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Consider a rule where if your investments increase by X% you allow your spending (or if not your spending, your spending limit) to increase by X%. And then keep this spending level as your new baseline, increasing it to keep up with inflation or X% of your investments, but never decreasing it.
This is what Stuart proposed in the comments section of SWR part 22 where he talked about "re-retiring". In the comments Stuart suggested using a 3.4% rate and then resetting your spending higher as your assets increased. Big ERN responded that 3.4% has historical failure cases. And that you would eventually end up locking yourself in, at the market peak, to a WR that has failed in the past. I understand that in this case it's almost like you are making a real effort to be one of the failure cases.
But what if you used a WR rate, like 3%, that doesn't have historical failure cases. It seems obvious that ratcheting up your spending lowers you chances of success. But that lower chance of success doesn't show up in the historical failure rate. Ratcheting your spending up to 3% of your current investments still leaves you with a 100% historical success rate.
Is this still a bad idea when my historical chances of success are still 100%?
Great question. Yeah, if the rate is low enough and you never had a historical failure that would give you some confidence that you'll never ratchet up to a failure, at least if the future is only just as bad as the past.
The only problem: 3% might be a bit too tight for some retirees. But if you over-accumulated already, sure, go for it!
I loved this question and all the detail, because I think it matches very closely with the questions that have been running in the back of my mind since I started reading the SWR series.
@earlyretirementnowcom , would you mind reviewing my own summary of how I'm thinking about @hubcity 's questions, and letting me know whether I have a good grasp on the issues? Everyone else, please feel free to weigh in here as well. Here it is.
Safe withdrawal rates should be thought of as having two fundamental qualities. One, in terms of a failsafe "floor" withdrawal AMOUNT on the low end, and two, the possibility for higher dynamic withdrawal AMOUNTS above that.
Let's put this into an example:
I figure that if I could receive $100k (real, inflation adjusted) a year for the rest of my life, that would make me financially independent. I want to be on the very safe side, and also leave a legacy to my family. I therefore decide on a "100% capital preservation" strategy with a 60 yr timeline, and will only tolerate a failure probability of 5% or less across any kind of market environment.
I use the spreadsheet and based on my portfolio the SWR that'd give me $100k real a year is a 3% SWR. I look at my hard-earned portfolio of $3.4M and say "hey, awesome, I'm financially independent and I'm retiring tomorrow".
Here I come to my summary, and where I'd like you to weigh in...
Withdrawing $100k real (3% of my portfolio on my first day of retirement) should be considered the "fixed withdrawal amount" failsafe of my retirement plan. In other words, I can be reasonably confident that no matter what, I can withdraw $100k real from my accounts every year. This is my "failsafe floor". 3% could therefore be referred to as my "failsafe-floor SWR at retirement date".
But then, beyond $100k real (3% of my portfolio on my first day of retirement), I can also re-examine market conditions to determine whether there may be a higher withdrawal amount that could still give me a successful strategy (<5% failure probability) moving forward. I re-run the spreadsheet and CAPE-Shiller withdrawal calculations and realize that, yes, I can actually safely withdraw more than $100k real this year, let's say $130k real. Note: that $130k may not necessarily be represented by a >3% SWR of the current portfolio value... These withdrawal amounts, and their corresponding SWRs of the current portfolio value are a "dynamic withdrawal rate" method.
So...in summary...I have a "failsafe floor SWR" corresponding to a fixed withdrawal amount (real) BUT I can also consider potential withdrawal amounts above that floor with dynamic SWRs (using CAPE-Shiller).
I guess, what I'd like to know is, am I thinking about everything correctly here?
Thank you all for the help here and love the SWR series and the questions from this forum. Really high quality stuff!
Hey, thanks. I really appreciate the reply.
Please excuse me as I ramble on about this a little more.
It seems that every recent (2009-2019) early retiree using an inflation adjusted withdrawal rate that was either safe (< 3.25%) or even slightly risky (3.25% or higher depending on when they retired) has already faced this issue of having over-accumulated.(1) By their very nature any relatively safe withdrawal rate would have eventually put most historical retirees in a position of having over-accumulated.
This was my attempt at making a rule to determine when it is safe to make a permanent increase in spending. None of the other rules seemed to fit. The CAPE-based rules tell you how to react to market moves, but they have too much volatility to be used to make permanent spending increases. The CAPE rules seem more appropriate to help you answer one-off questions that could have a different answer every year. Questions like, should we go on a big vacation or did I spend too much last year? They don't seem to be much help in terms of long term planning. The different guardrail rules seem weirdly ad-hoc and sometimes call for a decrease in spending. This ratcheting 3% rule has the advantage of being simple and having a 100% historical success rate.
Being confident in an inflation adjusted historically safe withdrawal rate is basically saying "I'm confident that my retirement year is not going to be any worse than any other retirement year in history". Being confident in a historically safe ratcheting withdrawal rate like I am proposing is much closer to saying "I'm confident that none of the years of my retirement are going to be a worse year to retire than any other retirement year in history".(2) That's obviously a different and more risky thing to be confident of, but it still has a historical success rate of 100%. I'm having a hard time deciding exactly how to think about that.
Obviously having extra money is the best financial "problem" that you could have. Also it seems that it's a problem that most retirees who start with a safe withdrawal rate are going to have. Have any of the 2009-2019 early retirees talked about what they did or is everyone just over-accumulating?
A co-worker used to say to me, after I'd talked around a problem for a while, "What's the real issue?". The real issue is that it's becoming increasingly clear that I will have extra money. I'm trying to determine at what point can I make long-term financial commitments that increase my spending level. At the risk of making this apply to me and maybe not many others: I have no problem with leaving a legacy. But it bothers me to think that my siblings won't get to share in my "extra" unless I die before them. I can certainly continue to live very comfortably on my original inflation adjusted initial retirement spending level. But sharing with them now could make a real difference.
Apologies for the wall of text. Deciding on the "right" way to think about this has been on my mind a lot recently.
(1) At the risk of this becoming a case study, I will note that someone who retired in Aug 2016 with about a 70/30 split and a slightly risky 3.5% inflation adjusted withdrawal rate has a withdrawal rate of about 2.5% of current assets today.
(2) The math doesn't exactly say this because your retirement gets shorter with every year that goes by. But I'm just going to wave my hands at this and say that it's mostly true for the first couple of decades of an early retirement.
I do love the cape based rules since they are auto adjusting to market conditions, yet the year to year withdrawals are pretty stable and seem great for a person with lot of discretionary spending in their budget such as someone with a paid off house who travels a lot, but I see your point that you can't make inflexible long term spending increases based on them. Someone who retired with $1 million and now has $1.2 million is probably wondering, can use some of this extra money to buy a new house/RV/car/kitchen/boat?
One simple approach to solving this is if you retire and have say a 50 year horizon, and your assets significantly appreciate in the first X years, just look at the fail safe withdrawal rate of a (50 - X) year horizon. So in your example, someone who retired in 2016 with a withdrawal rate of 3.5%, which is now down to 2.5%, they could now bump up their rate to ~3% or whatever they deem safe withdrawal rate is for their remaining horizon.
Another consideration that I don't think enough early retirees consider, is the effect of a very modest social security payout has on withdrawal rates even if they are 15-20 years from receiving them. For instance, someone who retired at 40 and has the same or higher portfolio at 45 should be able to bump up their safe withdrawal rate a couple tenths of a percent depending on their assumptions on taking SS in the future. I realize with the current state of social security benefits have a good chance at getting cut or delayed to keep the system solvent but the closer you get to them the more likely they are to a reality. I wouldn't bump up my withdrawals in my 30's based on SS but once one gets into their 40's/50's, one can feel a little more comfortable with slight bumps to their spending knowing they have the SS "guard rail" coming in 10-20 years.
@figuy1 I like your approach. It is certainly more precise than mine. My approach makes an almost comically incorrect decision by sticking with 3% which assumes you always need to calibrate your spending for 60+ years of additional retirement no matter how long your retirement has already lasted. That assumption is really conservative financially so I shouldn't worry about my approach giving me a number that is too high. But I do worry. Your approach, which is more mathematically accurate, gives an even higher number. I'm not sure what to do with that.
When I do my personal calculations I do account for SS, but in a similarly imprecise way. My current federal tax is zero due to almost all of my income being capital gains in the 0% cap gains bracket. When I begin drawing from my tIRA my withdrawals will be taxed at the ordinary income rates resulting in a big increase in my taxes. Around the time I begin withdrawing from my tIRA I'm assuming that SS will exist, possibly in a reduced form, and that it will be enough to cover my federal taxes, but not substantially more than that. This assumption may be wrong, but it is conservative and it makes things simple. I will be happy if my SS allows me to increase my spending, but I'm not counting on it.
I'd reset the SWR to 3% every few years, but be ready to go the other way too.
Another option is to pull some money off the top for a big expenditures (major trip, boat, etc.) and retain old withdrawal based on inflation adjustment.
Reading through this thread and your reply, I came to the following question:
When you say above "...but be ready to go the other way too", what do you mean?
Do you mean "be ready to reset to a lower SWR", or to "be ready to reset to a lower withdrawal amount"?
My assumption is that I could re-phrase what you said as "but be ready to reset to a lower SWR, albeit one that still gives you the an amount at or above the (real adjusted) withdrawal amount when you originally retired".
Interested if you can respond and clarify, maybe I'm missing something here. Thanks!
By the way, I find that idea of pulling some money off the top as a very interesting one!
@j-harrison First, I think Big ERN has shown in all historic cases you'd be fine with 3%, so likely you will be fine always raising back up to 3%. If withdrawal drops down to 2.75% due to good returns, then raise spending (trips, gifts, etc.) to get back to 3%.
The way you re-phrased is correct on my thoughts.
I am big fan of mental benchmarking, so I would keep track of original spending level (inflation adjusted) as the floor you are mentally prepared to drop down to in worst case.
I think ratcheting up spending is only way to balance being safe to avoid going broke and also not end up with 10xorginal at the end.
Hey, thanks for the response! Great to hear that others are tracking this conversation the same way I am. Really helps clarify things for me.
@navypack Yes, 3% seems very safe. One can also make use of the fact that the horizon is getting shorter. So 10y into retirement you can probably ratchet up to something much higher than the initially safe 3% rate.
Also, it's important to keep track of equity valuations. If the CAPE drops down to 22 or 25 again, and your current withdrawals are still only 3% of your assets you can obviously raise the WR closer to 4%. Just a thought...
@earlyretirementnowcom Certainly, most are planning for a bad scenario (0-2% failure rate), but the much more likely case is we end up with 3x or more of original account.
Makes sense to be safe early, but ramp up when you can. The challenge is the early years are when you have health to spend money!
If your portfolio appreciates substantially and you "ratchet up" but are still within a 100% SWR such as 3% with an 80/20 portfolio, you actually shouldn't ever have to lower it back down (assuming history repeats itself of course). If you've determined that a 3% SWR is 100% safe over 50 years and its appreciated so much in 5 years that its now a 2.75% withdrawal rate, increasing your spending to 3% should be safe without ever needing to cut your budget. In other words, if 3% is 100% safe for 50 years then just pretend that you just retired again and should be 100% safe for a 45 year horizon. The only time you can't give yourself a raise, is if you pick a <100% SWR starting point such as 4%.