Episode 340 Ben Mathew: The Lifecycle Model vs Safe Withdrawal Rates SWR

And that’s because it’s coming from this lifecycle model that’s telling us to try to maintain that 50/50 allocation or some fixed asset allocation on the total portfolio. And then over time, the human capital part reduces because you have less and less years remaining to collect your future income. The financial capital, your savings portfolio increases because you have more and more savings that’s grown.

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Let’s try to figure out that it’s upward sloping. It turns out that the rate of growth changes over time. It might be one percent early on, but later it goes up by three, four percent per year.

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On the bond side, we can use duration matching to limit the impact of that. So that would be a sensible thing to do in light of the fact that we don’t know how it’s going to change. And we want to minimize the impact of changing expected returns. But, usually, after a crash, you can reasonably expect that the expected returns has gone up.

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• It doesn’t matter if it doesn’t turn out as great as they expected or hoped.
• This was created by a financial planner named Bill Bengen in 1994.
• Once people see that, people do get excited about it.
• For investor with a relative risk aversion of around 3, Mertn’s formula would imply a stock allocation of around 30%.
• Then later, you have to reduce the probability of success to decrease the speed.

We say you can be variable if you want it to be. A 15% drop in the stock market might only be a 10% drop in the savings portfolio, and that might only be a 7% drop in your total wealth when you factor in your future income. Even beyond that, only part of your total wealth is allocated towards retirement spending. Your wealth is funding both retirement spending and legacy. It’s appropriate to take more risk on legacy than on your retirement spending.

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Now we have a third force to add to our real rate of interest and the time preference rate. Step two then is to take this total wealth and figure out what kind of spending can you schedule with this total wealth. If the interest rate is 3% and if you want spending to grow by 1%, what would you spend every year?

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And Sober House Rules: A Comprehensive Overview then if you look 10 years after the crash, the drop would have reduced to 6%. 21% drop would have reduced to 6% 10 years after the crash. The investor would not have known that at the bottom of the crash. But we can look back and see that it did recover. And the main point here is that if the market recovers, the spending would also recover with it.

Episode 340 – Ben Mathew: The Lifecycle Model vs. Safe Withdrawal Rates (SWR)

• Even now, risk is increasing over time.
• I’m still not going to lose my house and car, so I’m going to take more risk and increase my stock allocation.” On the flip side, you can say I have everything that I need.
• Fixed spending is just spending that’s fixed for a while, and then you run the risk of a big drop in spending if you run out of money.
• It was supposed to be like for a few weeks, he’s going to turn that spreadsheet into software, and then he got really into it.

Then we look at a bunch of different scenarios, different sequences. It could be based on historical sequences. But you look at what fraction of the time would this retiree have succeeded or not run out of money?

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That means roughly two-thirds of the time, the change in spending would be 6% or less. About 95% of the times, almost all of the time, the change in spending would be twice the standard deviation or 12% or less. The biggest decline that I saw in one year for one of these cohorts was 16%. That gives a flavour of the year-to-year variability. Obviously, the reason we want to save during our working years is really because we don’t want to have that sudden drop in spending when we start retirement.

It doesn’t translate to anything meaningful here. It did mean something in the fixed withdrawal scheme, but it doesn’t mean anything in the variable withdrawal scheme. Over longer horizon, stocks become less likely to underperform bonds. But when they underperform bonds, they underperform by more. But there’s another one that’s actually much more insidious and not obvious at all, the impact of this fixed withdrawals.