When I first started this blog, I thought I would be doing lots of posts about asset protection. I thought it was a really important part of personal finance. However, after learning a few things about it, I realized it isn't very important at all compared to other personal finance topics. The reason why is because the likelihood of a physician being successfully sued for more than their malpractice policy limits is so incredibly small. I calculate it at 1/10,000 per year in my specialty of emergency medicine. And a significant chunk of my assets (retirement accounts, etc.) aren't accessible to the creditor in that sort of a scenario anyway. So not only did I quit spending any time worrying about it, but I don't write about it very often either.
I feel similarly about retirement withdrawal topics. Let me explain why.
There are blogs, books, forums, and commercial products out there designed to help you decide how much you need to retire, how much you can withdraw from a portfolio in any given year, and what sort of an asset allocation you should have in retirement. The arguments on this topic are endless. Engineer types seem to particularly revel in them. There are academics such as Wade Pfau who have made an entire career mostly out of the topic. A good example of these sorts of discussions is found on the very comprehensive Early Retirement Now blog, Ultimate Guide to Safe Withdrawal Rates, a source that is often cited in discussions in the comments section of this blog or on the WCI Forum.
I think it is actually really important to know a little bit about this topic. But it is NOT important to know a ton about it. And the reason why is because there are lots of people who think knowing a lot about this topic will somehow allow them to come up with a scheme that will allow them to maximize their happiness and spending while minimizing their risk of running out of money should they live a long time. Which is pretty much nonsense.
So today, I'd like to discuss seven simple principles you need to know about withdrawing from your portfolio in retirement, the last of which is the very most important factor.
# 1 You Are Mortal
I know. It seems so obvious. But too many people have designed a retirement withdrawal plan that, if you look at it carefully, assumes they are immortal. The most common problem in this department is best illustrated by the phrase “Never spend principal”. Well, I've got news for you. While never spending principal does ensure you will never run out of money, it also ensures you will die with at least as much money as you retired with. Because you will die. Any retirement spending plan that doesn't acknowledge that fact will result in you spending less than you otherwise could. And if that spending could have made your life happier, that's a real tragedy. The goal of a retirement withdrawal/spending plan is not to make you the richest guy in the graveyard.
# 2 Start in the Right Neighborhood
The second principle is to make sure that your withdrawal plan is in the right neighborhood. That neighborhood is four percent. The 4% rule of thumb was best publicized by the Trinity Study. The Trinity Study was designed to answer this question:
In the past, how much money could someone spend each year, adjusted upward for inflation each year, and not run out of money during a 30-year retirement?
That's it. That's the question. And it is a very important question. Because prior to this time, the general consensus was that if your portfolio averaged 8-10% a year, you could spend 8-10% a year. Seems logical, right? The problem with that is what is called Sequence of Returns (SOR) risk. That is, the risk that even though you average 8% (or whatever) returns over your retirement, if the crummy returns show up early, the combination of bad returns and portfolio withdrawals will cause you to run out of money early. So the amount you can safely take out each year must be low enough that if SOR risk shows up, you still don't run out of money. It turns out that number is somewhere around 4%.
People love to argue about this. Sometimes the arguments become insane. Like when people start arguing for a 2% safe withdrawal rate, which is basically the same thing as “Never Spend Principal” since the stock market yield and the 10-year treasury yield are both around 2%. But the point of the Trinity Study wasn't to rigidly define whether a 3.62% withdrawal rate was safe or a 4.22% withdrawal rate was safe. I mean, it just looked at round numbers, and those round numbers started at 3%. The point was that you can't withdraw 8% a year. The lesson to take from the Trinity Study (and pretty much every other one like it) is that the right neighborhood is somewhere around 4%. So start there. If you need much more than that, then you'll need a different plan to fund your retirement than portfolio withdrawals—like SPIAs and Reverse Mortgages.
The other thing to realize with withdrawal rate studies is that most of the time at 4% you die with way more than you retired with. On average, after 30 years, a 4% withdrawal rate leaves you with 2.7 times what you retired with. The 4% rule of thumb is set low to cover the worst-case scenarios. If your scenario doesn't look like that, you can likely get away with spending a little more.
# 3 The Importance of Portfolio Growth in Retirement
Another key principle to understand about withdrawal rates is that the longer the time period, the more important it is for your portfolio to continue to grow. Inflation is one of the greatest enemies of the investor, and it is a particularly lethal enemy to a retiree. Unless your retirement is very short, it is important that your portfolio contains at least some risky assets such as stocks and/or real estate to boost the portfolio returns sufficiently to survive a lengthy retirement where your spending is increased each year with inflation. This is easily illustrated with the data from the Trinity Study:
As you can see, 4% worked pretty darn well in the past, except for when the retirement period was very long and the asset allocation was not very aggressive. Very early retirees looking to hedge their bets not only lean toward an initial withdrawal rate less than 4%, but also toward a more aggressive asset allocation (i.e. more stocks).
# 4 The Data Sucks
Here's another thing people don't seem to get about this. The data that all of these studies are based on is terrible. At most, it's based on about 90 years worth of data. That's really only three completely independent 30-year periods. And most of the studies look only at US-based stock and bond returns. Few of them look at real estate. Few of them look at the data from other countries, or if they do, it's based on an even shorter time period. In medicine, meta-analyses not only look at the data, but also consider the quality of the data. If retirement withdrawal rate studies were a meta-analysis, this data is not only retrospective, but it is also very limited. It is barely better than expert opinion. Keep that in mind as you draw any sort of conclusions from it. It doesn't matter how much the academics manipulate and massage it, there just isn't much data there to work with. The good news? Every year there's one more year of it!
There was a lot of uncertainty that occurred in Canyonlands National Park over Memorial Day. This is me dealing with it.
# 5 Be Comfortable with Uncertainty
Some people don't deal with uncertainty very well. There is a lot of uncertainty in life. I specialize in it. I'll bet a majority of my patients leave the emergency department without a definitive diagnosis for the complaint that brought them in. We rule out some bad stuff, give them some precautions, treat their symptoms, and disposition them to primary care, a specialist, or an inpatient unit for additional observation or evaluation. When I go skiing in the backcountry, I check the avalanche forecast. The risk of avalanche is rated low, moderate, considerable, high, or extreme. When the danger is high, you stay out of avalanche terrain and ski low angle slopes in the trees. But there really is no guarantee of anything. Life is uncertain. Retirement is uncertain too. You don't know how long you'll live. You don't know how many big expenses will come up. You don't know what kind of market returns your portfolio will see nor in what sequence. Deal with it. If you are not willing to, it will cost you a lot of money either in foregone returns (from less aggressive asset allocations) or insurance premiums (SPIAs, longevity insurance, etc.).
# 6 Don't Believe Precision
The funniest part about some studies and the things some people say in this regard is the false precision they use. I've seen withdrawal plans where the withdrawal rate went to three decimal points. Give me a break. You're doing well if you can get the first digit right (i.e. 3%, 4%, 5%, etc.). Don't kid yourself. Just because someone (or some Monte Carlo simulator) spits out some incredibly precise answer doesn't mean the answer is accurate.
# 7 Adjust Your Retirement Withdrawal Plan as You Go
Finally, we get to the topic of this blog post. The most important factor in your retirement withdrawal plan is not your asset allocation, nor your longevity, nor your initial withdrawal rate. It is your flexibility. The ability to adjust spending as you go was the key to being financially successful during the accumulation phase. It is also the key to being financially successful in the distribution phase. Start in the right neighborhood and adjust as you go. If you end up with two bull markets and a very minor bear in your first decade of retirement, you can probably adjust spending up or give more of your assets away. If sequence of returns risk rears its ugly head on you, cut your spending a little. Vacation in Mexico instead of Switzerland. Hold on to that car for a couple more years. Give $50 to the grandkids for birthdays instead of $100. Eat out once a week instead of twice.
Of course, this all assumes you have the ability to cut back on spending. Just like in the accumulation phase, set up your financial life in the distribution phase so that the ratio of fixed expenses to variable expenses to truly discretionary expenses is as low as possible. Fixed expenses might be property taxes, utilities, and insurance. Variable expenses are food and gasoline. Discretionary expenses are charitable contributions, gifts, and vacations. If only 20% of what you spend is truly fixed and only 30% is variable, you can relatively easily cut your spending by 50-60% if sequence of returns risk shows up. And if it doesn't? Great! You keep living “the good life”. In fact, some people even go a step further and make sure they have enough guaranteed income (Social Security, Pensions, SPIAs, etc.) to cover their fixed and a portion of their variable expenses. So in the event of a market downturn, they can literally eliminate portfolio withdrawals completely. This sort of flexibility is invaluable in making sure you don't run out of money.
So I'm not going to spend a lot of time on this blog analyzing 3.75% and 4.2% withdrawal rates and go over a dozen different systems for withdrawal. Like advanced asset protection techniques, it just doesn't matter much in the grand scheme of things. What does matter? Well, your asset allocation and starting withdrawal percentage matter a little, but what really matters is maximizing your flexibility. Put your effort there and you can afford to ignore an awful lot of the withdrawal rate chatter out there on blogs and internet forums.
What do you think? Do you agree that flexibility is the most important factor? Why or why not? Comment below!
Good stuff Jim, I agree. Sometimes I read posts from bloggers who are only in their early 30’s and have calculations down to two decimal places and already have their withdrawal strategy etc etc. I’m thinking, “aren’t you going to live your life? Lots of stuff is going to happen in there ya know…”
It is all about flexibility – and of course having the knowledge to deal with whatever happens when things do indeed flex.
And wow, that’s some serious 4-wheelin!
I started a retirement blog for docs to address these issues. http://doctoroffinancemd.com To me the most important thing the 4% rule does is it allows you to calculate a target nest egg. You need to figure out your spending and multiply by 25 and you have it. It continues to amaze me the number of doctors that I encounter who have no idea what they spend.
As you pointed out the data is imprecise because none of us know how long we will live, the rate of return of our portfolios, or future tax policy. We can estimate these but certainly not to 3 decimal points.
After spending the last 30 years or so thinking about this the 4% rule works fine at anywhere near traditional retirement age. I would use 3% if I was going to fire.
The other take away is you really need continued equity exposure. I have more difficulty with the “Age in Bonds” rule. I currently have my age in stocks not bonds.
That last piece of advice is golden.
Flexibility is key! This is the same message I preach when I talk to people about financial independence having two sides: Saving aggressively, and living with your means. Just because you make $250,000 doesn’t mean you need to live on $250,000. If you decide to live on $80,000 or $120,000 you can become financially independent much faster. That can only happen if you build flexibility into your lifestyle and if you grow into it slowly rather than letting it explode when you finish training.
In the FIRE community, I’ve always assumed that safe withdrawals needed to be between 3-4% because of the longer horizon, but your last point is infinitely more important than that number.
TPP
Yes, there isn’t much fancy math required to achieve success. Monte Carlo simulators have built-in assumptions that may not be true in the future. Historical trends can be studied, but may not repeat in the same way. Beware of financial planners offering sophisticated investment approaches offering “certainty” (as one proposed to me last week). Keep a high savings rate during your working years. Keep a low withdrawal rate in your retirement years. Invest in some stocks. Not rocket science. The “dynamic withdrawal rate” is key. It has been studied some but isn’t talked about much in blogs. Also, early retirees have the option of going back to work -at least part-time- if needed.
Thanks! Mirrors our plan- no plan but maintain flexibility. Now that 80 yo I mentioned to you WCI privately- any advice convincing her she can very safely withdraw 4 to 10%, probably even more! (in addition to Social Security and pension) as long as she is flexible? wish me luck.
You are right that the data sucks. Most historical comparisons go back 30 – 40 years when bonds paid 6% – 8% and includes the early 80s when they paid 10%
If you go into retirement with 50% bonds, you must really believe that 8% bonds are coming back……..Gordon
I actually think this article was about your comment. Uncertainty. You don’t know if 8% bonds are coming back or not. Even if you think they are not. You don’t know. No one knows. Exposure to stocks is a comfort level to uncertainty. Flexibility is the solution and acceptance of uncertainty.
Or you’ve planned for lower returns from your bonds. Also note that inflation is lower as are expected returns on stocks. The effects of taxes on bond returns also have a lesser effect since taxes are paid on nominal returns.
BEST to have a BUCKET of safe vehicles to cover fixed expenses(cds, bonds, munis, annuity, etc) And a BUCKET of equities for grown
SEQUENCE OF RETURNS is PARAMOUNT
You need to be more conservative in the early years of retirement and best to have OVERSAVED for security and ability to own more stocks
I really enjoyed reading your perspective on this. I have been obsessing over calculators and various models, at some level hoping that one would just say, “Yup, you’re good to go.” In reality, that must come from within. Neither FIRECalc, portfolo visualizer, nor Big ERN are ever going to deliver that message in a direct and meaningful way.
Nonetheless, I stil find it to be enjoyable to read blogs like ERN, just to understand some of the math modeling and assumptions. I think that the need to be flexible is obvious and would be human nature to do so.
It is also natural that a person who is a saver will remain a saver, and a spender will remain a spender. Watching the behavior of people throughout my life suggests that people rarely change in that regard, especially not later in life.
Great synopsis. Within reason – boosting guaranteed income:SS,pension, longevity annuities (QLAC) and adding a hybrid LTC policy (for the big unknown expense) are what I have done. Along those same lines covering the unknown medical expenses with a Medigap policy is something else not to forget. I would also add international equity diversification as the rest of the world has greater growth potential. Whenever I hear the 4% quoted and Monte Carlo I also like to know if the spaker even knows where the 4% even comes from!
“So in the event of a market downturn, they can literally eliminate portfolio withdrawals completely. This sort of flexibility is invaluable in making sure you don’t run out of money.”
If you are 70.5 you are required to take RMD regardless of what market is doing. You can not eliminate portfolio withdrawals as you state. Yes, your portfolio may go down so amount you are required to take is down but you still have to take money out which could hurt your portfolio balance negatively (sequence of returns). Flexibility in spending is key, but RMD is out of your control for the most part.
One advantage of FIRE here is that you can avoid RMD. You’ll likely have enough time to empty out all your pretax accounts via Roth conversion ladder before you actually need that money.
It seems unwise to me to “empty” a pre-tax account. Why so much fear over an RMD? What’s the big deal? You don’t want to spend 3.6% of your IRA the year you turn 70? I think I’ll probably just spend that money.
I don’t think WCI meant that you could actually not take withdrawals, but rather that you don’t have to spend the _% per year that you may have targeted for your withdrawal rate. You may have to make RMDs once you reach a certain age, but you don’t have to spend them. You can easily take that money and put it right back into the market in a brokerage account. While technically the paper value of your portfolio would be reduced because of the taxes you paid, in reality it would not change at all because the tax-deferred account is not realistically valued at it’s full amount prior to withdrawal and the resulting taxation event.
@Laurel – yes and no. In a down year after age 70.5 you will have to take your RMD and pay some taxes, but then you take that money in excess of your needs and put it back into the market in your “normal” “after-tax” brokerage account where it may grow. The Tax drag may hurt but it is not as if you can’t keep the bulk of your portfolio invested in a down year.
An RMD just means you take the money out of an IRA, not that you spend it. Portfolio withdrawals are very different from moving money from the IRA to the taxable account.
@ Laurel,
If you do a little planning ahead with your retirement account all you need to do is turn off the dividend reinvestments on any stocks or bonds you have in your IRA when you reach age 69 and you won’t likely need to sell anything in a down market, at least for the first few years.
In any event you should not have money invested in stocks or stock funds they you know you will need to withdraw for an RMD, that is why I suggest you let any dividends do at least some of that heavy lifting. Thinking you are just going to sell funds whenever you need to is something that has only worked during this present 9 year bull market and won’t work forever. As WCI mentions RMDs are nothing to fear, even if you don’t need the money and in fact if you are in the 12% tax bracket in retirement you will most likely not pay any tax on dividends or long-term capital gains in money moved to your taxable account.
Your last point on flexibility is the biggest key imho. I didn’t know where I’d be at 25 when I was 20, 30 when I was 25, 35 when I was 30, etc. So why would I ever know what life would be like at sixty? Planning is important but accuracy is really low that far out. Plan accordingly.
WCI- I completely agree that flexibility is key in ensuring that your retirement savings do not dwindle to unsafe levels too early. However, I think it’s worth noting that the assumption that you can cut spending by ~50% means that the individual has spent the accumulation period oversaving for what is NEEDED in retirement and that they actually spent years working and saving to be able to afford quite a bit of what they WANT in retirement. While this blog’s readership may be in that latter camp due to high earnings and much better than average personal finance knowledge and behaviors, most Americans, and even most docs, are not. So while it’s not as critical to figure out if your SWR is 3% or 5% if you have oversaved and have therefore built a lot of potentially flexibility into your plan, the vast majority of people will have much more riding on a reasonable SWR because it helps determine what is needed to save before retirement. If an average family needs $50k to live and gets $25k a year from SS, then a 3% SWR assumes that they need a nest egg of $833K, while a 5% SWR would lead to a nest egg of $500K. For most, that $333K is a big range, which translates to years if not decades of work. It’s a different conversation when talking about the flexibility needed to move from $250K to $150K vs the flexibility that a lot of folks find themselves needing to exercise to move from $55K to $45K. I certainly recognize the target audience of this blog, but felt compelled to acknowledge the increased importance of a SWR for those that are not in a position to build as much flexibility into their financial lives in retirement.
I fully acknowledge the truth of your statement. If you barely have enough to meet your needs in retirement, you don’t have much flexibility. You’re also likely a great candidate for SPIAs and reverse mortgages.
But just because somebody undersaved or “just barely saved” doesn’t exclude them from the fact that the data is still terrible and the future may very well differ from the past. The more flexible they can be, the better.
Great addition to CL Collins practical articles on 4% rule. Amazing again how I’m thinking about a topic and then WCI blogs about it within a week or so. Great article. No reason for this to be complicated.
Thank you for admitting the data sucks! The Trinity Study, cFireSim and all the enthusiastic 4% bloggers are basing their plans on very minimal data (no wonder most of them have a post-retirement job) that looks at a very specific period of American history. I wish more of the FI world would be more honest about the paucity of data, but I guess no one wants come off as negative.
Great post.
As WCI suggests, all of the latest and greatest science, rules, guidelines, guardrails etc. are next to worthless. A 4% SWR may be as good as any rule of thumb, but still mostly worthless. WCI is right that the exercise of good judgment and flexibility are the most important elements of retirement planning.
However, there is an eighth point that is as important – understanding all facts that are material and relevant to the retiree as the basis for such judgment. What the retiree needs is an accurate, comprehensive and continually updated analysis of the annual cash flows that will be available to him during retirement, considering all relevant and material scenarios.
The Trinity Study and Bengen base the SWR on the WORST CASE SCENARIO
3-4% SWR will easily work with 20-25% in stocks
DO SOME ROTH CONVERSIONS as well-According to LANGE its almost universally a WIN
Can you afford a 50% decline in stocks nearing or at retirement that we saw 10years ago
The market comes back but that is not guaranteed
LOOK AT JAPAN!
What about Japan? What lessons learned?
To diversify?. Demography is destiny? Avoid speculative real estate bubbles?
Others?
Remember when Japan was going to rule the world in the 80s. Biggest real estate bubble of all time. I am relieved to have not invested there.
I assume Mr. Tobin was referring to pitiful state of the Japanese stock market, which has not recovered from its crash in the early 90s. Demographic change has caused a downward spiral from which their market cannot seem to recover.
The US has avoided this with its higher birth rate and more importantly its openness to immigration. The birth rate is declining and immigration is also declining. At least one of these will have to change for the stock market to continue to climb long-term.
It’s a legitimate concern.
A severe loss at or near ret. is devastating
When you win the game, take most chips off the table
I enjoyed this post.
I keep telling people they are going to die…but no one listens to me. I have a 58 y.o. friend in from out of town and her father is about 82 years old and has cardiac issues, has had an MI, survived prostate cancer and is almost certainly in his “decade of declining health and abilities.”
He has a million dollar plus portfolio and a paid off house worth $450,000.
I would start gifting money to my children and grandchildren and spend an “extra” chunk per year on world travel before I left over a million on the table…
I also agree with your analysis of not getting hung-up on the exact number and how many decimal places to seek for accuracy. One thing I’d like to bring up that is slightly different than the analysis itself, is the TRANSITION that one makes in going from working to retired. When working, one is in the asset accumulation phase and when one retires, one tends to be in the asset spend phase. I retired early (55) and only when I hit 62 and was informed (by Social Security) that I was eligible for Social Security, did I realize that I did not have the same deep grasp on the financial details of asset spend (Social Security, RMDs, Estate Planning…) that I did for asset accumulation. So, I’d add to to this conversation to be on the ‘look-out’ for this transition as there are all kinds of factors, such as when to you elect to take your SS benefits, roll over IRAs/Conversions, RMDs and the effect of these latter mentioned factors on any estate planning activities.
Generally, I’ve done all my financial planning my self and used a Financial Planner at some key junctures (such as when I retired for asset allocation purposes). I went back to get a financial plan done again to do a deep dive into the various aspects and impacts of RMDs, SS, Medicare and estate planning as mentioned. So, this is a head’s up to let you know to be aware that when you make the transition, it’s something to think about holistically as to all these other factors and how they relate to whatever percentage you decide is your magic number.
We have NO CONTROL over so many of those factors that are used to estimate our SWR. Even carefully saving under the assumption that you’ll get the worst possible sequence of returns doesn’t protect you from the single most important variable in your retirement planning – yourself!
Behavior is the most important independent variable in both the accumulation and distribution phases. It’s also the only one you really have final control over. When people freak out over the uncertainty in the future and fret about a percentage point in one direction or other on FIRECalc or any other calculator, what are they worried about? That they’ll spend a destitute life alone and starving on the street? If someone is paying enough attention to their retirement plan to know about FIRECalc, they’re saving enough to fund SOME sort of retirement. The real question is whether they’ll take their big vacation in Switzerland or Mexico, to paraphrase Jim. In other words, we’ll be okay as long as we follow a basic retirement savings framework because we will (have to) adjust to the retirement savings we have. Relax and keep to your plan. You adjust your spending behavior to be perfectly happy whatever the final result.
I totally agree with number 7 being most important. You have to adjust as you go. Considering sequence of returns, your own life needs, and unexpected things that come up. You need to start with a good solid plan, but know that you may need to tweak it as you go.
investorsadvantagereport.com
Via email:
As we used to say in Navy “ keep your eye on the ball”. which is when the pilot is approaching the carrier deck for landing he is watching a little ball at deck level and constantly adjusting flight path for a safe landing, the same can be said for watching and adjusting our withdrawal rate “flight path “ as well
Thanks for the mention!
A few comments:
In case this wasn’t already 100% obvious from the post, I’m most definitely not one of the uber-conservative bloggers advocating for an unnecessarily low SWR. Anything below 3% is certainly way too cautious. I set a 3.5% target for myself and in 10 case studies I posted on my blog, only 3 recommended SWRs were below 4%. They ranged from 3.75% to 6% (though the latter was an outlier, the second highest was “only” 4.6%).
So, we probably have more points of agreement than disagreement.
Here would be a few items where I like to differ:
Precision: Reporting the withdrawal amount down to the $ or cent is overkill. But notice that even a 0.05% step in the SWR ($500 per million dollar principal) can make a six-figure difference over 60 years, the horizon of many early retirees. That can make the difference between running out of money and making it.
Average final net worth (=2.7 times initial): I wish bloggers would stop quoting this utterly meaningless and misleading number. The average final net worth in the simulations is dragged up by the episodes where retirees start at the bottom of the bear market. Completely unrepresentative for today’s retirees. It’s like you want to calculate your commute time, you know it’s rush hour, but you average over all possible departure times, including the non-rush-hour times at 3am. Sure, you can use that number, but don’t be surprised if it’s completely wrong!
Flexibility: It’s overrated. I wrote about this in parts 24 and 25 of my series. People who advocate flexibility overlook two important problems:
1) the 50% cuts in withdrawals (or alternatively, the back-to-work route) will last much longer than most people realize. Much longer than the equity bear market. Sometimes 20+ years.
2) Type 2 Errors: flexibility creates a lot of false alarms, i.e., situations where people go through several years of cutting expenses even though the 4% Rule would have worked in hindsight.
These are all issues I wanted to sort out in great detail before I dared the plunge into early retirement (June 1 this year!!!), which means for me personally that I will irrevocably give up a cushy 6-figure job with a window office. So, the quote “it is NOT important to know a ton about it” is not going to cut it for me because to me it sounds more like “let’s not research this too carefully for fear of what we might find!” I can’t know enough about this topic!
But again, great post otherwise. We definitely agree on most of the issues!
Cheers!
-ERN
I’m sure you’ll keep us updated on how your retirement goes. Bear in mind, the article isn’t necessarily aimed at people retiring TODAY, more of an evergreen type article. But I’ll tell you this- people were saying the same thing about future returns in 2012, and those who retired then have made out like bandits with 6 years of great returns at the ideal time.
The problem with the future is it is just so unknowable.
I read your comment then checked out your Part 25 article, wow. You are apparently enamored of guidelines, guardrails, Guyton and gimmicks. WCI got it right when he said that all you need to do is start in the right neighborhood of 4%: “What does matter? Well, your asset allocation and starting withdrawal percentage matter a little, but what really matters is maximizing your flexibility. Put your effort there and you can afford to ignore an awful lot of the withdrawal rate chatter out there on blogs and internet forums.”
My advice is to totally ignore SWR, MCS and all other formulas and rules. The retiree should instead focus on his specific financial information. Each retiree should create a comprehensive analysis of after-tax, inflation-adjusted future cash flows under base case, worst case, and any other relevant scenarios. Comparing this analysis with actual and planned expenditures will provide the necessary background information for applying the flexible approach that WCI recommends.
After you totally ignore all of that SWR research, please educate me how much I can actually withdraw today under the following parameters:
1: A $3,000,000 portfolio, invested mostly in equities.
2: About $1,800 in Social Security benefits (in today’s dollars) in 26 years.
3: A horizon of 50-60 years
4: I’d like to adjust my withdrawals by CPI-inflation every year.
5: I’d like to leave at least 25%-50% of the portfolio (in today’s dollars) to our daughter and charities.
As a professor of mine always used to say “it takes a model to beat a model” so if you don’t like my approach, that’s fine. But you’d have to show me a better approach.
Also regarding the “average result in trinity was 2.7 times initial portfolio”: trinity study adjusted withdrawals for inflation but did not adjust the portfolio value for inflation. So the 2.7 times after 30 years is entirely making up for 3% inflation. So it’s accurate to state that the average result was for your portfolio to stay intact inflation-adjusted while you lived off it inflation adjusted. Still great but not 2.7 times!
Yes, the 2.7 is a nominal figure and not a real one. Over 30 years, it would require average inflation of 3.4% for 2.7X nominal to equal 1X real.
Edited
OK, but your situation is unique and requires a unique but simple analysis. I take your facts as correct: that the actual SS for you and your wife is 1800, you and wife have no pensions, deferred comp etc., and you do not expect any outside income from blogs, speaking, etc. In this case, ignore for now the small SS 26 years hence, and look only to the 3m, mostly equities.
Given your 60-year time horizon, maximum spending should be limited to expected total returns, after tax. Do a quick TurboTax run of you new income, which consists of cap gains and ordinary income on the 3m. That after-tax return, for starters, is your maximum withdrawal. How does that square with your expected annual after-tax expenditures? But wait, we can’t forget Taleb’s Black Swans and Bernstein’s Deep Risk. So figure, worst case, that the 3m drops to 1.2m and take another look at your expected future total returns after-tax. In the Taleb situation the decline is permanent (starting new with normal total returns), but that result is unlikely, so look again, but assume that the 60% decline reverses in the same manner as 2008. Now you have a realistic base case, worst case, and a somewhat likely other negative scenario, each of which you can compare to your expected spending needs. In addition to this financial analysis, you should also evaluate your own behavioral response to each scenario. Given all of this analysis (which should be repeated annually), how much do you think you should withdraw each year?
Guess what? You are now in the WCI world of flexibility. That is fine, and exactly where you should be.
ERN – I suppose WCI says to start with $60,000 (4% of $1.5MM if you want to spend only half of your $3MM). It might be a heuristic dressed up as a model, but I’d be curious to know how it compares to what you are actually doing?
Jim, I have a (moderately) different take on this issue regarding #s 2 and 3. I believe Sequence of Return Risk is key around the period before and after one’s retirement date, and recommend Kitces article on “Bond Tents” for further elucidation, https://www.kitces.com/?s=bond+tent. Also, market valuations are relevant to Equity Glidepaths, as discussed by your buddies Pfau (and Kitces), “Increasing Retirement Withdrawal Rates Through Asset Allocation (AAII, April, 2015).