Retirement Ahead – Do You Have Enough Gas? (photo credit.)

When a sign on the highway states Next Gas Station 167 Miles, the ride is a lot more enjoyable when you know there is enough gas in the tank. “I think we can make it” doesn’t quite cut it.

The 4% Rule tells us if our Retirement has enough gas, but we don’t know if we will coast into the next gas station on fumes or if we have enough to drive across the entire country without refueling.

As life expectancy continues to increase and the ERE movement sees people expecting 60+ year retirements, there is need for an improved withdrawal plan.

In this post I outline my own thinking on how to ensure our portfolio lives longer than we do.

The Trinity Study that birthed the 4% Rule defines success simply as having more than $0 in 30 years.  But $1 and $100 million are both more than zero.  Are both outcomes equally successful?  I think not.

Clear boundaries and outcomes make it easier to assess risk and make investment and spending decisions.

First, I sought a clear upper bound on spending, one that would guarantee the last check bounces.  What withdrawal rate would have resulted in a portfolio value in 30 years of exactly $0?

In 9 out of 10 cases for a 75% stock / 25% bond portfolio, this is greater than 4%.

WRtoZeroAt lower levels of spending the portfolio would have lasted longer than 30 years.  But how much longer?  It isn’t clear, and in fact some of the “successful” 30 year retirement periods in the original Trinity Study would fail if the portfolio had to support an extra 10 or 20 years.

This is a difficult question to answer, in part because we only have about 150 years worth of data for modern stock markets.  Further complicating things, for time frames longer than 30 years the data starts to lose credibility; the last consecutive 60-year period we can study began in 1955, long before anybody dreamed of Collateralized Debt Obligations or Quantitative Easing.

To address this problem, I took inspiration from Endowment Funds such as those Harvard, Yale, and MIT use to fund ongoing operations.  What withdrawal rates would result in a future real value equal to the initial portfolio value?  If the portfolio had a starting value of $1 million it would have a final value of $1 million when adjusted for inflation.

Short term investment returns are highly volatile and will cause frequent and significant dips in portfolio value.  Even over time frames as long as 25 years, in several cases a portfolio would have lost purchasing power even with zero withdrawals.  But if withdrawal rates are low enough, over a 25-30 year time frame the portfolio can recover to its initial value.

With relatively constant purchasing power over long periods, the portfolio would function like an Endowment Fund in Perpetuity and support a Forever Retirement.

WR_PerpetuityIn clear red and blue we can gleam a few interesting insights:

  • The gap between a 30 year and a Forever Retirement is small in most years.
    • The delta gives us clear guidance for degree of austerity required if we are trending towards failure (10% for 1982, 35% for 1965)
  • In 7 out of 10 cases, 4% withdrawal rates involve working too long. Those are much better odds than Vegas.
  • Striving for a withdrawal rate less than 3% is certainly going to involve working too long

To seek further truths I dug out an old copy of How to Lie with Statistics and a free license for StatPlus:mac LE.

Histogram_PerpetuityThis isn’t a perfect normal distribution (if withdrawal rate is < 0%, it is no longer a withdrawal rate) but the distribution provided a convenient snapshot of a large amount of data.  Statistics are your friend, and help reduce emotional decision making.

Stock weighting appears to significantly impact the Withdrawal Rate in Perpetuity, albeit at increased volatility (note the fatter distribution of the green line versus the blue) and even withdrawal rates above 4% can be viable with a high degree of margin (consistent with the payout data for University Endowment Funds.)

Since our withdrawal rate is below the -2sigma / 95% threshold for our current portfolio allocation (90% stock / 10% bonds – on path to 100% equities), and we are more than willing to implement austerity measures via global arbitrage, it looks like I’ve created the Go Curry Cracker Endowment Fund.

At a point in the distant future, we’ll make that a legal commitment (When it has the greatest tax benefit, naturally.)

How Do You Plan to Build Your Own Endowment Fund?

In future posts, I’ll use this idea of a withdrawal rate in perpetuity to predict future withdrawal rates and how long it would have taken to build an Endowment Fund in various economic environments of the past.