vendredi 3 mai 2024

Decumulation strategy for Vampire

Decumulation strategy for Vampires

Ever wonder why vampires are mostly viewed as having wealth beyond measures? For them, even saving a small fraction of their income would make them filthy rich. Remember the adage of saving early. The reason behind is that any balance left untouched for a long period grows to huge sum. 

Lets be real, a lazy vampire wouldn't want to work forever. Why be immortal if it is for a life of force labor? How early could a vampire stop working and just live off what he has accumulated? To answer this, we need to be real. How much would our vampire need in retirement? A million? How much should he spent each year 120k per year? 

How should vampires game the system? Let's say that they worked their mortal lifespan and accumulate, let's say, a million dollar. Would a vampire need to work? Or would he be able to live a lavish life? How would it evolve through time? Would he need to work again?

An immortal strategy would rely on keeping the principal intact. The first instinct is to remove the increase of the balance, like Dave Ramsey often quote, lets say you have 1 million and lets consider that the past historical average return of the stock market is 12%. Then out of it, you can comfortably lives on 1200k a year. Not bad. If you spent in excess, you will go broke. If you spent under the million would grow each year. 

However, our vampire would rapidly hit a wall. Such a thing as fluctuating market returns exist. Unless vampire overrun our world, they would only be a small part of the world and wouldn't be able to influence the entire market. In fact at 12% withdrawal would have only lasted at the worst historical time, the balance would have gone to 0 in less than 5 years. In other words, this would force our vampire to endure another lifetime of work and misery. If we slash in half the withdrawal to 6%, the worst historical period would force him back to slave work after 10 years. This is unacceptable.  

Before going further, lets not forget about an obscure concept of finance. Lets consider the impact of inflation. If say all your need costed 100k currently, but 104k next year, then we would have faced 4% inflation. Ideally we would reflect our vampire specific inflation, but lets take a proxy using the US inflation. If we did, it surprisingly increase the worst historical period before going back to work to 13 years, using the 6% withdrawal rate. This is because the worst period of returns were in the 1930s where the US faced deflation (ie your need of next year costed less than 100k).  Thus the vampire needs grows each year due inflation. 

Okay, with this established, what would be the safest withdrawal rate our vampire could use and never have to work again. To establish this, I gathered historical data from 1928 to 2023 for the returns on stocks/bonds and inflation. If you are curious see at bottom for all my reference. 

Our vampire would be safe to withdraw 3.5% per year of its initial balance if he elected an asset allocation of 40% bonds/60% stocks. In other word, even if he was unlucky and retire at the worst possible time in the last 100 years, he would have been fine to withdraw 35k from a 1 million initial balance. If we rather used a 100% stocks asset allocations, then he could have withdraw 23k out of that million. 

The last 100 years faced many troubling time. One of the worst was the period of 1929/1930 where the black Fridays occured. If we exclude the years 1929/1930, we can bump the withdrawal to 3.7% in an all stocks asset allocations. This is more or less in line with the 4% rule out there that was calculated by the trinity's study and Bengen's study for us mere mortal over a 40 years lifespan. 

A curious data point we see in the historical return is that the return just prior to those worst period is often golden. for example the return in 1928 were of 40%. Between 1923 to 1928, their initial balance of 1923 would have made be multiplied by 350%! This makes me a little less sympathetic towards the 'rich banker' who lost it all. What the hell did they do with so much increase in the wealth? Lets hope our vampire is more wise and less cupid. 

One way to mitigate this effect would be to use moving average estimate of the balance. Moving average are simply the averages of the last 5 years of balance adjusted by an estimated return. I will refer you to my spreadsheet for more info on this method. 

Another troubled period was around the 1970s; during this time, the issue was not around bad returns. Rather it was inflation. The cost of living increase at around 8% for the whole decade and 3 years above 10%! An underlying reason of the 1970s inflation was due to gas price. Perhaps our vampire could go back its horse riding days not follow the general inflation? Otherwise, I am not convinced that such elongated inflation should occurred in the future. We saw a single year at 8% in 2022 and every government bank in the world raise try to break the pattern like it was the plague.   

Vampire are known to be schemer. Let's further assume that our vampire is a planner. It would be expected for the vampire to prepare his retirement. Let's say he has $567k. At 12%, that should grow to a million easily in 5 years. A good vampire planer would thus take a withdrawal of x% * of the minimum between that million, the smoothed average or the balance at retirement. Using this conservative approach, the 100% stocks allocation safest rate of withdrawal increase from the 3.2% to 3.8%. As a side note, lowering the 100% stocks would have lead to worst results. 

I will explore further tricks that our vampire could use to further increase his laziness and wealth in future post. He could well be somewhat flexible about what he can withdraw. If the writing on the bloody walls appears and failure is on the horizon, wouldn't a vampire cut his spending? What about that pesky inflation? Could he skimp on it, instead of following exactly like a mindless ghoul? 

If you are curious you can grab my data and calculations from this file. It uses the excellent data from Aswath Damodaran, It essentially provides you with the data from 1928, just prior to the black friday, up to today. For the inflation data, please go to the free resource of the us inflation calculator

Let me know what you think! 

Decumulation strategy for Vampire

Decumulation strategy for Vampires Ever wonder why vampires are mostly viewed as having wealth beyond measures? For them, even saving a s...