Floor and Ceiling Retirement Strategy with 4 Percent Fixed Percentage

Floor and Ceiling Retirement Strategy with A Fixed Withdrawal Rate is one of variable withdrawal strategies in order to maximize withdrawals while at the same time incorporating some provision to reduce withdrawals.

The withdrawal amount is calculated as a percentage of the portfolio total value. The withdrawal amount is allowed to rise or fall with the performance of the portfolio. However, the withdrawal will neither fall below a floor nor rise above a ceiling.

As an example, the initial floor can be set at 3.6% and rise with inflation. And the initial ceiling can be set at 5% and rise with inflation. The withdrawal amount can be set initially at a fixed percentage like 4%. On a $1,000,000 portfolio, the withdrawal will not fall below an inflation-adjusted amount of $36,000. Nor will the withdrawal rise above an inflation-adjusted amount of $50,000.

Performance and Risks

We have four model portfolios. The floor and the ceiling for all five portfolios are set to be 0.036 and 0.05 respectively. The fixed withdrawal rate is 4% and the checking interval is two months.

  • The first portfolio starts from 01/01/1994 to 08/04/2009, investing only in one ETF-the SPY. The Sharpe ratio is 0.09 and the standard deviation is 0.206, which is not so satisfactory.

  • The second one invests in the same security as the first one does, but starts from 02/01/2000. It has done worse than the first portfolio, the Sharpe ratio being -0.409 and the standard deviation being 0.235.
  • The third one invests in two ETFs-the SPY and the EFA. It starts from 05/13/2006 to 08/04/2009, achieving a Sharpe ratio of -0.42 and a standard deviation of 0.308.

  • The fourth portfolio invests in two assets. One is an equity-represented ETF-the SPY, and the other one is a fix-income-represented mutual fund-the BEGBX. Starting from 01/01/1994, up to 08/04/2009, it achieves a Sharpe ratio of 0.094 and a standard deviation of 0.148. This is the best performance among all five portfolios.

From above, we can see that Floor and Ceiling Retirement Strategy with A Fixed Withdrawal Rate does not do very well when it comes to actual investment. The Sharpe ratios of some model portfolios are small, even negative. Especially for those portfolios which invest only in equity-represented ETFs, the Sharpe ratio is very low with a very high standard deviation. To improve the performance, you better add some fixed-income-represented mutual funds or ETFs to your portfolios.

Under this strategy, if the current withdrawal rate is 20% greater than the initial withdrawal rate, then cut withdrawal by 10%. And if the current withdrawal rate is 20% smaller than the initial withdrawal rate, increase the withdrawal by 10%.

See Also

William Bengen. "Conserving Client Portfolios During Retirement, Part IV". Journal of Financial Planning. May 2001


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