Stocks — Part XIII: Withdrawal rates, how much can I spend anyway?

4%.  Maybe more.

So, you’ve followed the jlcollinsnh big three:

You’ve avoided debt

You’ve spent less than you’ve earned

You’ve invested the surplus

eggs

Eggs

by Sergey Gusev

Now you’re sitting on your stash and wondering just how much you can spend each year and not run out.  This could be stressful, but it really should be fun. You might even be cheeky enough to ask, “What percent of his own stash does jlcollinsnh spend?”  We’ll get to that.

You don’t have to have read far in the retirement literature to have come across the “4% rule.”  Unlike most common advice, this one holds up to our beady-eyed scrutiny pretty well, even though it is really very little understood.

Back in 1998 three professors from Trinity University sat down and ran a bunch of numbers.  Basically they asked what would happen at various withdrawal percentage rates to various portfolios, each with a different mix of stocks and bonds, over 30 year periods depending on what year the withdrawals were started.  Oh, and both with adjusting withdrawals for inflation and with not adjusting withdrawals. Whew.  Then they updated it in 2009.

Out of the scores of options, the financial media seized on just one of these models:  The 4% withdrawal rate, 50/50 stock/bond portfolio, adjusted for inflation.  Turns out, 96% of the time, at the end of 30 years such a portfolio remained intact.  Put another way, there was just a 4% chance of this strategy failing and leaving you destitute in your old age.  In fact, it failed in only two of the 55 starting years measured:  1965 & 1966.  Other than those two years, not only did it work, many times the remaining money in the portfolio had grown to spectacular levels.

Think about that for a moment.

What that last line means is that in most cases the people owning these portfolios could have taken out 5, 6, 7% per year and done just fine. In fact, if you gave up the inflationary increases and took 7% each year you would have done just fine 85% of the time.  Most of the time taking only 4% meant at the end of your days you left buckets of money on the table for your (all too often ungrateful) heirs.  Great news were that your goal.  Also great news if you anticipate living on your portfolio for longer than 30 years.

But the financial media knows that most people don’t like to think too hard.  By reporting the results at 4% they could report on just about a sure thing.  Roll it down to 3% and we have as sure a thing as we’ll ever see short of death and taxes.  Oh, and that’s giving yourself annual inflation increases.

While 1965 & 1966 were the last and only two years where 4% failed, remember that more recent start years have not yet had their own 30 year measurable runs.  My guess is that if you began your own withdrawals in 2007 and the early part of 2008 just prior to the recent collapse, you will have hit upon two more years in which the 4% plan is destined to fail.  You’ll want to scale back.  On the other hand, if you started with 4% of your portfolio’s value as of the March 2009 bottom, you’re very likely golden.

Here’s the Trinity Study Update.  The prose is a bit dry, it is written by PhDs after all, but don’t feel you need to read it closely.  What you should take a close look at are the very cool charts showing how differing scenarios play out.  If you want a detailed answer to the question of what percent works for you and your own unique situation and attitudes, you can figure it out here.  Plus, you’ll need to refer to those charts to follow along in the rest of this post. So go ahead. Take a look. I’ll wait.

Here’s the Cliff Notes version:

    • 3% or less is a near sure bet as anything in this life can be.
    • Stray much further out than 7% and your future will include dining on dog food.
    • Stocks are critical to a portfolio’s survival rate.
    • If you absolutely, positively want a sure thing, and your yearly inflation raises, keep it under 4%.  Oh, and hold 75% stocks/25% bonds.
    • Give up those yearly inflation raises and you can push up towards 6% with a 50% stock/50% bond mix.
    • In fact, the authors of the study suggest you can withdraw up to 7% as long as you remain alert and flexible. That is, if the market takes a huge dive, cut back on your percent and spending until it recovers.

When you look at the article you’ll see it has four charts.  The first two look at how various portfolios performed over time and at various withdrawal rates.  The difference is the second one assumes you increase your dollar withdrawal amount each year to account for inflation.  So if you look at Chart #1 and at the 50/50 mix with a 4% withdrawal rate, you see you have a 100% chance of your portfolio surviving 30 years.  Chart #2 tells you that if you take those same parameters but give yourself inflation raises, your portfolio’s chance of survival drops to 96%.  Makes sense, no?

Charts 3 & 4 tell us how much money remains in the portfolios after the 30 years have passed and this, to me, is really compelling stuff.  Again, Chart 3 assumes a straight percentage withdrawal and Chart 4 assumes giving yourself inflation raises.  Let’s take a look at some examples.

Assume a 4% withdrawal rate on a portfolio with an initial value of $1,000,000.  Here’s what you’d have left (median ending value) after 30 years:

Chart 3:

  • 100% stocks = $15,610,000
  • 75% stocks/25% bonds =  $10,743,000
  • 50% stocks/50% bonds= $7,100,000

Chart 4:

  • 100% stocks = $10,075,000
  • 75% stocks/25% bonds =  $5,968,000
  • 50% stocks/50% bonds = $2,971,000

Very powerful stuff and it should give you a lot to feel warm and fuzzy about as you follow The Simple Path to Wealth.

As you look over these charts, one thing that should become very clear to you is just how powerful and necessary stocks are in building and preserving your wealth.  This is why they hold center stage in my Portfolio Ideas.

What is likely less obvious, but every bit as important, is the critical importance of using low-cost index funds to build your portfolio.  When you start paying 1-2% or more to active mutual fund managers and/or investment advisors all these cheerful assumptions wind up in the trash heap.  Blogger Wade Pfau in this article says it best:

“For an example of this, the 50-50 portfolio over 30 years with 4% inflation-adjusted withdrawals had a 96% success rate without fees, 84% success rate with 1% fees, and 65% success rate with 2% fees.”

In other words, using the Trinity Study projections with portfolios built from anything other than low-cost index funds is invalid.

 So, now to answer that question: What withdrawal percent do I personally use in my retirement?  I confess I pay so little attention it took a few moments to figure it out and even then it’s not exact.  But this year my best guess is it is running somewhere north of 5%.  If you are a regular reader, this casualness probably surprises you.  But there are mitigating circumstances:

1.  I have a kid in college.  That is a huge annual expense, but in 1.5 years it goes away.  The money for it is figured into my net worth, but it is also earmarked as “spent.”

2.  Since my retirement, my wife and I have accelerated our travels and the related spending has spiked sharply. Not to be morbid, but at my age I am more worried about running out of time than money.  If the market were to tank in a major way, this is an easy expense to adjust.

3.  Sometime in the next few years we will have two nice new income streams coming on-line in the form of Social Security.

4.  Most importantly, I know I’m well under the 6-7% level that requires close attention.

Within that 3-7% range, the key to choosing your own rate has less to do with the numbers than with your personal flexibility.  If as needed you can readily adjust your living expenses, find work to supplement your passive income and/or are willing and able to comfortably relocate to less expensive places, you will have a far more secure retirement no matter what rate you choose.  Happier too I’d guess.

If you are locked into certain income needs, unwilling or unable to ever work again and your roots go too deep to ever seek out greener pastures, you’ll need to be much more careful.  Personally, I’d work on adjusting those attitudes.  But that’s just me.

My pal, Mr. Money Mustache, did a fine piece on this a while back.  It is as good an explanation/defense of the 4% rule I’ve yet to read. Nothing, of course, is guaranteed. That why we all need to remain flexible, alert and, well, Mustachian.

Last Spring I dealt with a lengthy comment from reader “ddrem” describing the disastrous position the world is in today and calling into question my portfolio recommendations accordingly. (See: http://jlcollinsnh.wordpress.com/2012/05/12/stocks-part-vi-portfolio-ideas-to-build-and-keep-your-wealth)

No worries.

sea by Gusev

Sea

by Sergey Gusev

Not only will we muddle thru, it is my belief we are on the verge of another great bull market. For lots of reasons, not the least of which is simply these things go in cycles and the drumbeat of pessimism (always a bullish sign) seems unusually high.  People seem to believe the world will end on their watch. But it never does. It is the dark that sets the stage for the dawn.

If I’m wrong and the dawn is still a ways off, that’s OK too. There are lots of adjustments I can make and options to explore.

4% is only a guide. Sensible flexibility is what provides security.

Addendum 1: For another way to look at this, consider The Rule of 300, courtesy of Johnny Moneyseed.

Addendum 2:  Vanguard Retirement Nest Egg Calculator

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61 Comments

  1. Posted December 8, 2012 at 1:45 am | Permalink

    Enjoyed this post Jim. It gives me a lot of confidence my wife and I are doing the right thing. Wife is a bigger spender than I am, but more conservative on the withdrawal end. She wants to draw 0% and live off of other monies.

  2. Another Investor
    Posted December 8, 2012 at 8:50 am | Permalink

    My problem with the Trinity study and FIREcalc is they are based on returns in a rapidly growing economy. I’m not convinced these returns will be repeated in a more mature US economy with a lot of competition from outside. Current and future taxes are also an issue.

    I prefer a mix of dividend yielding stocks and real estate for the income portfolio. I limit myself to only considering the net income from my assets as my potential income – I do not decumulate and spend principal. I worry less about the vicissitudes of the market and keep less of a wary eye on inflation this way. Better tax treatment as well.

  3. Naomi
    Posted December 8, 2012 at 6:21 pm | Permalink

    Wow, this is great information. I’m curious – have you ever seen studies that go beyond 30 years? With the increases in both life expectancy and “extreme” early retirements it seems that people will need their portfolios to last longer than 30 years.

    • Posted December 8, 2012 at 7:21 pm | Permalink

      Thanks Naomi…

      That’s a great question and I’ll probably edit the post to address it.

      The Mr. Money Mustache article I linked to talks about this and he claims that the math is much the same for periods beyond 30 years. That is, if it works for 30 it very likely works for 60. I believe he uses FIRECalc in arriving at this conclusion. Since I am unfamiliar with that tool I can’t vouch for it.

      Since 1989 I’ve “retired” several times for periods lasting from 3 months to 5 years. (See: http://jlcollinsnh.wordpress.com/2012/05/26/mr-money-mustache/)
      Always got drawn back into work, but never because the money was running out. In fact, much as the Trinity Study would have predicted (although I had yet to hear of it at the time) my net worth actually increased during these periods.

      For those years I withdrew around 3-5% and paid close attention to my portfolio. Had it begun to drift down, I would have adjusted my lifestyle and spending. Problem solved.

      Were I about to embark on a 60+ year retirement (and even at my advanced age who’s to say I haven’t?) I’d do much the same. In fact, that’s exactly what I am doing. It is about the flexibility I discussed in the post.

      Trying to select a “set it and forget it” percentage, especially with annual inflation raises, that will last in every circumstance over multiple decades of time seems a fool’s errand. And unnecessary.

      The beauty of the Trinity Study is that it tells you exactly what has happened across multiple scenarios over multiple decades. Examining that data provides a great framework to assess your personal situation and what might work for you. It also points the way should the market move dramatically for or against you in the early years.

      Or just use 3% on a 75% stocks/25% bonds portfolio with no inflation adjustments. Very conservative and all your surprises will very likely be extremely pleasant.

  4. Posted December 8, 2012 at 8:37 pm | Permalink

    Just curious Jim as to why you decided to receive Social Security payment at age 62? It’s a nice post idea to explore different age vs monthly SS income… and, of course, tax implications.

    • Posted December 8, 2012 at 10:32 pm | Permalink

      Actually my wife and I were just discussing this over dinner (and a nice bottle of wine) this evening.

      I haven’t taken SS as yet and probably won’t until I’m 70. Mine will be larger than my wife’s. Since she is very likely to outlive me by a couple of decades, this will give her more security and a bigger check once I’m gone. We plan to have her begin with hers at age 66.

      So not yet for either of us. But for planning purposes, we know it’s coming and if needed we could always take it sooner.

      We are not the least bit concerned about it being there and, in my opinion, nobody 55 or over needs to be.

      It would be a very interesting post, but I’m not qualified to write it. I’m still trying to figure it out. If I ever get to the point where I feel I can, I’ll put one together.

      I try to write only about stuff I actually know about. Yes. I know. That’s not always apparent. :)

      • Posted December 8, 2012 at 11:51 pm | Permalink

        You are a wise man, my friend!

      • Posted January 23, 2013 at 4:55 pm | Permalink

        Do you have any opinion on planning for social security for those under 55? I’d like to think there will be at least some SS when I’m ready for it in about 30 years, but there are days when I think it’s unlikely. Ideally I’d like to plan as if there won’t be any SS and then if it’s there it’ll just be a nice extra, but I’m not sure that I’ll be able to manage that. Either way, I’m curious as to your perspective.

        • Posted January 23, 2013 at 6:02 pm | Permalink

          Hi CC….

          Do I have an opinion??? :)

          Actually, I’ve been meaning to write a post about SS and your comment might just be the motivation I need. For now:

          Your intention to plan as if it won’t be there is a good one. In fact this is what we did and surprise, it’s here for us.

          I think it will be there for you, too, but in a less generous form.

          I expect that retirement ages will be increased, payment reduced and the income ceiling (currently around 108k per year) that’s taxed will be raised. But it will be there.

          Remember:

          1. SS is backed by the most powerful lobby in history: AARP.
          2. Geezers are an increasing proportion of the population.
          3. Geezers vote.
          4. Politicians rarely try to take anything away from a large population that votes.
          5. This is why all the possible solutions being suggested will effect only those 55 and under.

          Hope this helps!

          • Posted January 23, 2013 at 10:01 pm | Permalink

            Thanks for sharing your thoughts! I think you’re right about politicians being unwilling to take a benefit away from such a large voting block, but at the same time, that can’t change the math. I’m also thinking there will be something, but will be smaller. You make a good point about them raising the retirement age even more. I wonder how high they’d let it go? Longevity runs in my family, so I’m planning a long retirement anyway, but I wonder if they would be able to get away with starting it at 70+ or if they’d hit too much resistance. Oh, where’s that crystal ball when we need it?

      • jcw
        Posted February 8, 2014 at 2:52 pm | Permalink

        Here’s the strategy my wife and I will be following wrt drawing SS. I’ll be 64 this coming Nov and she’ll be 63 this coming July. I plan on applying for and then suspending my SS at 66+7months (the month my wife turns 66). Suspending my payments allows my benefit to continue to grow (at ~8% per year) until I’m 70. Applying for mine at 66+7 months allows my wife to apply for spousal benefits (50% of my 66+7mo rate). At 70 I’ll start taking my 100% benefits and then, 7 months later my wife will switch over to her 100% benefits. Then, assuming I die first (a good bet), she will begin to collect 100% of my benefit. This strategy results in the most return on our investment in SS over all those working years of putting in. It’s the best plan to maximize our benefit.

  5. Prob8
    Posted December 8, 2012 at 8:44 pm | Permalink

    Wow, any time I want to feel better about the crappy returns I’ve had over the last 7 years I just need to read this blog to realize that over the long run things will get better. Couple questions . . . it looks like the study focuses on large companies for the stock allocation and a certain type of bonds. No mention of real estate. Give that the main fund in the Simpler Path is a total market fund and a reit plays a significant role, does that have an impact on the results? Also, is rebalancing necessary? I suppose the key is to remain flexible and adjust the withdrawal rate based on market conditions.

    • Posted December 8, 2012 at 10:40 pm | Permalink

      great question.

      yep, my simple path calls for 50% VTSAX (total stock market), 25% bonds and 25% REITS. For reasons I discuss elsewhere on the blog I think this is the most powerful combo for wealth building and preservation.

      As such, my bet is it should do even better than the purely stock/bond portfolios in the study.

      Yes, rebalancing is important with this approach and, indeed, any approach that uses asset allocation. Once a year is fine and I suggest on your birthday. Too much other trading and dividend/capital gains payouts happen at year end by the big firms and I prefer to avoid that time.

      If the market were to have a huge tick up or down in a short time frame, as in late ’08 & early ’09, I’d also rebalance then too.

  6. Posted December 9, 2012 at 6:28 am | Permalink

    Really liked this and all your posts on stocks Jim! Glad your back and had a good trip.

    • Posted December 9, 2012 at 10:54 am | Permalink

      Thanks Keichi….

      Already planning the next one. In a couple of weeks we’re headed to France to visit our Daughter who is there for the year. 5 days in Paris and 5 days in Valencia where I’ll get to abuse still more Spanish speakers with my broken and floundering attempts at their language.

      • Posted December 10, 2012 at 7:11 am | Permalink

        Haha, just keep using it and you’ll have to improve. That’s the way our brains work.

  7. MMM-JLCNH fan
    Posted December 9, 2012 at 7:59 am | Permalink

    Thanks for another great post. You mentioned MMM using FIREcalc to come to his conclusions. With FIREcalc, you can select various timelines as you mention. FIREcalc is set up to look at portfolio survival, just like the Trinity study. However, you can make it analyze the wealth accumulation phase by setting the annual portfolio spending as a negative number to reflect $ being added every year. Running it that way suggests that an all-stock portfolio (as you recommend in your Simple Path to Wealth post http://jlcollinsnh.wordpress.com/2011/06/08/how-i-failed-my-daughter-and-a-simple-path-to-wealth/ and elsewhere ) gives the best results during the accumulation phase and following the Trinity recommendations linked above (i.e. adding bonds to the mix) gives the best result during the retirement phase (as you have previously suggested here: http://jlcollinsnh.wordpress.com/2012/05/12/stocks-part-vi-portfolio-ideas-to-build-and-keep-your-wealth/ ).

    • Posted December 9, 2012 at 10:51 am | Permalink

      Thanks, Fan, for the clarification.

      As I mentioned, I’m unfamiliar with FIRECalc, but I gather it is a useful tool. And, since it seems to confirm my portfolio ideas, they must be doing something right! :)

  8. Acorn
    Posted December 9, 2012 at 10:02 am | Permalink

    This was so useful, I always have had a bit of trouble understanding withdrawal rates. This post makes it so simple to understand.

    • Posted December 9, 2012 at 10:48 am | Permalink

      So glad to hear it, Acorn….

      If I remember correctly, it was your question a while back that inspired it.

  9. Posted December 9, 2012 at 12:21 pm | Permalink

    Thank you so much for sharing my paintings on your blog. My video master class:
    http://gusevs.wordpress.com/video/

    • Posted December 10, 2012 at 11:10 am | Permalink

      My pleasure, Sergey….

      Thanks for letting me use them. Very cool video!

  10. Posted December 10, 2012 at 12:47 am | Permalink

    Presumably, dividends are included in the 4% math?

  11. Posted December 10, 2012 at 10:15 am | Permalink

    I am a LTBH individual stock investor now, at some point in the future I’ll make a decision if I want to re-balance my portfolio to something like VTSMX/VTSAX, VGSTX/VTIAX, VBMFX/VBTLX, which is a simple and effective portfolio.

    I recently blogged about retirement calculators that some commenters mentioned (http://mreverydaydollar.com/retirement-income-planning/). The two I like the most are FIRECalc and RIP. The major difference between them are that FIRECalc uses actual market returns whereas RIP uses a Monte Carlo simulation model. Who’s output is right? Both. I think you’ll want to use a combination.

    The more I learn and gain experience with early retirement planning, and I’m about 9 years away, the harder the conviction that *none* of it is an exact science. But it also doesn’t have to be, as adjustments can be made to your lifestyle depending on market conditions, just as you mentioned Jim.

  12. Posted December 12, 2012 at 3:15 pm | Permalink

    Thanks for tackling a tough subject with such clarity Jim. It’s a fascinating topic that I’ve read and written on quite a bit too.

    You got my attention with your point that using the Trinity Study projections with portfolios built from anything other than low-cost index funds is invalid. Technically speaking, high-cost funds just add to expenses in retirement, but the way you phrased it gets people to sit up and pay attention to investing expenses — which is what matters!

    I’m on board with most of your conclusions, except I’m a little less confident in the 4% rate itself. Research from Wade Pfau questions whether we can assume that past U.S. history is an accurate model of future returns, and has demonstrated that the safe withdrawal rate is a function of market valuations when you retire. Jim Otar says the sequence of returns in the early years of retirement are critical: it may not be possible to recover from a “lost decade” in a mostly-stock portfolio. Todd Tresidder doesn’t believe you can draw on principal at all for retirements much past 20-25 years.

    My view is that there is no definite answer to this question, since it requires predicting far into the future. The key for me, just as you say, is more about personal flexibility than the exact numbers. Monitoring your retirement portfolio, and responding to an extended downturn with either more income (via part-time work or passive streams), and/or ratcheting lifestyle spending down, is a powerful approach to handling those scenarios where the 4% rule won’t work.

    • Posted December 12, 2012 at 7:56 pm | Permalink

      Hi Darrow…..

      Great to see you here and glad you like the post.

      4%, and indeed all the scenarios in the Trinity study, are only guide posts as to what we can reasonably expect as we plan for our futures. But importantly, these guideposts indicate a much rosier future than most take into account, as indicated by the HUGE median balances left in most of these portfolios after 30 years.

      While I am unfamiliar with Mr. Otar, I absolutely agree with his idea that returns in the early years of retirement are critical. As I said in the post:

      “My guess is that if you began your own withdrawals in 2007 and the early part of 2008 just prior to the recent collapse, you will have hit upon two more years in which the 4% plan is destined to fail. You’ll want to scale back. On the other hand, if you started with 4% of your portfolio’s value as of the March 2009 bottom, you’re very likely golden.”

      It’s that flexibility thing. :)

      As to “whether we can assume that past U.S. history is an accurate model of future returns” I would say possibly not. But I cringe at the assumption they will be worse. They could be much better. Make no mistake, the past has not been some golden cakewalk. It has been a very rocky road. My guess is the future holds the same.

      Market crashes are to be expected. What happened in 2008 was not something unheard. It has happened before and it will happen again. And again. I’ve been investing for almost 40 years. In that time we’ve had:

      –The great recession of 1974-75.
      –The massive inflation of the late 1970s & early 1980.
      –Mortgage rates were pushing 20%. You could buy 10-year Treasuries paying 15%+.
      –The now infamous 1982 Business Week cover: ”The Death of Equities,” which, as it turned out marked the beginning of the greatest bull market of all time.
      –The Crash of 1987. Biggest one day drop in history. Brokers were, literally, on the window ledges and more than a couple took the leap.
      –The recession of the early ’90s.
      –The Tech Crash of the late ’90s.
      –9/11.
      –And that little dust-up in 2008.

      Thru all those traumas the market returned an average of 12% per year. Those were many of the years the Trinity Study covers.

      The market always recovers. Always. And, if someday it really doesn’t, no investment will be safe and none of this financial stuff will matter anyway. Understanding this is the beginning of this series:
      http://jlcollinsnh.wordpress.com/2012/04/15/stocks-part-1-theres-a-major-market-crash-coming-and-dr-lo-cant-save-you/

      I am also unfamiliar with Mr. Tresidder’s work. I would need to know what sort of portfolio he is thinking about if he “doesn’t believe you can draw on principal at all for retirements much past 20-25 years.” For a portfolio as described in the Trinity Study, I would suggest this is an unnecessarily conservative approach. In return for severely restricting your retirement income to only dividends and interest, you gain some security and the high likelihood of leaving a huge pile behind.

      Better, as you and I agree, to be a bit more optimistic while keeping your eyes open and being ready to adjust. :)

  13. Posted January 17, 2013 at 10:54 pm | Permalink

    I’ve written further about this here: http://schof.org/2013/01/17/investment-returns-the-four-percent-rule-and-your-personal-pucker-factor/

    There’s a number of factors that call into question the 4% rule, including lower returns in our current environment, estimates of a slower-growing GDP in the future, and, most convincingly for me, the different SAFEMAX rates in different countries, ranging from under 1 for war-ravaged Japan to 2 and 3 (fairly common). 4 seems like a pretty optimistic rate.

    As a sidenote, love the blog and the series on stocks. I’ve listed this site as essential reading, because I think it is. http://schof.org/financial-competence-reading-list/
    Schof

    • Posted January 17, 2013 at 11:21 pm | Permalink

      Hi John…..

      Thanks for the kind words.

      There is always a pessimistic case to be made, but I confess I have little patience for it. Mostly it is based on the idea that the past 40+ years have been some sort of golden time not likely to be repeated.

      They were anything but golden. For my litany of challenges during that time, check out my reply to Darrow below. Could the next 40 years be worse? Sure. But it wouldn’t be all that hard for them to be better.

      As I try to show in the post, the data indicate that, if anything, 4% has proved to be too conservative in the vast majority of cases.

      Nobody can predict the future. Nobody, around here at least, is suggesting that 4% is an iron-clad set it and forget it guarantee. But as a reasonable guideline for planning, 4% is as good as it gets.

      Any sensible investor should keep a close eye on their stash, especially in retirement. Last year I spent 4.5% of my stash and by year end it was worth 11.4% more than when I started. This year I plan to do much the same, but should the market tank in some 2008 type fashion, of course I’ll cut back.

      4% is only a guide. Sensible flexibility is what provides security.

  14. Prob8
    Posted February 2, 2013 at 7:35 pm | Permalink

    Your rationale for holding the REIT fund makes sense to me – and I do hold some of that fund. Can you refer me to a study or other data that supports the concept that a REIT will react faster to inflation than VTSAX? It would be nice to have some filler reading between JLC posts. The Trinity Study was a nice review.

    Also, do you consider your home equity to be a part of your real estate allocation? In other words, if 15% of your net worth was in your house, would you only put 5-10% in the REIT? It seems to me that they are two very different types of assets. A house is a money sucker while the REIT pays me.

    • Posted February 3, 2013 at 9:30 am | Permalink

      Hi Prob8…

      Off the top of my head I can’t think of any studies to point you to….

      I do consider the house equity in calculating my allocations. As you point out, a home and a REITS investment are very different animals. But in terms of an inflation hedge, they both serve the purpose.

      Once we sell the house, the full real estate allocation will be in the fund and my guess is that will provide better and certainly smoother performance over the years.

  15. Mari
    Posted March 11, 2013 at 12:58 pm | Permalink

    Hi there
    I came over here from MrMoneyMoustache and it is very interesting and confusing.
    I am new to investing and trying to max out my 401k. You keep mentioning index funds and my father has suggested all stocks in my 401k. It has done well the last year but looking today I see the management fees are high I think (they show costs of 3.50/1000?). The index funds show lower costs of 1.50/1000 but their performance isn’t as strong. So I am trying to understand how this all comes out 20 years from now. The options I have are all U.S. indexed funds (US TIPS, Fixed Income, Equity Index, Small Cap, and International. Ovviously no Vanguard which on Fidelity is closed to new investors. Do you have any opinion on these funds? Because of the lower management cost are they still better than individual stocks ? Sorry if this is not very clear!

    • jlcollinsnh
      Posted March 12, 2013 at 12:36 am | Permalink

      Hi Mari…

      It is a bit confusing, and I think because you don’t quite understand what’s in your 401k and so explaining it is difficult.

      I’d suggest you read (or re-read) my stock series. It should help you better understand this stuff.

      Based on what I think you are asking and assuming you are a young person with at least 20 years ahead:

      I agree with your dad that all stocks in your 401k is a sound choice.
      The way to own these stocks is with an Index Fund.
      The specific Index Funds should be either an S&P 500 Index Fund or a Total Stock Market index fund.
      It sounds like your 401k offers Fidelity Funds and if it does it very likely offers their version of one of these. That’s what you want.

      Hope this helps.

  16. Posted March 11, 2013 at 4:00 pm | Permalink

    When I first heard of the 4% rule, I thought it meant “withdraw 4% of your investments every year” (i.e. the actual amount will differ from year to year).

    But it sounds like the Trinity study defines the rule as “withdraw 4% of your investments on day 1 of retirement” and then either “withdraw that same amount every year till you die” (Chart 3) or “withdraw that same amount plus inflation every year till you die” (Chart 4).

    I have two questions:

    1. Am I understanding the Trinity definition of the 4% rule correctly?
    2. Does my (mistaken) definition of the 4% rule have any merit to it, compared to the real definition?

    Seems like it would be a simple way to codify your advice to “stay flexible” yet still have a formula for yearly withdrawals.

    • jlcollinsnh
      Posted March 12, 2013 at 1:01 am | Permalink

      1. Yes.

      2. Your “withdraw 4% of your investments every year — the actual amount will differ from year to year” concept would work very well indeed. Effectively you are trading the risk of running out of money for the risk of having your income vary year-to-year.

      As long as you have the flexibility to absorb these yearly income variations, it is a fine idea. It is, in fact, pretty much what I actually do as described in the post.

  17. Darrel
    Posted July 2, 2013 at 2:15 pm | Permalink

    Hi JCollins

    I’ve been reading your blog for a while. I think I got sent over here from the Mr Money Mustache blog. In fact, I just read the interview with you, MMM, and your daughter. I really enjoyed it. I noted that you said something to the effect of “When you have your savings to where you can live off of 4%, “retire” even if you keep working and just send your paycheck to savings.” I like this idea.

    My question: I always see this 4% thing, and I understand the concept. What I don’t really get is the mechanics of employing it. Do you pull up your stock holdings every month multiply by .04 and divide by 12 then sell that quantity of VTSAX shares to pay yourself each month?

    (stock holdings X .04) / 12

    I hope that makes sense. I just don’t totally understand the mechanics. Thanks!

    • jlcollinsnh
      Posted July 2, 2013 at 2:30 pm | Permalink

      Thanks Darrel….

      Glad you found your way over here.

      I’ve moved your comment to this post as it is a better fit and more people will get to share in our conversation here.

      As to the mechanics of withdrawing the 4%, you’ve basically got it.

      If your investments are in tax advantaged accounts, since your dividends and capital gains are not taxed, the easiest way is to have them reinvested and then just pull out whatever percentage you choose. Just like you said. For example:

      Suppose you have 100k in VTSAX and you want to draw 4% ($4000) per year from it. You could have Vanguard sell $4000 worth of shares and send the money to your bank. Or you can divide by 12 and instruct them to send $333.33 to your bank each month. Easy-peasy!

      If your investment are in a taxable account, since you have to take and pay tax on your dividends and capital gains, you could just have the fund pay these to you. In the case of VTSAX, about 2%. You’d get the other 2% as above. Make sense?

  18. Darrel
    Posted July 10, 2013 at 2:21 am | Permalink

    Hi JCollinsH

    I’ve been following your blog for a while now. I found you through the Mr. Money Mustache blog. When I was reading the interview you did with MMM and your daughter (can’t think of the blog it was on now), I was reminded of a question that constantly comes up for me.

    You mentioned that when you reach enough in savings to be able to live off of 4%, you can “retire” whether you keep working or not. Just, from that point on send all income from work or other sources to savings. I love this idea (I also have seen plenty of back and forth talk about the 4% rule not being perfect, but I’m all for it).

    How do the mechanics of this work? I mean, since you aren’t earning 4% dividends you are actually selling off some of your shares to pay yourself right? I’m not the best at this, but here is how my brain says it would work:

    Month 1 of retirement: I have 1.5 million in my stock accounts and I need to pay myself so I:
    (1,500,000 X .04) / 12 = 5,000 and I pay myself 5,000 dollars

    Month X of retirement stocks have been taking a bit of a hit: I have 1.3 million in my stock accounts:
    (1,300,000 X .04) / 12 = 4333.33 and I pay myself 4,333.33 for the month.

    Is this how it works? Do you maybe take out 3 months or 6 months or whatever at a time?

    Thanks!

    Darrel

    • jlcollinsnh
      Posted July 10, 2013 at 7:49 am | Permalink

      Hi Darrel…

      Interestingly I’ve gotten just this question a couple of times now in recent weeks. Maybe I should do a post on it.

      But in short, it really is pretty simple and there are a couple of ways you could do it.

      The classic 4% rule says you can pull 4% of your assets each year, and increase this year-to-year to account for inflation, from a stock/bond portfolio without ever having to change a thing. As described in the post above, depending on the stock/bond mix this approach has up to a 96% chance of surviving 30 years. But like you, I prefer better odds.

      What you described would work just fine and, yes, you could set it up monthly, 3, 6 or 12 months.

      If your investments are in tax advantaged accounts, since your dividends and capital gains are not taxed, the easiest way is to have them reinvested and then just pull out whatever percentage you choose. For example:

      Suppose you have your 1.5m in VTSAX and you want to draw 4% ($60,000) per year from it. You could have Vanguard sell $60,000 worth of shares each year and send the money to your bank. Or you can divide by 12 and instruct them to send $5000 to your bank each month. Easy-peasy!

      If your investments are in a taxable account, since you have to pay tax on your dividends and capital gains distributions, you could just have the fund pay these to you. In the case of VTSAX, dividends are around 2%. You’d get the other 2% as above. Make sense?

      The 4% rule is designed to be able to survive most stock downturns, so you don’t have to worry about monthly market fluctuations. Although changing your 4% pull each month to reflect your actual stash value is certainly a safer way to play this out. You could also set aside a portion of the monthly 6k to build a cash reserve to draw on in down times with your approach. That is, spend only 5.5k each month and bank $500. Then when the time comes that you need to cut your pull to 4k, you can make up the balance with this cash. In fact I use a variation of this.

      Personally, I draw a set amount each month that is actually around 5% because the market has been so strong. But I also hold about 5% of my stash in cash for lean time and I am prepared to make serious cuts when the inevitable downturn comes.

      It is all about being flexible.

      Hope that helps!

  19. Posted November 22, 2013 at 5:06 am | Permalink

    Great! Now I know. Mmmm, better think twice about quitting my day job….Thanks for the valuable information.

  20. Woodreaux
    Posted December 31, 2013 at 9:32 pm | Permalink

    “Not only will we muddle thru, it is my belief we are on the verge of another great bull market. ”
    Written in December 2012 and now I’m reading it on the last day of 2013!
    I believe I heard on the radio that the S&P finished up nearly 30% since you posted this.
    Congrats on a great year.
    One of the reasons i enjoy reading your stuff.
    Keep up the great work thru the New Year!

  21. Elisabeth
    Posted March 25, 2014 at 12:02 pm | Permalink

    Hi Jim. I’ve spent the past week reading almost all your blogs and it’s been wonderful! A friend helped me find MMM and he lead me to you. I thank all of you for posting all this great advice to help me achieve freedom as soon as possible! And for free!

    I understand the principles of 4% and calculating what I need my net worth to be but I’m struggling with details. Based on our current spending I’d like our retirement expenses to be about $40k. That means I need to save $1m before we are free. But, how is inflation calculated? I understand I need $1m in today dollars but if we can get there in 10 years do I keep tracking to $1m, or will this number go up as the years go by? Because in 10 years we will need more than $40k due to inflation.

    My husband and I are in our early 30s and while we have saved a lot over the past 10 years it all hasn’t been invested, earning maximum returns for us. We’ve stepped up the rate and I hope to get there in 10 years I’m just struggling with the details of calculating what my “freedom fund” needs to be.

    Thanks for the help!!!
    Elisabeth

    • jlcollinsnh
      Posted April 10, 2014 at 4:36 pm | Permalink

      Welcome Elisabeth…

      Glad you found your way here.

      There are a couple of ways to approach your question.

      You could estimate the rate of inflation and plug it into one of the many on-line calculators and let it figure how much you’ll need to replicate the spending power of 40k when you retire. The problem, of course, is that inflation will likely not unfold as you predict.

      Better, it seems to me, to simply aggressively build your freedom fund and track how much it can throw off at 4% each year as it grows. At the same time you can assess each year how much you’ll need/want when you retire.

      Over the years, those numbers will come together. When they intersect, you’re there!

      That’s what I did anyway! :)

      Eric Bahn also just put up a nice post on this subject you might find helpful: http://lifeafterliquidity.com/2014/04/04/f-you-money/

      Good luck!

      • Elisabeth
        Posted April 15, 2014 at 8:53 pm | Permalink

        Jim – thanks for your insight and link to that article. Another well articulated explanation of the 4% concept. I was reading along, understanding everything until I saw he wanted me to multiply my annual expenses by 1.5 to account for taxes and other expenses!!! 1.5 really changed things. I fortunately live in a state with no income tax and as long as we plan to stay here or go to another income tax free state, my only taxes should be from capital gains on my invesents and income tax on my 401k withdrawals. Capital gains are 20% from what I understand and I keep my effective fed tax rate around 15%. So I’m figuring I’ll use 20% as a conservative tax estimate in my calculations. Would you recommend the same?

        Also I think I understand better that I am chasing a moving target trying to figure out how much my total stash of money needs to be. I realize I’m working on a very fine detail. Using my number 40k, I would need 1M to retire today. If I retire in 10 years I’ll need almost 54k per year (if I assume an average inflation of 3% per year) so that means I need 1.35M. Unfortunately that is a bigger number which means more time. But, I think I understand it better and can better plan! Since nothing can be planned, I now believe your statement of watching it year to year and when the intersection point hits when your fund can throw out 4%, you’re done!

        It’s so helpful to have you and others out there to help people like me plan and end the working phase of my life as quickly as possible!!! THANK YOU!

        Elisabeth

        • jlcollinsnh
          Posted April 24, 2014 at 11:06 pm | Permalink

          Hi Elisabeth…

          Yes, I think 20% should work fine for your “what if” analysis.
          One thing to keep in mind is that once you reach age 70 you will be faced with Required Minimum Distributions (RMDs).

          If you have been a successful saver/investor over the decades you could see those push you into a higher tax bracket. A “first world” problem, as they say, and not a bad one at that. But something to be aware of.

          As for your total stash, your thinking is correct.

          One thing that might help is that a bit of inflation, say 3%, is actually very healthy. It allows companies pricing power and helps them grow. That equals better results for your investments.

          Of course, if it gets out of hand as it did in the 70s, that’s a problem.

          But the key thing is you’ll get there and watching the progress will be fun.

          Remember, too, when the market drops (as it surely will) and your stash takes a few ugly steps back, the stage is just being set for a stronger rebound. Kinda like how a broken bone heals stronger. :)

  22. Dom
    Posted March 26, 2014 at 9:52 am | Permalink

    Hi Jim,
    New reader here! Found this blog from the Mad Fientist. I gotta say, between you, Mad FI, and MMM I have learned an incredible amount. Reminds me of one of my favorite quotes from Socrates: “Employ your time in improving yourself by other men’s writings, so that you shall gain easily what others have labored hard for.”
    Anyways, great article but I think the link to the updated trinity study is no longer valid? I am having trouble finding it on google, do you know where else it might be available?

    • jlcollinsnh
      Posted April 10, 2014 at 4:27 pm | Permalink

      Welcome Dom…

      Glad you found your way here.

      You’re right, that link wasn’t working and it was a pain trying to find it again on Google. But I think I got it if you want to give it another try.

      Thanks for letting me know!

  23. Jorge
    Posted April 15, 2014 at 10:27 am | Permalink

    Vanguard recently updated their white paper on withdrawal strategies called “A more dynamic approach to spending for investors in retirement”.

    It presents a “hybrid approach” between the two most common strategies: “percentage of portfolio” & “dollar amount grown by inflation”. For anyone reading this post, I highly recommend the paper.

    Jim: I’d love to see your comments on this hybrid approach.

    Thanks for this wonderful site!

    • jlcollinsnh
      Posted April 24, 2014 at 11:22 pm | Permalink

      Welcome Jorge…

      and thanks for the link.

      Like most things coming out of Vanguard, this is well reasoned and well worth reading.

      That said, I think it is also a bit more complex than needed.

      As they say in the conclusion, flexibility is key and ” Because circumstances constantly
      change, investors and their financial counselors
      need to review portfolio performance and strategy regularly to assess the status of their spending plans.”

      That’s really all you need to do: Target around 4% and pay a bit of attention.

      If the market takes a major hit, cut back spending to give it a chance to recover. This is the same thing we’d all do if during our working years we had to take a pay cut.

  24. Cody
    Posted January 16, 2013 at 8:33 pm | Permalink

    Mr. Collins,

    I just wanted to thank you for doing the blog. I’ve been reading the jlcollinsnh blog and Mr. Money Mustache. You guys have truly shaped my life.

    I work in IT as a computer programmer. In 2007 at the ripe old age of 20 I started as an intern with my former company. I got promoted to full time status, the company gave me a 10% raise which only came out to be $1.20 an hour(What I thought was a fortune at the time). Later I discovered the other programmers on staff were making almost double what I was. After 4 years of being screwed over by my old employer I took an entry level position with another company here in town. They saw my work ethic and I quickly moved up the ladder. I got a promotion which doubled my pay. I didn’t adjust my lifestyle to live more lavishly. Actually I have paid off our car (4K), my student loans (6.8K) and my wife’s student loans(10K) will be done this month. My wife and I will save over 60% of our income each month!

    I am very excited to start putting money in to VTSAX! I’m 25 but close enough to 26 to read the welcome mat on the front doorstep. My goal for this coming year is to max out Roth IRA contributions for my wife and I(5,500 * 2 people = 11K) and I just upped my 403B contribution at work to 10% with a 4% employer match. Retirement at 35 seems possible, 40 seems very likely, and 45 seems like a certainty.

    I just wanted to thank you for your wisdom.

  25. Posted January 16, 2013 at 9:02 pm | Permalink

    Hi Cody….

    That’s awesome! My guess is you’ll have F-you money closer to 35 than 45. These things tend to snowball.

    Your story is an inspiration and might help others on their paths. I wish I’d started as early and wisely as you.

    Cheers,

9 Trackbacks

  • By Ekonomiskt oberoende on May 19, 2014 at 1:12 pm

    […] Stocks — Part XIII: Withdrawal rates, how much can I spend anyway? – jcollinsnh […]

  • […] on the “4% Rule“ and your projected 70k annual spending rate, you are already comfortably well into […]

  • […]  The numbers in the chart above assume an 8% annual investment return and that you’ll live on the classic 4% withdrawal rate which implies assets of 25 times your annual needs. So, this is not a gospel, but a guideline. The […]

  • […] There are countless stories of people of modest income who by way of fugal living and dedicated savings get there in remarkably short time.  You can find some here.  If you can live on $7000 per year, $175,000 gets it done figuring an annual withdrawal rate of 4%. […]

  • […] much do you have? As we’ve discussed, the basic 4% rule is a good guideline in deciding how much income your assets can reasonably be expected to provide […]

  • […] can read a more in depth discussion in an article by JLCollinsNH. Here’s two article that punch holes in the 4% rule: by Financial Mentor and by […]

  • By Hvor mye penger er nok? | Finansnerden on August 18, 2014 at 6:20 pm

    […] Tygg litt på hva dette betyr. Er du nysgjerrig på mer, så anbefaler jeg at du leser hva jlcolinsnh har å si. […]

  • By Stocks — Part XXVI: Pulling the 4% on August 25, 2014 at 12:14 am

    […] and how much cash flow you require. In any event, your assets will have reached the point where by providing ~4% they can cover all your financial needs. Or said another way, your assets now equal 25-times your […]

  • By Hvor mye penger er nok? on September 9, 2014 at 5:41 pm

    […] Tygg litt på hva dette betyr. Er du nysgjerrig på mer, så anbefaler jeg at du leser hva jlcolinsnh har å si. […]

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