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Living Off Your Money: How Much Can You Safely Withdraw from Your Portfolio When You Retire Early?

The strategy you use to accumulate wealth in an investment portfolio isn’t the same strategy you use to take your money out of a portfolio (decumulation).  You need a completely different strategy. Taking money out of an investment portfolio needs to be done very carefully. You don’t want to run out of money in your old age when you may not be willing or able to work.

Most people think they can simply move to a somewhat more conservative asset allocation once they retire. And that they can withdraw an inflation adjusted 4% a year. This traditional retirement withdrawal strategy is based on the 4% Rule of Thumb devised by William Bengen and confirmed by the Trinity Study. And, yes, you can do this. But the traditional fixed withdrawal strategy may not be the optimal strategy for early retirees or those who may live more than 30 years after retiring. While the 4% is a decent rule of thumb, you may want an individually calculated withdrawal rate based on your unique financial situation. 

What if you need that portfolio to fund 40 to 60 years of retirement thanks to being an early retiree? Even if you retire in your 50’s you may need to account for living another 40 to 50 years. Most of the research indicates that 3% or 3.5% would be a safer withdrawal rate for a very long, early retirement. Rather than take a stab in the dark, wouldn’t it be nice to figure out what your own optimal withdrawal rate is based on your personal situation and the state of the stock markets at the time you retire? 

Early retirees and very healthy individuals and couples will need to live off their assets for much longer than the traditional retirement plan. With projected increases in longevity, it may be that even not-so-early retirees will need to plan for a longer retirement. If you retire at 50 or 55, you could have another 45 to 50 years to live. If you retire at 65 then a 40-year retirement plan is a good benchmark. 

According to the Society of Actuaries there is 6% chance that a 65-year old male will outlive a 30-year retirement plan, a 12% chance for a 65-year old female and an 18% chance that one person in a 65 year-old couple will outlive the 30 year plan. Hence a 40-year plan that is designed to go the distance becomes absolutely essential because the real risk in retirement is that you might run out of money (longevity risk). Nice to live long but not so nice if you can’t afford to eat or pay for medical expenses.   

How long will you live? I have no idea, but Professor Moshe Milevesky does. He suggests using your biological age to better estimate your lifespan. See his appearance on the podcast, Rational Reminder, if you are curious.

I’m simply estimating 100 as a lifespan and planning on leaving a small inheritance. If we live longer than 100, the kids probably won’t get much of an inheritance. But they should be well established and fully independent by that time and not need one.

There are a lot of different theories and strategies about how you might safely withdraw money from your retirement. There is the bucket strategy of keeping various amounts of money in different accounts for different purposes. Also, there is the benchmark 4% safe withdrawal rate method originally proposed by Bengen. Then there is Michael Kitces’ rising equity glidepath method that has you increase your equities in retirement instead of holding a static percentage of your portfolio. 

Which should you choose? How do you know which is the best strategy for you? Wouldn’t it be nice to know that these various strategies were empirically and mathematically tested so that you could choose one that doesn’t just sound good, but that has been stress-tested against historical past returns and thousands of retirement periods? And wouldn’t you like to choose the safest strategy that has the greatest withdrawal rate possible so you can spend more and enjoy your life to the max in retirement?  

Well, you are in luck because Michael McClung, author of Living Off Your Money, has crunched the numbers. He has done the comparisons and tested not just what is the best percentage to withdraw depending on the length of your retirement, but also the best percentage to withdraw based on how the stock market is valued. He has developed a way to determine the optimal asset allocation strategies in retirement. [In markets with high valuations (based on a high CAPE ratio over 20 in the USA), the risk of a market crash is greater. So your safe withdrawal rate gets adjusted down. In markets that have low valuations (CAPE below 20), you get to withdraw a higher percentage, as it is likely stocks are going higher in the future]. 

Wouldn’t it be nice to also know what the optimal asset allocation is in retirement? How much should you have in stocks, bonds, REITs, cash? And how should this allocation change as markets change and you get older? Or should your asset allocation stay the same regardless of age? What if you have an unexpected emergency expense and your roof needs repair or you have a costly health issue? What sort of portfolio will be robust enough to survive an unexpected and somewhat chunky withdrawal for a roof repair or a medical issue or to help out your children? 

Thankfully, McClung has done the painstaking work and mathematically tested and compared the most popular retirement decumulation strategies to find out which are the best performing and safest strategies. His research is a big advance for all retirees, not just early retirees. He backs all his research on historical testing so you know he isn’t just hypothesizing. Hooray! I can’t tell you how important this is. I’ve been looking for years. And I’ve seen many very intelligent financial experts differ in opinion and strategy. 

How do you know which strategy is the best? It is very hard to compare decumulation strategies without an advanced degree in computing and significant experience in financial modelling.

McClung is the man. Heads up, his excellent book is not light reading. But he does provide clear explanations as well as a variety of examples. He admits you may need to take a good week to go through the book and reread as necessary. McClung shows the numeric facts. And he explains why one strategy might not work as well as another. He ends the book by suggesting the optimal withdrawal strategy with the greatest likelihood of keeping your income intact over 30 to 40 year periods. An optimal withdrawal strategy that is designed to weather world wars, depressions, recessions and everything in between. This is no small task!

I’m particularly interested in this. As self-employed business owners, we don’t have a traditional workplace pension. We will need to rely heavily on our investment portfolio to live on in retirement. I couldn’t figure out which strategy we should use until I read Living Off Your Money

Thanks to McClung’s research, I now know exactly what to do to manage our family finances. I know how to set ourselves up for investing success when we retire. It’s a plan that is built to last for the next 40-45 years. It is especially important to take into consideration global results, not just USA stock market results regardless of where you are retiring. There is no guarantee that the USA will continue to outperform the world in the future. I hope it does, but there are never guarantees in investing.

So, it’s best to hedge your bets. Go for a well-diversified global dynamic asset allocation strategy, as McClung suggests. The traditional retirement plan was based on both static withdrawals and a static asset allocation strategy. The latest research indicates you’ll be safer with a dynamic withdrawal strategy and a dynamic asset allocation strategy. Bummer! No ‘set and forget it’ if you want both a higher withdrawal rate with less overall risk.

What are the key elements of a robust decumulation strategy? 

1. It has been mathematically tested for as long a term as possible.

2. A robust strategy is broadly and globally diversified. It doesn’t rely on the performance of one or two asset classes that might underperform in a particular period.

3. It allows for the greatest possible retirement income with the greatest possible safety in not running out of money. You get the best of both worlds, a minimum of risk with the maximum of retirement income.

4. A robust strategy takes into consideration market valuations at the start of retirement. Thereby, you reduce sequence of returns risk. This is the risk that you’ll draw too much money out at the start of retirement in a down market and never recover, depleting your portfolio too quickly and running out of money.

5. It determines the best possible asset allocation strategies, the best withdrawal strategies, and the best ratio of stocks to bonds over 30 to 40 year retirement periods. Thus, it provides superior results with lower levels of risk.

6. Also, it takes into consideration the use of different types of guaranteed income from an inflation-adjusting annuity. So you can determine whether or not an annuity is an affordable option. Counterintuitively, the more a retiree allocates to guaranteed inflation-adjusting annuities, the higher the risk of not being able to cover unexpected expenses. (You can’t withdraw a lump sum from an annuity once it is started. Liquidity is given up when you purchase an inflation-adjusting annuity, which provides a stable income. But it doesn’t allow you to take out a lump sum for an emergency should one arise. For this reason, it is important to make sure you have another method of covering emergency or unexpected expenses in retirement). 

7. It is flexible and resilient enough to allow for the occasional emergency withdrawal without undermining the overall plan.

As you can see, this is quite a tall order! Taking money out of an investment portfolio isn’t as easy as it sounds.  And this doesn’t even account for any of the psychological issues you may confront when you suddenly need to reverse course and take money out of your investment portfolio. Once you are in the habit of putting money in, you may find withdrawing it isn’t as easy as you’d imagine.

Good savers tend to prefer adding to their portfolios. They get squirmy about taking it out. You have to have real confidence that you’ve chosen a rock-solid plan. The traditional advice is now considered out of date given the advances in portfolio construction and our knowledge and testing of decumulation strategies. 

For any resilient retirement strategy, you not only need a solid, thoroughly tested plan, but also a robust backup plan. 

If you aren’t already on the path to financial freedom and an earlier retirement, you might be curious to learn how you can retire in ten years or less

Get on the fast path to financial freedom, learn how in the Financial Independence, Retire Early (FIRE) Course.

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