Sensible Withdrawals

This strategy proposes not to use a fixed annual withdrawal rate. Instead, it first sets a minimum withdrawal rate( the floor),and then adjusts it according to the market and portfolio conditions.

  • Set a minimum annual withdrawal rate just to cover basic needs,

The minimum rate is called the floor. It can be set at a low level and rise with inflation, just as Bengen’s Floor and Ceiling method.

  • Check the portfolio

We check to see if the portfolio has increased since a year ago, even after the withdrawal. If the total value of the portfolio has increased at least by the inflation rate, then we withdraw some more.

  • Withdraw more if the market is good to us

The additional withdrawal is an additional fraction of the extra gains-the increased value of the portfolio after initial withdrawal. And the extra amount of withdrawal can be capped at a maximum amount which is also inflation-adjusted.

As an example, let’s say the initial floor is set at 3%. And let’s further say that the extra withdrawal amount will be 50% of the portfolio gain after taking the “floor” withdrawal. If we start with a $1,000,000 portfolio and the portfolio gains 10% in the first year and inflation is 3%, we first take $30,900 ($1,100,000*(1+3%)*3%) as the floor withdrawal. The portfolio then is worth $1,069,100 ($1,100,000 -$30,900). The resultant portfolio has risen by at least the rate of inflation ($1,030,000).

So the extra gain would be $39,100 ($1,069,100 - $1,030,000). Then an additional amount is taken -- in this case, 50% or $19,550. So at the end of the first year, $50,450 was withdrawn ($30,900 + $19,550).

Performance and risks

  • We have two model portfolios. The performance of both portfolios is measured from 01/01/1994 to 07/22/2009, and the floor for both of them is 0.03.
  • The first portfolio invests in only one security-the SPY, an equity represented ETF. The Sharpe ratio in the period is -0.169 and the standard deviation is 0.225.The second one 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. It achieves a Sharpe ratio of -0.149 and a standard deviation of 0.167.

See Also


Peter Ponzo (Gummy). Sensible withdrawals.

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