PP, Retirement, and Safe Withdrawal Rates

General Discussion on the Permanent Portfolio Strategy

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Tyler
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PP, Retirement, and Safe Withdrawal Rates

Post by Tyler » Tue May 19, 2015 1:10 pm

This doesn't cover anything that hasn't already been discussed here in one thread or another, but after writing a long post on another forum I thought it would also be good to cross-post it here for posterity.

*****
Interested Investor wrote:All portfolios composed of only stocks and bonds are vulnerable to periods of high inflation; thus, they are vulnerable to portfolio failure. Reducing the withdrawal rate will lessen, but not remove this vulnerability.  The Permanent Portfolio addresses this vulnerability by adding more asset classes; although, I am not familiar with any studies trying to ascertain a safe withdrawal rate for the Permanent Portfolio.
I've studied this pretty extensively. I'll try to keep it brief, but it's a complicated topic. 

First, it's very important to understand that retirement calculators like CFireSim do not model the Permanent Portfolio well at all.  There are two basic reasons for this: 1) the PP only applies to the time period after 1972 when the US came off the gold standard, and 2) the bonds in CfireSim and Firecalc are not long-term treasuries and the cash is not short-term treasuries.  So only 25% of the portfolio is accurately modeled for PP purposes. I know these calculators are fun, but for the purpose of studying the PP throw them out. 

Second, because of point #1 above, it's difficult to run the same 30-year analysis of the PP and compare apples-to-apples to the Trinity study.  Starting in 1972, you just won't get enough full 30-year periods to have a statistically significant sample for "percent success" numbers.

Third, as an early retiree I've always been dissatisfied with the Trinity study's basic assumption that only having one dollar left in your account after 30 years would constitute a "success".  I would feel pretty desperate having only $1 in investments 30 years from now.  So even the basic "percent success" numbers are meaningless to me. 

Knowing all of this, I still wanted to know whether the PP was a good retirement portfolio.  So I modeled it myself using excel (adjusting the initial WR for inflation each year, withdrawing from cash, and rebalancing by the traditional method when a 15/35 band was crossed by one of the assets).  Instead of 30-year periods, I used 10-year periods.  To compensate for the shorter timeframes, I used a much more conservative assumption that "success" means having the same inflation-adjusted balance in ten years as you did when you started.  That means that if you set your initial WR to the lowest point on the chart, you will have the same inflation-adjusted balance in ten years and more than that in every other 10-year period.  Then I ran a bunch of optimizations.  Here are the results:

Image

The blue line is the PP.  The red is a typical 50/50 Stock/Bond Boglehead portfolio.  The BH portfolio looks really nice in this timeframe because of the stock run in the 80's and 90's, but remember that the Trinity study still only recommended a 4% WR.  Why is that?  Because of multiple historic rolling periods like the left side of the chart where the real CAGR was negative for more than 10 years at a time.  In contrast, this shows how the PP consistently generates real returns of 4-6% in all kinds of economic environments, including ones where stocks and bonds struggle.

I have lots of other charts and tables if anyone is interested, but the basic takeaway is that while a traditional stock/bond portfolio is generally assumed to accommodate a 4% SWR and not go broke in 30 years, the PP has historically handled the same 4% SWR and maintained principal with a much smoother ride along the way. 

Image
Note that this image shows the CAGR for your investments after expenses. 

So yes, I do have 100% of my investments in the permanent portfolio.  And no, I don't follow my calculations blindly in the same way I don't recommend people put all their eggs in the Trinity Study basket.  If you're not willing to adjust to adversity, you're not ready to retire.  But hopefully this helps people understand the PP as a viable alternative to traditional retirement portfolios.
Last edited by Tyler on Tue May 19, 2015 1:44 pm, edited 1 time in total.
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Re: PP, Retirement, and Safe Withdrawal Rates

Post by dualstow » Tue May 19, 2015 1:52 pm

I appreciate the cross posting. It'll be easier to refer people to this thread.
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Re: PP, Retirement, and Safe Withdrawal Rates

Post by Libertarian666 » Tue May 19, 2015 2:08 pm

On a related topic, I'm making pretty good progress on my program to model retirement withdrawal optimization including the effects of taxes. I'll probably be ready for beta testers sometime this fall.

Maybe earlier if I get laid off from my job if/when the project I'm on crashes and burns, which there is every indication it will.
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Re: PP, Retirement, and Safe Withdrawal Rates

Post by Jake » Wed May 20, 2015 2:03 pm

Tyler your research is great. Did you ever think of publishing it all in a book?
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Re: PP, Retirement, and Safe Withdrawal Rates

Post by Desert » Wed May 20, 2015 6:44 pm

Tyler, this is good stuff. 

When backtesting, I only go back to Jan 1 1975, when legal restrictions on private ownership of gold were repealed in the U.S.  The returns on gold in '72, '73 and '74 were 49%, 71% and 72%.  The returns for those three years, when ownership of gold was still restricted, have a large effect on calculated return and risk effects of a gold allocation. 

Tyler, are you planning a 4% withdrawal rate for more than 30 years with 100% in the PP? 
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Re: PP, Retirement, and Safe Withdrawal Rates

Post by MachineGhost » Wed May 20, 2015 7:52 pm

Desert wrote: When backtesting, I only go back to Jan 1 1975, when legal restrictions on private ownership of gold were repealed in the U.S.  The returns on gold in '72, '73 and '74 were 49%, 71% and 72%.  The returns for those three years, when ownership of gold was still restricted, have a large effect on calculated return and risk effects of a gold allocation. 
That was just for domestic ownership.  Owning gold physically in Switzerland was doable if you were wealthy enough.  A lot of the brilliant uncirculated pre-1933 gold coins are from caches and hoards held outside the country.
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Re: PP, Retirement, and Safe Withdrawal Rates

Post by Tyler » Wed May 20, 2015 8:51 pm

Desert wrote: When backtesting, I only go back to Jan 1 1975, when legal restrictions on private ownership of gold were repealed in the U.S.  The returns on gold in '72, '73 and '74 were 49%, 71% and 72%.  The returns for those three years, when ownership of gold was still restricted, have a large effect on calculated return and risk effects of a gold allocation. 
Excellent point.  I always prefer analysis that studies all rolling periods versus ones that just start in a single year.  For clarity, be sure to think of the line graph above not as retiring at the left end of the chart and tracking balances as you go, but as retiring every year along the way and plotting the original WR that would (in retrospect) have sustained your inflation-adjusted principal for the next ten years.  If you want to discount the early part because you feel the gold performance was anomalous, just ignore the first three data points.  FWIW, the interesting thing data-wise is that gold taking off in the early 70's did not affect the portfolio the way you'd expect.  The stock market in '73 and '74 was brutal, and PP returns actually went up after 1975. 
Desert wrote: Tyler, are you planning a 4% withdrawal rate for more than 30 years with 100% in the PP? 
I did not make my early retirement decision based solely on a SWR.  I needed to line up other things first and also be confident in our expenses, and in the process we saved even more.  My current WR is under 3%.  Our investments are 100% in the PP, and I'm as comfortable as I can be about our financial plan without knowing the future.

Let me put it this way -- I don't believe any magical withdrawal percentage will save you from being responsible for monitoring your finances as you age.  For that reason you'll note I also don't make any statements about what withdrawal rate is "safe" with the PP.  However, I would personally be more comfortable withdrawing 4% from the PP for 30+ years than I would be in a traditional stock-heavy portfolio that most people use as the baseline for retirement calculations.  And I'm happy to be the guinea pig. 
Last edited by Tyler on Wed May 20, 2015 9:46 pm, edited 1 time in total.
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Re: PP, Retirement, and Safe Withdrawal Rates

Post by Tyler » Wed May 20, 2015 8:58 pm

Jake wrote: Tyler your research is great. Did you ever think of publishing it all in a book?
Thanks!  I haven't really thought about it.  But it is something I think I can contribute that would be helpful to people, so I guess I wouldn't rule it out.  I feel like I'll need to read a lot more to be qualified to write a whole book on the topic.  Craig and MTex have set an intimidatingly high bar.  :)
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Re: PP, Retirement, and Safe Withdrawal Rates

Post by Desert » Wed May 20, 2015 9:38 pm

Tyler wrote: Excellent point.  I always prefer analysis that studies all rolling periods versus ones that just start in a single year.  For clarity, be sure to think of the line graph above not as retiring at the left end of the chart and tracking balances as you go, but as retiring every year along the way and plotting the original WR that would (in retrospect) have sustained your inflation-adjusted principal for the next ten years.  If you want to discount the early part because you feel the gold performance was anomalous, just ignore the first three data points.  FWIW, the interesting thing data-wise is that gold taking off in the early 70's did not affect the portfolio the way you'd expect.  The stock market in '73 and '74 was brutal, and PP returns actually went up after 1975. 
Yeah, I understand the graph, and I really like the 10 year periods you selected.  It is indeed a very positive history for the PP.  And I agree that the PP performance after 1975 is very impressive.  Gold cranked out an amazing return of 126% in '79 that sure didn't hurt! 
I did not make my early retirement decision based solely on a SWR.  I needed to line up other things first and also be confident in our expenses, and in the process we saved even more.  My current WR is under 3%.  Our investments are 100% in the PP, and I'm as comfortable as I can be about our financial plan without knowing the future. 

Let me put it this way -- I don't believe any magical withdrawal percentage will save you from being responsible for monitoring your finances as you age.  For that reason you'll note I also don't make any statements about what withdrawal rate is "safe" with the PP.  However, I would personally be more comfortable withdrawing 4% from the PP for 30+ years than I would be in a traditional stock-heavy portfolio that most people use as the baseline for retirement calculations.  And I'm happy to be the guinea pig.
That all makes perfect sense, and I agree that the PP looks like a better portfolio to sustain a given WD than a 50/50 portfolio.  Can you remind me what age you retired? 
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Re: PP, Retirement, and Safe Withdrawal Rates

Post by Tyler » Thu May 21, 2015 12:43 am

Desert wrote: Can you remind me what age you retired?
37.  It's actually less of a retirement and more of a new beginning.  I consider being secure enough in a financial plan to walk away from one's previous career and embrace new opportunities regardless of the financial reward to be an exciting starting point rather than a finish line. 
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Re: PP, Retirement, and Safe Withdrawal Rates

Post by Desert » Thu May 21, 2015 9:41 am

Tyler wrote:
Desert wrote: Can you remind me what age you retired?
37.  It's actually less of a retirement and more of a new beginning.  I consider being secure enough in a financial plan to walk away from one's previous career and embrace new opportunities regardless of the financial reward to be an exciting starting point rather than a finish line.
That's great.  And I like the concept of a new beginning.  I'm looking forward to that step as well, although It'll be at a much later age than you achieved! 

I'm sure many of us will be interested to hear what you decide to do in the future. 
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