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Smoothing Fixed Percentage Withdrawals
Walt Dardenne 11-06-2000, 1:32 AM | Post #31854 | 
One possible strategy for retirement withdrawals is to withdraw a fixed percentage of the portfolio each year. Bill Bernsteins article The Retirement Calculator from Hell (See Efficient Frontier or Bills new book) has shown that such a strategy (1) will last indefinitely, (2) can, however, lead to infinitesimally small withdrawals if conditions are really bad or your withdrawal percentage is too large, and (3) can result in a widely fluctuating annual spending budget. Ozark has referred to this strategy as Market Variable Income (MVI) (See Rely #3 to Conversation #599 below and/or earlier Ozark posts).

A Motley Fool early retiree, Galeno, has posted a retirement withdrawal strategy that is a slight variation on the fixed percentage withdrawal strategy that smoothes out some of the year-to-year variations. Galenos strategy is as follows:

1. Divide the total portfolio value by 360 to determine the starting monthly draw. [This is equivalent to a withdrawal rate of 3.33% of the portfolio for the first year. Galeno is an early retiree and has chosen a withdrawal rate that is somewhat low, but arguably appropriate for someone with a long retirement ahead of them.]

2. Start with 60 months of living expenses in cash (money markets, short-term treasuries, etc.). [This is equivalent to a buffer of 5 years living expenses. Frank Armstrong and others usually recommend 5 to 7 years of living expenses in readily accessible fixed income instruments.] Invest the balance of the portfolio in stocks. [Note that this results in an allocation of 16.66% in Fixed Income and 83.33% in stock. This is aggressive for most retirees, but maybe not for a young one with a low percentage withdrawal.]

3. Every January, sell 4% of the stock portfolio and add the proceeds to the cash buffer. [Note that if equities still represent 83.33% of the portfolio, then 4% of the equities equal 3.33% of the total portfolio.]

4. Divide the new cash buffer sum by 60 to get the new monthly draw.

Steps 1 through 3 are pretty close to what most of us interpret as the fixed withdrawal percentage or Ozarks MVI strategy. Any particular retiree might use somewhat different specific values depending upon their unique retirement circumstances and risk tolerance. Step 4 is an interesting variation that helps smooth out the year-to-year volatility of portfolio performance. If the market has a downturn, the portfolio withdrawal drops, but the next years budget does not bear the full brunt of the reduction. Instead, the reduction is spread out over the next 5 years (or the selected "cash buffer" duration). Likewise, if the market is up, the annual budget doesnt spend the full reward of that bounty. The benefits are a smoother ride while still taking into account the realities of actual market performance. This moderated feedback approach is similar to the autopilot technique recommended by Bud Hebeler at the AnalyseNow! site.

When time allows, I plan to compare this modified method to the example given by Bernstein and see just how much it smoothes the year-to-year variation in spending budget when a large market down turn hits near the beginning of a retirement.

Originally posted in thread: 599
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