The concept of a safe withdrawal rate is important for anyone planning for retirement with or without a financial planner. It helps you to make estimates of how much you might need for retirement and gives a reasonable guideline for how much you can spend each year while expecting your money to last. I did a recent audiovisual presentation on QuantiaMD explaining this concept. This is # 5 in my series of eight presentations there explaining some of the basics of personal finance and investing. If you have missed the other presentations, you can find links to them below. Although QuantiaMD is designed for doctors and other health care workers, you should be able to watch all of these presentations without signing up for the site. If you are a health care worker, I suggest you sign up anyway because there is lots of other good stuff there.
My most recent presentation on QuantiaMD was # 5 in the series. This is really a fun format if you haven't seen any of the others. They are 8-15 minutes long, contains slides, polls (usually with much different results than the ones I do of regular site readers), and audio. If you haven't seen the first four, you can find them here:
#1 Live Like A Resident (804 comments)
#2 Student Loan Management (398 comments)
#3 Your Largest Tax Break (705 comments)
#4 The Backdoor Roth IRA (390 comments)
Number five in the series is all about The Safe Withdrawal Rate. Future presentations include How Much Do You Really Need to Retire, The Basics of Estate Planning, and The Basics of Asset Protection. Click the link below to view the presentation.
# 5 The Safe Withdrawal Rate on QuantiaMD
At any rate, check this presentation out and then come back and let me know what you think in the comments section. Do you find the concept of a safe withdrawal rate useful? How? Do you know anyone who actually blindly follows an SWR in retirement? How do you plan to withdraw your retirement money? Comment below!
By my reckoning, a $2.5-3M bond portfolio will generate around $5-6k income per month (maybe even better going forward?). Add in social security and some rental income. I think this will be all I need when considering: 1) Lower tax rate; 2) No debt; 3) No need for aggressive savings. In other words, I hope to withdraw 0% and give my heirs a big fat trust fund.
That might just work. Keep in mind that if you’re spending all the income from a bond portfolio, that portfolio isn’t going to provide inflation indexed withdrawals. After 20 years, you’ll be getting less in real money if you’re not willing to spend down principal.
Great presentation and I may have missed it but did the Trinity Study not include investment expenses in their data analysis? I can’t recall if they did.
I don’t think it did. So if you’re paying an advisor 1% a year, that 4% is now 3%.
It can be even worse than just reducing your take from 4% to 3% as time goes on– especially if your portfolio does really well. The withdrawl amount only increases by rate of inflation- and that inkflation multiplier is only multiplied by that small portion—, but the amount the “advisor” scams – um oops, I mean -skims off is 1% of all the increase on the entire portfolio. The first year he takes 0.25 (1/4 of the money withdrawn to spend -1% of the 4%). If the portfolio were to grow by 10% and inflation by 3%. The next year’s withdrawl is reduced by 0.256. And that is after only 1 year…suppose the portfolio doubles in 10 – 15 years..if inflation stays at 3% and advisor keeps getting 1% of the portfolio, the advisor reduces the withdrawn amount by 0.32-0.37!!! (Now instead of giving away one fourth of your money to the advisor every year – now advice costs 1/3 of the money you withdraw to cover your expenses!
While obviously the larger your portfolio, the larger an AUM fee, I don’t think your math is right that there is an extra penalty above and beyond the 1% per year. You can either subtract the fee from the size of the portfolio, or subtract it from the withdrawn amount, but not both.
Let’s use a simplified example:
You have a $1 Million portfolio. Your advisor charges an AUM fee of 1% based on the amount in the account at the beginning of the year, but takes it out at the end (I know, that’s weird, but it allows the example to stay simple.) Let’s say the portfolio makes 7% that year. Your advisor takes $10K as his fee. You, knowing the effect of that fee on the 4% rule, only take $30K out. The portfolio is now worth $1,030,000 at the start of year two. It gains another 7%, and at the end of year two would be worth $1,102,100 before fees ($10,700) and withdrawals ($32,100), and $1,059,300 after them. The portfolio is still growing by 3%, providing you a 3% withdrawal, and providing the advisor a 1% fee. There is no extra penalty there that I can see.
That effect does take place during the accumulation years (since the account grows at a lower rate) but not during the distribution years.
I don’t think your math works…first of all I know of no advisor who sets his fee at one end of the year and collects it at the other…they are way too greedy to do that…they take it when they calculate. But much more clearly erroneous is your second year withdrawl of $32,100–it is too high! It’s 7% higher! In the classic SWR studies the amount withdrawn each year is supposed to rise only by the rate of inflation. Not by the rate of portfolio return….
Sure, it’s usually calculated quarterly based on the quarter end assets. That was a total simplification. I think I mentioned that. If you’d like to do the more complicated version you must have more time than me.
As far as the math, you’re right. I blew that. Your withdrawal should be $30,000*1.03%= $30,900, so after fees and your withdrawal, the portfolio would be at $1,060,500 after year two. Same conclusion.
However, I think I now see what you’re getting at. If the portfolio is continuing to grow despite withdrawals and fees, the asset management fees get larger and larger each year, growing faster than your withdrawals are. In that situation, the fees would be more than 1/4 of the withdrawal each year (because they’re calculated on the AUM, not the withdrawal). Of course, the opposite is also true. If the portfolio is shrinking, those AUM fees may represent less than than 1/4 of the withdrawal amount. Interesting to look at, I don’t think I had ever looked at it from that angle before.
2.5 million in bonds will start loosing its value to inflation. You are far better off having 30% in equities. 2.5 million will generate 8,333 per month and that is without your real estate earnings or social security. You can always choose to spend less and actually have your investments grow instead of lose value from inflation.
Although it appears you are very risk averse, I think 100% bonds is actually more risky than have a small allocation in equities such as an S&P index fund.
Schwab had this article out today on SWR. Same idea as your table but a little different way of looking at the data. Their stock/bond mix was a little different than your table so hard to check for sure numbers match up. Thanks for another great presentation.
http://www.schwab.com/public/schwab/nn/articles/Retirement-Spending-How-Much-Can-You-Afford?cmp=em-QYD
Thanks for a great presentation on this topic. No matter how I often I read something about SWR and “get it”, I need frequent info like this to remind me the rationale behind it.
Out of curiosity, what stock/bond AA are you initially planning on using when you retire?
I haven’t decided yet. There are obviously advantages and disadvantages to keeping that ratio high. I haven’t changed it in 10 years, and might not change it in another 10. There is no rule saying you have to change your stock to bond ratio as you age and get closer to retirement.
Good presentation. There is a lot of press about this lately. A retirement researcher that I find very insightful is Wade Pfau, Phd. He’s publishing a ton about retirement planning.
http://wpfau.blogspot.com/2013/01/new-research-article-4-rule-is-not-safe.html
Yes, he’s very conservative on this question. I think too conservative. His arguments are based on low future expected returns. I wrote a bit about that here:
https://www.whitecoatinvestor.com/making-different-choices-due-to-low-expected-returns/