Guardrail

Investing Strategies Retirement Investing
1

I have a question about the guardrail method for safe withdrawal rate.

It says that if the withdrawal rate is between initial withdrawal rate (IWR) 1.2 and IWR0.8 then we take the initial withdrawal. If outside these bounds then we reduce or increase the withdrawal by 10% or reduce by 10% depending on if the portfolio increase (when it falls below the lower bound) or if the portfolio decrease (when it falls above the upper bound.

The initial withdrawal rate means the withdrawal rate at year 1 of retirement. Is that correct?

if your withdrawal rate increase in time then you will not have enough to survive a couple of decades.
For example if you assume the S&P500 returns from 1928 to 1979, there was a catastrophic 3 years of downmarket and there were a couple of those in the 30s and early 40s.
How the portfolio of a retiree in 1928 would have survived with a 3 or 4% withdrawal rate? Is that the very worst sequence? The retiree starting in 1967 or 1968 would not have fare well either.

What all this says to the 2022 or 2023 retiree with no pension?

tj

2

TMF usually recommends that retirees carry five years of living expenses in a laddered maturity bond portfolio. That is to avoid being forced to sell equities in a down market to cover living expenses.

For those who decide to retire this year with markets down, it would be good to have that five year bond portfolio in place and live off that for now–until markets recover. If that five year bond portfolio is not in place, then better to defer retirement while you accumulate it.

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3

The initial withdrawal rate means the withdrawal rate at year 1 of retirement. Is that correct?

Not quite.

The IWR is used once and only once. Which is to determine the dollar amount of the FIRST YEAR withdrawal and to set the guardrails (+/- 20%) for the non-ajusted tentative withdrawal (NATW or IR) for each successive year.

Th NATW for the next year is the dollar amount of this year’s scheduled withdrawal adjusted upward for inflaion.

Then you compute what that percentage is of your EOY portfolio balance. If it goes past one of the guardrails (percentage), you increase or decrease the NATW to arrive at your actual, scheduled withdrawal dollar amount for the upcoming year.

There are a few web sites that walk through the calculations. It’s not hard once you understand it all.

Based on papers, pick your SWR (IWR) to be 4% or 4.5%.

Synopsis of the Rules:
 Each year, compute the dollar amount of the draw for the upcoming year.
1       IR:     Raw new annual is prev year amount increased by the CPI (inflation) (Max 6%).
        Compute the new (proposed) (raw) % W/D.  Dollar amnt vs. actual portfolio value.
2       MWR:    No increase if the annual portfolio return is NEGATIVE and the
                raw IR w/d % is more than the IWR.
3       PR:     If the W/D% computes as less than 20% below SWR, increase the W/D $ by 10%. "Floor"
                This supercedes MWR, should they occur simultaneously.
4       CPR:    If the W/D% computes as more than 20% above SWR, reduce the W/D $ by 10%. "Ceiling"
                This supercedes MWR, should they occur simultaneously.
                Note: CPR rule applies only up to age 85. After that, ignore the CPR rule.
         MWR =  Modified Withdrawal Rule
         PR =   Prosperity Rule
         CPR =  Capital Preservation Rule
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4

TMF usually recommends that retirees carry five years of living expenses in a laddered maturity bond portfolio. That is to avoid being forced to sell equities in a down market to cover living expenses.

That does not make sense.

If you do the commonly recommended portfolio rebalancing, in a down market you will be selling bonds and buying equities as you rebalance.

Think about it.
If you start with $1,000,000 and have 60/40 asset allocation, you start with $600,000 stocks and $400,000 bonds.
At beginning of the year you withdraw 4% = $40,000.
Now your portfolio is $576,000 stocks and $384,000 bonds.

Say that at year-end bonds yield 4% and stocks lost 20%. Medium bad bear market.
Now your portfolio is $460,800 stocks and $399,360 bonds.
Total portfolio is $860,160.

Your desired 60/40 alloction is $516,096 stocks and $344,064 bonds. You have too much in bonds and too little in stocks.

You need to SELL bonds ($399,360 - $344,064 = $55,296 worth)
and BUY stocks ($516,096 - $460,800 = $55,296 worth).

Of course you also need to withdraw $40,000 (assume 0% inflation) so you need to do that at the same time.
The new portfolio balance will be $820,160 ($860,160 - $40,000).
The actual target amounts will be 60/40 of that, or $492,096 stocks and $328,064 bonds.

So:
Stocks: desired amount $492,096 vs. actual amount $460,800. Buy $31,296 stocks.
Bonds: desired amount $328,064 vs. actual $399,360. Sell $71,296 bonds.
Put the $40,000 withdrawal in your checking spending account.

So you see, the conventional wisdom is not only naive, it is WRONG.

And also, that “keep 5 years living expenses” only seemingly makes sense if you assume that no bear market lasts longer than 3 or 4 years. What happens if stocks go down for 5 years in a row? Now your portfolio is way way down and instead of having sold stocks when they were 5% or 10% or 15% down, now you have used up all your “living expenses” account and have to sell your stocks at 50% down.

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5

What happens if stocks go down for 5 years in a row?

But, how often does that (5 had years in a row) happen?

In my limited experience of 36 years (1986-present) investing, the worst I’ve witnessed in my own portfolio is 2 down years in a row, which happened exactly twice: 1986-1987 and 2007-2008. 2000-2002 was probably the next worst stretch with 2 bad years out of three, but our portfolio was still up in 2001. I do note that the S&P500 was down all three years 2000-2002. And bad stretches are generally followed by a series of good years, so with a reasonable cash/fixed income/dividend stock allocation, it shouldn’t be too hard to ride out the bad years without having to sell (much) stocks at lows. I don’t think one has to keep a 5 year cash cushion, but perhaps a couple of years worth isn’t such a bad idea, particularly if it helps one sleep at night.

In what I’ll call our primary retirement portfolio, we are targeting 70% equity, 25% bond, 5% cash.
After allowing for dividend and interest income, which is not reinvested, we currently need to sell around 3% of the portfolio per year to fund our retirement. The way I’m approaching it, so far, is to sell whatever works best to roughly re-balance towards that 70/25/5 allocation at what appears to be an opportune time, maybe a couple of times a year. This year that was accomplished by selling a portion of equities just after the beginning of the year, which happened to be decent timing.

Right now, we are about 74/25/1, so will need to raise some cash before long. Waiting to see if a good sell opportunity presents itself, but may need to sell a little of the equities before the end of the year, or early next year at what will probably not be a good time for selling equities. Probably not a good time to sell bonds either. Such is life.

6

Hi Ray -

A couple of things to remember about bond ladders:

  1. Bonds have a maturity date. Assuming all goes as planned, when they mature, they turn to cash.
  2. Most people pay their bills with cash, not stocks or bonds.

With a well-functioning bond ladder, the maturing bonds become your source of cash to pay your bills. As those bonds mature and turn into cash, you’re naturally shifting your investment allocation towards stocks.

The issue becomes the fact that because bonds mature, what starts out as a potentially five-year ladder shrinks over time. So people who have bond ladders need to sell other assets (typically their stocks) to maintain the ladder.

The general guideline is that if stocks go up around what you’re expecting them to do, you sell enough stock to maintain the length of your Bond ladder. If stocks fall, you simply let your bond ladder shrink, waiting for signs of stock recovery before replenishing it. And if stocks go on a wild bull run, you can even sell more stocks to extend the length of your bond ladder beyond the starting length.

By managing your bond ladder in that fashion, you are tilting your asset allocation more towards stocks while they’re down, more towards bonds when stocks are up, and still giving yourself a reasonable chance of having cash show up on time to pay your bills.

Yes, an extended bear market could eat through a bond ladder that’s managed this way, but like everything else in the market, it’s about trading off risks and potential future returns.

One option if you’re worried about a really long stock market downturn is to start with longer than five years in the ladder. The trade off is that you’ll have more of your money tied up in bonds, which limits your potential returns.

Regards,
-Chuck
Home Fool

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7

But, how often does that (5 had years in a row) happen?

"Everything is unprecedented until it happens for the first time.” – Chesley “Sully” Sullenberger

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8

With a well-functioning bond ladder, the maturing bonds become your source of cash to pay your bills. As those bonds mature and turn into cash, you’re naturally shifting your investment allocation towards stocks.

This creates another problem. A psychological problem. As the bear market gets longer and longer, your stocks lose more and more value, and at the same time you shift your asset allocation heavier and heavier to stocks. Stocks which are crashing. Most people are not going to be happy with this.

Yes, an extended bear market could eat through a bond ladder that’s managed this way,

Yes. And that’s a low-probability high-risk bet. When the rope runs out, you are selling stocks 50% down instead of having sold when only 10% or 20% down.
That’s a risk you DON’T have to take.

Shifting your asset allocation more heavily to stocks in a downturn is, um, non-optimal, and not something people would voluntarily do, if they realized that that is what they were doing.

The problem is solved by rebalancing to your chosen asset allocation when you do the annual withdrawal.

The issue becomes the fact that because bonds mature, what starts out as a potentially five-year ladder shrinks over time. So people who have bond ladders need to sell other assets (typically their stocks) to maintain the ladder.

Right. So what is happening is that you are selling stocks to get cash, just with a 5-year side trip through bonds.

The mistake that a lot of people make is that they look at scenarios as a one-time event, and not as an on-going process. As a one-time event, “live off expiring bonds instead of selling stocks” works. But your life is not a one-time event.
The cash from the expiring bond today came from selling stock 5 years ago. And 5 years from now you will get cash from the bond that you buy today. But if you DON’T buy a bond today (because stocks are down) then you won’t have the maturing bond 5 years from now.

The only way I have been able to make all this work steady-state is to:

  1. Pick an asset allocation for your portfolio. 60/40 or 80/20 stocks/bonds.
  2. When you withdraw money, maintain that allocation.

========================
All this is rather academic right now. Bonds are pretty much “return-free risk” nowadays.

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9

That 's what I don’t get.

You are trying to keep the withdrawal rate within the guardrail, right?

Say your SWIR or IWR is 4%. On the 1st year your portfolio rise 38%. Great Start! But the next 4 years are down years: -12,-28,-47, -15% down.
So for the last 4 years you would reduce your withdrawal amount by 10% each year but in reality the actual withdrawal rate each of those years exceed your guardrails unless you reduce it by much (much) more than 10%.

Is the goal of this method to maintain your withdrawal rate each year within the guardrails set initially around the SWIR or IWR?

reducing 10% would not have worked for a retiree who retired in 1928 and expected 30+ years of retirement and who had a portfolio mimicking the S&P500.

tj

10

Is the goal of this method to maintain your withdrawal rate each year within the guardrails set initially around the SWIR or IWR?

Read the papers.

Guyton and Klinger (2006) defined a set of decision rules that serve as guideposts for the annual withdrawal. Using these rules, in periods of good investment returns, the annual withdrawal can be greater than would be justified with only inflationary increases. In periods of poor returns, the withdrawal might not keep pace with inflation. Guyton and Klinger showed, using Monte Carlo simulations, that using decision rules could improve the success rate for a given IWR by more than 20 percentage points. Put another way, the maximum safe initial withdrawal rate for a given confidence level increased by 200–300 basis points over scenarios where decision rules were not applied.

and

* This paper develops confidence standards to measure the probability of sustaining an initial withdrawal rate for at least 40 years and the percentage of purchasing power maintained during the withdrawal period.
...
* Consistently applying the two new decision rules effectively eliminates the risk of exhausting retirement assets.

With the standard 4% SWR it is most likely that the portfolio will be very large when you die but you’ve withdrawn much less that you could have.

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11

TMF usually recommends that retirees carry five years of living expenses in a laddered maturity bond portfolio. That is to avoid being forced to sell equities in a down market to cover living expenses.

Does one really have the option of not selling securities in a down market after Required Minimum Dividend (RMD) withdrawals start?

12

Of course they do. Your rmd can be transferred in mind to your taxable brokerage account and you can pay your taxes due from other funds.

Jk

13

OCD: in kind instead of in mind.

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14

Of course they do. Your rmd can be transferred in mind to your taxable brokerage account and you can pay your taxes due from other funds.

Jk

Or, RMD - taxes due = BR (Balance Remaining)
BR is the retiree’s funds to do as they wish
They could put 0 - 100% of BR in a taxable account and invest the funds

15

Of course they do. Your rmd can be transferred in [k]ind to your taxable brokerage account and you can pay your taxes due from other funds.

If your brokerage supports transfer-in-kind from a traditional IRA to a taxable account, it is still a sell transaction and a buy transaction at the current market price with commissions and transaction fees waived. Were one to do this tomorrow, one would still be selling in a down market.

Since starting RMD withdrawals in 2015, I have yet needed to use any of my RMD withdrawals to pay the federal or state income taxes on the withdrawals. The RMD is just transferred to a taxable account.

16

Since starting RMD withdrawals in 2015, I have yet needed to use any of my RMD withdrawals to pay the federal or state income taxes on the withdrawals. The RMD is just transferred to a taxable account.

I must be missing something here. Potato/potatoe. It’s my understanding once you begin making RMD’s you must pay taxes on those RMD’s. Maybe I should read your statement as “I make my RMD but I use my savings account as the source of the taxes I pay”.

Sorry for my ignorance or lack of knowledge as to how folks finance their tax payments.

Regards,

ImAGolfer

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17

Hi MCCrockett,

“If your brokerage supports transfer-in-kind from a traditional IRA to a taxable account, it is still a sell transaction and a buy transaction at the current market price with commissions and transaction fees waived.”

I do not believe any of this is true.

I have transferred shares from our trad IRA’s to Roth IRA’s as conversions and to our taxable account as an RMD and NEVER did a sell/buy transaction and never paid any broker fees to do it even when our trade fee was still in effect.

If my broker was to charge me a fee for it, I would find a different broker.

“Were one to do this tomorrow, one would still be selling in a down market.”

So what? You are simply transferring the shares from one account to another, not selling to cash.

If my stock drops, along with the market, from $50/share to $35/share, I would be ecstatic! I could transfer more shares for the same tax payment. For each $1,000 of RMD/conversion value, I can transfer about 28.5 shares at $35 vs only 20 shares at $50.

That isn’t a problem, it is a blessing!

Does that help you?

Gene
All holdings and some statistics on my Fool profile page
http://my.fool.com/profile/gdett2/info.aspx

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18

I must be missing something here. Potato/potatoe. It’s my understanding once you begin making RMD’s you must pay taxes on those RMD’s. Maybe I should read your statement as “I make my RMD but I use my savings account as the source of the taxes I pay”.

Your interpretation is correct. I deposit all my monthly guaranteed sources of income into a money market rate account at my credit union. I use EFTPS to withdraw Federal estimated taxes from that account each quarter and use California’s Webpay to withdraw State estimated taxes from that account three times each year. The value of the money market rate account is still larger than it was when I retired in 2013.

For the last two years, I’ve used a Qualified Charitable Distribution (QCD) to reduce taxes on my RMD. With this year’s market decline and Social Security’s 2023 COLA, I might be able to avoid using a portion of my RMD to pay income taxes until the 2024 tax year.

19

Does one really have the option of not selling securities in a down market after Required Minimum Dividend (RMD) withdrawals start?

No, but of course you can reinvest those RMD funds in the same securities in a taxable account preserving your investment position. You need only come up with funds to pay the income taxes on the RMD.

20

If your brokerage supports transfer-in-kind from a traditional IRA to a taxable account, it is still a sell transaction and a buy transaction at the current market price with commissions and transaction fees waived. Were one to do this tomorrow, one would still be selling in a down market.

The advantage is no slippage and avoiding any bid/ask spread. Etrade carried over my original basis, but they should have set the basis to the price of the conversion. But they let me edit the basis manually.

Since starting RMD withdrawals in 2015, I have yet needed to use any of my RMD withdrawals to pay the federal or state income taxes on the withdrawals.

Last couple of years I have used the RMD to pay the previous year’s tax.

Well-known trick #1:
Late December do an IRA withdrawal of the amount you estimate your tax bill will be, have it 100% withheld. That gets you to the withholding safe harbor.

Lesser-known trick #2:
Within 60 days, take your RMD in cash and do a 60-day rollover to replace the money from #1. Into that IRA or another IRA at a different broker.

Argh—Etrade/MorganStanley required a 60-day rollover money to be wired in to your IRA. Even if the money is in an Etrade checking account.