Variable Percentage Withdrawal (VPW)

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L84SUPR
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Re: Variable Percentage Withdrawal (VPW)

Post by L84SUPR »

longinvest wrote: Tue Mar 21, 2023 6:14 pm
L84SUPR wrote: Tue Mar 21, 2023 9:18 am Is the default Bond Growth Trend in the spreadsheet still valid if 70 percent of the total portfolio "bonds" is the bridging fund which is invested in the G Fund? My understanding is the Growth Trend values are real and I don't expect the G Fund to make 1.9 percent real over the next seven years.

My total AA is 50/50; excluding bridging fund the AA is 80/20. In rough numbers, total portfolio is invested as follows.

35 US Stock
15 XUS Stock
35 G Fund
15 Bonds (whatever is in Wellington and TD2065)

Target AA at age 70 is 70/30. I haven't decided what percentage of bonds will be G Fund but I don't think it will exceed 50 percent of bonds which could be 15 percent of total.

I have compared results from the spreadsheet (which includes the bridging fund) and table (which excludes the bridging fund) and they are within 1 percent even though they use different AAs. Overall, I think the Bond Growth Trend is good enough for my situation and will get better as the bridging fund is spent down. Just curious about the applicability of the default Bond Growth Trend value when a cash equivalent is included in "bonds".
L84SUPR, I don't know the G Fund. I made a quick internet search. If I understood correctly, it's a cash-like fund, in that it doesn't fluctuate in value.

...

In summary, I suggest choosing between using a dedicated cash bridge or letting the worksheet bridge future pensions using a stocks-and-bonds portfolio. If the cash bridge is chosen, it should be excluded from the worksheet portfolio balance, and bridged pensions should be marked as already started. I personally prefer the simpler approach of letting the worksheet bridge future pensions using my single stocks-and-bonds portfolio and tell me about the required flexibility.
The G Fund earns the average of medium and long-term US treasuries and is liquid. It is only available to US federal employees. I used it for our bridging fund to mitigate retirement date risk, and it did an outstanding job over the last year and a half, much better than diversified bond funds did. G Fund earned 2.8 percent nominal in 2022.

I'll try the approach of excluding the bridging fund and starting the pensions.

Thanks for the detailed response!
1/3rd VTWAX, 1/3rd Wellington, 1/3rd G Fund | All models are wrong. Some are useful.
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longinvest
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Re: Variable Percentage Withdrawal (VPW)

Post by longinvest »

L84SUPR wrote: Tue Mar 21, 2023 9:13 pm The G Fund earns the average of medium and long-term US treasuries and is liquid. It is only available to US federal employees. I used it for our bridging fund to mitigate retirement date risk, and it did an outstanding job over the last year and a half, much better than diversified bond funds did. G Fund earned 2.8 percent nominal in 2022.
L84SUPR, cash (including the G Fund) was effectively a much better place for one's money in 2022 than marketable stocks and bonds which both had negative returns. Inflation-indexed cash, like series I savings bonds (I bonds), was an even better place. If we could know these things in advance, there would be no need to diversify our investments. We would simply switch our money from asset to asset, capturing the returns of the winning asset over each period. The reality is that the future is uncertain. We don't know which asset will win. This site's investment philosophy is to broadly diversify long-term investments across the two major marketable asset classes using low-cost total-market index funds or ETFs.

Mathematically, someone who works for a sufficiently long time with a high-enough savings rate can afford to retire with dignity while never investing a single penny into marketable securities like stocks and bonds (often called risky securities), putting all the savings into cash vehicles and combining withdrawals with Social Security (and possibly a pension) during retirement. Note that this isn't an entirely risk-free approach. There's always uncertainty about one's particular future and the availability and returns of savings vehicles.

Investing into a portfolio of risky assets, like suggested on this site, is generally less expensive, often significantly less so, but there's no guarantee of superior outcome, just a very high likelihood.

The VPW approach to retirement takes a mixed approach of combining lifelong income streams (like Social Security and pensions) with withdrawals from a portfolio of marketable securities. It also includes the possibility of using home-made temporary bridge income streams for future pensions using cash vehicles (like you're doing).

"There is more than one road to Dublin." -- Taylor Larimore
Variable Percentage Withdrawal (bogleheads.org/wiki/VPW) | One-Fund Portfolio (bogleheads.org/forum/viewtopic.php?t=287967)
L84SUPR
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Re: Variable Percentage Withdrawal (VPW)

Post by L84SUPR »

longinvest wrote: Wed Mar 22, 2023 7:06 am
L84SUPR wrote: Tue Mar 21, 2023 9:13 pm The G Fund earns the average of medium and long-term US treasuries and is liquid. It is only available to US federal employees. I used it for our bridging fund to mitigate retirement date risk, and it did an outstanding job over the last year and a half, much better than diversified bond funds did. G Fund earned 2.8 percent nominal in 2022.
... This site's investment philosophy is to broadly diversify long-term investments across the two major marketable asset classes using low-cost total-market index funds or ETFs...

...Investing into a portfolio of risky assets, like suggested on this site, is generally less expensive, often significantly less so, but there's no guarantee of superior outcome, just a very high likelihood.

The VPW approach to retirement takes a mixed approach of combining lifelong income streams (like Social Security and pensions) with withdrawals from a portfolio of marketable securities. It also includes the possibility of using home-made temporary bridge income streams for future pensions using cash vehicles (like you're doing).

"There is more than one road to Dublin." -- Taylor Larimore
I believe we substantially agree. Prior to the pandemic I was invested in a target date 2035 fund. We reached our nest egg goal just prior to the pandemic and I realized we might be able to retire sooner than we thought. During the pandemic I read extensively on this site and on the Kitces blog and learned in our situation DW should take SS first and I should delay. I had already decided to construct a bond tent but changed my thinking toward a SS bridging fund. Your recommendation, among others, to use cash equivalents for a SS bridge led me to choose the G Fund for our bridge. This turned out to be terrific advice since we all learned, or relearned, in 2022 that stocks and bonds are not perfectly negatively correlated.

If I had known in 2018 that I would retire in 2023 I would have constructed our tent/bridge over five years. As it happened I did it in one key stroke.

When is the best time to reef the mainsail? When it first occurs to you.

OR

Never bear too much or too little risk. (Principle 3)
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bbrock
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Re: Variable Percentage Withdrawal (VPW)

Post by bbrock »

Hi Longinvest. Do sites such as (https://cfiresim.com/) or (https://ficalc.app/) reflect the VPW that you have discussed?
bbrock
SnowBog
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Re: Variable Percentage Withdrawal (VPW)

Post by SnowBog »

bbrock wrote: Wed Mar 29, 2023 3:34 pm Hi Longinvest. Do sites such as (https://cfiresim.com/) or (https://ficalc.app/) reflect the VPW that you have discussed?
Not Longinvest. But as I understand it - the answer is "sorta", "maybe", but "not really"...

More specifically, I don't believe either follow the "recommendation" (but not requirement) https://www.bogleheads.org/wiki/Variabl ... withdrawal) that states:
It is suggested to limit the withdrawal percentage to no more than 10%, after buying the SPIA with annual cost-of-living adjustments.
Which means these calculators will force a 100% withdrawal at age 100. Technically, that follows VPW and its tables.

Another example, they don't follow the "recommendations", which also includes things like:
Around age 80, if you're still alive, it is important to consider using part (but not all) of your remaining portfolio to buy a Single Premium Immediate Annuity (SPIA) with annual cost-of-living adjustments, so that total non-portfolio income (including Social Security, pension, and other lifelong income) is sufficient to live comfortably, independently of future portfolio withdrawals. This aims to reduce the financial risks associated with living past age 100.
So, one could argue they "reflect" VPW - just not the "recommended" version of it (most notable differences after age 80).

Where they deviate more drastically is they allow you to implement spending "floors" or "ceilings". Conceptually, these let you look at "I need a minimum of $x" and/or "I'll cap spending at $y". But both of these are not part of VPW, as the entire point of VPW is you need to be able to adapt your spending based on what the portfolio can support. If you artificially withdraw more (minimum/floor), you run the risk of pre-maturely depleting the portfolio - which is one of the things VPW was created to avoid. If you artificially cap withdrawals (max/ceiling), you'll end up far more likely to have an excessively large endpoint portfolio - which was another thing VPW attempted to avoid.

So, if you don't use the "floor" or "ceiling" options, and limit your review to before age 80, or age 89 if you have adequate "life long" income from pensions/social security/SPIA already accounted for, they can give you a reasonable approximation. (Or at least I think so.) Otherwise, they will give you something like VPW - but that is no longer actually VPW "as recommended" and/or as reflected in the VPW spreadsheet.
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longinvest
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Re: Variable Percentage Withdrawal (VPW)

Post by longinvest »

bbrock wrote: Wed Mar 29, 2023 3:34 pm Hi Longinvest. Do sites such as (https://cfiresim.com/) or (https://ficalc.app/) reflect the VPW that you have discussed?
Bbrock, unfortunately they don't reflect VPW as I explain it and as it's implemented in the VPW Accumulation And Retirement Worksheet (which I often call VPW worksheet). In particular, they ask users to predict future returns (asking for "expected returns"), they allow for specifying a "minimum" and a "maximum" withdrawal amount, and they provide for budgeting concerns (like specifying a specific extra withdrawal in a specific retirement year or specifying a specific bequest amount target) which could severely harm the portfolio. Their handling of future pensions seems weird too (I just haven't looked at it sufficiently to understand how it works). But, from the little I have experimented, it seems to have nothing in common with how bridging is implemented in the VPW worksheet.

The VPW worksheet protects the portfolio by not allowing more than 50% of the portfolio to be used for bridging future pensions (on paper, when projecting to suggest the current year's withdrawal, as all the portfolio remains exposed to market fluctuations after the withdrawal and no memory of the past is kept from year to year).

From what I have read about their bond data (they start form Shiller's rates), I remain quite skeptical about its representativeness of the typical (total-market index) bond allocation of a Bogleheads portfolio. Yet, this isn't a big problem. VPW was designed for unknown future returns. Being confronted to different past returns should be OK. If you're interested, the VPW backtesting spreadsheet uses bond data carefully reconstructed as described in this long thread: Historical Bond Returns - From Rates to Returns [Bond Fund Simulator].

This being said, I'll add the following.

The accumulation and retirement worksheet is a much better planning and stress testing tool than the backtesting spreadsheet. A simple yet very powerful stress test is to feed the initial "Portfolio Balance After Loss" (red cell) as "Portfolio Balance" (yellow input cell), and look at the resulting required flexibility assessment. This represents two consecutive -50% losses for stocks, or cumulative -75% losses (with rebalancing in between losses) at the worst of times, at the start of retirement immediately before first withdrawal. These are Great Depression types of losses without any quick recovery after losses. The retiree's comfort is probably affected, yet (hopefully) the retiree is likely to be doing better financially than many others in society if retirement was properly planned. The backtesting spreadsheet can't do such a simple and harsh test of the plan, as such deep losses without quick recovery never happened in the spreadsheet's data set (which includes U.S. stocks and bond returns for the last 150 years, since 1871).

I invite you to read this post. You'll find a simulation which illustrates the harshness of feeding the initial "Portfolio Balance After Loss" (red cell) as "Portfolio Balance" (yellow input cell) in the retirement worksheet's static model (where returns are constant, except for initial losses).

Putting all losses just before first withdrawal represents a worse than worst-possible return sequence.

Just in case you have some doubts (because a loss just before first withdrawal might seem weird), you'll find a slightly-less harsh simulation where the loss happen just after the first withdrawal in this post.

The worksheet's "after-loss" projection, when feeding the initial "Portfolio Balance After Loss" (red cell) as "Portfolio Balance" (yellow input cell), is really harsh. I don't see what backtesting can add to the provided information, for stress testing a plan.

I think that the main usefulness of backtesting is to help potential users learn how income fluctuations derive from portfolio fluctuations, and that bonds and pensions dampen total income fluctuations. The VPW worksheet is a much better planning tool.


I developed the VPW worksheet in part because too many users were using the backtesting spreadsheet as a prediction tool, thinking that if they were able to find a way for the "worst backtest" to be fine, they'd be fine in the future. Unfortunately, the data set has a very limited number of return sequences. Actually, it contains only two series of returns: one of approximately 150 years for U.S. returns, and one of approximately 50 years for Canadian returns. Users didn't seem to understand that this represents less than 3 independent data points for a 50-year U.S. retirement, and a single independent data point for a 50-year Canadian retirement. Consequently, I've decided not to implement the improvements of the new VPW worksheet into the old backtesting spreadsheet, as this could encourage users to continue misusing the backtesting spreadsheet.

It also gives me the opportunity to explain why the new worksheet is a much better planning tool when users ask for improving the backtesting spreadsheet.

Users interested to stress-test their plan just need to feed the initial "Portfolio Balance After Loss" (red cell) as "Portfolio Balance" (yellow input cell) into the Retirement worksheet, and look at the resulting Required Flexibility projection. If they have any doubt about it, they should go another time through the first simulation linked above.
Last edited by longinvest on Thu Mar 30, 2023 7:55 am, edited 1 time in total.
Variable Percentage Withdrawal (bogleheads.org/wiki/VPW) | One-Fund Portfolio (bogleheads.org/forum/viewtopic.php?t=287967)
bbrock
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Re: Variable Percentage Withdrawal (VPW)

Post by bbrock »

Thanks SnowBog and Longinvest for responding.

Longinvest I looked at those two links you posted and they are definitely some worst case scenarios - especially the drop right before withdrawal.

I’d like to look at your VPW accumulation and retirement worksheet, and to compare those to the the VPW in the two links that I posted.
Last edited by bbrock on Fri Apr 07, 2023 6:55 pm, edited 1 time in total.
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longinvest
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Re: Variable Percentage Withdrawal (VPW)

Post by longinvest »

bbrock wrote: Wed Mar 29, 2023 10:45 pm Thanks SnowBog and Longinvest for responding.

Longinvest I looked at those two links you posted and they are definitely some worst case scenarios - especially the drop right before withdrawal.

Lid like to look at your VPW accumulation and retirement worksheet, and to compare those to the the VPW in the two links that I posted.
Bbrock, here's the link to the VPW Accumulation And Retirement Worksheet. It's available in three formats: Google Sheets (online), Microsoft Excel (download), and LibreOffice Calc (download).

The Bogleheads wiki contains instructions for how to use VPW in general (here) and how to use the VPW worksheet in particular (here).

Finally, there's a detailed example of how the VPW worksheet could be used during retirement, along with lots of explanations, in the ongoing VPW forward test thread. I strongly suggest reading it.

Enjoy!
Variable Percentage Withdrawal (bogleheads.org/wiki/VPW) | One-Fund Portfolio (bogleheads.org/forum/viewtopic.php?t=287967)
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longinvest
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Re: Variable Percentage Withdrawal (VPW)

Post by longinvest »

In this upcoming weekend's forward test entry (for March 31, 2023), the retiree (age 68) will add a temporary pension from age 70 to age 78 in the Retirement sheet. In this post, I'll explain how delayed Temporary Retirement Income is handled in the VPW worksheet.

The VPW worksheet considers a pension as an income stream. It never tries to convert it into a marketable asset of the investment portfolio (for calculation purpose). On the contrary, the VPW worksheet converts (on paper) the investment portfolio into a variable income stream while also (1) filling the payment gap between retirement and the start of a pension and (2) investing part of pension payments into the portfolio, when necessary, to compensate for (i) termination of a temporary pension (explained in this post) and (ii) lack of cost-of-living adjustments of a fixed pension (explained here and here). The worksheet is careful not to convert (on paper) more than 50% of the investment portfolio into pension bridges to preserve lifelong liquidity.

This is consistent with the fact that a pension, like Social Security, isn't a marketable security. It doesn't have a market value because it can't be sold.* The investment portfolio, in contrast, is composed of marketable securities (stocks and bonds) and has a fluctuating market value. The VPW worksheet aims to determine how much the retiree can safely withdraw from the investment portfolio in the current year (or month).

* Some investors, including Jack Bogle in his writings, consider a pension as bonds. Doing so leads to an inflated hypothetical market value when bond yields are low, possibly pushing investors into buying more stocks. Yet, when bond yields are low, bond prices are necessarily high. Sometimes bond prices are high because most investments (stocks and bonds) are expensive due to high demand (possibly exacerbated by investors using cheap leverage due to low yields). Pushing investors to load up on (possibly) expensive stocks and sell their bonds, by considering a pension as bonds when aiming for a specific stocks/bonds allocation, seems imprudent to me. It can actually be impossible to achieve a desired target allocation if one would have to sell part of the pension to rebalance, unless leverage is introduced. But, leverage has costs and introduces the possibility of losing more than one possesses. Our wiki's page on leverage has a prominent warning indicating that "Leverage should never be used when saving towards retirement, as the level of risk taken with leverage is excessive and can jeopardize retirement savings". I think that it's best to treat a pension as an income stream and avoid considering it as an investment asset, which it isn't.

The VPW worksheet supports Temporary Retirement Income which starts during retirement (at the start of retirement or later), and stops no later than at age 80. The worksheet invests part of each temporary income payment into the portfolio (or, equivalently, reduces the suggested portfolio withdrawal by an equivalent amount). The upper age limit is in place to allow the retiree to consider buying a life annuity, when necessary at age 80, to dampen financial risks associated with living beyond age 100.

Let's pick the example of a temporary $545/month pension starting at age 70 and stopping at age 78. We want to determine P, the part of each $545 payment that should be put aside so that the accumulated portfolio, at age 78, allows for making ($545 - P) monthly VPW withdrawals.

For a 60/40 stocks/bonds portfolio, VPW uses a 3.76% growth trend. According to my financial calculator, investing $1,000/year for (78-70) = 8 years at 3.76% grows into a $9,479 portfolio. The VPW Table percentage at age 78 for a 60/40 stocks/bonds allocation is 6.5%, resulting into a ($9,479 X 6.5%) = $618 withdrawal (more exactly, when using non-rounded amounts and percentages, this is $617.7691857...). This means that if a retiree was to get a ($618 + $1,000) = $1,618/year temporary pension from age 70 to age 78, the retiree could spend $618/year and invest $1,000/year during these 8 years, accumulating a projected $9,479 portfolio at age 78 which would allow for $618/year withdrawals starting at age 78. In other words, the retiree should invest ($1,000 / $1,618) = 61.8% of temporary pension payments and spend the remaining ($618 / $1,618) = 38.2% (or, more precisely, when using non-rounded amounts, 38.18648489...%). That's the theory.

In practice, we don't need a financial calculator. The VPW Table already provides all the ingredients we need to calculate the exact same result. We can get the spending ratio by simply dividing the VPW Table percentage for age 70 (5.4%) by the VPW Table percentage for an 8-year depletion schedule (14.2%). When using the non-rounded VPW percentages (5.4121843...% and 14.173036...%), I get (5.4% / 14.2%) = 38.2% (that's 38.18648489...%), identical to the ratio calculated in the previous paragraph.**

** Interestingly, at age 71, in the second year of temporary pension payments, the money put aside at age 70 is now part of the VPW portfolio and is already resulting into higher portfolio withdrawals. But, the spending ratio for age 71 and a 7-year depletion schedule is smaller, resulting into the same $208/month total (in other words: additional VPW withdrawal + spending reduction = $0). The same applies for the next 6 years of the temporary pension. In the last year, at age 77, the spending ratio gets down to 6.3%, as most of the temporary pension has already been invested into the portfolio and is already generating higher VPW withdrawals. In other words, there's no need to manage a separate investment portfolio for the temporary pension. Neat, isn't it?

The temporary pension payment is $545/month. The retiree can spend ($545 X 38.2%) = $208 of it and P, the portion that should be invested into the portfolio, is $337. In other words, the $545/month temporary pension is more or less equivalent to a $208/month lifelong pension.

OK. If you're still with me, we're not done yet. There's still a 2-year payment gap from age 68 to age 70 that must be filled. The worksheet estimates the cost of filling a 2-year gap for an upcoming (12 X $208/month) = $2,497/year pension by dividing the annual pension payment by the VPW Table percentage for a 2-year depletion schedule (50.9%). That's a ($2,497 / 50.9%) = $4,904 cost for bridging the pension.

Note that if the estimated bridge cost was bigger than 50% of the investment portfolio, the VPW worksheet would reduce it to 50% of the portfolio and reduce the projected (and adjusted) $208/month pension payment proportionally for making bridge portfolio withdrawals.
Last edited by longinvest on Sat Apr 08, 2023 4:28 am, edited 13 times in total.
Variable Percentage Withdrawal (bogleheads.org/wiki/VPW) | One-Fund Portfolio (bogleheads.org/forum/viewtopic.php?t=287967)
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longinvest
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Re: Variable Percentage Withdrawal (VPW)

Post by longinvest »

In this recent post of the forward test thread, I stated that the impact of switching $545/month, 23% of the Social Security payment, from a lifelong pension starting at age 70 into a temporary pension from age 70 to 78, is -$302/month.

This can be explained as follows. The estimated cost for bridging a $545/month pension starting in 2 years is ((12 X $545) / 50.9%) = $12,843. The estimated cost for bridging a $208/month pension starting in 2 years is ((12 X $208) / 50.9%) = $4,904. Bridging the temporary pension is less expensive. It leaves us with an additional ($12,843 - $4,904) = $7,939 in the investment portfolio (on paper) from which VPW withdrawals are taken. At age 68, the VPW Table percentage for a 60/40 stocks/bonds allocation is 5.2%, resulting into an additional ($7,939 X 5.2%) = $415/year, or $35/month withdrawal. The bridge withdrawal is reduced by ($208 - $545) = -$337/month. In total, we get a ($35 + -$337) = -$302/month impact.
Variable Percentage Withdrawal (bogleheads.org/wiki/VPW) | One-Fund Portfolio (bogleheads.org/forum/viewtopic.php?t=287967)
jocdoc
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Re: Variable Percentage Withdrawal (VPW)

Post by jocdoc »

posting here because I couldn't find answer elsewhere. I downloaded VPW version 2.9 from bogle heads libre office download link (had been using a much older version).
On the retirement page I could not turn off defined pension 2. I only have SS and no pension. The best workaround is to set defined pension 2 to start age 85 and income $1. I have libre office 7.5.2.2
It had the same problem on the last version of libre office.
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longinvest
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Re: Variable Percentage Withdrawal (VPW)

Post by longinvest »

jocdoc wrote: Sun Apr 09, 2023 8:31 am posting here because I couldn't find answer elsewhere. I downloaded VPW version 2.9 from bogle heads libre office download link (had been using a much older version).
On the retirement page I could not turn off defined pension 2. I only have SS and no pension. The best workaround is to set defined pension 2 to start age 85 and income $1. I have libre office 7.5.2.2
It had the same problem on the last version of libre office.
Jocdoc, to remove Defined Benefit Pension #2, all of its entries must be emptied.

As soon as a name is provided for a pension, the worksheet assumes that the pension exists and, consequently, that the other cells of the pension must be filled. When the name cell is empty, the worksheet assumes that there's no pension and that other cells must be emptied.

Does this solve your problem?
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Re: Variable Percentage Withdrawal (VPW)

Post by billthecat »

jocdoc wrote: Sun Apr 09, 2023 8:31 am posting here because I couldn't find answer elsewhere. I downloaded VPW version 2.9 from bogle heads libre office download link (had been using a much older version).
On the retirement page I could not turn off defined pension 2. I only have SS and no pension. The best workaround is to set defined pension 2 to start age 85 and income $1. I have libre office 7.5.2.2
It had the same problem on the last version of libre office.
The easiest solution I found was to select all the applicable cells for the DP and hit delete, to empty them all at once.
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jocdoc
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Re: Variable Percentage Withdrawal (VPW)

Post by jocdoc »

Thank you. Longinvest.
That works. I tried deleting all the cells at once including the grey box defined benefit 2 and got error messages as well as emptying the cells below the name before deleting the name and got error messages.
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longinvest
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Re: Variable Percentage Withdrawal (VPW)

Post by longinvest »

jocdoc wrote: Sun Apr 09, 2023 12:46 pm Thank you. Longinvest.
That works. I tried deleting all the cells at once including the grey box defined benefit 2 and got error messages as well as emptying the cells below the name before deleting the name and got error messages.
Jocdoc, users should only change the content of yellow cells. You've probably broken your copy of the worksheet.

I suggest that you download a fresh copy of the worksheet. In the Retirement sheet of the fresh copy, you can simply select the E17 yellow cell which contains "Work Pension", representing the name of Defined Benefit Pension #2, and then press backspace to empty the cell (it should remain yellow, but stop containing "Work Pension"). You can similarly empty cells E18, E19, E20, and E21. Once this is done, the pension will be deleted and the worksheet will stop displaying an error.

Here's how it should look before:

Image

Here's how it should look after:

Image
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whyme
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Re: Variable Percentage Withdrawal (VPW)

Post by whyme »

A question about how to handle a "partial-cola" pension: I am expecting a state pension (CalSTRS) that has a peculiar adjustment that is not a true COLA. 2% of the initial pension is added to the total each year. This two percent does not compound, it is forever based on the initial pension. For example, if the starting pension were $50,000, $1000 (2%) would be added annually. Even if I'm still receiving a pension in 40 years, the annual increase will be $1000. It gets more complicated: the pension system calculates an ongoing amount they determine to be purchasing power parity, based on the starting pension. Once they figure (somehow) that the purchasing power has eroded below 85% of the initial value, supplementary payments kick in, designed to bring the ongoing payment up to that 85% level.

So my question is, how can I best represent this in the VPW calculations? Do I break the pension into two, one with COLA, and another without COLA? If so, would it be an 85/15 split, or something else? Thanks in advance.
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Re: Variable Percentage Withdrawal (VPW)

Post by Lastrun »

whyme wrote: Wed Apr 26, 2023 12:13 pm A question about how to handle a "partial-cola" pension: I am expecting a state pension (CalSTRS) that has a peculiar adjustment that is not a true COLA. 2% of the initial pension is added to the total each year. This two percent does not compound, it is forever based on the initial pension. For example, if the starting pension were $50,000, $1000 (2%) would be added annually. Even if I'm still receiving a pension in 40 years, the annual increase will be $1000. It gets more complicated: the pension system calculates an ongoing amount they determine to be purchasing power parity, based on the starting pension. Once they figure (somehow) that the purchasing power has eroded below 85% of the initial value, supplementary payments kick in, designed to bring the ongoing payment up to that 85% level.

So my question is, how can I best represent this in the VPW calculations? Do I break the pension into two, one with COLA, and another without COLA? If so, would it be an 85/15 split, or something else? Thanks in advance.
Does this post below help? For fun, I put into the retirement spreadsheet a 60-year old with $3.0 million portfolio at 50/50 stocks and bonds with a $50K a year pension starting at 65. With no cost of living adjustment the annual withdrawal is $157,555 a year, adjusted is $174,241 per year.
mtwhmemn wrote: Sat Feb 04, 2023 11:32 am
longinvest wrote: Sat Feb 04, 2023 11:28 am In the forward test thread, forum member Mtwhmemn asked:
mtwhmemn wrote: Sat Feb 04, 2023 10:36 am Sorry if this has been answered before...where can I assign a specific Cost of Living Adjustment, e.g. 2%, to an immediate annuity in Defined Benefit Pension? What is the default and how can I change it to 2% if that is where I'm supposed to put an annuity? Thanks.
Mtwhmemn, the simple answer is that, when the pension has cost of living adjustments, the "Cost of Living Adjustment" (COLA) choice should be set to "Yes". No further adjustment is needed.

Now, if a retiree thinks that a pension provides only half of the required cost of living adjustment, the pension could be divided in two halves, one half with COLA set to "Yes" and the other set to "No". It's simple and effective.
Makes sense and thanks for moving...I realize I put the question in the wrong place.
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Re: Variable Percentage Withdrawal (VPW)

Post by longinvest »

whyme wrote: Wed Apr 26, 2023 12:13 pm A question about how to handle a "partial-cola" pension: I am expecting a state pension (CalSTRS) that has a peculiar adjustment that is not a true COLA. 2% of the initial pension is added to the total each year. This two percent does not compound, it is forever based on the initial pension. For example, if the starting pension were $50,000, $1000 (2%) would be added annually. Even if I'm still receiving a pension in 40 years, the annual increase will be $1000. It gets more complicated: the pension system calculates an ongoing amount they determine to be purchasing power parity, based on the starting pension. Once they figure (somehow) that the purchasing power has eroded below 85% of the initial value, supplementary payments kick in, designed to bring the ongoing payment up to that 85% level.

So my question is, how can I best represent this in the VPW calculations? Do I break the pension into two, one with COLA, and another without COLA? If so, would it be an 85/15 split, or something else? Thanks in advance.
Whyme, in a 2% inflation world, it would take 35 years for the pension to gradually lose -15% of its real value and then be linked to inflation. I think that 35 years to adapt to such a mild reduction in stable income, with a guaranteed inflation-indexed 85% floor, is perfectly reasonable.

Of course, one could set up mathematical equations like in this post to find a solution for a perfect world of constant returns, constant inflation, and infinite life (this world doesn't exist). But, I don't see the point of spending maybe -7% less now to maybe spend 9% more in 35 years if still alive (before accounting for other income like Social Security and portfolio withdrawals), given the huge uncertainties of life and markets.

I think that you're lucky to have such a pension. If I had such a pension, I would indicate, in the worksheet, that the pension has cost-of-living adjustments. Then, I would go enjoy the money.
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whyme
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Re: Variable Percentage Withdrawal (VPW)

Post by whyme »

longinvest wrote: Wed Apr 26, 2023 8:03 pm If I had such a pension, I would indicate, in the worksheet, that the pension has cost-of-living adjustments. Then, I would go enjoy the money.
Got it, thank you. And thanks very much for your work on this worthwhile project, longinvest.
lucastx
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Re: Variable Percentage Withdrawal (VPW)

Post by lucastx »

I've tried to understand the change from withdrawal cushion to income cushion but I'm not getting it. In the forward test thread it says this:

To simplify calculations, the retiree switches from using a withdrawal cushion (which contains approximately 5 months of withdrawals) to an income cushion (which contains approximately 5 months of total retirement income). In order to do so, the retiree withdraws (5 X $1,000 monthly work pension payment) = $5,000 from the investment portfolio and adds it into the Ally Bank savings account.

This doesn't seem to be a big deal for someone with a $1,000 month pension, as it only requires $5,000 to be withdrawn and sit in the HYSA. But what if the situation were such that the pension was more significant, say $5,000/month alongside a portfolio withdrawal of say $5,000/month. This now requires the person to hold roughly $50,000 in the cushion account vs. $25,000 if just using a withdrawal cushion.

I don't understand the advantage of having that much more money pulled from the portfolio and sitting in the HYSA over the previous version.

Help please!
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Re: Variable Percentage Withdrawal (VPW)

Post by longinvest »

lucastx wrote: Sat May 06, 2023 2:15 pm I've tried to understand the change from withdrawal cushion to income cushion but I'm not getting it. In the forward test thread it says this:

To simplify calculations, the retiree switches from using a withdrawal cushion (which contains approximately 5 months of withdrawals) to an income cushion (which contains approximately 5 months of total retirement income). In order to do so, the retiree withdraws (5 X $1,000 monthly work pension payment) = $5,000 from the investment portfolio and adds it into the Ally Bank savings account.

This doesn't seem to be a big deal for someone with a $1,000 month pension, as it only requires $5,000 to be withdrawn and sit in the HYSA. But what if the situation were such that the pension was more significant, say $5,000/month alongside a portfolio withdrawal of say $5,000/month. This now requires the person to hold roughly $50,000 in the cushion account vs. $25,000 if just using a withdrawal cushion.

I don't understand the advantage of having that much more money pulled from the portfolio and sitting in the HYSA over the previous version.

Help please!
Lucastx, welcome to the forum!

The main advantage of an income cushion is simplicity. It works with pension bridges and temporary retirement income without any special calculations. It's easy to explain to a spouse or caretaker. It can be illustrated like this.

In contrast, a withdrawal cushion, while slightly more efficient, requires special calculations when a permanent or temporary pension starts or stops. These special calculations are simple for some people, but can be challenging for other people. Explanations were provided in this post of the forward test thread.
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Re: Variable Percentage Withdrawal (VPW)

Post by longinvest »

HOW TO OPERATE ON AN AFTER-TAX BASIS

The forward test thread illustrates a simple approach to generate monthly income, during retirement, combining a fixed $1,000/month work pension, future Social Security payments, and withdrawals from a One-Fund Portfolio entirely invested into the Vanguard LifeStrategy Moderate Growth Fund (VSMGX). The generated income is smoothed using a small cushion consisting of approximately 5 months of income parked into a savings account. All calculations, in that thread, are done before tax.

Here's an approach to translate this into (mostly) after-tax cash flows on a monthly basis.

THEORY

Each month:
  1. Use the VPW worksheet to calculate a (gross) portfolio withdrawal amount. Let's call it W.
  2. Calculate a gross monthly income (M), which is the sum of the gross withdrawal amount W and the gross amount of pension payments received during the current month (called P).
    • M = W + P
  3. Calculate a projected annual income (A) by multiplying the gross monthly income by 12.
    • A = M X 12
  4. Use tax software to estimate taxes on the calculated the gross annual income, assuming that the entire amount is taxable. Let's call T the estimated amount of taxes on A.
  5. Calculate a net monthly income (called N).
    • N = (A - T) / 12
  6. Calculate the effective (net) portfolio withdrawal amount (E) as the difference between the net monthly income and the (after-withholding) pension amounts deposited into the retiree's bank account (called D).
    • E = N - D
  7. Withdraw E from the portfolio and deposit it, along with the received pension payments (D) into the income cushion.
  8. Transfer one sixth (1/6) of the income cushion into a spending account.
How to handle taxes: Each year, withdraw any due tax amount from the portfolio to pay taxes. Note that any tax refund must be deposited back into the portfolio.

As portfolio withdrawals (E) are taken on an after-tax basis while assuming that all income is taxable, it's safe to withdraw the money from any account (Traditional, Roth, or taxable).

PRACTICAL EXAMPLE

I use the May 2023 forward test entry.

The worksheet suggests a (gross) $5,256 portfolio withdrawal. The (gross) work pension payment of May 2023 is $1,000. That's a total of ($5,256 + $1,000) = $6,256 for one month. The annual projection is (12 X $6,256) = $75,072.

To estimate taxes, I use the smartasset.com calculator assuming the retiree lives in California and I enter $75,072 as "Annual Retirement Account Income". This gives me a $12,341 estimate for taxes.

Image

Image

Image

I'll assume that a $850 amount, from the work pension, is deposited monthly into the retiree's bank account due to $150 being withheld for taxes.

The retiree's target net monthly income is (($75,072 - $12,341) / 12) = $5,228. The retiree already got $850 from the pension. The retiree withdraws the missing ($5,228 - $850) = $4,378 from the portfolio.

As the retiree is only 68, the $4,378 amount could possibly be withdrawn from the taxable account. (The retiree could also move money from a traditional account into a Roth account, taking advantage of gap years until the start of Social Security to do Roth conversions. Money movements between accounts aren't portfolio withdrawals.)

To make this simple, the monthly calculation could be added to the VPW Worksheet (look on the right):

Image

The user only has to provide the annual tax estimate for the provided Gross Annual Income and amounts deposited into the bank account for pension payments.

The income cushion now intuitively operates on an after-tax basis using the process illustrated in this post. Assuming that the income cushion initially contained $27,518.75, the $850 net pension payment and the $4,378 withdrawal are added to it, increasing it to ($27,518.75 + $850 + $4,378) = $32,746.75. The retiree transfers ($32,746.75 / 6) = $5,458 into the spending account.

As explained in the theory part, each year the retiree withdraws any due tax amount from the portfolio to pay taxes. As the monthly net estimates are conservative, it's safe to make these additional withdrawals to pay taxes. Note that any tax refund must be deposited back into the portfolio.

Questions, suggestions, and comments are welcome.
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Re: Variable Percentage Withdrawal (VPW)

Post by longinvest »

Eventually the retiree will have to take Required Minimum Distributions (RMD) from traditional (401k, IRA, etc.) accounts.

A traditional account withdrawal doesn't have to be a portfolio withdrawal. It can be a money transfer between accounts within the portfolio. The fact that the amount deposited into the target account might be smaller than the amount removed from the source account, due to tax withholding, isn't a problem when operating on an after-tax basis (as explained in the previous post).

For simplicity, some retirees might prefer to handle traditional account withdrawals as a single annual transfer between accounts, possibly in early January when the portfolio balance is still close to its December 31 value.

When operating on an after-tax basis, any taxes resulting from a traditional account withdrawal (in addition to the withholding) won't be due before the next year and will be handled with a tax withdrawal. In other words, the retiree doesn't need to make any special calculation or worry about it.

During the year, net monthly portfolio withdrawals can be taken from the taxable account. If it gets depleted, withdrawals can be taken from a Roth account. If taxable and Roth accounts get depleted, net withdrawals (after tax withholding) can be taken from traditional accounts.


In summary, the proposed approach consists of:
  1. Calculating monthly withdrawals on an after-tax basis, taking into account the effective amount deposited into the bank account for pensions.
  2. Handling tax-related cash flows separately, withdrawing money from the portfolio when taxes need to be paid, and depositing any tax refund back into the portfolio.
The conservative approach of copying a single number into tax software keeps things simple (especially for a less financially-inclined caretaker or surviving spouse).

I think that it's simple and good enough. What do you think?
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Re: Variable Percentage Withdrawal (VPW)

Post by longinvest »

The VPW worksheet doesn't make future return predictions. It simply assumes that asset returns will fluctuate.

The worksheet needs a discount rate for making a suggestion for the current month: how much to contribute to the portfolio (during accumulation) or how much to withdraw from the portfolio (during retirement). It uses a growth trend based on the long-term average real returns of world stocks and bonds which doesn't represent a prediction of future returns starting at the current point in time.

The idea of the VPW worksheet is to plan for a wide range of possible outcomes, and make a reasonable portfolio contribution or withdrawal today. The best time to contribute more to a portfolio is when assets prices get lower. The best time to withdraw more from a portfolio is when asset prices get higher. Similarly, it's best to buy less when high and to sell less when low. By using a constant unchanging growth trend, the VPW worksheet naturally leads to such a good investing behavior.

The fixed 3.76% growth trend for a 60/40 stocks/bonds portfolio doesn't predict future returns. Its main role is to distinguish between high returns and low returns. When the portfolio grows by 10% real during a year (more than 3.76%), withdrawals get increased (retirement) or contributions get reduced (accumulation). When the portfolio shrinks by -5% real during a year (less than 3.76%), withdrawals get reduced (retirement) or contributions get increased (accumulation).

Another way to look at it is to consider the wide range of future outcomes implied by the Required Flexibility calculation. The VPW worksheet projects that $10,000 invested into a 60/40 portfolio (3.76% growth trend) could grow to ($10,000 X (1 + 3.76%)^10) = $14,464 in 10 year (in constant dollars) if everything goes according to the unrealistic scenario of a fixed annual 3.76% real return. But, the -50% immediate stock loss Required Flexibility test provides a significantly lower projection of (((100% - (60% / 2)) X $10,000) X (1 + 3.76%)^10) = $10,125. This represents a tiny annual 0.12% real growth over a 10 year period.

That's a relatively wide range of 10-year outcomes (from 0.12% to 3.76%) for normal market outcomes (for a 60/40 stocks/bonds portfolio) which shouldn't affect the accumulating or retired investor's comfort, assuming that the worksheet was correctly used (making sure to adapt the budget to develop the required flexibility). Actual outcomes could get outside this range, requiring the investor to possibly start reducing comfort when outcomes drop below the required flexibility projection.
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Re: Variable Percentage Withdrawal (VPW)

Post by longinvest »

Time-value of money formulas (like the Payment formula) require a discount rate. That's like saying that a division requires a divisor.

Whether the discount rate represents a negotiated interest rate for a loan or something else is based on the particular context of use of the formula. That's like saying that the divisor of a division could represent a wide variety of things; it depends on the particular context of use of the division.

In the particular case of VPW, the chosen discount rate represents a general (not too bad) long-term trend for asset returns. The 3.76% growth trend, for a 60/40 stocks/bonds portfolio, doesn't aim to predict future returns. It's just a neutral rate that serves to determine a reasonable portfolio withdrawal amount to take in the current year within a multi-year plan with fluctuating withdrawal amounts. The VPW Worksheet is quite explicit about it. It says:
  • A growth trend is a timeless wild-ass guess that aims to represent an annual return that is lower than a high annual return and higher than a low annual return.
  • Its role is to distinguish between a high annual return and a low annual return.
  • It's not a prediction of future returns. It's fixed and must never be changed.
  • At the top of a bubble, it's likely higher than future returns. At the bottom of a crash, it's likely lower than future returns.
  • The selected growth trends are based on the long-term returns of world stocks and bonds from 1900 to 2018 according the Summary Edition of the Credit Suisse Global Investment Returns Yearbook 2019.
VPW is an iterative process of annual calculations. It would be a mistake to reason about VPW as if it only consisted of a single calculation. When considering the multi-year process, it becomes obvious that VPW isn't attempting to predict future returns with its chosen fixed discount rate. It's simply trying to adapt the withdrawal amount to realized portfolio returns, each year of retirement. After an up year (with returns higher than the growth trend), the withdrawal amount is increased. After a down year (with returns lower than the growth trend), the withdrawal amount is decreased.

According to Merriam-Webster, a prediction (noun) is something that is predicted, a forecast. And a forecast (noun) is a prophecy, estimate, or prediction of a future happening or condition.

A fixed timeless value doesn't represent what is commonly perceived as a prediction or a forecast.

When I think about a weather forecast, I think about The Weather Network's current prediction for New York City Saturday June 17: Light rain, High 70. In contrast, I don't see the average high temperature of approximately 79 (the mid point between 75 and 82) as a prediction. It just lets me know that Saturday will be on the cold side, for mid-June in New York City (as 70 is lower than 79). Note that 79 isn't a prediction of the average temperature for June 2023. After the fact, we'll be able to say if June 2023 was generally warmer or colder than usual over recorded history.

The growth trend is somewhat similar to the concept of average recorded temperature. It's definitely not a prediction of future returns.
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whyme
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Re: Variable Percentage Withdrawal (VPW)

Post by whyme »

longinvest wrote: Sun Jun 04, 2023 7:34 pm
In summary, the proposed approach consists of:
  1. Calculating monthly withdrawals on an after-tax basis, taking into account the effective amount deposited into the bank account for pensions.
  2. Handling tax-related cash flows separately, withdrawing money from the portfolio when taxes need to be paid, and depositing any tax refund back into the portfolio.
The conservative approach of copying a single number into tax software keeps things simple (especially for a less financially-inclined caretaker or surviving spouse).

I think that it's simple and good enough. What do you think?
I vote yes. This looks like an excellent addition to the worksheet, longinvest. Thank you again for your continued work on this project.

FWIW, I'm on the cusp of retirement and expect that I will adopt this plan (or a slightly modified version). I have moved into a voluntary reduced-income period, and am beginning to take modest portfolio withdrawals to make up the difference. My immediate move (which so far seems to offer a bit of peace of mind) was to segregate the anticipated tax payments (in my case, this also includes annual property taxes), in part to arrive at an understanding of my "take home" amount. All of this is to say that, anecdotally, bracketing taxes separately seems to offer a psychological benefit, even if the overall numbers are unchanged.
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Re: Variable Percentage Withdrawal (VPW)

Post by SevenBridgesRoad »

longinvest wrote: Sun Jun 04, 2023 7:34 pm

....I think that it's simple and good enough. What do you think?
I like it!

4 years retired and a VPW user. Thanks again for all the hard work, longinvest.
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Re: Variable Percentage Withdrawal (VPW)

Post by Ben Mathew »

longinvest wrote: Thu Jun 15, 2023 8:23 am The VPW worksheet doesn't make future return predictions. It simply assumes that asset returns will fluctuate.

The worksheet needs a discount rate for making a suggestion for the current month: how much to contribute to the portfolio (during accumulation) or how much to withdraw from the portfolio (during retirement). It uses a growth trend based on the long-term average real returns of world stocks and bonds which doesn't represent a prediction of future returns starting at the current point in time.
As I've stated before, this is a distinction without a difference. Expected return and discount rates are two sides of the same coin. To claim that the "growth trend" is an assumption about the discount rate and not about the expected return is nonsensical.

You are amortizing the portfolio with that rate and with no precautionary savings (g=0 in ABW). What that means is simply this:

- If future returns happen to be below the rate, withdrawals will decline
- If future returns happen to be above the rate, withdrawals will increase
- If future returns happen to be equal to the rate, withdrawals will stay constant

There is no additional meaning to the distinctions you're constructing. What you call the rate is irrelevant.

Some prior discussions we've had about this:
Ben Mathew wrote: Fri Feb 12, 2021 4:57 pm
longinvest wrote: Fri Feb 12, 2021 4:29 pm
Ben Mathew wrote: Fri Feb 12, 2021 2:48 pm It's different from VPW in that:

1. Expected future returns are based on forward looking estimates (current yields) rather than historical raw returns
Dear Ben Matthew,

This is a false statement about Variable Percentage Withdrawal (VPW). VPW doesn't use "expected future returns". VPW uses an internal growth trend which is timeless; it doesn't predict future returns.
Dear Longinvest,

You can call it what you want, but what you describe as the "timeless internal growth trend" is doing exactly the same job as the expected return in TPAW and more generally, in amortization based withdrawal (ABW). If you plug in the "timeless internal growth trend" for expected return in TPAW or ABW, you get the VPW withdrawal schedule. It's the same thing. VPW is absolutely making an assumption about future expected returns, whether you want to acknowledge it or not.

Best regards,

Ben
Ben Mathew wrote: Fri Feb 12, 2021 5:54 pm
longinvest wrote: Fri Feb 12, 2021 5:32 pm It would be correct to say that VPW uses a "discount rate", which is the proper term in finance within a time-value of money calculation. It's incorrect to claim that VPW uses "expected future returns".
In finance, the expected return of an asset will equal the discount rate used to price it.

To see why, consider the example of an asset that has an expected payout of $100 a year from now. Suppose the right discount rate to use for this asset is 5%. Then its price today is

$100/(1+.05) = $95.24

But then the expected return of this asset will also be 5% because

$95.24*(1+.05) = $100

Expected return and discount rates are two sides of the same coin.
Instead of trying to claim that you aren't making an expected return assumption, consider building in precautionary savings into VPW by amortizing the portfolio with a rate lower than the expected return (i.e. set g>0 in ABW). This will ensure that even If future returns happen to be below the expected return you're assuming, withdrawals won't decline that much. Amortizing the portfolio without that safety margin is problematic because it makes a spending decline as likely as a spending increase. Caution/risk aversion dictates that a spending decline be made less likely than a spending increase by amortizing more conservatively than the expected return (because the downside is more painful than the upside is pleasurable). Put differently, withdraw a bit less than today's full share to protect against potential bad outcomes tomorrow. This post shows that you need to care about the future significantly less than the present to get g=0 with Merton's formulas.

You are using a generous expected return (r) and zero spending tilt (g) to get a high withdrawal rate. It's important to recognize what those assumptions mean and understand how the strategy will play out under different future scenarios. How it plays out will depend on the numbers used for the amortization. It won't depend on what those numbers are called.
Total Portfolio Allocation and Withdrawal (TPAW)
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Re: Variable Percentage Withdrawal (VPW)

Post by longinvest »

Forum member Ben Mathew cited an excerpt of one of my recent posts:
longinvest wrote: Thu Jun 15, 2023 8:23 am The VPW worksheet doesn't make future return predictions. It simply assumes that asset returns will fluctuate.

The worksheet needs a discount rate for making a suggestion for the current month: how much to contribute to the portfolio (during accumulation) or how much to withdraw from the portfolio (during retirement). It uses a growth trend based on the long-term average real returns of world stocks and bonds which doesn't represent a prediction of future returns starting at the current point in time.
I'll include the subsequent post which clarified what I meant:
longinvest wrote: Thu Jun 15, 2023 7:24 pm Time-value of money formulas (like the Payment formula) require a discount rate. That's like saying that a division requires a divisor.

Whether the discount rate represents a negotiated interest rate for a loan or something else is based on the particular context of use of the formula. That's like saying that the divisor of a division could represent a wide variety of things; it depends on the particular context of use of the division.

In the particular case of VPW, the chosen discount rate represents a general (not too bad) long-term trend for asset returns. The 3.76% growth trend, for a 60/40 stocks/bonds portfolio, doesn't aim to predict future returns. It's just a neutral rate that serves to determine a reasonable portfolio withdrawal amount to take in the current year within a multi-year plan with fluctuating withdrawal amounts. The VPW Worksheet is quite explicit about it. It says:
  • A growth trend is a timeless wild-ass guess that aims to represent an annual return that is lower than a high annual return and higher than a low annual return.
  • Its role is to distinguish between a high annual return and a low annual return.
  • It's not a prediction of future returns. It's fixed and must never be changed.
  • At the top of a bubble, it's likely higher than future returns. At the bottom of a crash, it's likely lower than future returns.
  • The selected growth trends are based on the long-term returns of world stocks and bonds from 1900 to 2018 according the Summary Edition of the Credit Suisse Global Investment Returns Yearbook 2019.
VPW is an iterative process of annual calculations. It would be a mistake to reason about VPW as if it only consisted of a single calculation. When considering the multi-year process, it becomes obvious that VPW isn't attempting to predict future returns with its chosen fixed discount rate. It's simply trying to adapt the withdrawal amount to realized portfolio returns, each year of retirement. After an up year (with returns higher than the growth trend), the withdrawal amount is increased. After a down year (with returns lower than the growth trend), the withdrawal amount is decreased.

According to Merriam-Webster, a prediction (noun) is something that is predicted, a forecast. And a forecast (noun) is a prophecy, estimate, or prediction of a future happening or condition.

A fixed timeless value doesn't represent what is commonly perceived as a prediction or a forecast.

When I think about a weather forecast, I think about The Weather Network's current prediction for New York City Saturday June 17: Light rain, High 70. In contrast, I don't see the average high temperature of approximately 79 (the mid point between 75 and 82) as a prediction. It just lets me know that Saturday will be on the cold side, for mid-June in New York City (as 70 is lower than 79). Note that 79 isn't a prediction of the average temperature for June 2023. After the fact, we'll be able to say if June 2023 was generally warmer or colder than usual over recorded history.

The growth trend is somewhat similar to the concept of average recorded temperature. It's definitely not a prediction of future returns.
Forum member Ben Mathew started his text with:
Ben Mathew wrote: Sun Jun 18, 2023 4:04 pm As I've stated before, this is a distinction without a difference. Expected return and discount rates are two sides of the same coin.[...]
I'll get back to the difference. But, first, let's highlight forum member Ben Mathew's subtle change of words.

At no point, in my post, have I used the term "expected return". This is intentional, because "expected return" is a term which means different things to different people. For ordinary people, an "expected return" means "a return which is expected to happen". For other people, like economists, it can mean a very different thing. For example, forum member Lack_ey defined it as follows, a few years ago:
lack_ey wrote: Tue Jul 28, 2015 11:41 am I'll let others try to address the other issues if they wish, but just so we're on the same page...
longinvest wrote:By the way, back in the day, many, many years ago, when I took a probability course, an "Expected Value" was just the result of a calculation over a set of data. The meaning of "expected" was, if applied to historical data, that it would have been the thing to expect before the data unrolled. So, an expected value based on past data predicts the past!  If you are to provide a mathematical future "expected" value, you'll have to compute it on future data, of course. ;)
Calculating the mean of a data set is not the expected value. Depending on how you do sampling, what the underlying distribution is, etc., it may or may not be a decent estimate of the expected value.

We're dealing with stochastic processes with statistical characteristics that probably change over time. As you say, we are looking to the future, not the past. We are talking about what we think future distributions will more likely be. Expressing a view on what we think (future) expected value will be does not require crunching future data, as stated above. It is a guess, a prediction.
So, for member Lack_ey, an "expected return" is a guess.

VPW doesn't use the concept of "expected returns" and doesn't modulate withdrawals according to such a thing. A change in market state usually leads to a change in "expected returns". In particular, "expected returns" are typically higher at the bottom of a crash and lower at the top of a bubble. This is the only way that "expected returns" can match the explanation of Investopedia that "an expected return is calculated by multiplying potential outcomes by the odds of them occurring and then totaling these results". It would make no sense for the odds of higher returns occurring not to be higher when markets are down, and the odds of lower returns occurring not to be higher when markets are up.

If you read again the definition of VPW's growth trend provided in my copied post, above, you'll see that it explicitly states that:
  • It's fixed and must never be changed.
  • At the top of a bubble, it's likely higher than future returns. At the bottom of a crash, it's likely lower than future returns.
It's obvious that VPW's growth trend doesn't match Investopedia's concept of an "expected return". It isn't higher at the bottom of a crash or lower at the top of a bubble. More specifically, it isn't an odds-weighted average of future possible outcomes.

In this VPW thread, I try to use words with their usual meaning for common people. As I explained in my copied post, above, most people consider "Saturday June 17: Light rain, High 70" as a weather forecast, but they don't consider "average historical mid-June temperature of 79" as a forecast. Similarly, here's what common people typically consider as market predictions: The 2023 Boglehead Contest. VPW's growth trend doesn't match what people typically consider as a market prediction.

Why is this important? Because, using a fixed timeless (not dependent on current market state) growth trend is fundamental to VPW. It provides VPW with many desirable properties such as immunity to sequence of returns risk (see this post) and avoiding the "sell less high, sell more low" behavior of modulating withdrawals using (perfect) 10-year return predictions (see this post).
Last edited by longinvest on Mon Jun 19, 2023 8:15 am, edited 4 times in total.
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Ben Mathew
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Re: Variable Percentage Withdrawal (VPW)

Post by Ben Mathew »

longinvest wrote: Sun Jun 18, 2023 5:58 pm If you read again the definition of VPW's growth trend provided in my copied post, above, you'll see that it explicitly states that:
  • It's fixed and must never be changed.
  • At the top of a bubble, it's likely higher than future returns. At the bottom of a crash, it's likely lower than future returns.
It's obvious that VPW's growth trend doesn't match Investopedia's concept of an "expected return". It isn't higher at the bottom of a crash or lower at the top of a bubble.
What this says is that you're using a poor expected return assumption, not that you have eliminated the need for an expected return assumption when amortizing a portfolio.

Amortization requires an expected return assumption. If you want level payments from an amortization, the rate you enter has to be the growth rate of the amount being amortized:
  • If you amortize a loan with interest rate r, you'd enter the interest rate r to get constant payments.
  • If you amortize a portfolio with fixed growth rate r, you'd enter the growth rate r to get constant withdrawals.
  • If you amortize a portfolio with expected growth rate r, you'd enter the expected growth rate r to get constant expected withdrawals.
And
  • If you enter a rate x% more than the expected growth rate, expected withdrawals will decline x% per year over time.
  • If you enter a rate x% less than the expected growth rate, expected withdrawals will rise x% per year over time.
You can't amortize the portfolio without taking a position, implicit or explicit, about the growth rate of the portfolio. Another way of asking this question: If the markets perform as expected, are VPW withdrawals expected to decline over time, rise over time, or stay constant over time? If the answer is "stay constant over time" then you are assuming that the expected return of the portfolio equals the growth trend/WAG.
Last edited by Ben Mathew on Sun Jun 18, 2023 7:08 pm, edited 1 time in total.
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Re: Variable Percentage Withdrawal (VPW)

Post by longinvest »

Ben Mathew wrote: Sun Jun 18, 2023 7:06 pm If the markets perform as expected, are VPW withdrawals expected to decline over time, rise over time, or stay constant over time? If the answer is "stay constant over time" then you are assuming that the expected return of the portfolio equals the growth trend/WAG.
The answer to forum member Ben Mathew's question is "stay variable over time". So, even through this narrow lens, VPW doesn't use an "expected return".

By design, VPW assumes that market returns will fluctuate. It's explicit in the name of the method: "Variable Percentage Withdrawal". Withdrawals are variable because market returns are assumed to fluctuate.

I'll repeat, yet again, what I previously wrote:
longinvest wrote: Thu Jun 15, 2023 7:24 pm VPW is an iterative process of annual calculations. It would be a mistake to reason about VPW as if it only consisted of a single calculation. When considering the multi-year process, it becomes obvious that VPW isn't attempting to predict future returns with its chosen fixed discount rate. It's simply trying to adapt the withdrawal amount to realized portfolio returns, each year of retirement. After an up year (with returns higher than the growth trend), the withdrawal amount is increased. After a down year (with returns lower than the growth trend), the withdrawal amount is decreased.
VPW's growth trend has a clear definition which doesn't match the generally-accepted definition of an "expected return" as found on Investopedia.

Like the divisor in a division, the discount rate of a financial formula can be many different things. VPW uses a constant timeless growth trend as discount rate.
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Re: Variable Percentage Withdrawal (VPW)

Post by longinvest »

In a previous post, I explained that VPW is, by design, immune to sequence of returns risk (SORR), but VPW withdrawals are exposed to market risk (MR).

Here's a detailed illustration.

Chapter 3 of the Pensionize your nest egg book, by Moshe Milevsky and Alexandra Macqueen, uses a triangle with three returns, 7%, -13%, and 27% which have a 7% arithmetic average. The book shows how starting from one or the other of these three returns changes the outcome from retirement success to the ruin of the retiree when making constant (inflation-adjusted) withdrawals.

I'll use this idea to illustrate how the 7th withdrawal remains unaffected by the sequence of annual returns leading to it, when using VPW, despite the intervening annual withdrawals, as long as the cumulative time-weighted return from retirement until this 7th withdrawal remains unchanged.

Let's pick a 65 years old retiree with a $1,000,000 balanced (60/40 stocks/bonds) portfolio, and $1,403/month Social Security. Stock returns are (7%, -13%, 27%) repeated twice, but staring at a different point in each of the three cases. Bond returns are 0.8% (without any fluctuation, for simplicity). All calculations are done in constant 2023 dollars (so that there's no need to change Social Security amounts).

The VPW table has the following withdrawal percentages for a 60/40 stocks/bonds allocation from ages 65 to 71: 5.0%, 5.1%, 5.1%, 5.2%, 5.3%, 5.4%, and 5.5%.

Note how the 7th withdrawal, at age 71, is $50,739 in all three cases, resulting into a total retirement income of $65,575. This is because VPW withdrawals are unaffected by the sequence of returns leading to them.

Actually, if we look carefully, we see that at ages 65, 68 and 71, the withdrawals are identical for the three cases. This is because over each 3-years period, the cumulative time-weighted portfolio return is 12.677% in all three cases. This is the immunity against sequence of returns risk at work.

But, when we look at other years, withdrawals differ. In the unlucky 3rd case, the retiree withdraws less ($44,826) in the second year after stocks lose -13%, giving a chance for the portfolio to recover. This is market risk at work. Lower returns lead to lower withdrawals. Higher returns lead to higher withdrawals. That's the "variable" in variable percentage withdrawal.  

Case 1: Starting with 7%

Code: Select all

 Age     Portfolio     VPW    Withdrawal    Remaining    Stocks   Bonds   Social Security Total income  
  65      $1,000,000   5.0%       $50,000      $950,000     7.0%    0.8%   $16,836         $66,836
  66        $992,940   5.1%       $50,640      $942,300    27.0%    0.8%   $16,836         $67,476
  67      $1,097,968   5.1%       $55,996    $1,041,972   -13.0%    0.8%   $16,836         $72,832
  68        $964,032   5.2%       $50,130      $913,903     7.0%    0.8%   $16,836         $66,966
  69        $955,211   5.3%       $50,626      $904,585    27.0%    0.8%   $16,836         $67,462
  70      $1,054,022   5.4%       $56,917      $997,105   -13.0%    0.8%   $16,836         $73,753
  71        $922,521   5.5%       $50,739      $871,783                    $16,836         $67,575
Case 2: Starting with 27%

Code: Select all

 Age     Portfolio     VPW    Withdrawal    Remaining    Stocks   Bonds   Social Security Total income  
  65      $1,000,000   5.0%       $50,000      $950,000    27.0%    0.8%   $16,836         $66,836
  66      $1,106,940   5.1%       $56,454    $1,050,486   -13.0%    0.8%   $16,836         $73,290
  67        $971,910   5.1%       $49,567      $922,342     7.0%    0.8%   $16,836         $66,403
  68        $964,032   5.2%       $50,130      $913,903    27.0%    0.8%   $16,836         $66,966
  69      $1,064,879   5.3%       $56,439    $1,008,441   -13.0%    0.8%   $16,836         $73,275
  70        $933,009   5.4%       $50,382      $882,627     7.0%    0.8%   $16,836         $67,218
  71        $922,521   5.5%       $50,739      $871,783                    $16,836         $67,575
Case 3: Starting with -13%

Code: Select all

 Age     Portfolio     VPW    Withdrawal    Remaining    Stocks   Bonds   Social Security Total income  
  65      $1,000,000   5.0%       $50,000      $950,000   -13.0%    0.8%   $16,836         $66,836
  66        $878,940   5.1%       $44,826      $834,114     7.0%    0.8%   $16,836         $61,662
  67        $871,816   5.1%       $44,463      $827,353    27.0%    0.8%   $16,836         $61,299
  68        $964,032   5.2%       $50,130      $913,903   -13.0%    0.8%   $16,836         $66,966
  69        $845,543   5.3%       $44,814      $800,729     7.0%    0.8%   $16,836         $61,650
  70        $836,922   5.4%       $45,194      $791,728    27.0%    0.8%   $16,836         $62,030
  71        $922,521   5.5%       $50,739      $871,783                    $16,836         $67,575

EXPLANATION

Mutiplication is commutative (e.g. 5 X 3 = 3 X 5). Taking a 5.0% withdrawal is equal to multiplying the portfolio balance by (1 - 5%) = 0.95. Similarly, taking a 5.1% withdrawal is equal to multiplying the portfolio balance by 0.949. And so on. After the withdrawal is taken, the portfolio grows (or shrink) by the annual return. For a 7% stock return and a 0.8% bond return, this is equal to multiplying by (1 + ((60 % X 7%) + (40% X 0.8%))) = 1.0452. The other two factors are 1.1652 and 0.9252.

So, in case 1, the portfolio balance after 6 years, just before taking the 7th withdrawal, is equal to:
  • $1,000,000 X (.95 X 1.0452) X (.949 X 1.1652) X (.949 X 0.9252) X (.948 X 1.0452) X (.947 X 1.1652) X (.946 X 0.9252)
In case 2, the portfolio balance after 6 years, just before taking the 7th withdrawal, is equal to:
  • $1,000,000 X (.95 X 1.1652) X (.949 X 0.9252) X (.949 X 1.0452) X (.948 X 1.1652) X (.947 X 0.9252) X (.946 X 1.0452)
Case 3 can be expressed similarly.

As multiplication is commutative, the terms can be reordered without changing the result. In all three cases they can be arranged as follows, resulting into an identical portfolio balance after 6 years, just before taking the 7th withdrawal:
  • $1,000,000 X (.95 X .949 X .949 X .948 X .947 X .946) X (1.0452 X 1.0452 X 1.1652 X 1.1652 X 0.9252 X 0.9252)
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Re: Variable Percentage Withdrawal (VPW)

Post by Ben Mathew »

longinvest wrote: Sun Jun 18, 2023 7:51 pm
Ben Mathew wrote: Sun Jun 18, 2023 7:06 pm If the markets perform as expected, are VPW withdrawals expected to decline over time, rise over time, or stay constant over time? If the answer is "stay constant over time" then you are assuming that the expected return of the portfolio equals the growth trend/WAG.
The answer to forum member Ben Mathew's question is "stay variable over time". So, even through this narrow lens, VPW doesn't use an "expected return".
Of course, amortizing the portfolio will result in variable withdrawals over time. So the answer "stay variable over time" doesn't convey any new information.

Let me ask it differently:

In your opinion, which of the following is the most likely outcome for VPW users?

(A) They are likely to end up with lower withdrawals in late retirement than they started with
(B) They are likely to end up with higher withdrawals in late retirement than they started with
(C) They are likely to end up with similar levels of withdrawals in late retirement as they started with
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Re: Variable Percentage Withdrawal (VPW)

Post by longinvest »

Using 10-year return predictions (even when perfect) as discount rate, to modulate withdrawal amounts from a portfolio, exposes the portfolio and withdrawals to sequence of returns risk (SORR).

This is easy to prove with an example. I'll use a relatively similar setup to my previous post, involving three stock returns and a fixed bond return where every 3-years the cumulative time-weighted portfolio return is 12.677%. We'll look at withdrawal amounts in years 1, 4 and 7 corresponding to ages 65, 68 and 71.

This time, we need to have enough returns to look into the future to perfectly-predict the annualized future 10-year return. I'll use two specific sequences of 18 annual returns for stocks. Each of the two 18-year sequences is composed of three identical 6-year sub-sequences:
  • Case 1: 7, 27, -13, 27, 7, -13, 7, 27, -13, 27, 7, -13, 7, 27, -13, 27, 7, -13
  • Case 2: -13, 7, 27, 7, -13, 27, -13, 7, 27, 7, -13, 27, -13, 7, 27, 7, -13, 27
As baseline, let's look at the first 7 withdrawals when using VPW (which is immune to sequence of returns risk):

VARIABLE PERCENTAGE WITHDRAWAL

Case 1

Code: Select all

 Age     Portfolio     VPW    Withdrawal    Remaining    Stocks   Bonds   Social Security Total income  
  65      $1,000,000   5.0%       $50,000      $950,000     7.0%    0.8%   $16,836         $66,836
  66        $992,940   5.1%       $50,640      $942,300    27.0%    0.8%   $16,836         $67,476
  67      $1,097,968   5.1%       $55,996    $1,041,972   -13.0%    0.8%   $16,836         $72,832
  68        $964,032   5.2%       $50,130      $913,903    27.0%    0.8%   $16,836         $66,966
  69      $1,064,879   5.3%       $56,439    $1,008,441     7.0%    0.8%   $16,836         $73,275
  70      $1,054,022   5.4%       $56,917      $997,105   -13.0%    0.8%   $16,836         $73,753
  71        $922,521   5.5%       $50,739      $871,783                    $16,836         $67,575
Withdrawal amount at ages 65, 68 and 71: $50,000, $50,130 and $50,739.

Case 2

Code: Select all

 Age     Portfolio     VPW    Withdrawal    Remaining    Stocks   Bonds   Social Security Total income  
  65      $1,000,000   5.0%       $50,000      $950,000   -13.0%    0.8%   $16,836         $66,836
  66        $878,940   5.1%       $44,826      $834,114     7.0%    0.8%   $16,836         $61,662
  67        $871,816   5.1%       $44,463      $827,353    27.0%    0.8%   $16,836         $61,299
  68        $964,032   5.2%       $50,130      $913,903     7.0%    0.8%   $16,836         $66,966
  69        $955,211   5.3%       $50,626      $904,585   -13.0%    0.8%   $16,836         $67,462
  70        $836,922   5.4%       $45,194      $791,728    27.0%    0.8%   $16,836         $62,030
  71        $922,521   5.5%       $50,739      $871,783                    $16,836         $67,575
Withdrawal amount at ages 65, 68 and 71: $50,000, $50,130 and $50,739.

As expected, when using VPW which is immune to SORR, portfolio balances and withdrawal amounts are identical for both Case 1 and Case 2 at ages 65, 68 and 71 because the cumulative time-weighted portfolio return, every three years, is 12.677% in both cases.

PREDICTION-DRIVEN WITHDRAWALS

Now, let's use the "Payment" financial function (PMT in Microsoft Excel) with a perfect annualized 10-year forward return prediction as changing discount rate, every year, to calculate a prediction-driven withdrawal rate:

Case 1

Code: Select all

                        Perfect      Withdrawal                                                                                              
 Age     Portfolio     Prediction       Rate       Withdrawal    Remaining    Stocks   Bonds   Social Security Total income               
  65      $1,000,000         5.24%          6.0%       $59,816      $940,184     7.0%    0.8%   $16,836         $76,652             
  66        $982,680         5.24%          6.0%       $59,405      $923,275    27.0%    0.8%   $16,836         $76,241             
  67      $1,075,800         2.84%          4.6%       $49,277    $1,026,523   -13.0%    0.8%   $16,836         $66,113             
  68        $949,739         4.10%          5.4%       $51,724      $898,015    27.0%    0.8%   $16,836         $68,560             
  69      $1,046,367         4.10%          5.5%       $57,893      $988,474     7.0%    0.8%   $16,836         $74,729             
  70      $1,033,153         2.84%          4.9%       $50,218      $982,935   -13.0%    0.8%   $16,836         $67,054             
  71        $909,412         5.24%          6.4%       $58,621      $850,791     7.0%    0.8%   $16,836         $75,457             
                                                                                27.0%    0.8%                                               
                                                                               -13.0%    0.8%                                               
                                                                                27.0%    0.8%                                               
                                                                                 7.0%    0.8%                                               
                                                                               -13.0%    0.8%                                               
                                                                                 7.0%    0.8%                                               
                                                                                27.0%    0.8%                                               
                                                                               -13.0%    0.8%                                               
                                                                                27.0%    0.8%                                               
                                                                                 7.0%    0.8%                                               
                                                                               -13.0%    0.8%                                               
Withdrawal amount at ages 65, 68 and 71: $59,816, $51,724 and $58,621.
At age 67, the withdrawal amount significantly decreases despite the portfolio having just gained 27%. At age 71, the withdrawal amount significantly increases despite the portfolio having just lost -13%. "Sell less high, sell more low!"

Case 2

Code: Select all

                        Perfect      Withdrawal                                                                                            
 Age     Portfolio     Prediction       Rate       Withdrawal   Remaining   Stocks   Bonds   Social Security Total income               
  65      $1,000,000         4.10%          5.2%       $52,199    $947,801   -13.0%    0.8%   $16,836         $69,035             
  66        $876,905         4.10%          5.3%       $46,390    $830,515     7.0%    0.8%   $16,836         $63,226             
  67        $868,054         5.24%          6.1%       $53,070    $814,984    27.0%    0.8%   $16,836         $69,906             
  68        $949,619         2.84%          4.7%       $44,325    $905,294     7.0%    0.8%   $16,836         $61,161             
  69        $946,214         2.84%          4.8%       $45,048    $901,166   -13.0%    0.8%   $16,836         $61,884             
  70        $833,758         5.24%          6.4%       $52,968    $780,790    27.0%    0.8%   $16,836         $69,804             
  71        $909,777         4.10%          5.7%       $52,096    $857,681   -13.0%    0.8%   $16,836         $68,932             
                                                                               7.0%    0.8%                                               
                                                                              27.0%    0.8%                                               
                                                                               7.0%    0.8%                                               
                                                                             -13.0%    0.8%                                               
                                                                              27.0%    0.8%                                               
                                                                             -13.0%    0.8%                                               
                                                                               7.0%    0.8%                                               
                                                                              27.0%    0.8%                                               
                                                                               7.0%    0.8%                                               
                                                                             -13.0%    0.8%                                               
                                                                              27.0%    0.8%                                               
Withdrawal amount at ages 65, 68 and 71: $52,199, $44,325 and $52,096.
At age 68, the withdrawal amount significantly decreases despite the portfolio having just gained 27%. At age 70, the withdrawal amount significantly increases despite the portfolio having just lost -13%. "Sell less high, sell more low!"


There is no consistency between Case 1 and Case 2. Except for the initial $1,000,000 portfolio balance, other portfolio balances and withdrawal amounts are all different at ages 65, 68 and 71, despite the portfolio having had the exact same 12.677% cumulative time-weighted portfolio return every three years.

This proves that prediction-driven withdrawals* are exposed to sequence of returns risk (SORR).

* Where the discount rate used to calculate the withdrawal rate is changed, every year, to match a perfect forward 10-year return prediction.
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Re: Variable Percentage Withdrawal (VPW)

Post by longinvest »

SevenBridgesRoad wrote: Sun Jun 18, 2023 3:10 pm
longinvest wrote: Sun Jun 04, 2023 7:34 pm ....I think that it's simple and good enough. What do you think?
I like it!

4 years retired and a VPW user. Thanks again for all the hard work, longinvest.
SevenBridgesRoad, thanks for the feedback and the nice comment.
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Re: Variable Percentage Withdrawal (VPW)

Post by longinvest »

whyme wrote: Sun Jun 18, 2023 2:18 pm
longinvest wrote: Sun Jun 04, 2023 7:34 pm In summary, the proposed approach consists of:
  1. Calculating monthly withdrawals on an after-tax basis, taking into account the effective amount deposited into the bank account for pensions.
  2. Handling tax-related cash flows separately, withdrawing money from the portfolio when taxes need to be paid, and depositing any tax refund back into the portfolio.
The conservative approach of copying a single number into tax software keeps things simple (especially for a less financially-inclined caretaker or surviving spouse).

I think that it's simple and good enough. What do you think?
I vote yes. This looks like an excellent addition to the worksheet, longinvest. Thank you again for your continued work on this project.
Whyme, thanks for the feedback and the nice comment.

I illustrated how the worksheet could easily be modified to add the simple calculation, but I'm reluctant to implement this modification into the official VPW worksheet for two reasons:
  1. It adds complexity to the worksheet. This could be intimidating to new users.
  2. It requires a multi-step monthly calculation process consisting of (1) estimating gross annual income using the worksheet, (2) entering the gross income into tax software to get a tax estimate, and finally (3) entering the tax estimate into the worksheet to estimate a net monthly portfolio withdrawal.
It's probably best to let users decide whether they prefer operating on a gross (pre-tax) basis or on a net (after-tax) basis and, if the later, figure out how to best implement it. I've illustrated one possible implementation which consists of adding the simple calculation into the worksheet itself. Another implementation (which I prefer, but slightly more complex) would be to use a separate spreadsheet with one line per month (like the returns spreadsheet), and let the user manually copy the projected annual income from the VPW worksheet and add the tax software estimate. The advantage of this second approach is that there wouldn't be an old tax estimate left into the tax cell when making a calculation for a new month, reducing the chances that a user might forget to update the tax amount.
whyme wrote: Sun Jun 18, 2023 2:18 pm FWIW, I'm on the cusp of retirement and expect that I will adopt this plan (or a slightly modified version). I have moved into a voluntary reduced-income period, and am beginning to take modest portfolio withdrawals to make up the difference. My immediate move (which so far seems to offer a bit of peace of mind) was to segregate the anticipated tax payments (in my case, this also includes annual property taxes), in part to arrive at an understanding of my "take home" amount. All of this is to say that, anecdotally, bracketing taxes separately seems to offer a psychological benefit, even if the overall numbers are unchanged.
Nice.
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Cannoli
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Re: Variable Percentage Withdrawal (VPW)

Post by Cannoli »

I never saw the point in fine tuning to a large degree because eventually RMD raid the game and change the rules.
Perhaps a withdrawal rate simply based on that might be better.
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TimeRunner
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Re: Variable Percentage Withdrawal (VPW)

Post by TimeRunner »

Hi Longinvest, I also prefer a separate sheet for the new functionality. I've already incorporated the 'simple' VPW sheet into a Google sheets file where it pulls the portfolio values for my wife and I from other sheets and calculates our current individual monthly withdrawal suggestions. The additional functionality adds unneeded complexity in our use case, which isn't to say that it's not worthwhile in other use cases. Thanks again for creating and maintaining this. :beer
Edit: Corrected Longinvest's name from Longvest. (Sorry!)
Last edited by TimeRunner on Sat Jul 15, 2023 8:50 pm, edited 1 time in total.
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longinvest
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Re: Variable Percentage Withdrawal (VPW)

Post by longinvest »

TimeRunner wrote: Sat Jun 24, 2023 2:29 pm Hi Long[in]vest, I also prefer a separate sheet for the new functionality. I've already incorporated the 'simple' VPW sheet into a Google sheets file where it pulls the portfolio values for my wife and I from other sheets and calculates our current individual monthly withdrawal suggestions. The additional functionality adds unneeded complexity in our use case, which isn't to say that it's not worthwhile in other use cases. Thanks again for creating and maintaining this. :beer
TimeRunner, thanks for the feedback and nice comment.
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tj
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Re: Variable Percentage Withdrawal (VPW)

Post by tj »

TimeRunner wrote: Sat Jun 24, 2023 2:29 pm Hi Longvest, I also prefer a separate sheet for the new functionality. I've already incorporated the 'simple' VPW sheet into a Google sheets file where it pulls the portfolio values for my wife and I from other sheets and calculates our current individual monthly withdrawal suggestions. The additional functionality adds unneeded complexity in our use case, which isn't to say that it's not worthwhile in other use cases. Thanks again for creating and maintaining this. :beer
This is nifty! How'd you set that up? Is your portfolio holdings automated somehow or do you have to go in and manually input?
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Re: Variable Percentage Withdrawal (VPW)

Post by TimeRunner »

tj wrote: Sun Jul 02, 2023 9:53 pmThis is nifty! How'd you set that up? Is your portfolio holdings automated somehow or do you have to go in and manually input?
Manually input. Another incentive to maintain simple portfolios and streamline financial institutions and accounts. Other sheets in the workbook project monthly income, cash flow, and rough estimated taxes for the current year, as well as track mortgage progress. I also use Quicken mostly to track banking activity but prefer using Google Sheets for portfolio tracking, and I use the simple tracking feature in Quicken for investment accounts (tracks positions only) because the brokerage website already has all that data and reports, and there's CSV file export available there if needed. Again, simple portfolios make data management simple. 8-)
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ososnilknarf
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Re: Variable Percentage Withdrawal (VPW)

Post by ososnilknarf »

longinvest, I am a regular follower of this thread and the forward test thread, and have found it to be one of the most valuable contributions on these boards. Thank you for all of your work on this.

My question is about something I've seen you say several times, which is that we should never change the baseline growth trend assumption used for the spreadsheet. My question is if this applies to changing the asset allocation of your portfolio, or just the underlying % used for the growth trend assumptions for stocks/bonds?

The reason I ask is that my retirement plan is to wait until 70 to collect SS, but I may retire somewhere between 55 - 59. Before 70, I'll want to have a more conservative AA (like 40/60, or 50/50), to ensure that I have a stable base that will cover my essential living expenses, and allow the discretionary spending to fluctuate more.
But after 70, SS will cover the vast majority of my expenses, so I could switch to a very aggressive AA, like 80/20 or something like that.

Thanks again for sharing all of your effort and work with the community.
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longinvest
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Re: Variable Percentage Withdrawal (VPW)

Post by longinvest »

ososnilknarf wrote: Thu Jul 06, 2023 11:18 am longinvest, I am a regular follower of this thread and the forward test thread, and have found it to be one of the most valuable contributions on these boards. Thank you for all of your work on this.

My question is about something I've seen you say several times, which is that we should never change the baseline growth trend assumption used for the spreadsheet. My question is if this applies to changing the asset allocation of your portfolio, or just the underlying % used for the growth trend assumptions for stocks/bonds?

The reason I ask is that my retirement plan is to wait until 70 to collect SS, but I may retire somewhere between 55 - 59. Before 70, I'll want to have a more conservative AA (like 40/60, or 50/50), to ensure that I have a stable base that will cover my essential living expenses, and allow the discretionary spending to fluctuate more.
But after 70, SS will cover the vast majority of my expenses, so I could switch to a very aggressive AA, like 80/20 or something like that.

Thanks again for sharing all of your effort and work with the community.
Ososnilknarf, thanks for the nice words.

I'll provide a short and a longer answer to your question: Should the retiree keep the asset allocation constant during retirement when using VPW?

The short (and probably best) answer is: I would keep the asset allocation constant during retirement. I would pay attention to the required flexibility to make sure there's ample comfort after loss (see this post for details), when choosing the asset allocation, and then stick with it for the rest of retirement.

Note that the VPW worksheet is meant to be used with the retirement portfolio. Additional investments, not needed for retirement, can be managed as a separate portfolio with its own asset allocation and, consequently, be kept entirely out of worksheet calculations.*

* See this post for ideas about what to do with excess money. One possibility is to use a separate portfolio, but possibly give it while alive to the receiving charity organization.


Here's the longer answer.

Theoretically, it would be acceptable for the portfolio to use a predetermined asset allocation glide (with an increasing bond or stock allocation), as the VPW percentages for the rest of retirement could still be predetermined before retirement while doing so, preserving important resilience features of VPW. But, I'm not a big fan of this because, relative to a constant allocation, (1) an increasing bond allocation is likely to gradually reduce withdrawal amounts (subject to market fluctuations) during the glide, and (2) an increasing stock allocation gradually increases the exposure of withdrawal amounts to stock market fluctuations.

Your post takes as example a special case where the VPW worksheet combines VPW withdrawals with bridge withdrawals to a future pension starting 15 years after retirement. Would such a situation justify using a glide? Theoretically, again, one could divide the portfolio into two distinct portfolios, separately managed. The VPW portfolio would have a constant allocation, and the bridge portfolio would be in cash, I-bonds, or something that doesn't fluctuate like a CD ladder (or, possibly, something that delivers non-fluctuating payments, like a specially-constructed non-rolling TIPS ladder). But, this would add complexity (especially for a less-knowledgeable caretaker or surviving spouse). The end result, when considering the sum of the two portfolios, would be an effective increasing stock allocation during the bridge depletion period of 15 years. Would the impact be as big as gliding from 40/60 stocks/bonds to 80/20 stocks/bonds? I think that this is unlikely, unless the bridge portfolio is significantly bigger than the VPW portfolio (possibly exposing the retiree to a lack of liquidity once the bridge is depleted).

Let's go back to the simpler unified approach of the VPW worksheet and look at an example, similar to the situation described in your post, chosen so that, after loss, the bridge part represents 50% of the portfolio. The retiree is of age 55, has a $1,100,000 portfolio with a 40/60 stocks/bonds allocation and will get $3,000/month Social Security payments starting at age 70. The worksheet calculates a $62,795 annual income for 2023 with a $53,879 after-loss projection. That's a -14% income reduction after loss at age 55. The initial bridge estimate is $438,805, leaving $661,195 for VPW withdrawals in a hypothetical world of constant 3.14% real portfolio returns. The VPW percentage for a 40/60 stocks/bond allocation is 4.1% at age 55 and 5.0% at age 70. The projected residual portfolio at age 70 (once the bridge part is depleted) is ((4.1% / 5.0%) X $661,195) = $532,011. For a $532,011 portfolio balance at age 70 with $3,000/month Social Security payments, the worksheet calculates a $62,795 annual income (same as at age 55, thanks to constant returns) with a $57,436 after-loss projection. That's a -9% income reduction after loss at age 70; it's smaller than the projected loss at age 55. We could increase the loss back to almost -14% by increasing the stock allocation to 60/40 stocks/bonds, resulting into a $64,793 annual income with a $56,155 after-loss projection. But $64,793 is barely 3% more than $62,795. I don't think that it's worth the trouble to make the asset allocation change for such a minor impact, just to keep the stock loss projection constant (in the model, before applying real life returns). Note that a bigger initial portfolio relative to bridge cost (possibly due to a shorter bridge period) would have resulted into an even smaller allocation change.

As I wrote in my short answer, I would choose simplicity with a constant asset allocation.

Thanks for your interesting question.
Variable Percentage Withdrawal (bogleheads.org/wiki/VPW) | One-Fund Portfolio (bogleheads.org/forum/viewtopic.php?t=287967)
StillGoing
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Re: Variable Percentage Withdrawal (VPW)

Post by StillGoing »

Ben Mathew wrote: Sun Jun 18, 2023 9:19 pm
longinvest wrote: Sun Jun 18, 2023 7:51 pm
Ben Mathew wrote: Sun Jun 18, 2023 7:06 pm If the markets perform as expected, are VPW withdrawals expected to decline over time, rise over time, or stay constant over time? If the answer is "stay constant over time" then you are assuming that the expected return of the portfolio equals the growth trend/WAG.
The answer to forum member Ben Mathew's question is "stay variable over time". So, even through this narrow lens, VPW doesn't use an "expected return".
Of course, amortizing the portfolio will result in variable withdrawals over time. So the answer "stay variable over time" doesn't convey any new information.

Let me ask it differently:

In your opinion, which of the following is the most likely outcome for VPW users?

(A) They are likely to end up with lower withdrawals in late retirement than they started with
(B) They are likely to end up with higher withdrawals in late retirement than they started with
(C) They are likely to end up with similar levels of withdrawals in late retirement as they started with
In terms of the future, I don't think your question can be answered. However, for the past, the answer was dependent on what country you lived in. For example, the following figure shows the real withdrawal (expressed as a percentage of the initial portfolio value) as a function of time after retirement at the 0th, 10th, 25th, 50th, and 75 percentiles for three countries: USA, UK, and Japan (post 1948). Return and CPI data from macrohistory.net, 35 year planning horizon with 3.76% historical value, for the purposes of this test there was no cap on withdrawals late in retirement (i.e., 35th withdrawal will empty the portfolio). A portfolio with 60% domestic stocks and 40% domestic bonds was held (rebalanced annually) and no fees were deducted.

Image

So, the answer to your question was historically more likely higher late withdrawals for retirees holding domestic assets in Japan and the US and historically more likely lower for a retiree in the UK.

It is also useful to note that the UK gave a much larger worst case drop in the real withdrawals (5% to less than 2% in 2 years for a retirement starting in 1973, although the portfolio subsequently recovered) than either of the other two countries.

cheers
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ososnilknarf
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Re: Variable Percentage Withdrawal (VPW)

Post by ososnilknarf »

longinvest wrote: Thu Jul 06, 2023 6:36 pm
ososnilknarf wrote: Thu Jul 06, 2023 11:18 am longinvest, I am a regular follower of this thread and the forward test thread, and have found it to be one of the most valuable contributions on these boards. Thank you for all of your work on this.

My question is about something I've seen you say several times, which is that we should never change the baseline growth trend assumption used for the spreadsheet. My question is if this applies to changing the asset allocation of your portfolio, or just the underlying % used for the growth trend assumptions for stocks/bonds?

The reason I ask is that my retirement plan is to wait until 70 to collect SS, but I may retire somewhere between 55 - 59. Before 70, I'll want to have a more conservative AA (like 40/60, or 50/50), to ensure that I have a stable base that will cover my essential living expenses, and allow the discretionary spending to fluctuate more.
But after 70, SS will cover the vast majority of my expenses, so I could switch to a very aggressive AA, like 80/20 or something like that.

Thanks again for sharing all of your effort and work with the community.
Ososnilknarf, thanks for the nice words.

I'll provide a short and a longer answer to your question: Should the retiree keep the asset allocation constant during retirement when using VPW?

The short (and probably best) answer is: I would keep the asset allocation constant during retirement. I would pay attention to the required flexibility to make sure there's ample comfort after loss (see this post for details), when choosing the asset allocation, and then stick with it for the rest of retirement.

Note that the VPW worksheet is meant to be used with the retirement portfolio. Additional investments, not needed for retirement, can be managed as a separate portfolio with its own asset allocation and, consequently, be kept entirely out of worksheet calculations.*

* See this post for ideas about what to do with excess money. One possibility is to use a separate portfolio, but possibly give it while alive to the receiving charity organization.


Here's the longer answer.

Theoretically, it would be acceptable for the portfolio to use a predetermined asset allocation glide (with an increasing bond or stock allocation), as the VPW percentages for the rest of retirement could still be predetermined before retirement while doing so, preserving important resilience features of VPW. But, I'm not a big fan of this because, relative to a constant allocation, (1) an increasing bond allocation is likely to gradually reduce withdrawal amounts (subject to market fluctuations) during the glide, and (2) an increasing stock allocation gradually increases the exposure of withdrawal amounts to stock market fluctuations.

Your post takes as example a special case where the VPW worksheet combines VPW withdrawals with bridge withdrawals to a future pension starting 15 years after retirement. Would such a situation justify using a glide? Theoretically, again, one could divide the portfolio into two distinct portfolios, separately managed. The VPW portfolio would have a constant allocation, and the bridge portfolio would be in cash, I-bonds, or something that doesn't fluctuate like a CD ladder (or, possibly, something that delivers non-fluctuating payments, like a specially-constructed non-rolling TIPS ladder). But, this would add complexity (especially for a less-knowledgeable caretaker or surviving spouse). The end result, when considering the sum of the two portfolios, would be an effective increasing stock allocation during the bridge depletion period of 15 years. Would the impact be as big as gliding from 40/60 stocks/bonds to 80/20 stocks/bonds? I think that this is unlikely, unless the bridge portfolio is significantly bigger than the VPW portfolio (possibly exposing the retiree to a lack of liquidity once the bridge is depleted).

Let's go back to the simpler unified approach of the VPW worksheet and look at an example, similar to the situation described in your post, chosen so that, after loss, the bridge part represents 50% of the portfolio. The retiree is of age 55, has a $1,100,000 portfolio with a 40/60 stocks/bonds allocation and will get $3,000/month Social Security payments starting at age 70. The worksheet calculates a $62,795 annual income for 2023 with a $53,879 after-loss projection. That's a -14% income reduction after loss at age 55. The initial bridge estimate is $438,805, leaving $661,195 for VPW withdrawals in a hypothetical world of constant 3.14% real portfolio returns. The VPW percentage for a 40/60 stocks/bond allocation is 4.1% at age 55 and 5.0% at age 70. The projected residual portfolio at age 70 (once the bridge part is depleted) is ((4.1% / 5.0%) X $661,195) = $532,011. For a $532,011 portfolio balance at age 70 with $3,000/month Social Security payments, the worksheet calculates a $62,795 annual income (same as at age 55, thanks to constant returns) with a $57,436 after-loss projection. That's a -9% income reduction after loss at age 70; it's smaller than the projected loss at age 55. We could increase the loss back to almost -14% by increasing the stock allocation to 60/40 stocks/bonds, resulting into a $64,793 annual income with a $56,155 after-loss projection. But $64,793 is barely 3% more than $62,795. I don't think that it's worth the trouble to make the asset allocation change for such a minor impact, just to keep the stock loss projection constant (in the model, before applying real life returns). Note that a bigger initial portfolio relative to bridge cost (possibly due to a shorter bridge period) would have resulted into an even smaller allocation change.

As I wrote in my short answer, I would choose simplicity with a constant asset allocation.

Thanks for your interesting question.
Thank you for the very illuminating and helpful answer!
L84SUPR
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Re: Variable Percentage Withdrawal (VPW)

Post by L84SUPR »

Does VPW assume decreasing, constant, or increasing expenses? I recently read distributions from VPW are "front loaded". I understand the percentages increase but assumed they were balanced by a decreasing portfolio, in theory. Is there an intentional tilt toward real increasing or decreasing expenses/distributions?
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longinvest
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Re: Variable Percentage Withdrawal (VPW)

Post by longinvest »

L84SUPR wrote: Sat Jul 15, 2023 3:54 pm I recently read distributions from VPW are "front loaded".
L84SUPR, instead of believing one person or another, I suggest taking the time to read my posts in this thread. I provide complete explanations of the various aspects and calculations of the VPW accumulation and retirement approach so that readers can make up their mind about VPW without having to believe me. I think that it's much better to use logic for reasoning instead of a belief system.
L84SUPR wrote: Sat Jul 15, 2023 3:54 pm Does VPW assume decreasing, constant, or increasing expenses? [...] I understand the percentages increase but assumed they were balanced by a decreasing portfolio, in theory. Is there an intentional tilt toward real increasing or decreasing expenses/distributions?
Withdrawal amounts delivered by the variable percentage withdrawal method fluctuate, sometimes up, sometimes down. I'm unable to predict whether they'll fluctuate more up or down. This depends on future market returns.

It's easy to fall prey to recency bias, a common behavioral pitfall. In the following chart of the forward test thread, we see (inflation-adjusted) monthly retirement income (blue line) slowly increasing from mid-2019 until late 2021, and then decreasing somewhat more quickly from early 2022 until mid-2023. (The drop of last 3 months of the chart is mostly due to starting to consider 23% of promised Social Security benefits as a temporary pension from age 70 to age 78).

Image

A look at the portfolio balance (red line) provides the explanation of what happened. From mid-2019 to late 2021, the portfolio fluctuated mostly up, leading to increasing portfolio withdrawals. During 2022, the portfolio fluctuated down quite sharply (due to both negative nominal returns and relatively high inflation), leading to decreasing portfolio withdrawals. The use of a small cash cushion significantly smoothed retirement income fluctuations.

It would be a mistake to see any retirement income front-loading pattern (from mid-2019 to late 2021) in the above chart. Retirement income simply fluctuated up and down, but less than markets because of current and future stable non-portfolio income streams (as well as smoothing with cushion).
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Zizou
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Re: Variable Percentage Withdrawal (VPW)

Post by Zizou »

you proba ly have answered this question before: what if the AA is 10/90 (equities/bonds)? Any way to input that ?
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longinvest
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Re: Variable Percentage Withdrawal (VPW)

Post by longinvest »

Zizou wrote: Sun Jul 23, 2023 5:45 pm you proba ly have answered this question before: what if the AA is 10/90 (equities/bonds)? Any way to input that ?
Zizou, it's part of this site's philosophy to never bear too much or too little risk. As a consequence, the VPW worksheet assumes that at least 30% of the portfolio is invested into stocks to provide some (hoped for) growth. It's also designed this way to keep required flexibility calculations simple with a -50% stock loss projection.

Both stocks and bonds fluctuate. While not frequent, it isn't unusual for stocks to lose -50% of their value. Bonds to fluctuate too, but significantly less than stocks.

To estimate a required flexibility for the retiree's plan, the worksheet calculates the impact of stocks immediately losing -50%. It also restricts the asset allocation to include at least 30% in stocks, thus testing at least a -15% portfolio loss for a bond-heavy portfolio.

The required flexibility estimate isn't a prediction that stocks will lose exactly -50% and that bonds will remain perfectly stable. It's just a simple calculation that can easily be understood and replicated without using a spreadsheet. It's meant to help the retiree plan for the possibility of bad future returns. These bad returns could be due to stocks, to bonds, or to both. Losses could be immediate, later, or spread over time. Losses could be worse, forcing the retiree to adapt. Losses might never happen. We simply don't know.

I'll add that proper use of VPW requires accompanying stable lifelong income like a pension or Social Security (possibly delayed to start later), dampening the impact of portfolio losses on total retirement income.
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Re: Variable Percentage Withdrawal (VPW)

Post by 4nursebee »

L84SUPR wrote: Sat Jul 15, 2023 3:54 pm Does VPW assume decreasing, constant, or increasing expenses? I recently read distributions from VPW are "front loaded". I understand the percentages increase but assumed they were balanced by a decreasing portfolio, in theory. Is there an intentional tilt toward real increasing or decreasing expenses/distributions?
I agree that reading through his posts will help understand this better, but I would start with understanding all withdrawal methods. For me, the VPW explanation here is quite sufficient: https://www.bogleheads.org/wiki/Withdrawal_methods
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