How do you withdraw 4% from your portfolio when you enter FI

[Asgard01]

Hi all,

I want to test my knowledge of withdrawing an income from my portfolio when I reach FI In 5 years time at 32.

Right, let's say that it is 5 years from now. My money has grown at a real 5% rate per year which would be nice. This is from my mix of 80/20 stocks bonds and some 60/40 stocks bonds funds (vanguard). I have reached my target of $233707 which gives me all my basic necessities and bills at 4% withdrawal rate $779 a month.

In the past, I assumed that you took the dividends from this which may be 4% but forgive my lack of knowledge, my funds only give around 1.7% dividends and I have read that the higher yielding funds often do not grow very well. Am I right or wrong in thinking that every month I workout what 4% of my total amount is, divide this by 12 and then sell that amount of my stocks/bonds fund.
I can then draw 5% or more to account for inflation etc after the first year.

My next question is as there is pretty much always inflation, does that not mean I would always be withdrawing 5-6% after year 1 in the same way each month - 5.5% of total (1.5% inflation) divided by 12 then sell this amount of stocks/funds. I would repeat this every month from then on.

If the market was in a bad year or couple of years then I would be best to stick to 4% without accounting for inflation and if there was a bull market then I could even withdraw 7-8%. By doing this, it would be likely that my money would last 30 years. Depending on how markets go up and down relative to my retirement, I could withdraw a higher amount and still not touch my principle or I would have to withdraw a lower amount of say 3% which could slowly eat into principle but should keep you going for 30years. Depending on how lucky you get with timing your retirement, you could get a way with a higher withdrawal rate. And finally the higher your stocks percentage, 40, 60 or 80%. The more likely you can draw that 4% continuously.

Thanks for your time,

Chris

[IlliniDave]

If you want to correlate what you do with the studies that lead to the SWR idea (e.g., the Trinity Study) you would determine 4% of your invested assets and withdraw that much total during the first year (remember that 4% number in dollars). Whether you do it monthly or quarterly or whatever is primarily just a matter of convenience for you. The next year (and following years) you adjust that initial 4% upwards to match inflation, without making any adjustments based on what your investments actually do year-to-year. You only apply the inflation to the amount you withdraw, so if inflation was 2% and your 4% was $10K, in year 2 you'd withdraw $10.2K. You don't add the 2% inflation to 4% and take 6% of your starting balance (which would be $15K in my example). You'll likely go broke quickly doing that.

That's the academic process--and it gives you a steady real (after inflation) income throughout the withdrawal period.

That said, you could simply withdraw 4% of your balance each year. That way you'd never run out on money. The downside is the income will vary year-to-year which can be a headache to manage.

As you allude to, there are all kinds of common sense adjustments you can make if the markets hit a rough patch. In practice those kinds of implementations are probably far more common than strict imitation of the academic assumptions.

Typically you'll take what you get in dividends and interest (since you're paying tax on them anyway) and then sell enough assets to get up to 4%. You are correct in that unless you've got some sort of max dividend strategy going on, dividends will be around 2% in something like an SP500 index fund, with intermediate-term bonds paying similar.

[Carlos]

At age 32 most people would say 4% would not be a SWR, if there is any such thing. For such a long time horizon I'd recommend no more than 3% WR of your portfolio to start if you have zero desire to return to work.

[SimpleLife]

I agree with Carlos. The 4% rule was for people retiring at a more traiditional age, not in their 20's or 30's.

[tylerrr]

i just plan on withdrawing 4% of my total value assets invested each January. Whatever my total balance is, i'll take 4% of that each January. If I don't use all the money during the year, I'll just put remaining balance back into my investments.

[henrik]

Whether you do it monthly or quarterly or whatever is primarily just a matter of convenience for you.

If there are per-trade costs or fees it might make a difference.

[IlliniDave]

Whether you do it monthly or quarterly or whatever is primarily just a matter of convenience for you.

If there are per-trade costs or fees it might make a difference.

Maybe true, convenience sometimes comes at a price. OP doesn't say whether everything is in funds at VG (generally no transaction fees) or whether he's got a brokerage account there or elsewhere. Many people seem to do their withdrawals annually, OP seemed to want to do them monthly. The question seemed more about the general mechanics than it did optimized tactics for a specific detailed situation. As you allude to, and others regarding the specific withdrawal rate, there is another level of fine tuning that should occur when accumulation ends and the plan is put into action.

[IlliniDave]

I agree with Carlos. The 4% rule was for people retiring at a more traiditional age, not in their 20's or 30's.

If I were doing this in my 20's/30's and was determined to stick to the constant annual inflation-adjusted dollar withdrawal I'd use 2%. I'll be starting in my 50s so I'll probably use 3% until RMDs force me higher. But I will be more flexible with my withdrawal strategy and take less out when it seems prudent to do so (assuming I'm not backed into some corner).

Remember the old math problem where you start at point A and continually move half the distance from A to B? You never reach B.

If once a year you just take x% of your balance that day to fund yourself for the coming year you'll never run out of money (unless your assets just lose all their value), but it could result in substantially fewer dollars per year over time if x% is too high. Even if x% is well-sized there could be a lot of fluctuation year-to-year using that method, so it doesn't get discussed a whole lot. But it's something a flexible young person with a lot of human capital left could consider. It becomes increasingly difficult with age.

[UrbanHermit]

Using FIRECalc's default settings I get:

4% WR, 30 years = 94.7%
4% WR, 60 years = 81.9%
3% WR, 60 years = 100.0%

3% looks pretty safe as a SWR for a thirty-year-old to me. 4% doesn't look so bad either when you consider this is (1) a constant spending model but in reality people cut back on withdrawls during recessions (2) assuming zero income of any kind forever, which is unlikely for a thirty something, and (3) largely determined by sequence-of-returns risk in the first few years of retirement, which for a thirty-something would mean going back to work for a few years at fourty, not living on catfood in their twilight years.

4% is the number I use, I'd rather hustle a bit to make it work for me than work 1.5-2x longer saving assets I may never need for a worst-case that may never occur.

--

edit: actually, I forgot to account for actuarial data... that's only the portfolio survivability. When you factor in your (progressively lower) chance of being still being alive at the time of portfolio failure the numbers look a lot rosier. With some simplified assumptions I get close to 90% for the 4%/60y case.

[theprincereturns]

4% is the number I use, I'd rather hustle a bit to make it work for me than work 1.5-2x longer saving assets I may never need for a worst-case that may never occur.
.

I concur with UrbanHermit. My observation of most FI people in their 30s is that they take a couple years figuring out what they think is valuable to them and what they enjoy doing with their time. but eventual end up doing something that results in at least a small amount of income that reduces their needed withdraws down to at least 3% or lower . Also if your income needs are so low that you could do an "untrained" job or a minimum wage job and cover almost all of your expenses if needed, then that pretty much offsets all remaining risk. And hey, it might even be fun to work as a white water rafting instructor for a summer just to get some good exercise and tons of "free" rafting in

[Asgard01]

Thanks for all your replies guys. Just to confirm then according to the trinity study etc, I need to calculate 4% of total portfolio. Which to me is two vanguard life strategy funds, one at 80% stocks and one at 60% stocks. I can then draw 4% in full and pay myself each month or keep the money in stocks and draw 4% divided by 12 each month which would take one sell or 2 if I took money from both funds or I could leave the money in the funds and draw per month which could total 24 sells a year.

The inflation bit is confusing me, I understand you use the static amount of portfolio at the start rather than take 4% every year as I assume this will then account for the large swings both upward and downward of the whole portfolio during the various bull and bear markets. What I don't get is, do you add the inflation that the government say happens each year and add that to static 4%, so add 1.5% of initial 4% of say $275,000 which is $11000. Do I then add 1.5% to $11000 which would be $165. The following year would then be $11165. Let's say the following year is then 2% inflation. Is that then 2% of $11165 which would be $223 giving me $11388. I then do this for the following 28 years which statistically based on past information will give me in the 80's in percent chance of not running out of money. Can someone please advise on how it does work if that is indeed wrong.

Kind regards
Chris

[Asgard01]

Thanks Toska. It always struck me that 4% was quite low, I mean a couple years ago I could have got a 5 year UK savings ISA at 5% and a couple years before then, even at 8%. I guess the 4% simply accounts for the swings of the stock market and also it provides inflation protection which most other things don't. The current UK best ISA is 3% for 5 years for example. I guess if the ISA market got back to levels of 8% then this would be time to switch back to cash (in the UK at least).

I currently have 2 jobs, 1 that's pays 95% of my salary and another where I do 3.5 hours a week as a personal assistant to my disabled friend. In 3 years if growth continues at 5% and I keep putting down $1546 a month, I will be able to switch to the personal assistant job which gives me $170 a month and pack my other job in leaving $630 coming from portfolio at 4%. Thing is, I intend to use FI to allow me to choose a job I want that has less hours and for the inherent pleasure and purpose of the job rather than being paid to survive. This money would then pay for fun money, Hols etc and putting a bit in shares too. This to me will offset any 4% risk but allow me to leave jobs for months at a time if I please.

I look forward to 3 years time at 30 years of age when I can do that

Thanks
Chris

[IlliniDave]

I believe the 4% was determined experimentally based on back-testing against US historic market returns assuming a range of asset allocations (stock/bond splits). Inflation is built into the withdrawal rate so the strategy is effectively designed to preserve income versus the real return of investment assets (insofar as investments perform similar to historic US assets).

Since the study had traditional-aged retirees in mind, there's an implicit assumption that a subject retiree can't just unretire 20 years down the road and start working for a living again. So the strategy was intended to produce very high rates of success (very low probability of shortfall) when tested with Monte Carlo techniques. The median result for a robust strategy typically shows an increase in assets over the test period (even after inflation is accounted for). In other words, to the extent that assets behave with the characteristics of historic US assets, you're more likely than not to wind up wealthier as time goes by than poorer.

I emphasize historic US assets underlying the study as they could behave substantially different from US (and ex-US) assets going forward. The general (though not unanimous) consensus is that longer-term US real returns (going forward 10-20 years) will average 1-2% below the historic real return averages, which is why we're seeing increasing discussion SWRs being below 4% for future retirees.

The biggest vulnerability is hitting a severe market downturn over the first few years (so-called sequence of returns risk). My strategy for dealing with that is to start off with a very conservative initial withdrawal rate for at least the first 5 years, maybe 10, then reassess based on how my income-producing assets hold up. I have children, so having something left when I die is not "bad" outcome. I'll probably be 55 when I start, so asset depletion 20 or 25 years down the road is potentially a pretty big problem.

I guess that's a long-winded way of saying that I would tend to agree that a young ERE in good health could probably withdraw more aggressively so long as they're willing to stay flexible, pay attention, and adjust as conditions warrant. Something as simple as finding a fun, part-time job that pays minimum wage can go a long way toward increasing the resilience of a nest egg during rough times according to my home-spun simulations.

[George the original one]

> Something as simple as finding a fun, part-time job that pays minimum wage can go a long
> way toward increasing the resilience of a nest egg during rough times according to my
> home-spun simulations.

Finding jobs during tough times may not be as easy as we'd like to think since everybody else will be doing likewise.

[IlliniDave]

> Something as simple as finding a fun, part-time job that pays minimum wage can go a long
> way toward increasing the resilience of a nest egg during rough times according to my
> home-spun simulations.

Finding jobs during tough times may not be as easy as we'd like to think since everybody else will be doing likewise.

That's very true. Simple and easy are not always the same. A younger person might have the option of just riding it out a few years until things got better then picking up some income. Being older myself, I'll probably try to pick up the "fun part-time occupation" as soon as I can after ER to let its benefits accrue ahead of any black swans that might show up (on top of using a max 3% or lower withdrawal strategy).

[George the original one]

For the traditional "base 4% SWR and adjust for inflation" scenario, someone (linked to a blog on here? on Seekingalpha?) studied what actual withdrawl rate should trigger the panic button as historically portfolios never recover if that withdrawl rate is surpassed.

It was somewhere above 10% (11.x%?), so most folk should be okay if they make adjustments when it hits 10%. Adjustments like going back to work or reducing expenses or finding a sugar daddy.

[IlliniDave]

For the traditional "base 4% SWR and adjust for inflation" scenario, someone (linked to a blog on here? on Seekingalpha?) studied what actual withdrawl rate should trigger the panic button as historically portfolios never recover if that withdrawl rate is surpassed.

It was somewhere above 10% (11.x%?), so most folk should be okay if they make adjustments when it hits 10%. Adjustments like going back to work or reducing expenses or finding a sugar daddy.

I've not seen that particular analysis. I'm not a very courageous person, so I don't think I'd want to take it right to the cusp of the point of no return myself. I'll have to try to look that up and at least be aware of what the point halfway between my withdrawal level and the cliff is, and use that to trigger a search for contingency plans should things go really awry. I really would like to stick with 3% as my ceiling but life is full of surprises. That said, I recognize that I am perhaps far more conservative than I should be, and certainly don't suggest what I have to do to sleep well at night should be followed by anyone else. Thanks for the "tip"!

[jacob]

It was somewhere above 10% (11.x%?), so most folk should be okay if they make adjustments when it hits 10%. Adjustments like going back to work or reducing expenses or finding a sugar daddy.

I didn't completely understand this.

Are you saying that you can withdraw 10-11% annually insofar that you reduce expenses or go back to work if/when your portfolio is reduced to 1/10th of its starting value?

[7Wannabe5]

GTOO said: It was somewhere above 10% (11.x%?), so most folk should be okay if they make adjustments when it hits 10%. Adjustments like going back to work or reducing expenses or finding a sugar daddy.

Yeah, but for the last option you would have to do all sorts of complicated math such as multiplying the likelihood that you will look 62% as good as Christie Brinkley at age 60 by the survival rate of the Boomer generation of men by the percentage of this demographic group likely to be in possession of retirement assets in excess of their own needs/wants adequate to meet your expense shortfall.

Given that housing/food is a major expense in most budgets and most retired men are in possession of under-utilized bed and garden space which is already heated or planted in lawn grass, I think this is a pretty safe bet for a security net and also a good thing to do for conservation of natural resources and society (since it leads to fewer grouchy old men.) Also, probably 80% of what one would have to do to attempt to look as good as Christie Brinkley at age 60 is also highly likely to prevent totally disabling hip fractures in later years... so win-win except for the $1000/year approximately one would have to spend on Botox etc. Of course, YMMV.

[robby152]

It was somewhere above 10% (11.x%?), so most folk should be okay if they make adjustments when it hits 10%. Adjustments like going back to work or reducing expenses or finding a sugar daddy.

I didn't completely understand this.

Are you saying that you can withdraw 10-11% annually insofar that you reduce expenses or go back to work if/when your portfolio is reduced to 1/10th of its starting value?

What he is saying is if you set the anchor of withdrawal amount according to the methodology in the Trinity Study (i.e. 1M portfolio yields 1st year withdrawal of 40K which is then adjusted up or down based only on inflation, not on remaining portfolio balance), that if 3 years into the future, inflation has been flat (and thus the annual withdrawal is still 40K), but the portfolio balance has dropped to 400K (10% of remaining portfolio), you need to hit the panic button and reduce your withdrawal amount.

Most people here don't use the Trinity withdrawal methodology, but instead use a fluctuating withdrawal amount based on remaining portfolio value at a set % (2.5-4%). Thus, an ERE type would only withdraw 16K on the portfolio above, since the remaining portfolio dropped in value to 400K, instead of blindly continuing with the initial set amount +- inflation adjustments.