Tag Archives: retirement income

Searching for a Safe Withdrawal Rate: the Effect of Sampling Block Size

Posted By |
Image by Mohamed Hassan from Pixabay

By Michael J. Wiener

Special to the Financial Independence Hub

How much can we spend from a portfolio each year in retirement?  An early answer to this question came from William Bengen and became known as the 4% rule.  Recently, Ben Felix reported on research showing that it’s more sensible to use a 2.7% rule.

Here, I examine how a seemingly minor detail, the size of the sampling blocks of stock and bond returns, affects the final conclusion of the safe withdrawal percentage.  It turns out to make a significant difference.  In my usual style, I will try to make my explanations understandable to non-specialists.

The research

Bengen’s original 4% rule was based on U.S. stock and bond returns for Americans retiring between 1926 and 1976.  He determined that if these hypothetical retirees invested 50-75% in stocks and the rest in bonds, they could spend 4% of their portfolios in their first year of retirement and increase this dollar amount with inflation each year, and they wouldn’t run out of money within 30 years.

Researchers Anarkulova, Cederburg, O’Doherty, and Sias observed that U.S. markets were unusually good in the 20th century, and that foreign markets didn’t fare as well.  Further, there is no reason to believe that U.S. markets will continue to perform as well in the future.  They also observed that people often live longer in retirement than 30 years.

Anarkulova et al. collected worldwide market data as well as mortality data, and found that the safe withdrawal rate (5% chance of running out of money) for 65-year olds who invest within their own countries is only 2.26%!  In follow-up communications with Felix, Cederburg reported that this increases to 2.7% for retirees who diversify their investments internationally.

Sampling block size

One of the challenges of creating a pattern of plausible future market returns is that we don’t have very much historical data.  A century may be a long time, but 100 data points of annual returns is a very small sample.

Bengen used actual market data to see how 51 hypothetical retirees would have fared.  Anarkulova et al. used a method called bootstrapping.  They ran many simulations to generate possible market returns by choosing blocks of years randomly and stitching them together to fill a complete retirement.

They chose the block sizes randomly (with a geometric distribution) with an average length of 10 years.  If the block sizes were exactly 10 years long, this means that the simulator would go to random places in the history of market returns and grab enough 10-year blocks to last a full retirement.  Then the simulator would test whether a retiree experiencing this fictitious return history would have run out of money at a given withdrawal rate.

In reality, the block sizes varied with the average being 10 years.  This average block size might seem like an insignificant detail, but it makes an important difference.  After going through the results of my own experiments, I’ll give an intuitive explanation of why the block size matters.

My contribution

I decided to examine how big a difference this block size makes to the safe withdrawal percentage.  Unfortunately, I don’t have the data set of market returns Anarkulova et al. used.  I chose to create a simpler setup designed to isolate the effect of sampling block size.  I also chose to use a fixed retirement length of 40 years rather than try to model mortality tables.

A minor technicality is that when I started a block of returns late in my dataset and needed a block extending beyond the end of the dataset, I wrapped around to the beginning of the dataset.  This isn’t ideal, but it is the same across all my experiments here, so it shouldn’t affect my goal to isolate the effect of sampling block size.

I obtained U.S. stock and bond returns going back to 1926.  Then I subtracted a fixed amount from all the samples.  I chose this fixed amount so that for a 40-year retirement, a portfolio 75% in stocks, and using a 10-year average sampling block size, the 95% safe withdrawal rate came to 2.7%.  The goal here was to use a data set that matches the Anarkulova et al. dataset in the sense that it gives the same safe withdrawal rate.  I used this dataset of reduced U.S. market returns for all my experiments.

I then varied the average block size from 1 to 25 years, and simulated a billion retirements in each case to find the 95% safe withdrawal rate.  This first set of results was based on investing 75% in stocks.  I repeated this process for portfolios with only 50% in stocks.  The results are in the following chart.

The chart shows that the average sample size makes a significant difference.  For comparison, I also found the 100% safe withdrawal rate for the case where a herd of retirees each start their retirement in a different year of the available return data in the dataset.  In this case, block samples are unbroken (except for wrapping back to 1926 when necessary) and cover the whole retirement.  This 100% safe withdrawal rate was 3.07% for 75% stocks, and 3.09% for 50% stocks.

I was mainly concerned with the gap between two cases: (1) the case similar to the Anarkulova et al. research where the average sampling block size is 10 years and we seek a 95% success probability, and (2) the 100% success rate for a herd of retirees case described above.  For 75% stock portfolios, this gap is 0.37%, and it is 0.32% for portfolios with 50% stocks.

In my opinion, it makes sense to add an estimate of this gap back onto the Anarkulova et al. 95% safe withdrawal rate of 2.7% to get a more reasonable estimate of the actual safe withdrawal rate.  I will explain my reasons for this after the following explanation of why sampling block sizes make a difference.

Why do sampling block sizes matter?

It is easier to understand why block size in the sampling process makes a difference if we consider a simpler case.  Suppose that we are simulating 40-year retirements by selecting two 20-year return histories from our dataset.

For the purposes of this discussion, let’s take all our 20-year return histories and order them from best to worst, and call the bottom 25% of them “poor.”

If we examine the poor 20-year return histories, we’ll find that, on average, stock valuations were above average at the start of the 20-year periods and below average at the end.  We’ll also find that investor sentiment about stocks will tend to be optimistic at the start and pessimistic at the end.  This won’t be true of all poor 20-year periods, but it will be true on average.

When the simulator chooses two poor periods in a row to build a hypothetical retirement, there will often be a disconnect in the middle.  Stock valuations will jump from low to high and investor sentiment from low to high instantaneously, without any corresponding instantaneous change in stock prices.  This can’t happen in the real world. Continue Reading…

Living off the Dividends?

Posted By |

 

By Dale Roberts, cutthecrapinvesting

Special to the Financial Independence Hub

It is the most popular rallying cry for self-directed investors in Canada and the U.S. – I plan to “live off of the dividends.” Or in retirement – “I am living off of the dividends.” The notion leaves money on the table in the accumulation stage and living off of the dividends leaves a lot of money on the table in retirement. Don’t get me wrong, I love the big juicy (and growing) dividend as a part of our retirement plan. But as an exclusive strategy, the income approach simply comes up short.

It’s not a popular Tweet, but I have suggested that no investor with a viable and sensible financial plan would live off the dividends. Add this to the points made in the opening paragraph; it might not be tax-efficient. Also, the dividend would have no idea of what is a financial plan and what is the most optimal order of account type spending. Check in with the our friends at Cashflows&Portfolios and they can show you a very efficient order of asset harvesting.

On Seeking Alpha, I recently offered this post:

Living off dividends in retirement; don’t sell yourself short.

Thanks to Mark at My Own Advisor for including that post in the well-read Weekend Reads.

Financial Planner: It may be a bad idea

From financial planner Jason Heath, in the Financial Post.

Why living off your dividends in retirement may be a mistake.

Retirement planning is a personal decision, but you might be making a big mistake if you go out of your way to ensure you can live off your dividends, since you will be leaving a great deal of money when you die. In the process, you may have worked too hard at the expense of family time or spent too little at the expense of treating yourself.

In that Seeking Alpha post, I used BlackRock as the poster child for a lower-yielding dividend growth stock. The yield is lower but the dividend growth is impressive. That can often be a sign of underlying earnings growth and financial health.

2022 update: BlackRock is falling with the market (and then some); the yield is now above 3%.

Making homemade dividends

In that Seeking Alpha post, I demonstrated the benefit of selling a few shares to boost the total retirement take from BlackRock. The retiree gets an impressive income boost, and only had to sell 2.8% of the initial share count. The risk is managed.

Starting with a hypothetical $1 million portfolio, $50,000 in annual income represents an initial 5% spend rate. That is, we are spending 5% of the total portfolio value. Without share sales the retiree would have been spending at an initial 3.3%.

Share Sales (in the table) represents the income available thanks to the selling of shares: creating that homemade dividend.

The retiree who has the ability to press that sell button to create income enjoyed much higher income. In fact, the retiree would have been able to sell significantly more shares (compared to the example above) to create even more additional income.

Plus the dividend growth is so strong, it quickly eliminated the need to sell shares.

BlackRock Dividend Growth – Seeking Alpha

In fact, the BlackRock dividend quickly surpasses the income level of the Canadian bank index. It can be a win, win, win. Even for the dividend-loving Canadian accumulator, BlackRock is superior on the dividend flow.

But of course, the aware retiree will keep selling shares and making hay when the sun shines. They might cut back any share sales in a market correction: also known as a variable withdrawal strategy.

It’s a simple truth. Don’t let the income drive the bus. It doesn’t know where you need to go. This is not advice, but consider growth and total return and share harvesting.

Don’t sell yourself short.

In the Seeking Alpha post, I also offered:

The optimal mix of income and growth for retirement Continue Reading…

Moshe Milevsky and Guardian Capital unveil a Modern Tontine in new Retirement solution

Posted By |
Moshe Milevsky

A revolutionary new approach to preserving portfolio longevity through a modern “Tontine” structure was unveiled Wednesday by Guardian Capital LP and famed author and finance professor Moshe Milevsky.

GuardPath™ Longevity Solutions, created in partnership between Guardian and Schulich School of Business finance professor Milevsky, is designed to address what Nobel Laureate Economist William Sharpe has described as the “nastiest, hardest problem in finance” 1

Announced in Toronto on September 7, a press release declares that the “ground-breaking step” aims to “solve the misalignment between human and portfolio longevity.” See also this story in Wednesday’s Globe & Mail.

Over the years, I have often interviewed Dr. Milevsky about Retirement, Longevity, Annuities and his unique take on how the ancient “Tontine” structure can help long-lived investors in their quest not to outlive their money. Milevsky has written 17 books, including his most recent one on this exact topic: How to Build a Modern Tontine. [See cover photo below.]

Back in 2015, I wrote two MoneySense Retired Money columns on tontines and Milevsky’s hopes that they would one day be incorporated by the financial industry. Part one is here and part two here. See also my 2021 column on another pioneering Canadian initiative in longevity insurance: Purpose Investment Inc.’s Longevity Pension Fund.

Addressing the biggest risks faced by Retirees

In the release, Milevsky describes the new offering as a “made-in-Canada” solution that addresses “the biggest risks facing retirees and are among the first of their kind globally. Based on hundreds of years of research and improvement and backed by Guardian Capital’s 60-year reputation for doing what’s right for Canadian investors, I am confident these solutions will revolutionize the retirement space.”

Milevsky’s latest book is on Modern Tontines

In an email to me Milevsky said: “You and I have talked (many times) about tontines as a possible solution for retirement income decumulation versus annuities. Until now it’s all been academic theory and published books, but I finally managed to convince a (Canadian) company to get behind the idea.”

In the news release, Guardian Capital Managing Director and Head of Canadian Retail Asset Management Barry Gordon said that “for too many years, Canadian retirees have feared outliving the nest egg they have worked so hard to create.” It has answered that concern by creating three solutions that aim to alleviate retirees’ greatest financial fears: The three solutions are described at the bottom of this blog.

With the number of persons aged 85 and older having doubled since 2001, and projections suggesting this number could triple by 2046,2 Guardian Capital says it “set out to create innovative solutions that this demographic could utilize when seeking a greater sense of financial security.”

Tontines leap from Pop Culture to 21st Century reality

Tontines were one of the most popular financial products for hundreds of years for individuals willing to trade off legacy for more income, Guardian says. Once in a  while the tontine shows up in popular culture, notably in the film The Wrong Box, where the plot revolves around a group of people hoping to be the last survivor in a tontine and therefore the recipient of a large payout.

“With our modern tontine, investors concerned about outliving their nest egg pool their assets and are entitled to their share of the pool as it winds up 20 years from now,” Gordon says, “Over that 20-year period, we seek to grow the invested capital as much as possible to maximize the longevity payout. Along the way, investors that redeem early or pass away leave a portion of their assets in the pool to the benefit of surviving unitholders, boosting the rate of return. All surviving unitholders in 20 years will participate in any growth in the tontine’s assets, generated from compound growth and the pooling of survivorship credits. This payout can be used to fund their later years of life as they see fit, and aims to ensure that investors don’t outlive their investment portfolio.” Continue Reading…

Retired Money: Rising rates make annuities more tempting for Retirees

Posted By |

My latest MoneySense Retired Money column looks at whether the multiple interest rate hikes of 2022 means its time for retirees to start adding annuities to their retirement-income product mix. You can find the full column by clicking on the highlighted headline here: Rising rates are good news for near-retirees seeking longevity insurance.

The Bank of Canada has now hiked rates twice by 50 basis points, most recently on June 1, 2022.  That’s good for GIC investors, as we covered in our recent column on the alleged death of bonds, but it’s also  welcome news for retirees seeking longevity insurance.

As retired actuary Fred Vettese recently wrote, retirees may start to be tempted to implement his suggested guideline of converting about 30% of investment portfolios into annuities. As for the timing, Vettese said it is “certainly not now: but it could be sooner than you think.” He guesses the optimal time to commit to them is around May 2023, just under a year from now.

After the June rate hikes, I asked CANNEX Financial Exchanges Ltd. to generate life annuity quotes for 65- and 70-year old males and females on $100,000 and $250,000 capital. The article provides the option of registered annuities and prescribed annuities for taxable portfolios. It also passes along the opinion of annuity expert Rona Birenbaum that she greatly prefers prescribed annuities because of the superior after-tax income. Of course, many retirees may only have registered assets to draw on: in RRSP/RRIFss and/or TFSAs.

For a 65-year old male investing $100,000 early in June 2022, with a 10-year guarantee period in a prescribed (non-registered) Single Life annuity, monthly income ranged from a high of $548  at Desjardins Financial Security with a cluster at major bank and life insurance companies between $538 and $542. (figure rounded). Comparable payouts on $250,000 ranged from $1299 to $1,390. Because of their greater longevity, 65-year old females received slightly less: ranging from around $500/month to a high of $518, and for the $250,000 version from $1238 to $1319.

Here’s what Cannex provides for comparable registered annuities (held in RRSPs):

For a 65-year old male (born in 1957), $100,000 in a Single Life annuity nets you between $551 and $571 per month, depending on supplier; $250,000 generates between $1,399 and $1,461 a month. For 70-year old males (born 1952), comparables are $625 to $640/month and $1,578 to $1,634 a month. Continue Reading…

An income strategy for new retirees: HDIF

Posted By |
By David Kitai,  Harvest ETFs

(Sponsor Content)

One third of recently retired Canadians surveyed by RBC insurance said they retired sooner than they planned because of the COVID-19 pandemic. That same survey found that retirees, especially new retirees, are increasingly concerned about affording their retirement.

More than 78% of survey respondents said they were concerned about the impact of inflation on their savings. 47% said they were concerned about a lack of guaranteed income and 48% said they worry about outliving their savings.

All three of these concerns come down to income. New Canadian retirees, many of whom retired early due to COVID, are worried that they don’t have a stable source of income that can overcome the rapidly rising cost of living and last for their whole lifespans.

One income asset class can help with those worries.

Inflation worries come after years of low-yielding bonds

The income concerns discovered by the survey should come as no surprise. For the better part of a decade income yields from fixed income investments have been at or near historic lows. Retirees used to live on the income these investments provided but yields at sub 2% levels have been unsustainable.

More recently, rates have begun to rise as central banks attempt to reign in inflation. However, with inflation in spring of 2022 hitting levels above 6%, those rising bond yields are still paying negative real income.

That trend is reflected in the fact that 78% of survey respondents said they were concerned about inflation. Many traditional income sources seem incapable of matching what inflation has done to ordinary retirees’ balance sheets.

Many income sources, but not all.

Equity Income ETFs for retirees

An equity income ETF takes a portfolio of equities — stocks — and uses a combination of dividends and a covered call strategy to generate consistent monthly cashflows for unitholders. This results in an ETF with a target annual yield that can be as high as 8.5%, paid in the form of a monthly cash distribution. These assets can still participate in market growth opportunity, like an ordinary equity ETF, albeit with some growth opportunities limited due to the covered call strategy. The end result is a product paying consistent income with exposure to market growth opportunities. Continue Reading…