In ips we talk about 5% spending rules with higher returns for inflation and fees. Someone said recently that he felt normally if one pulls out more than 4% of a portfolio it could self destuct, but with the current economic environment, if one pulls out more than 2% it could self destruct. I’m curious what data there is on this. any thoughts?
Why do you feel this is true: “but with the current economic environment, if one pulls out more than 2% it could self destruct?”
In the US market we’re in the seventh year of a bull market and inflation remains low. Will it continue? Who knows but I don’t think anything crazy will happen. Are you (or is that guy) one of those people who believe people on CNBC know what they’re talking about and not simply trumping up fear because it helps their ratings?
Considering the S&P 500 has a 2% dividend yield and 30-year Treasuries yield 2.4%, you could easily design a portfolio that you could withdrawal 2% per year and not touch the principal balance. There are tradeoffs, of course, most notably the long duration is subject to interest-rate risk, but if your goal was to design a long-term portfolio where you could withdraw 2% with no spend-down of principal you could do it easily.
I’m not saying any thing is true. Just trying to get clarification. What you suggest will produce 2% but that is still a far cry from 5% and /or keeping the real value of a portfolio. If I recall correctly, i think the thoughts were on the bond side interests rates are low and because of the economy they don’t appear to have improved. Also the equity market is at a high and with the shape of the USA and world economy I have heard two people predict it will be volatile with lower than average past returns for a while. Then again, I heard that predicted 3 years ago and we are at a record high. If a portfolio returns apx 5% with volatility, then when the market is good your pulling out profit. When it is a down year you pull out principle. For example, if there is a down year of 40% and you pull out 5%,then really pulled out over 8% of your principle and will have to earn 81% just to break even. Again this is just things i heard and not quoting as fact. I’m just asking what those more knowledge able about these things feel as to what causes the discrepancy of opinion and how to interpret these thoughts.
I agree 5% is aggressive if you want to preserve the real value of the portfolio. If you assume management fees are 1% and inflation is 2% that’s an 8% return (it would be more if the entity was taxed). If you go all equities you’ll average 9%-10% over the long term but year-to-year fluctuations can hurt you. If you remember the curriculum addressed timing of withdrawals would effect projections.
My feelings are in the real world an endowment or a private individual would attempt to limit withdrawals during down markets even if the 5% was agreed upon. Also, if a big change in the market occurs there’s nothing preventing you from doing another IPS with the client to addres the changed market conditions.
I don’t agree. We are talking about foundations that will ideally have higher risk tolerance. International markets have performed extremely well over last 5 years. Look at the indices of Japan and India for instance, you will know that 5% return and preserving capital is not a big ask
this makes more sense… consistently generating 8-9% will be a challenge…but then when market is good FM should target generating in excess of 8-9% and use that excess return as cushion during bear market or recession
It really depends on the time horizon. A 5% real return bogey would be difficult to acheive over the next ten years. Over 30 or 40 years however, a 5% real return is quite manageable, especially considering most endowments are equity/alternatives-heavy. Since endowments are considered to operate perpetually, the longer-term capital market expectations are likely more important when setting asset allocation and spending policy in an IPS.
In reality, most endowments have some sort of smoothing applied to their annual spending, and their are many more ways to smooth spending than those mentioned in the curriculum. This, as we should all know by now, provides for greater capital preservation in the event of a steep market decline.