Building On a 45-Year Retirement

Previously, I showed how to reach Year 45 with a traditional approach using my calculators. You could withdraw 4.5% of your original balance (plus inflation).

This time, I paid closer attention to the human element. I introduced Benjamin Graham’s constraint. I kept both stock and bond allocations between 25% and 75%. You can withdraw 4.2% (plus inflation).

From Designing a 45-Year Retirement

In Designing a 45-Year Retirement, I showed how you can use my 15-Year and 30-Year calculators back-to-back. Those calculators were in my Yahoo Briefcase. Now you can access them easily by pressing buttons on the left side of your screen. You can also access the TIPS Table, which shows what happens with 100% TIPS.

Designing a 45-Year Retirement

The highest level of safety corresponds to a probability of success of 95% or better. The reasonable level of safety corresponds to a probability of success of 80% or better. I use the term “Likely Success” to describe conditions with a probability of success of 50%.

Using the Year 15 SWR calculator and the TIPS Table, followed by the Year 30 SWR calculator, I found that you can withdraw 4.5% of your original balance (plus inflation) safely for 45 years.

This time, I paid closer attention to the human element. Even though history tells us to invest entirely in TIPS today, doing so can be very difficult, especially as stocks reach new highs (in terms of nominal prices).

This time, I introduced Benjamin Graham’s constraint. Both stock and bond allocations lie between 25% and 75% at all times.

Switching A

The Switching A algorithm adjusts valuations in accordance with P/E10 while satisfying Benjamin Graham’s constraint. If I require final balances of 20%, 30% or 40% (plus inflation) for 15 years using Switching A, my Safe Withdrawal Rates are 5.1%, 4.6% and 4.0%, respectively. My Reasonably Safe Rates (80% probability of success) are 5.7%, 5.1% and 4.6%, respectively. My Likely Success Rates (50% probability of success) are 6.3%, 5.7% and 5.2%, respectively.

Focusing on withdrawal rates close to 4.5%, I notice that the Year 15 balance is more than 30% at the Safe Withdrawal Rate and 40% at the Reasonably Safe Rate (80% probability of success).

It is reasonable to plan on having 40% of your original balance (plus inflation) at Year 15 when applying Benjamin Graham’s constraint (Switching A).

To continue withdrawing 4.5% of the original balance (plus inflation), I need to plan on withdrawing 4.5%/0.40 = 11.25% of my Year 15 balance.

Bargain Prices

Now see what happens when P/E10 falls to bargain prices, P/E10=8 or less.

If I require final balances of 0%, 50% or 100% (plus inflation) at Year 30 (following the first fifteen years) using Switching A, the Safe Withdrawal Rates are 7.8%, 7.0% and 6.3%, respectively. The Reasonably Safe Rates (80% probability of success) are 8.1%, 7.4% and 6.7%, respectively. The Likely Success Rates (50% probability of success) are 8.5%, 7.8% and 7.2%.

If I require final balances of 0%, 50% or 100% (plus inflation) at Year 30 using 80% stocks, the Safe Withdrawal Rates are 9.10%, 8.8% or 8.5%, respectively. The Reasonably Safe Rates (80% probability of success) are 9.7%, 9.3% and 8.9%, respectively. The Likely Success Rates (50% probability of success) are 10.3%, 9.8% and 9.3%, respectively.

If I require final balances of 0%, 50% or 100% (plus inflation) at Year 30 using 100% stocks, the Safe Withdrawal Rates are 10.0%, 9.9% or 9.8%, respectively. The Reasonably Safe Rates (80% probability of success) are 10.9%, 10.6% and 10.4%, respectively. The Likely Success Rates (50% probability of success) are 11.8%, 11.4% and 11.0%, respectively.

To reach the desired 11.25% withdrawal rate in terms of the Year 15 balance, we must switch entirely into stocks.

Varying the Year 30 balances, I found that an 11.25% Likely Success Rate (50% probability of success) corresponds to a Year 30 balance between 60% and 70%.

This is 0.40*60% to 70% = 24% to 28% of the original balance (plus inflation).

Interim Findings

To withdraw 4.5% of the original balance (plus inflation) for the entire 45 years, I was not able to stay with Benjamin Graham’s constraint. I needed to invest entirely in stocks when P/E10=8.

Switching A, although optimized, is optimized for high valuations. A simple 80% or 100% stock portfolio does better when market prices are very low.

Reduced Withdrawal Rate of 4.2%

I examined several withdrawal rates less than 4.5%.

This is what happens with a withdrawal rate of 4.2% of the original balance, starting with Switching A and ending with 80% stocks-20% TIPS.

The Reasonably Safe Rates (80% probability of success) are 4.6% with a 40% Year 15 balance and 4.1% with a 50% Year 15 balance. Interpolating between these values, a 4.2% withdrawal rate retains 48% of the original balance (plus inflation) at Year 15.

The Year 30 required Reasonably Safe Rate is 4.2%/0.48 = 8.75% for P/E10=8. With 80% confidence, the final balance at Year 45 is a little bit more than 50% of the original balance (plus inflation).

Conclusions

Reducing the withdrawal rate to 4.2% of the original balance (plus inflation) allows us to incorporate Benjamin Graham’s constraint. This minimizes regret.

The numbers would tell us to do otherwise, but trusting the numbers by themselves is not always a good idea. We should anticipate surprises. Not everything is found in the historical record. The bubble that peaked in the Year 2000 was more extreme than previously seen in the United States.

Additional Remarks

This study involved the traditional liquidation approach. I believe that we can do better.

The approach incorporates the Delayed Purchase concept, but only minimally. It excludes the more promising dividend approaches. It excludes my Income Stream Allocator findings.

It makes sense to consider many different investment strategies because of uncertainty. Even the best analysis can fail because of a hidden flaw or a blind spot. Diversification among strategies makes sense. But it comes at a cost.

Have fun.

John Walter Russell
May 27, 2007