# Modeling retirement investment yield



## james4beach (Nov 15, 2012)

As a young guy I never thought too much about income cashflows (yield from a portfolio), and I've been a bit unfair in my criticisms to others on this topic. But it's clearly important for people like my parents and I'm trying to get a grasp on expectations. At this stage it's not about a final portfolio but getting some expectations on what the capital can provide based on typical investments with typical risk tolerance.

The scenario I'm considering is someone who is retiring now (say at age 60 - 70) with a chunk of retirement savings capital, sitting in their discount brokerage. Let's assume they want to preserve capital but the door is always open to liquidation to get return of capital as more 'income', which I'll tack onto the end of my equation

*Overall income "yield" = capital gains + dividends and interest income + liquidation ROC*

First thought: write off capital gains to 0. At this age, they don't have sufficient time to count on "long term average stock market returns". The stock market is very volatile and I look at charts like these and think, since they don't have 20 to 30 years horizon, they really shouldn't have any expectations for "X% a year growth" (or whatever) in stocks. In fact they could just as well see declines. So I'm thinking: count on 0% capital gains.

Even if capital gains are possible (and let's face it most people around here seem to think it's a guarantee) there's also risks of capital loss, and risk of dividend and interest income yields _declining_, plus future loss of income due to ROC eating away at capital in my final equation... so I'm pretty comfortable netting these out and calling it capital gains = 0.

Second thought: using a 50/50 investment mix (arguably this is still too much equity exposure for seniors) using things that exclusively provide dividends and interest income while preserving capital. Otherwise if there's ROC embedded in it you're going to get an unrealistic number ; I'm breaking out ROC totally separately in my overall equation anyway and I want control of the ROC variable. So for example, XTR is not eligible since it internally liquidates and has ROC. Are REITs eligible here? -- does the ROC they spin off eat away at capital, or can one reasonably expect preservation of capital? Similarly the covered call ETFs and other exotic ETFs are not eligible since they inherently eat away at capital.

Here's my (rough) model and yields after MER, for both the equity and fixed income portions. I think this is pretty close to what 'monthly income' funds do:








So from the 3.92% dividend yield and 2.47% interest yield, I get a portfolio average 3.2% yield:

Overall "yield" = 0 + 3.2% + liquidation ROC

At this point all that remains is tweaking the ROC portion according to their desired income needs. Say the capital is 500k and they want 25k annual cashflow, this can be done by liquidating 1.8% of the portfolio each year:

Overall "yield" = 0 + 3.2% + 1.8% = 5.0%

Also shows me that the income you get in the end is pitifully small... even half a million $ with significant risk exposure (half in equities!) only generates 25k a year.

My questions:

1. Does it look like I'm figuring this correctly?
2. Are REITs eligible for my criteria of preserving capital? They have ROC, but does that ROC degrade capital?
3. Where's the disconnect... why do all these articles give figures like 5% to 6% income yield?
... is it because they're considering ROC (and capital liquidation) just like in my final step?
... or are they assuming people take on more risk than in my model?
... or is there another factor that I've left out?


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## james4beach (Nov 15, 2012)

I'll add that of course I realize there _could_ be capital gains, which would boost the portfolio, but my goal here is to model a reasonable expectation... something that can be counted on, not just hoped for. Perhaps those 6% yield promises out there come from a bit of ROC + a sprinkle of hope for capital gains?


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## humble_pie (Jun 7, 2009)

3.2%? what are your parents thinking of? If you were my son i'd fire you.

there's no choice. It's either learn to add option trading or else rob banks. The parents, i mean, not yourself. You, alas, are already too old.

just show your parents to Dmoney's thread, please.


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## AltaRed (Jun 8, 2009)

james4beach said:


> I'll add that of course I realize there _could_ be capital gains, which would boost the portfolio, but my goal here is to model a reasonable expectation... something that can be counted on, not just hoped for. Perhaps those 6% yield promises out there come from a bit of ROC + a sprinkle of hope for capital gains?


If you are talking about some of those Managed Portfolios that the banks promote (such as RBC) where one can pick from a 5%, 6% or 7% yield, they are banking on some capital gains (there being more equity component in the 6% one than the 5% one, etc.) to feed the withdrawal. If not, there has to be ROC. 

Even some of the plain vanilla income funds have ROC, albeit partly because bonds bought at a premium mature at 100. My bro and I have our very elderly mother in, amongst other things, the RBC Monthly Income fund Series D. It pays out about 4% (after MER) but the T3 slip includes some ROC (whether or not the fund unit NAV has experienced a capital gain). I am happy to the extent the NAV holds its own (more or less over a longer period).... and even if it decreases marginally over time, it will outlast her anyway.

Basically, any managed portfolio, balance fund or income fund has an equity component that the sponsor is hoping will provide enough performance to fund the payouts and minimize impact on NAV. In your case, I think you are being too pessimistic in not assuming some capital gains.


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## james4beach (Nov 15, 2012)

OK so if I want to assume some capital gains the same way everyone else does, do I simply add another 2% to my equation in place of the zero?


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## AltaRed (Jun 8, 2009)

james4beach said:


> OK so if I want to assume some capital gains the same way everyone else does, do I simply add another 2% to my equation in place of the zero?


Think of equities on a Total Return basis. There is some thought that perhaps equities will give you 5-7% going forward on a 10 year rolling basis. Part of that is dividends and part of it is capital appreciation. So perhaps use 6% (cap gains + dividends) in your overall 'yield' equation. Portfolio managers are more likely to stick to blue chip dividend paying equities to help fund distributions in balanced and income funds (and managed portfolios) so the equity component is likely to be weighted to dividend paying stocks in the Total Return package. Ultimately, it does not matter much to the investor whether that is 3+3, 4+2 or 2+4 other than tax treatment of cap gains vs DTC.


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## doctrine (Sep 30, 2011)

You're inevitably going to get capital gains out of ZCN, but it might be a problem relying on them for income. The TSX stock prices could fall by 50% in a crash. If you are relying on 2% a year in selling stocks on an initial investment, if the TSX falls by 50% then you're going to need to sell twice as much (4%) to maintain income. A model that depends on selling more in a depressed market is not a winning formula, in my opinion.

Income funds do this, and I think it's ridiculous. Some of them sell 3-4% a year to make 6-7% distributions and take fees.


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## gibor365 (Apr 1, 2011)

james4beach, just wondering why you restrict equity portfolio with only 3 ETFs, won't be better to create portfolio with solid blue chip stocks like PM, MO, JNJ, ABBV, KMB, MCD, LMT couple of Canadian banks and telecoms, couple of UN like SRV.UN, CHE.UN... thus you can have yield around 4.5-4.7% and most of those "guys" would increase dividends every year.
For fixed income , I'd rather invest into PT who gives 3% on TFSA and 1.9% on saving account


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## james4beach (Nov 15, 2012)

Maybe I should have clarified, I'm talking about cashflow here. A retiree who needs to generate cashflow from their portfolio, because they have already retired and are living off of the portfolio. This person can't just sit there watching their account value fluctuate (as I have the luxury of doing). They need the cash to live off of.

I realize what you guys are saying about average 5% to 7% historically -- and I agree historically and for very LONG periods -- but I really don't feel like this translates to portfolio *income* in the time horizon of a retiree. Isn't this the whole reason classical investment thinking says that seniors have to reduce equity exposure, getting towards nil exposure as they age? Because equities are too volatile and you can't count on those positive returns in periods like 1 year.

Let's say for the sake of argument that we stick to the idea that total stock returns will on average be 6%, and the dividend yield is 3% and so we expect that the rest will be made up with 3% capital growth (which is an annualized average... not like clockwork or anything). This seems to be the mainstream thinking for retirement portfolios.  So the portfolio is generating cash at 3%, which you extract. You need another 3% to make up the total desired cashflow to the retiree. The promise was to provide 6% distribution per year.

What's the mechanism to make this happen? doctrine if you're not going to liquidate a constant 3% each year, then how else would you do it?

This is where I see a big problem with trying to "extract" that 3% capital growth. That's why I'm thinking you can't rely on capital appreciation for such a portfolio meant to deliver cashflow. 6% average return for someone sitting and watching a portfolio... yes. But 6% cashflow for someone living off a retirement portfolio? I don't see how you get that.


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## james4beach (Nov 15, 2012)

gibor said:


> james4beach, just wondering why you restrict equity portfolio with only 3 ETFs


Well this was just for the sake of working with some numbers. So let's say with your picks the dividend yield is more like 4.5%, meaning another 1.5% in capital appreciation is expected to give that magic 6% total average return (as the financial world promises us we will get).

My question is, how do you "tap into" that other 1.5% ? Do you sell 1.5% of the portfolio every year, or do something else?

Asking all this because the literature out there (including pension funds) seem to be saying that a retirement portfolio can generate a 6% annual return and I'm just asking, how? To generate 6% you have to get those capital gains cashed out and you clearly can't wait until you're on your death bed to cash out capital gains. So when do you do it?


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## james4beach (Nov 15, 2012)

To give a concrete example of the "literature" I'm talking about, see this article.

They write: "Any financial planner worth his/her salt could tell you that if you could generate a 4% investment return annually from $10 million, that’s a whopping $400,000 a year of income. *Yes, a balanced portfolio of stocks and bonds could probably do better than that: perhaps 6%*"

And I'm asking. OK. How? If the authors are correct, then how would that 6% annual income be generated (clearly capital gains are being relied on in this figure). Would that 6% annual income have to drop substantially in years where the index failed to go up? And if so, what kind of retirement income is that?


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## AltaRed (Jun 8, 2009)

james4beach said:


> Let's say for the sake of argument that we stick to the idea that total stock returns will on average be 6%, and the dividend yield is 3% and so we expect that the rest will be made up with 3% capital growth (which is an annualized average... not like clockwork or anything). This seems to be the mainstream thinking for retirement portfolios. So the portfolio is generating cash at 3%, which you extract. You need another 3% to make up the total desired cashflow to the retiree. The promise was to provide 6% distribution per year.
> 
> What's the mechanism to make this happen? doctrine if you're not going to liquidate a constant 3% each year, then how else would you do it?
> 
> This is where I see a big problem with trying to "extract" that 3% capital growth. That's why I'm thinking you can't rely on capital appreciation for such a portfolio meant to deliver cashflow. 6% average return for someone sitting and watching a portfolio... yes. But 6% cashflow for someone living off a retirement portfolio? I don't see how you get that.


The mechanism is 'reverse rebalancing'. If equities are down, then the SWR (sustained withdrawal rate) comes from the FI side of the portfolio disproportionately, or totally for a few years. After all, the FI side of the asset allocation would have gotten out of hand (high) when equities are down. So the retiree takes his/her dividends, interest income, and some capital out of the FI side. When equities come rushing back, then the withdrawal rate is disproportionately taken from the equity side again.

SWR at a fixed percentage rate becomes a problem IF markets are down, or flat, for a disproportionate period of time. That is when the retiree may need to pull back on withdrawal rate and work at part time work for awhile to supplement income There is a school of thought that GDP growth and thus capital markets in the developed world will never bounce back to prior levels and that 4% SWR runs a real risk of running out of money. It probably should be reduced to 3%. If true, these Managed Portfolio and/or balanced mutual funds are in for a heap of trouble longer term.


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## james4beach (Nov 15, 2012)

Wow AltaRed thanks. Well that part really makes sense, switching the liquidation to the fixed income side when stocks are depressed. That also makes the case for a healthy fixed income cushion. I wonder if 50/50 is enough fixed income for a retiree (many of these 'monthly income funds' are balanced funds).

Regarding the 'disproportionate period of time' though, that's my worry. I think the stock market could stay easily depressed for a decade.

When I calculated in my basic little balanced portfolio,
Overall "yield" = 0 + 3.2% + 1.8% = 5.0%

Is 1.8% what you call the SWR ? Are we talking about the same thing... liquidating some of the stocks/fixed income, as the case may be based on the 'reverse rebalancing' approach you describe?


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## GoldStone (Mar 6, 2011)

Take a look at the buckets withdrawal strategy. Here's the general idea:

Bucket #1
5 year GIC ladder. Each GIC covers one year worth of living expenses. When a GIC matures, you move funds to HISA and consume them the next year.

Bucket #2
Fixed income. It covers years 5 to 15 or 5 to 20 or whatever you think is appropriate. Each year you move one year worth of living expenses to Bucket #1, to purchase a new 5 year GIC.

Bucket #3
Equities. You move funds from Bucket #3 to #2 when equities are in good shape.

As far as I know, this strategy is rather controversial among retirement planners. Some argue that it's just a sexy way to repackage the standard asset allocation. In any case, I think it's an interesting idea worth exploring.


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## james4beach (Nov 15, 2012)

And if the reverse rebalancing allows me to now "reliably" tap into capital gains on the equity side, then maybe I can add capital gains expectations to my original example.

Does the following math work?

The equity side now has _expected_ total return of 6.0% per year, of which 3.92% is dividends and the remaining 2.08% hopefully comes from capital gains.
Fixed income side still has total return of 2.47%
And I'll add in another 1% liquidation ROC, killing some capital, just to boost the income cashflow.

This gives the portfolio a distribution (something the retiree would make constant)
= (0.5 x 6.0%) + (0.5 x 2.47%) + 1% = *5.24% fixed cashflow*

Here is where this distribution comes from:
a) Stock dividends, 0.5 x 3.92% yield = 1.96%
b) Fixed income interest, 0.5 x 2.47% yield = 1.24%
c) Some liquidation (ROC) hopefully from capital gains but maybe from FI, 0.5 x 2.08% = 1.04%
d) ROC purely taking from capital = 1%
... which adds up to create the 5.24% total distribution. I think the SWR = 1.04+1.00 = 2.04%

This doesn't look too bad to me. 5.24% fixed distribution is nothing to sneeze at. It's being funded by rather standard 50/50 stocks & fixed income, assuming a 6% total return from stocks. Additionally I'm drawing out just 1% of the fund to boost the distribution. And SWR of 2.04% seems pretty low right?

Am I figuring this correctly?


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## james4beach (Nov 15, 2012)

doctrine: what are your thoughts on the model suggested in my last post, in light of your criticisms from post #7 ? The way I have it above, with that reverse rebalancing, there wouldn't be any selling of depressed stocks. It also relies on selling off a reasonably small amount (2.04%) to make that 5.24% total distribution. If stock returns keep up with the 6% expectation, then only 1% is actual return-of-capital / liquidation... which would be far less than most of those income funds and barely noticeable, I think.


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## doctrine (Sep 30, 2011)

If you need more income then you need higher dividend yields. They are obtainable in the Canadian market, although more difficult with just ETFs. If you're into modelling then I would just stick with ZRE and ZDV. You could also stick in ZUT and then you'd have a little more diversification but still > 5% yield. I dislike ZDV and ZUT but I think they're your only ETF option. 

I would be interested in researching some options for higher yields in the Canadian market. For example, what do the 30 highest yielding stocks on the TSX Composite of ~246 stocks look like? If you excluded the 10 highest (for potential danger), what would you be left with? Perhaps something you could work with on an "automatic" basis. (I never favor pure automatic approach but this is 'modelling').


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## humble_pie (Jun 7, 2009)

doctrine normally i agree with everything you say, but this is a first to disagree with! this post is so unlike you!

i'd have a strong bias against tilting any senior's portfolio heavily in favour of *high* income stocks, especially those in canadian market. The reason - as is said so often - is that these can be thinly-traded, weak stocks whose dividend sustainability may even be at risk. Merely eliminating the top-paying 10 from a universe of 246 canadian stocks is not enough of a precaution imho. It would be necessary to look skeptically at something like the top 50 to 70.

bref, these stocks are not good candidates to form 100% of a retired person's portf imho. 

one has only to recall the hysterics from seniors' associations when finance minister flaherty snuffed out hi-yielding unit trusts, in order to understand how portfolios stuffed w thinly-traded stocks paying doubtful dividends are not suitable for most over-65s.

often, there are heirs to think about as well. The family does not want to see the capital eroded either by collapse of the market price of a doubtful stock or by the practice of selling off bedrock shares in order to raise "income."

any portfolio can yield better when far out-of-the-money call options are sold. One has only to look at Dmoney's diary to read how his options income is outstripping his dividend income & has been for some time now.

it's true that Dmoney is running an option portfolio that is far more aggressive than any that should be modelled for retirees. But i think - from considerable experience - that another 2-2.50% in current yield, all in the form of tax-favoured capital gains, can be extracted from a conservative covered call portfolio that sedately sells calls far out in time & several increments above market price.

i also bellieve that the stocks to be considered for such a portfolio - bce would be a good example - are far less risky in terms of dividend sustainability than, say, some of the wilder REITs or other obscure, thinly-traded hi-income products.

i realize that some parties in this thread, including the OP, are biased against options because they don't understand them. However, investment counsel JC Hood in ontario runs a successful practice for many retiree clients that concentrates on a conservative covered call strategy utilizing highly liquid etfs such as XIU & XFN.


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## gibor365 (Apr 1, 2011)

doctrine said:


> I would be interested in researching some options for higher yields in the Canadian market. For example, what do the 30 highest yielding stocks on the TSX Composite of ~246 stocks look like? If you excluded the 10 highest (for potential danger), what would you be left with? Perhaps something you could work with on an "automatic" basis. (I never favor pure automatic approach but this is 'modelling').


I'm wondering if I can find all TSX stocks with yields in one table? It would be interesting to look at it....

_i realize that some parties in this thread, including the OP, are biased against options because they don't understand them._
HP, You are absolutely correct 
I don't understand options, and also scared to go into it, as I have impression (probably wrong one) like I will be sitting at poker table with pros or compete with option trading with "gurus" like you. 
HP, can you recommend any book or website describing a conservative covered call strategy for dummies?


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## AltaRed (Jun 8, 2009)

james4beach said:


> Is 1.8% what you call the SWR ? Are we talking about the same thing... liquidating some of the stocks/fixed income, as the case may be based on the 'reverse rebalancing' approach you describe?


No. SWR is the sustained withdrawal rate of the entire portfolio including income. The SWR is 5%, or in your post following that, 5.24%. It intentionally depletes capital over 30 years, so that a 65 yr old retiree dies broke at 95. Many Monte Carlo simulations have been run on this by many studies to calculate the probability of success on this, with most, if not all, studies run from a US centric approach. A simulator for this is FIRECalc http://www.firecalc.com/ which I have run many times substituting Canadian inputs. In Canada, RRIFmetic http://www.fimetrics.com/ does a similar thing (have never used it) but the software must be purchased.

That said, the point is that the only thing that would provide one with 'certainty' would be a GIC ladder or a RRB ladder, or an indexed annuity. Since that is unrealistic, everything else is a series of probabilities. You cannot count on a 5 or 6% cash flow rate from any investment mix without depleting capital. SWR historically has used a 'rule of thumb' of 4%, but with reduced global growth going forward, the trend is to now reduce SWR to circa 3%. 

Part of that depends on how efficient one's portfolio is though and SWR has usually been built on the basis of a professionally managed portfolio by a Portfolio Manager with embedded fees. As we all know, costs matter, whether via MER or percent of AUM, and for the DIY investor saving more than 1% on fees from professionally managed portfolios, I would say that a well run DIY portfolio with less than a 50bp cost probably can still operate with an SWR of 4% going forward. 

The bucket approach mentioned by GoldStone has been controversial but I believe can be effective as well. It has had much air play in many forums, such as the Early Retirement Forum in the USA. The question really is whether retirees over the long term really want to manage such portfolios. The answer is probably not, and if not, then what? It is then probably time to annuitize at least part of the portfolio.


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## james4beach (Nov 15, 2012)

I don't have options experience and so I'm definitely not going to suggest that my parents start employing some kind of options strategy in their retirement portfolio.

Guys I'm just wondering if my basic math and logic is correct.  The portfolio can always be tweaked...

Basically do my post #15 calculations look right? It seems to me that if you use the assumption of 6% stock returns, even this conservative mix (combined with just 1% return of capital) creates an overall income flow of 5.24% per year... that all looks pretty good to me but I'm wondering if I'm missing something.

Even if you choose different stocks, or higher dividend stocks, the total return expectation is still 6% right? Makes no difference, it seems to me. I'm just trying to understand the math that converts total returns (6% in stocks and 2.5% in fixed income) into an income cashflow payout... which I calculated in my example as 5.24%


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## james4beach (Nov 15, 2012)

AltaRed said:


> No. SWR is the sustained withdrawal rate of the entire portfolio including income. The SWR is 5%, or in your post following that, 5.24%. It intentionally depletes capital over 30 years, so that a 65 yr old retiree dies broke at 95.


Oh I see that's what SWR means, it's just what I've been calling the portfolio distribution yield.

I don't follow the intentional capital depletion part though.

Since the fixed income side generates income without depleting capital, and 6% stock returns can be extracted without depleting capital, isn't it only my 1% ROC that is depleting capital?

Are are you saying that the 1% ROC that I threw in there is large enough in itself to kill the portfolio in the long term?


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## james4beach (Nov 15, 2012)

AltaRed: or maybe I muddied it unnecessarily with my extra 1% ROC.

Say you had just the balanced fund. Stock side earns 6% total return, fixed income side earns 2.5%.
So the whole thing earns the average, 4.25% ish

If you're extracting (SWR) that 4.25%, why is that unsustainable? You were telling me that stocks can be relied on for 6% returns so how is that depleting capital? Is it because the volatility that happens within the portfolio and is that what the simulations show... that when your stocks jump all over the place, you actually can't steadily withdraw based on the 6% assumption?


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## andrewf (Mar 1, 2010)

james, what about sequence of returns risk? Drawing down at 4% of original value on a portfolio that has fallen by 50% means withdrawing 8% of the remaining value.


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## james4beach (Nov 15, 2012)

andrewf said:


> james, what about sequence of returns risk? Drawing down at 4% of original value on a portfolio that has fallen by 50% means withdrawing 8% of the remaining value.


Well the number isn't as large as that because the 50% crash is only on half of the balanced portfolio and the dividends are still intact, but I get your point... I can see how that really hurts the picture.

You'll recall that my first post only relied on the dividends + interest income without counting any capital gains. So if you stick to only divs & interest, then _that_ is sustainable right? i.e. no shares are sold out of the portfolio.


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## AltaRed (Jun 8, 2009)

james4beach said:


> Say you had just the balanced fund. Stock side earns 6% total return, fixed income side earns 2.5%.
> So the whole thing earns the average, 4.25% ish
> 
> If you're extracting (SWR) that 4.25%, why is that unsustainable? You were telling me that stocks can be relied on for 6% returns so how is that depleting capital? Is it because the volatility that happens within the portfolio and is that what the simulations show... that when your stocks jump all over the place, you actually can't steadily withdraw based on the 6% assumption?


Andrewf is correct in when stocks (and sometimes bonds too) are down, there is more capital depletion and it is that capital depletion, once depleted, that is no longer around for the stock recovery part of the business cycle. Monte Carlo simulations will prove that. Imagine a person who retired in July 2008 just before stock markets swooned. That person would have been depleting capital early on, capital which cannot recover in 2010+. 

In other words, stocks do not provide a steady 6% return (and by the way, that is a forecast going forward, not certainty). They could be negative for multiple years. Chances are a 4% SWR will work just fine for, say, 95% of the time (historically), or let's say 75% of the time going forward. What about the other 25% of the time? How does one manage? One way that I mentioned above is to reduce the withdrawal rate during the lean years of depressed stocks to minimize the cannibalization of capital, and live with a reduced budget or get a part time job.

Balanced and/or income funds advertised for their 5%, 6%, 7% payouts will most likely deplete over time. Not being an expert, I suspect the companies peddling these eye catching numbers are betting on a 50% success rate. After all, these so called professionals know about SWR too.... and the 'rule of thumb' of 4%. Not only that, by the time the investor sees their investment being depleted (reducing NAV) at a noticeable, or alarming, rate, it will likely be many years, and too late to do anything about it. The companies peddling these products will just say..... the markets did not perform as expected. Sorry.

And to your last point. Yes, if you withdraw only the INCOME from the assets (dividends and interest), then that is sustainable (inflation vs price appreciation notwithstanding). That is a goal many here aspire to.. to have enough capital to live off the income.


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## doctrine (Sep 30, 2011)

> doctrine normally i agree with everything you say, but this is a first to disagree with! this post is so unlike you!
> 
> i'd have a strong bias against tilting any senior's portfolio heavily in favour of *high* income stocks, especially those in canadian market. The reason - as is said so often - is that these can be thinly-traded, weak stocks whose dividend sustainability may even be at risk. Merely eliminating the top-paying 10 from a universe of 246 canadian stocks is not enough of a precaution imho. It would be necessary to look skeptically at something like the top 50 to 70.


humble_pie, until I actually look at the list of companies, its difficult to say how risky it is. There may actually be nothing wrong with the highest yielding of the composite companies. For example, BCE and BMO could easily be a major part of such an income portfolio; BCE yielded 5.5% and BMO yielded 5% for much of this year, with yields well in excess of the TSX Composite, but in my opinion are hardly high risk stocks that are reaching into troubled areas. Not only do you get a great yield, but lots of potential for increases at or above the rate of inflation. Those two companies could definitely be a major part of a retirement income portfolio. As you say, options may be another way to generate income, but this is not an area I can offer advice.


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## MoneyGal (Apr 24, 2009)

james4beach said:


> Oh I see that's what SWR means, it's just what I've been calling the portfolio distribution yield.
> 
> *I don't follow the intentional capital depletion part though*.
> 
> ...


Some people don't have a financial legacy motive, but want to calculate a withdrawal rate that is sustainable (i.e., provides sufficient income) over a defined period (typically 30 years). So there is very deliberate encroachment upon capital through retirement. 

If you have "enough" capital (+ annuitized assets i.e., CPP) to produce sufficient income via distributions alone, the concept of a sustainable withdrawal rate is less relevant (although ROC, as you've pointed out, muddies the waters, potentially significantly over time). Very few people amass sufficient nest eggs to live on distributions through retirement, which is why this is not a strategy for which you will find much support in mainstream financial publications or mainstream financial thinking.


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## humble_pie (Jun 7, 2009)

doctrine said:


> humble_pie, until I actually look at the list of companies, its difficult to say how risky it is. There may actually be nothing wrong with the highest yielding of the composite companies. For example, BCE and BMO could easily be a major part of such an income portfolio; BCE yielded 5.5% and BMO yielded 5% for much of this year, with yields well in excess of the TSX Composite, but in my opinion are hardly high risk stocks that are reaching into troubled areas. Not only do you get a great yield, but lots of potential for increases at or above the rate of inflation. Those two companies could definitely be a major part of a retirement income portfolio. As you say, options may be another way to generate income, but this is not an area I can offer advice.



agree absolutely, BCE, BMO & probably all the chartered banks are prime candidates for a retiree's portf. As a matter of fact, for anybody's portf imho.

i haven't looked recently. But the last time (roughly 2 years ago) i looked at a screener presentation of TSX yields, i was shocked at how far down one had to go before encountering anything of reasonably decent quality. At least the top quarter of the list had to be dismissed. The BCEs & the BMOs were surprisingly far down.

i would imagine that the dividend class mutual fund managers do sneak in some risky hi-payors here or there in order to boost yield. Presumably they monitor very closely in order to watch over sustainability of the dividend. This is not how we want our seniors to be spending their days? (wasn't there some thread in cmf about an unhappy canadian hi-payor called Just Energy?)


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## james4beach (Nov 15, 2012)

MoneyGal said:


> Some people don't have a financial legacy motive, but want to calculate a withdrawal rate that is sustainable (i.e., provides sufficient income) over a defined period (typically 30 years). So there is very deliberate encroachment upon capital through retirement.
> 
> If you have "enough" capital (+ annuitized assets i.e., CPP) to produce sufficient income via distributions alone, the concept of a sustainable withdrawal rate is less relevant (although ROC, as you've pointed out, muddies the waters, potentially significantly over time). Very few people amass sufficient nest eggs to live on distributions through retirement, which is why this is not a strategy for which you will find much support in mainstream financial publications or mainstream financial thinking.


Interesting. So let's say the retiree in question decides, I simply don't have enough capital to live purely off generated income, therefore I am willing to deplete some capital and generate higher cashflow with the result being a shrinking account value over time. (I suspect this is what my parents will decide though I don't know how much capital they're willing to deplete)

If that's the goal going in, then does my post #15 look about right as far as mechanism to generate cash? I realize that 5.24% wouldn't be "sustainable" -- if one _were_ trying to sustain capital. But is what I propose there sensible in terms of liquidating some, which I hope will come from capital gains, and a little extra purely for capital depletion, along with a technique like reverse rebalancing to try and do it as sustainably as possible?

If stocks keep up with the 6% total return expectation it looks to me like only minimal ROC is going to be relied upon for the cashflow and I feel like the numbers I have there look better than a lot of monthly income products I've seen


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## MoneyGal (Apr 24, 2009)

Agreed that your numbers look reasonable, but I haven't spent a lot of time thinking about your proposition. 

I am not a fan of reverse rebalancing (or similar variants).


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## Spudd (Oct 11, 2011)

MG, why not? I'm curious, since in thinking about my retirement it seemed like reverse rebalancing (i.e. sell whichever asset is overweighted to bring things back to the desired asset allocation) would be the way to go.


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## MoneyGal (Apr 24, 2009)

Spudd said:


> MG, why not? I'm curious, since in thinking about my retirement it seemed like reverse rebalancing (i.e. sell whichever asset is overweighted to bring things back to the desired asset allocation) would be the way to go.


Here's the counterexample:

http://www.ifid.ca/pdf_newsletters/PFA_2006OCT_Buckets.pdf

It's a variant on sequence risk.


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## Sampson (Apr 3, 2009)

Thanks for the post MGal. Interesting and essentially boils down the likelihood of experiencing a major crash over the period of the first bucket - and if shifting asset allocation (towards holding less cash as it is depleted in the bucket) is favorable.

One would think a good place to start finding info would be this book Pensionize your nest egg.


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## MoneyGal (Apr 24, 2009)

(can't tell if previous poster knows I co-wrote the book he is recommending or not)


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## gibor365 (Apr 1, 2011)

MoneyGal said:


> Very few people amass sufficient nest eggs to live on distributions through retirement, which is why this is not a strategy for which you will find much support in mainstream financial publications or mainstream financial thinking.


Reading posts on seekingalpha.com and some other bloqs, there are quite a few retired who lives strictly on distributions without touching principal..
Also, last several years there is a trend for North American to retire abroad
, for example in Panama, Thainland, Mexico, Ecuador, Spain, Portugal etc 
http://internationalliving.com/ , Forbes and some other sources state that in those countries North American's couple can comfortable retire having income $1,200 - 2,500/month that is pretty achievable with moderate portfolio


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## AltaRed (Jun 8, 2009)

gibor said:


> Reading posts on seekingalpha.com and some other bloqs, there are quite a few retired who lives strictly on distributions without touching principal..
> Also, last several years there is a trend for North American to retire abroad
> , for example in Panama, Thainland, Mexico, Ecuador, Spain, Portugal etc
> http://internationalliving.com/ , Forbes and some other sources state that in those countries North American's couple can comfortable retire having income $1,200 - 2,500/month that is pretty achievable with moderate portfolio


That works for a specific segment of the population who have some ties in the place of interest, or does not have, or doesn't much care about, home ties to friends and family. Retirees cannot expect their working children (and families) to incur the expense of visiting them. Either retirees pay the travel expenses or the retirees make frequent visits back home. HGTV capitalizes on this trend with their programming. Seldom does one hear about the downside. I am not knocking it for those can make it 'work' in all aspects, not just the financial aspect.


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## Toronto.gal (Jan 8, 2010)

gibor said:


> for example in Panama...


Yup, and some live right next to a volcano there, which is dormant.... for now.  But the view just breathtaking.

Another example, the British flocking to Turkey.


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## AltaRed (Jun 8, 2009)

MoneyGal said:


> Here's the counterexample:
> 
> http://www.ifid.ca/pdf_newsletters/PFA_2006OCT_Buckets.pdf
> 
> It's a variant on sequence risk.


I agree re-balancing, or bucket, approach contains risk. So does any SWR plan (fixed rate). Markets can stay bad longer than an investor can stay solvent. Which is another way of saying, it needs to be 'actively' managed by the investor, i.e. be ready to throttle back withdrawals, or as many would argue, annuitize part of the nest egg for a safety net and let others take on some of the risk.

I suspect an investor would cut back if s/he had nothing other than a good, e.g. Mawer, balanced fund because s/he would see (like a brick between the eyes) their monthly/quarterly statement with dramatic decreases in NAV in bad times and intuitively cut back. I, for one, did not lump sum my DB pension at retirement. I wanted it to be part of my safety net along with CPP and OAS, allowing me slack in my other investable assets.


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## Sampson (Apr 3, 2009)

MoneyGal said:


> (can't tell if previous poster knows I co-wrote the book he is recommending or not)


I couldn't tell either and the pieces I've read are great so I'm happy to give the plug. Also, there really are only a handful of reasonable ways to approach this problem, so seems good to choose the one that fits the person's 'profile'.

Aside: In terms of pension products, are their ones that also provide a payout upon death for heirs?


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## MoneyGal (Apr 24, 2009)

Sampson said:


> I couldn't tell either and the pieces I've read are great so I'm happy to give the plug. Also, there really are only a handful of reasonable ways to approach this problem, so seems good to choose the one that fits the person's 'profile'.
> 
> Aside: In terms of pension products, are their ones that also provide a payout upon death for heirs?


Yes. In fact GMWBs are the classic illustration of this solution. However, you can also buy a single premium income annuity (SPIA, the "basic" life annuity) with guarantees - typically a guarantee that the payments continue (to a surviving spouse or other heir) over a defined period of time. Most annuities in Canada are sold in registered accounts with a 10-year guarantee.


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## gibor365 (Apr 1, 2011)

AltaRed said:


> Retirees cannot expect their working children (and families) to incur the expense of visiting them. Either retirees pay the travel expenses or the retirees make frequent visits back home. HGTV capitalizes on this trend with their programming. Seldom does one hear about the downside. I am not knocking it for those can make it 'work' in all aspects, not just the financial aspect.


Sorry, don't know what is it HGTV 
You're not so right about visiting relatives.... It's pretty common that parents and grown up children live in different provinces, and air ticket from Toronto to BC or AB will be about the same that Toronto to Nicaragua, Panama or Ecuador ( even sometimes tickets to Europe is cheaper).... and life in those countries are much cheaper and more interesting... I think my kids would be more frequently visit us in any other countries than in different province of Canada....
Recently I had discussion with Canadian who sold his house, invested into dividend stocks, GIC, ETF and retired in Mexico (Pacific part), he rented from Canadian and pays for rent 2bedroom condo 2 blocks from the beach $1,000 all included, live is much cheaper, there are tons of North Americans who lives there .... once per year he plans to come to Canada to visit relatives and friends...and he's very happy over there....
We're not sure that we'd like retire abroad (long term travel is more appealing to us), but it's definitely possibility.... 

P.S. I was born in Siberia, but for sure won't miss nasty Canadian winter


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## AltaRed (Jun 8, 2009)

gibor said:


> Sorry, don't know what is it HGTV
> You're not so right about visiting relatives.... It's pretty common that parents and grown up children live in different provinces, and air ticket from Toronto to BC or AB will be about the same that Toronto to Nicaragua, Panama or Ecuador ( even sometimes tickets to Europe is cheaper).... and life in those countries are much cheaper and more interesting... I think my kids would be more frequently visit us in any other countries than in different province of Canada....


You are right - the same issue applies to living in distant parts of Canada. In the families I am most familiar with, being more than about 2000 km away becomes a significant barrier to travel. It matters not if people are reasonably wealthy, but a middle class family of four travelling any significant distance is a significant expense (more than $2k better spent on mortgage, consumer debt, appliances, furniture). 

My partner and I considered having a winter place in Costa Rica but realized that no one we knew would spend the money to visit us there over the 3-5 months we would be there. So instead, we will winter in the southern USA a month or two at a time - which is all we need to do given our location in the Okanagan Valley.

HGTV is the home and garden cable channel on TV. They oversimplify and overglorify exotic places to spend winter.


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## gibor365 (Apr 1, 2011)

AltaRed said:


> My partner and I considered having a winter place in Costa Rica but realized that no one we knew would spend the money to visit us there over the 3-5 months we would be there. .


Too bad you don't know us....we'd cone to Costa Rica  
Also. our kids would more likely to visit us there than 25th time to go to Cuba 
To tell you the truth, we used to big distances...for many years we lived in Toronto, my mom in Israel and my brother in Finland.... and everyone travelled from country to country 
Usually we fly about 3 times per year for vacations, but we'd like to have several months long term vacation in Europe or S. America


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## liquidfinance (Jan 28, 2011)

gibor said:


> james4beach, just wondering why you restrict equity portfolio with only 3 ETFs, won't be better to create portfolio with solid blue chip stocks like PM, MO, JNJ, ABBV, KMB, MCD, LMT couple of Canadian banks and telecoms, couple of UN like SRV.UN, CHE.UN... thus you can have yield around 4.5-4.7% and most of those "guys" would increase dividends every year.
> For fixed income , I'd rather invest into PT who gives 3% on TFSA and 1.9% on saving account


Gibor. Whilst I love SRV.UN I think this is way way beyond any level of risk that James would be willing to take and I really only hold it now because I can afford to take the risk. I wouldn't consider it in my pension fund that's for sure.


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## Cal (Jun 17, 2009)

I think it is safe and conservative of you to factor in the captital gains at 0%.

Also, you may want to consider some preferred shares or an etf like XPF for increased income.


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## gibor365 (Apr 1, 2011)

liquidfinance said:


> Gibor. Whilst I love SRV.UN I think this is way way beyond any level of risk that James would be willing to take and I really only hold it now because I can afford to take the risk. I wouldn't consider it in my pension fund that's for sure.


If you noticed I listed first banch os dividend champions, canadian banks and telcos.... I gave only example SRV and CHE (it can be former trust LIQ or PZA or something else) - to add couple of trusts to increase yield a bit.... I agree that SRV.UN and similar are risky, but if your total allocation to those trusts 5-7% , imho it's OK for retirement portfolio also. And I think that ZUT given in example is not safer than many trusts... Probably from utilities perspective it's more save to include in this portfolio FTS or EMA or big US utility like D, SO, DUK...


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## james4beach (Nov 15, 2012)

Interesting thought process here of the intrinsic dangers of taking a fixed cashflow ('distribution') out of a portfolio. As AltaRed is saying making it a constant amount can land you in trouble... after all everything is subject to change. If they're dividend paying stocks, the dividends can get cut. If they're regular stocks, the index can decline. etc

I still am upset that the financial industry hammers away at this idea that perpetual positive stock market returns are virtually guaranteed... it's giving a lot of people the wrong idea about what their retirement portfolios can do for them

You would have thought that 2008 would have been a valuable lesson, but markets bounced back so quickly (this time -- due to stimulus) that the message was somewhat lost. Markets could have stayed depressed a lot longer than this, and it *has* happened before.

In Japan, stocks were depressed for around 30 years I think


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## Eclectic12 (Oct 20, 2010)

james4beach said:


> ... I still am upset that the financial industry hammers away at this idea that perpetual positive stock market returns are virtually guaranteed... it's giving a lot of people the wrong idea about what their retirement portfolios can do for them
> 
> You would have thought that 2008 would have been a valuable lesson, but markets bounced back so quickly (this time -- due to stimulus) that the message was somewhat lost. Markets could have stayed depressed a lot longer than this, and it *has* happened before.
> 
> In Japan, stocks were depressed for around 30 years I think


True ... but then again, how comparable is the environment one is investing in versus the Japanese environment?

And likely of more importance - what if any steps is the individual investor taking to factor this in and/or make use of drops like 2008?


Cheers


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## andrewf (Mar 1, 2010)

How is assuming zero capital gains and spending income on a portfolio yielding 3% different than using a SWR of 3% on any balanced portfolio, regardless of its yield? Based on historical returns, a 3% withdrawal rate is pretty conservative. I think you all are way overthinking it, and getting caught in the yield illusion. Yield is no more guaranteed than CGs. Spending only the initial yield is no guarantee you won't deplete your savings.


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## My Own Advisor (Sep 24, 2012)

Spending only the initial yield is no guarantee you won't deplete your savings. +10.

True, but it is more tangible than CGs, meaning, you actually see/get paid the money. There is an opportunity cost here, get paid now or hope to get paid (even more) later.


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## MoneyGal (Apr 24, 2009)

Useful reading for the mathematically- and statistically-oriented among you: http://wpfau.blogspot.ca/2013/06/asset-valuations-and-safe-portfolio.html


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## Sampson (Apr 3, 2009)

My Own Advisor said:


> True, but it is more tangible than CGs, meaning, you actually see/get paid the money.


Yes, tangible, and equally tangible if you lose it. I think any retiree needs multiple strategies and multiples streams of income - spread the risk to lower the impact of losing any stream.

I know people get greedy and don't want to hand over potential profits to insurance companies, but I'm really starting to believe in annuity products. I'm sure we are a few years removed to understanding how the last market crash has affected recent retirees, more aged workers, more seniors with debt.


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## MoneyGal (Apr 24, 2009)

Surely those people also don't hand their yearly fire insurance premiums over to insurance companies, right?

:chuncky: (adding a smilie so I don't come off as overly combative)


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## Sampson (Apr 3, 2009)

MoneyGal said:


> Useful reading for the mathematically- and statistically-oriented among you: http://wpfau.blogspot.ca/2013/06/asset-valuations-and-safe-portfolio.html


Sweet! thanks for the link.


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## MoneyGal (Apr 24, 2009)

LOOK CAREFULLY, MY BOOK IS VISIBLE ON THAT PAGE

Seriously, Wade is a great thinker and a great guy because he is immensely curious and immensely creative.


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## Sampson (Apr 3, 2009)

MoneyGal said:


> Surely those people also don't hand their yearly fire insurance premiums over to insurance companies, right?
> 
> :chuncky: (adding a smilie so I don't come off as overly combative)


I only mean that the perception of the product is often misguided, and I think most DIYer's are typically over confident, so given the published payout rates from those annuities, comparing those to a DIY portfolio, and seeing how much is 'skimmed' off the top, I certainly used to feel that I would want to assume the risk. Probably because I'm younger and don't actually have to make the decision at this point.


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## MoneyGal (Apr 24, 2009)

Well, not to overly hijack this thread, but IMO this is where the distinction of "yield" comes into play and why the implied longevity yield is a useful metric: the annuity payout is guaranteed. What is the equivalent payout from a similarly-guaranteed product? Of course equities have a higher expected return, this is the essence of MPT. But when what you want from a portfolio is yield, not growth, equity returns over long periods are much less relevant.


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## Sampson (Apr 3, 2009)

MoneyGal said:


> Wade is a great thinker and a great guy because he is immensely curious and immensely creative.


Still scanning through quickly, but it seems it is too bad they didn't model using different (CAPE:bond yields). That would almost form an 'instructive' proposal for safe withdrawal rates.

At least they publish all the details of the model... I wonder if any CMFers are inclined to run a few more simluations.


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## james4beach (Nov 15, 2012)

Wow great article thanks for posting. I'm certainly on the same page as Wade as I observe, as he does (using for instance CAPE) that we simultaneously have overpriced stocks and bonds. My argument has been for a while that we're experiencing a bubble in everything: stocks, bonds, real estate.

Notice however his model is based on April bond yields and the yields are significantly higher now on the 10 year. And he mentions that the outcome of his study is very sensitive to the yield parameter. After all the 10 yr yield has increased by a whopping 120 basis points since the time he analyzed the numbers.

He calculated a 48% success probability on the example scheme... that success probability is certainly higher today.


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## doctrine (Sep 30, 2011)

I'm not sure why anyone would use 2% coupons on a portfolio of 60% bonds to sustain a 4% withdrawal rate and expect anything other than disaster.


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## MoneyGal (Apr 24, 2009)

Yabbut do a Google search on "sustainable withdrawal rate" and see 4% quoted as if it came down from the mountains with Moses.


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## james4beach (Nov 15, 2012)

The Federal Reserve and Bank of Canada have killed the traditional assumptions on fixed income.

Thanks Carney! Pumped the real estate market sky high and left savers with < 3% yields. Bravo, glad you left before we got the 'encore'.


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## andrewf (Mar 1, 2010)

On a CAPE basis, it's really only the US that's very expensive. Canada is moderately expensive and EAFE/EM indexes are right around 16.5, which is a reasonable mean.


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## andrewf (Mar 1, 2010)

james, I don't think you would have liked the alternative universe where monetary policy had been kept tight and we experienced a severe recession.


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## Sampson (Apr 3, 2009)

doctrine said:


> I'm not sure why anyone would use 2% coupons on a portfolio of 60% bonds to sustain a 4% withdrawal rate and expect anything other than disaster.


Because in times past, CAPE would be low and their difference could be made from the equities portion of the portfolio.


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## My Own Advisor (Sep 24, 2012)

"Yes, tangible, and equally tangible if you lose it. I think any retiree needs multiple strategies and multiples streams of income - spread the risk to lower the impact of losing any stream."

Solid point Sampson and you're right. This is why I'm hoping for the following income stream to fund my retirement: pension + dividend stocks + broad-market equity ETFs + laddered GICs. I don't plan owning an annuity until my 60s, if at all based on this formula.

CPP and OAS are a bonus and I'll definitely take it if and when I can, likely CPP at 60 with all the fun penalties associated with it.


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## MoneyGal (Apr 24, 2009)

"actuarial adjustment" not penalty! 

Also, it is generally understood that annuities should wait until age 70 or later. The classic paper on this point is here: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=289548


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## My Own Advisor (Sep 24, 2012)

I also read about that in your book MG. I have it in front of me  "The overall lesson here is that if you have both pensionized assets and an investment portfolio, then the greater the amount of pension income, the more you can withdraw from your portfolio in the early years of retirement, all else being equal."

Sub-title: Pensions Change the Game.


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## james4beach (Nov 15, 2012)

andrewf said:


> james, I don't think you would have liked the alternative universe where monetary policy had been kept tight and we experienced a severe recession.


I'm hesitant to get off track on my own thread, but I think the central bank intervention made things worse. Because now we're right back to the same old financial excesses as pre-crisis, PLUS we have denial that problems exist, PLUS we have a national housing bubble. We'll see how it all turns out.


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