Preventing Your Own Withdrawal Rate Problem

rogernusbaum

An important ideal in how I've tried to structure my life is to try to prevent or solve my own problems. I write about this in various places and the sentiment is a huge personal priority. One potential problem to prevent or solve relates to how much to withdraw from your portfolio in retirement especially early in retirement and especially if the market has a nasty decline at the same time you plan to start withdrawing. The decline at, just before, just after retirement problem is of course sequence of return risk. An example of an adverse sequence would be that six months after you retire stocks crash 33% in two weeks, like they did last spring, but that they don't snap back as quickly as they did in 2020.

Christine Benz from Morningstar had a recent article looking at the idea that instead of the 4% rule, maybe retired investors should plan on a 3% rule. Even if you disagree with 3%, it is important to understand that the 4% rule relies on bond yields that no longer exist. As a reminder, the 4% rule says that you can withdraw 4% in the first year of retirement and then adjust up each year by the rate of inflation. It is not realistic in my opinion that people are going to nudge their annual withdrawal rate by $409.68 (made up example). My spin has always been, whatever you got; no more than 4%. This accounts for asset inflation and you'd take less if the market does something hideous. Yes, my idea can result in a lumpier income stream but the willingness/flexibility to endure a lower portfolio income for a year or two helps to prevent the problems that might go with taking an oversized withdrawal right after a large decline in the equity market.

There are several ways to mitigate sequence of return risk for the start of retirement. Beyond working longer and cultivating other streams of income retirees can take a more tactical approach in their portfolios by raising cash based on some sort of technical indicator. Like any type of portfolio action, the tactic could turn out to be right (sell enough to cover a couple of years and the market does indeed go down a lot) or it could turn out to be wrong (the chosen technical indicator turns out to be wrong and the market rockets higher but at least you're still mostly invested). Another option is just raising cash ahead of time to cover whatever period would make you comfortable and letting the rest of portfolio go along for the market's ride for better or for worse. The second option certain would be less work and depending on the psychological makeup of the end-user, maybe easier emotionally too.

As I was reading Benz' article a twist on the raising cash option occurred to me in the context of being willing/flexible enough to alter spending patterns in the face of an adverse market sequence. Ideally, how much would you want to take from your portfolio in the first couple of years, maybe three or four years, of retirement? Now, what is the absolute minimum you need to take from your portfolio in the first X years of retirement? Maybe your ideal is $39,000 but you could get by taking just $23,000 by forgoing traveling and eating out less. If your comfort zone was having three years of expected ideal portfolio need in cash then you could set aside $117,000 ($39,000 times three years). The twist is setting aside $69,000 ($23,000 times three years) of just getting by portfolio need. If nothing bad happens in the stock market you'd still be able to take the $39,000 but the ability to just take $23,000 goes a long way to solving your problem that could be caused by an adverse sequence of returns.

Not everyone can have the flexibility that I am talking about here but to the extent you can, you will make your retirement much easier (less stressful).

Comments (2)
No. 1-1
Ernle
Ernle

Hi, Supersaver here. I'm closer than you, Roger, to mandatory withdrawal. To me this is just a tax and regulation issue. After all, withdrawal forces me to pay taxes as income from sheltered assets that mainly grew through capital gains; once withdrawn, it will have to be reinvested. So optimization of withdrawal is somewhat a speculation on taxes, now and in future.

1 Reply

rogernusbaum
rogernusbaum

Editor

exactly, that's how the gov't gets paid; RMD