A.I.M. Users Bulletin Board

[ls7550]

RE: Dynamic Income type AIM

Not really an AIM, but this does work something along similar lines.

Income for living expenses might be drawn from your investments based on an initial capital value amount, say 4% of the fund value in $ terms, and uplift that $ amount by inflation every year as the amount drawn. This provides a regular/known income each year, but runs the risk that if the fund doesn't grow sufficiently well and consistently enough you can end up drawing down the fund to zero.

Income might alternatively be drawn at a percentage of the fund value each year - again say 4%. This has less risk of going totally broke as the income just gets smaller if the fund isn't growing sufficiently, but it means that your income is more variable. Fund up 20% one year, your income is 20% higher than the previous year. Fund down -20% in another year and your income declines -20%

It is good practice to keep a rainy-day pot of money that can be called upon in times of need. Which got me thinking about using a similar method in investing. If instead of withdrawing income in a fixed like manner we instead withdraw some funds in good times (UP years), but don't withdraw any in bad (DOWN) years, then that is a bit like reducing-high, adding-low (AIM like).

I ran a backtest using this concept as shown in the image below. The choice of assets invested in is irrelevant in this case as I'm just demonstrating the concept, not the actual underline investment choice (FT/RtW is my name for a blend of Fat Tail Minimisation and a Riding the Waves combination). Prices/gains were adjusted for inflation and in years where a gain occurred 66% of those gains were removed and deposited in the rainy day pot. In down years no funds were withdrawn, so you'd have to rely upon the rainy-day pot to service your income needs in those years.

The chart is based to real value, so a constant 1.0 over all of time would have been = inflation. In real (after inflation $ adjusted amounts), the fixed withdrawal method averaged $0.076 real withdrawals per $ each year, whilst the dynamic withdrawals averaged $0.074 per $. Whilst the dynamic approaches real $ amount was lower, countering that is that at times those funds might have been sitting in a rainy-day cash account and earned a bit of income.



Note how a similar reward both in income and growth was achieved over the period, but the dynamic income approach did so with the fund enduring less volatility along the way (compare the blue and grey lines in the above image).

Whilst the fixed withdrawals averaged a 5.5% yearly withdrawal rate for the end value to be near 1.0 (remainder of fund paced inflation) and the dynamic withdrawal approach averaged 6.08%, for much of time the fixed fund value was relatively higher than the dynamic funds value, so that lower average 'yield' just reflects the average higher price over that particular period of time.

The conclusion that I draw is that using dynamic methods can potentially be better than using fixed methods, especially when during good times you increase withdrawals and in bad times use accumulated reserves in support.

The spreadsheet containing the historic price data I used is http://www.jfholdings.pwp.blueyonder.co.uk/riding_the_waves_yearly_1927.xls

I found this article/document if anyone's interested in reading a bit more about a similar concept http://www.bobsfinancialwebsite.com/pdfs/Dynamic_Rebalancing.pdf

PS I set 1978 to a 0% gain year as RtW was solely in silver that year and silver made a 267% gain in that year - which would have distorted the figures.