OmegaNot income harvesting, down in the weeds

  1. Is OmegaNot any better than simple annual rebalancing?
  2. Is one particular variant of OmegaNot better than any other?
  1. Failure rates: tie
  2. Maximum Safe Withdrawal Rate (MSWR): tie
  3. Maximum Perpetual Withdrawal Rate: tie
  4. Shortfall years: OmegaNot
  5. Downside-Risk Adjusted Success: mixed, slightly favoring OmegaNot
  6. Coverage Ratio: Annual Rebalancing
  7. Ulcer Index: OmegaNot (though the advantage is slight)
  8. Certainty Equivalent Withdrawals (average): Annual Rebalancing
  9. Certainty Equivalent Withdrawals (minimum): mixed, slightly favoring OmegaNot
  10. Harvest-Rate Efficiency (average): OmegaNot (though the advantage is slight)

The problem with averages

However, I wasn’t entirely truthful with you. I expected that we wouldn’t see anything particularly compelling in the previous tests. We already knew that just looking at averages can, in the worst cases, be downright misleading. What we really want to look at are distributions of results, especially the left hand of the distribution (the less-good cases).

Shortfall Years

Shortfall years was almost the only metric that showed a clear & not-just-marginal improvement: OmegaNot performed better. Shortfall years seems like a good proxy for what retirees care about, so the outperformance on this is intriguing. Maybe it is a sign that OmegaNot is better, if only we can find the right metric, or set of metrics, to highlight the improvements?

Maximum Safe Withdrawal Rate (MSWR)

Coverage Ratio

Ulcer Index (Portfolio)

Remember that lower values are better for the Ulcer Index, that it is a bit like standard deviation.

Certainty Equivalent Withdrawals

It feels

Harvesting-Rate Efficiency (HREFF-4)

The Harvest-Rate Efficiency metric is attractive because it directly incorporates the notion of a spending floor. If we drop below $40,000, that’s when we really worry.

Harvesting-Rate Efficiency (HREFF-3)

We can lower our floor to $30,000 in an attempt to create a bit more space for differences to be highlighted.

Ulcer Index (Withdrawals)

We can take the same math underlying the Ulcer Index and apply it to withdrawals instead of portfolios. In theory, retirees should care way more about withdrawal draw downs — “I used to withdraw $52,000 a year but now I can only withdraw $33,000 a year” — than portfolio draw downs.

Ulcer Floors for Withdrawals

What are we really trying to measure here with our “Ulcer Index for Withdrawals”? We want to know how much stress due to withdrawals under our benchmark. In this case, we’ll treat $40,000 as our benchmark. We want to know how much stress is caused by low withdrawals, not medium withdrawals that happen to be lower than our previous, slightly higher, also medium withdrawals.

SumSq = 0
MaxValue = 0
for T = 1 to NumOfPeriods do
if Value[T] > MaxValue then MaxValue = Value[T]
else SumSq = SumSq + sqr(100 * ((Value[T] / MaxValue) - 1))
UI = sqrt(SumSq / NumOfPeriods)
SumSq = 0
Benchmark = 40000
for T = 1 to NumOfPeriods do
if Value[T] < Benchmark then
SumSq = SumSq + sqr(100 * ((Value[T] / Benchmark) - 1))
UI = sqrt(SumSq / NumOfPeriods)

Recap

Once we stopped looking at averages and started looking at quantiles, the improvements from OmegaNot, at least in the worst 20–30% of cases, became clearer. It was clearest with the shortfall years, certainty-equivalent withdrawals, HREFF-3, and “Ulcer Floors for Withdrawals”.

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EREVN

EREVN

Learn how to enjoy early retirement in Vietnam. With charts and graphs.