatility assumptions as well). Theoretically, this might even be modeled with non-static assumptions over time - e.g., instead of assuming a set return and volatility for the whole 30-year time period (however you adjust those assumptions), you might assume a lower return and higher volatility period for the first 15 years, and a higher return and lower volatility period for the next 15 years, to try to apply the Monte Carlo engine in a manner that fits more accurately to the secular market trends we tend to see throughout history. Unfortunately, though, no Monte Carlo software I'm aware of will allow this level of flexibility, so you would probably need to build your own Monte Carlo software to try to model such scenarios (we're working on building some of our own internally with my firm).

I hope that helps a little!

Respectfully,
- Michael E. Kitces, MSFS, MTAX, CFP(r), CLU, ChFC
Publisher, The Kitces Report, www.kitces.com
Blogger, Nerd's Eye View, www.kitces.com/blog

Thanks Amadeus!

I assume that the following also jibe with your study :

Things get ugly if a portfolio takes a 20% hit!


Based on the past 36 years of market returns, the table below shows probabilities of recovery from loss for different allocations,  for a retirement portfolio , with a 5% initial WD at end of first year, and with 3% annual increase for inflation in subsequent years (from a study done a year ago by Craig Israelsen, Ph.D.)

Note: the losses relate to the portfolio and not to benchmarks.


Allocation....Avg. ......Std.Dev......Prob.of
.....................Ret.... ..................recovery.within
..................................................5yrs,after a loss of
.....................................................10%.....20%


All stocks...........11.......17........66%....63%

All bonds...............8......5.5.......31........9%

60%stocks 
 & 40% bonds....10.....11.........66......47%

Global Multi
Asset....................11......7.8.......75......38%


Notice that the 60/40 allocation did better than the more diversified portfolio after a  20% hit. Why?


Allocations:

60%Stocks/ 40% Bonds = 50% Lrg US stocks, 5% Sm US stocks, 5% Intern stocks, 35% bonds, 5% cash

Global Multi Assets = 15% Lrg US stocks, 15% Sm US stocks, 15% Intern stocks, 15% Commodities (including RE), 35% bonds, 5% cash.


The table below shows the probabilities of recovering within 5 yrs after a loss depending on the WD rate from the Global Multi Asset Portfolio (as described above), while boosting WDs 3% annually for inflation:


WD=..........3%......4%.......5%......6%

Loss............Probabilities (%)

-35%.........20......07.......00......00
-30%.........35......20.......05......00
-25%.........50......35.......20......08
-20%.........75......48.......38......20
-15%.........80......78.......48......40
-10%.........88......80......75.......50
-05%.........98......90......80.......77
-02%.........98......98......85.......77
00%..........100....98.......90.......80



Notice:  for a portfolio that lost more than 20%, only a miracle would help restore it back within 5 years for any WR above 3%.
********************************************************************

Example:


WELLINGTON fund (VWELX)

(a balanced fund allocated 60% to equity)


In 1973 Wellington lost (-11.9%). In 1974 it lost an additional (-17.7%) bringing the total loss for the two years to (-29.6%). An investor who started to withdraw 4% COLAd in 1972 would see the portfolio value drop to a min of 81% of its initial value in 1975, in NOMINAL terms and NOT rebound back till 1982 when it reached 106% in NOMINAL terms and 44% in REAL terms. By 2004 the portfolio reached 450% value in NOMINAL value and 96% in REAL value. So going by the actual returns and CPIs Wellington held OK overall, but it took almost ten years to  " bounce back "  to its NOMINAL initial value.

What would have happened if Wellington was not such a low cost, super fund?

" Financial adviser Guyton, who argues against withdrawal equations that don ' t allow for flexibility, compares Kitces ' recommendation to " driving a car with no brakes and no mirrors " because it doesn ' t permit any midstream corrections. Retirees who follow an inflexible schedule could feel deprived when the markets are flush and worry when the markets are getting pummeled, he says. Guyton believes initial withdrawals can be as high as 5.2% to 5.6% for portfolios that contain at least 65% stocks. In return, however, retirees must follow certain rules, including maintaining their annual withdrawal at the previous year's amount following a year of market losses."







That Guyton seems to be a character. Firstly, he himself  came out with the study "   Could the Safe Withdrawal Rate be too safe ", which Mike is saying now.  Secondly, he was going  to acquire a PATENT on his withdrawal method, which seemed to be a selfish act (Bill Bengen complained about it). Thirdly, in his report, Guyton, never mentioned Bill Bengen as a source from whom he learned all about the 4% story. Fourthly, Guyton, suggests 65% (and 85%!) allocation to equities for retirees in the withdrawal stages,  which rimes with sleepless nights (or plenty of Ambien Rx).

Vig,
With all due respect to the author of the Business Week article, she presented Jon Guyton's comments to imply controversy and disagreement where in fact there is none. Like Guyton, I don't advocate that advisers literally apply the precise safe withdrawal rate methodology with clients without any room for adjustments along the way. The framework is developed with a rigorous structure, because that's what is necessary as a part of a 'scientific' approach to isolate a single variable to analyze (in my case, it was starting market valuation).

The Guyton point was simply that it's inappropriate to arbitrarily set the withdrawal rate once, and never revisit the status again in the future. And I'd agree with him on that point. Obviously, the Guyton framework from his articles builds the future decreases and increases into the approach - because that is the exact variable he was tring to evaluate - while my latest research did not, because I wasn't trying to test mid-path adjustments in my study (not the least of which, because Guyton {& Klinger} already have!).

So in short, notwithstanding what the Business Week article implied, Guyton and I are actually in agreement that my latest research simply represents another step in the development of the body of knowledge about safe withdrawal rates. It shouldn't be applied mechanistically with clients, but it does tell us more about how we can evaluate retirement spending, and incorporate more factors to yield a more rigorous client recommendation.

Respectfully,
- Michael E. Kitces, MSFS, MTAX, CFP(r), CLU, ChFC
Publisher, The Kitces Report, www.kitces.com
Blogger, Nerd's Eye View, www.kitces.com/blog

The following letter to the editor is being posted with permission:


I just read your comment regarding the Kitces report on alternative distribution options for retirees.  I think it's very interesting that he chose as the starting point the year 1871.  I used a history of the stock market from almost its inception in 1802 as shown in "Stocks for the Long Run" by Siegel to check his numbers.  What I found was that history has uniquely favored stocks from exactly 1871 to the present.  The first 70 years shows an entirely different history than the last 136 years.  During the first period, corresponding to manifest destiny and the industrial revolution, returns for stocks, bonds and cash were all about 5.5-6% annually, much lower than the latter period when stocks outperformed by a wide margin, roughly 10% versus 5% and 3%, respectively.  You can't say that we didn't have progress during the earlier period.  Consider the railroads, telegraph, canals, gold rushes and great productivity increases as well as a phenomenal growth in the size of the country.

We now are burdened with population straining, the ability of the earth and the seas to be able to feed us all, global warming, scarcity of affordable energy and other factors leading me and many prominent forecasters to expect a much lower level of future returns than the post-1871 period.  If we ever get cheap energy again, say from nuclear fusion, perhaps the future will look brighter, but fusion looks to be 30-50 years out and we must live in the here and now.  Better to be safe than sorry.

-Steve Kessler