In my planning to see if I am ready to be Financially Independent, or Financially Secure, I want to ensure that I have a good plan when it comes to spending down my money from my wealth machines.
How can I get a % or a fixed amount of money from my wealth?
What is a good spending plan? A good plan, to me, is one that:
- I know to a good extend what it means to spend down my money
- What are the challenges when it comes to spending down my money
- What are some of the assumptions that academics put into their plan
- What are the plans and their pros and cons
- Which plan fits my needs
If you are on the path to retirement, planning for financial independence or security, it will be advisable to factor these considerations into your plan.
In this article, I share with you my plan after building up my wealth machine(s) to a suitable size, then how I intend to withdraw the money:
- discuss what are the challenges we normally have to face
- what are some of the methods that knowledgeable people have came up with to tackle this
- my philosophy to spending down and my plan
This article is useful for the folks who are planning their retirement, financial independence, or financial security.
Specifically, for those who have taken the steps to accumulate wealth and build up to a certain size, they can start exploring whether they have enough to be financially secure or independent, and now, HOW to withdrawal the cash flow systematically.
We will be going through some wealth spending or withdrawal concepts:
- Safety First Spending
- Probability Based Spending
- Constant Inflation Adjusting Spending Strategy or 4% Rule
- Constant Percentage Spending Strategy
- Vanguard’s Ceiling and Floor Spending Strategy
- Bengen’s Ceiling and Floor Spending Strategy
- Guyton and Klinger’s Guardrail Decision Rules
- Zolt’s TPA
What is Wealth Withdrawal?
Withdrawal is an official term that the academics studying retirement use a lot. What it means is how you would extract a sum of cash flow periodically during retirement phase.
For example, you build up a retirement sum of $1,000,000.
When you want $50,000 this year to spend, you are doing a wealth withdrawal.
This is use interchangeably with spending your retirement sum, or wealth de-accumulation.
My Original Wealth Accumulation and Withdrawal Plan
I started reading on a few retirement articles when I turned 30, and then I chance upon the concept of early retirement, financial independence.
In recent years, it finally click in my head that financial security is a very desirable position to be in, and much more achievable.
I have always budgeted and have work out how much I spent annually (read my annual expenses and how it relates to my financial security plan), so I know roughly what I need now. That allows me to work out my, and what I need in a future scenario.
In my article on how much do we need to achieve financial security or independence, I outline the formula on how much our wealth machines need to generate, so that we can have a good confidence that our wealth machine(s) could allow us to spend down our money annually.
The formula for how much rate or return you require in financial independence (FI in short, which is applicable for security and retirement as well) is as follows:
Rate of Return required in FI = Rate of Return to generate cash flows in FI + Rate of Return to keep up with Inflation in FI
I worked out that:
- my rough plan budget annually is $24,000
- my rate of return to generate cash flows for withdrawal is 5% of my wealth machine(s)
- the rate of return to keep up with inflation to be 2%/yr
- this means my total rate of return for my wealth machine(s) need to average 2%+5% = 7%/yr
- this means I need to accumulate $24,000/0.05 = $480,000 for my wealth machine(s)
When I arrive at this rough estimate, I am not sure if 7% is conservative or not. Stock markets fluctuate and we do not earned an average return like 7% every year. In some years we earn 30%, some years -20%. Some other years 5%, some other years -10%.
This is the trigger for me to explore how I can tweak my plan so that my plan can be
- a systematic way to de-accumulate my wealth machine(s) annually
- so that my wealth could last as long as I am alive
- and what don’t I know that I really need to know (the assumptions and my risks)
The Challenges with Planning to Withdraw Cash Flows from our Wealth Machine(s)
The academics, and ourselves have always been trying to solve this retirement problem and they have researched what are some of the problems faced.
I will list them out here.
1. Scarce Resources
The majority of us are not born rich. Due to that, we have to work and diligently save up a sum so that we can retire.
If we are rich, say we have $2 million, and my annual spending budget is $24,000/yr, at a rate of return of 0%, this sum can last me 83 years.
However, if I have the same budget, but I only build up $100,000, at rate of return of 0%, this sum will only last 4 years.
In retirement, financial independence or security, I will need my $100,000 to grow at a high rate of return (for withdrawal and inflation) to ensure I can still withdraw $24,000.
We do not know how long we will live.
We can look at the latest medical research which will predict in general what is the median, average rate at which we will live until. And due to medical research it is getting longer and longer.
Longer means, our wealth machines need to last even longer.
However, for some of us, we might not live so long. Would we be comfortable accumulating so much and not being able to spend them?
This is a conundrum. How do you vary your spending according to your mortality?
How do we plan when we do not know how long we will live?
Inflation is defined as your money having lesser in purchasing power to buy goods and services. The opposite is deflation. dis-inflation is the deceleration of inflation.
Over time, the world tends to be inflated, which means my $2000/mth budget can buy lesser and lesser things.
My $480,000 would have to grow more, than my withdraw rate so that my wealth machine can still disburse a sum that is worth the purchasing power of $2000/mth today.
The problem is that we do not know the future inflation rate. We know the past based on historical, however, what if we are in a period where inflation will be very far out of the norm?
4. Adequate Spending Budget
The role of retirement saving, and our wealth machine(s) is to provide a cash flow so that we can spend without working.
This amount have to be adequate to cover our spending.
What is adequate amount to cover our spending? This is subjective. It could be $100,000/yr for your family it could be $25,000/yr for me.
Our different situation affects this amount.
Many financial planner sought to cover their clients existing or 75% of their existing budget. These form of standard rule of thumb do not work really well compared to doing a more detail fact finding there. It could result in a smaller or larger than expected wealth machine(s) required.
5. Stock Volatility and Sequence of Return Risk
As in #1, we have identified that resources for most of us is scarce, we will need to push our wealth machine(s) to generate a higher rate of return. This will mean taking on more risk, and the value of our assets will go through more volatility in valuation.
In the accumulation phase of our wealth building, volatility is good as it enables us to collect assets at lower prices.
However, during withdrawal, we are hit by the inverse of dollar cost averaging, where in the worse case the value of our assets becomes negative AND we are spending the wealth down further.
In the example above, the rate of return between portfolio A and B are mirror images. If there is no withdrawal, portfolio A and B at the end of 21 years is the same.
However, because both portfolios have $7,000 withdrawn from them yearly, the sequence of returns becomes important. Portfolio A, with more negative returns in the starting years, eventually ran out at year 13, while Portfolio B, with more positive returns in the starting years, continue to grow very well.
The simple conclusion is that, for retirement, financial independence and security planning, the first few years return of your wealth machine(s) is very important to whether your money can last for longer.
The academics defined failure as when your wealth machine(s) reaches a value of $0, where you cannot withdraw an amount for your retirement, earlier than expected.
I have written an article to elaborate on Sequence of Return Risk, and how we can plan our Wealth Machine(s) to address this challenge.
6. Cognitive Abilities
As we age, our thinking and decision making abilities go down. We have heard of many worried children who have parents making unwise money decisions.
They could be easy prey for swindlers or unprofessional financial advisers, who would advise them to put their money in something that destruct their wealth.
For those who have been using an active approach to wealth building, this is an area to think about.
Choosing between a Safety First Strategy versus a Probability Based Strategy
Given the challenges, our plans should be structured to handle these challenges well.
I will tackle cognitive abilities separately so for now let us discuss the plans that are out there which considered challenges 1 to 5.
In general when we plan to spend down our wealth, we have to have a flexible mindset.
Many folks believe that what build their wealth with are good to help them de-acccumulate their wealth. This may not always be the case.
You could put your wealth in 1, or 2 or 5 different financial assets that come together as a well defined de-accumulation strategy.
In Even Safety-First Retirement Income Strategies Are Probability-Based – The Real Distinction Is Risk Transfer Vs Risk Retention, financial planning expert Michael Kitces highlight how we should look at the various withdrawal strategies. Notably, he presented a ladder of popular withdrawal strategies consolidated by the retirement researcher Wade Pfau.
The strategies actually span between a spectrum.
On one end is Probability-based. This means that the success of the strategy depends very much on whether in the future, the stock and bond markets behave closer to which 30 year period in the past. It could be a very good 30 year bull market, a very bad 30 year bear market or an average market.
Wealth builders who are probability based take more risk in their choice of financial assets, in order to earn a higher rate of return during their withdrawal phase.
It should be pointed out that this is a strategy that describes a 50% stocks and 50% bonds portfolio, which is subjected to the sequence of return risk that we pointed out.
This strategy are usually for the people which are resource scarce and need to push their wealth to have a higher return.
On the other end is Safety First. In this case, the plan is not to take as much risk. Predictability is the most important. The people in this category would wish their financial assets give them a peace of mind so that what they see is what they get.
The financial assets that fits closest to this is a single premium annuity. When you purchase an annuity, you transfer the risk of managing your wealth to the insurance company, who guarantee based on their financial standing, a stream of cash flow that you can predictably spend, regardless of how long you live.
It takes care of:
- Adequate Spending Budget
- No sequence of return risk
- Cognitive abilities
This is a good plan. However, you need to accumulate a larger sum of wealth.
You can see the contrast between probability based and safety first. It is more like a contrast between someone with a small amount of wealth and someone with a lot of wealth. In my case it would be between someone who started saving late and can only accumulate $300,000 versus someone who did very well, sold their business to have $3,000,000.
In between these two, you have various strategies, some leaning closer to safety, some leaning closer to probability based.
I will not be going through the various strategies, but you can Google their name.
The take away from this:
- How much you need depends on how you want to spend your wealth machine(s) in financial independence
- How you spend down depends on how much you have (in contrast to the first)
- The financial assets you use to withdraw your wealth during financial independence can differ from the financial assets you use to accumulate your wealth
- You can choose a strategy that are in the middle, leaning closer to probability based or safety first. There is no one size fits all
When Resources are Scarce
Given the choice, most people would want a strategy where they can put $2,000,000 in AAA rated government bonds yielding 2%, which distributes $40,000/year for you to spend.
You could create a bond ladder which keeps up with inflation.
Or as we previously mentioned, an annuity will solve a lot of the problems.
However, retirement is a problem for many.
In a survey published on Feb 2016, 1 in 3 Singaporeans were concerned about retirement BUT are not planning for it. They are befuddled by the options that they have for retirement. They are only willing to set aside $300/mth to build up to $1 million at age 65 for retirement.
Suffice to say, majority of us are resource scarce then rich.
I am also facing a resource scarce situation, and thus I actively try to find the options that are closer to probability based but not so close to probability based.
This is when I found Variable Withdrawal Spending strategies.
Introducing Variable Withdrawal Strategies
Variable withdrawal strategies are a series of dynamic ways to spend your wealth when you achieve financial independence or security and in retirement.
In these strategies, you are allow to vary the amount that you withdraw yearly, based on the situation that you and the environment is going through.
To understand why I came to believe variable withdrawal strategies are better, we need to understand a non-variable withdrawal strategy.
Pause… Here is a Google Spreadsheet of the Various Withdrawal Strategies
There will be different spending withdrawal strategies being covered and its difficult to visualize.
I came up with a Google Spreadsheet Here so that you can take a look at how some of these strategies work.
Just go to File > Make a copy and you can use it.
The 4% Safe Withdrawal Rate or Constant Inflation-Adjusting Spending Strategy
In 1994, William Bengen, a certified financial planner in USA published in the Journal of Financial Planning his research on the 4% Safe Withdrawal Rate.
Mr Bengen sought to look through the data of the past USA stock and bond returns, and find out what is a withdrawal rate that can be a success, regardless of the financial market’s performance.
This means that at the end of 30 years, your money will not be depleted to $0 and you can spend and keep up with inflation.
Mr Bengen used the term SAFEMAX to identify the historical worst case scenario sustainable withdrawal rate. He went through a number of Monte Carlo simulation and determine that a safe withdrawal rate of 4% gives a high degree of probability that the money can last for 30 years.
How would you spend your money in a constant inflation adjusting strategy?
The wealth machine is a 50% stocks and 50% bonds diversified index portfolio.
We first determine an inflation rate. This is based on a historical average, which result in many people use 3%. We decide that we will withdraw an initial annual cash flow of 4% of the portfolio.
For example I have a portfolio of stocks and bonds that is valued at $500,000.
We withdraw an amount to spend for next year. In Year 0, we withdraw based on the initial 4% to spend $20,000 and we are left with $480,000.
Due to a -40% change in portfolio value, we start Year 1 with $288,000. In Year 1, we withdraw $20,000 x 1.03 (inflation rate) = $20,600 to spend.
Due to a 30% rise in portfolio value, we start Year 2 with $347,620. In Year 2, we withdraw $20,600 x 1.03 = $21,218.
This spending strategy is called the constant inflation-adjusting spending strategy because the inflation rate is always consistent. It is always going up.
- Your spending keeps up with inflation better
- Your spending can meet your needs that you have planned for
- If what you face in the future is similar to one of the third simulated conditions, you know that your initial withdrawal rate will be Ok and it simplifies your planning
- There is not a lot of things to remember, just know how much you could withdraw
- A bad sequence of return will rapidly deplete your portfolio value (this example shows a rather bad sequence)
- To factor in many low yielding scenarios, the safer withdrawal rate would mean your initial withdrawal rate will have to be much lower just to be safe (likely closer to 2.5%/yr)
- Even in a bad market sequence, your constant spending further depletes your portfolio value
- There is a probability you will run out of money
The problem with the Constant Inflation-Adjusted Spending Strategy
Many people use the 4% withdrawal rate as a planning standard.
As a target it is good for us to aim for.
However, it has many shortcoming that make actual implementation challenging.
Bond Yields are Much Lower than 20 years ago
We are currently in the midst of a 30 year bond bull markets in which prices are rising and bond yields are going down.
The returns of the portfolio depends very much on the returns of the underlying.
The future returns of bonds are less sanguine and due to that, the 4% safe withdrawal rate might not be very safe after all.
Wade Pfau did the same study and come to a conclusion that the safe withdrawal rate needs to be down to 3%.
Your Withdrawal Adjustment Always goes up regardless of the Value of the portfolio
Regardless of environment we are operating in, good or bad, inflation or deflationary, according to the constant inflation-adjusted spending method, your spending is always revised up.
Notice in our example, even if the value of the portfolio goes down by 40%, according to this strategy, you will be adjusting spending up.
This maximize the sequence of return risk.
In a few situations, such as during a recession, inflation are likely to be lower if not it is likely deflationary. It will be more logical that we do not increase the withdrawal amount in these situations.
The data researched on are based on USA Stock and Bond Performance
If you are an international wealth builder, and do not invest in USA, your mileage will vary. This likely means the safe withdrawal rate for you might be lower than this 4%.
The table above shows the real returns of various major markets around the world. One observation is that the stocks and bonds return can vary a lot depending on different markets. With the exception of Australia and South Africa, most of the stock market returns over the long run is lower.
If you assume the 4% safe withdrawal rate, and you do not invest in USA, by following this rigid strategy, it may result in the value of your wealth machine(s) dwindling down.
The Constant Percentage Spending Strategy – The Other End of the Spectrum to Constant Inflation Adjusted Spending Strategy
At the opposite end of the spectrum is the constant percentage spending strategy.
In this strategy, you identified an initial percentage of your portfolio that you would hope to withdraw and stick to this percentage.
Suppose we build up a portfolio of $500,000 and we decide the withdrawal rate is 5%.
The able above shows the change in stock market and its effect on your portfolio value.
The amount that you withdraw to spend for next year is a constant 5% of the starting portfolio value.
In the example above this is a very bad market sequence we have.
- You will never run out of money in this method because the amount you can spend is always a % of your portfolio. Your portfolio can go down in this example but the amount you withdraw gets lesser but never zero
- You lose purchasing power
- You have less money to spend, not able to meet your expenses if the asset value is dramatically reduced
- People cannot change their spending budget so readily. There are some things that are fixed and have to be spent and this method creates very volatile spending
- Your spending do not keep up with inflation
What is it good for:
- When you compartmentalize part of your portfolio to spend on rich living. If the amount is less, you live less richly
A More Flexible System – Variable Withdrawal System
The idea behind a variable withdrawal system is that we stop relying on a super safe withdrawal rate based on a historical tested result.
What we do is come up with a scripted decision plan to ensure that we take the necessary steps to adjust so that longevity risk, adequate cash flow and market cycles can be balanced.
To put it simply, the scripted decision plan tries to find a middle ground between constant inflation adjusting and constant percentage strategies.
Over the years, there are many thought leaders that came up with a few variable withdrawal systems.
I will go through some of those.
Vanguard’s Floor and Ceiling Spending Strategy
USA Index Unit Trust and ETF House Vanguard came up with an article in 2013 on a Better Spending Strategy for Retirement. You can read the article here.
The key characteristics is to come up with a middle solution between constant inflation adjusting and constant percentage.
- Ceiling: Maximum % Increase in Spending Each Year
- Floor: Maximum % Decrease in Spending Each Year
- Example 5% Ceiling and 2.5% Floor
- Tries to ensure that we keep our spending ability but do not deplete the portfolio
- If Floor and Ceiling Percentage Closer, it will be closer to the Constant Inflation Adjusting Strategy
- If Floor and Ceiling Percentage Wider, it will be closer to the Constant Percentage Spending Strategy
In the example above, the person have an initial portfolio of $1 mil and he intends to withdrawal 4% initially or $40,000.
The Ceiling and Floor is computed based on $40,000. This is to en
The proposed spending amount is computed based on the constant percentage withdrawal way which is based on the initial withdrawal % of the portfolio.
If this amount ($42,400) is out of the Ceiling and Floor boundary, the Ceiling and Floor is taken instead. In this case the Ceiling is burst. The recommended spending amount is then $42,000.
If we revisit the previous example, you can see that the strategy evaluates and recommends a spending amount after factoring the proposed amount based on constant percentage, ceiling amount and floor amount. Since this is a poor sequence of return, the recommendation is always to spend the floor amount.
(Note that the withdrawal rate used is 5% instead of $4%, as the flexibility allows a larger withdrawal)
- Downside is constrained
- Portfolio Survival Rate improves from 78% to 92%
- Allows you to vary the percentage used for the ceiling and floor if you understand how they work
- Upside is constrained
- You may lose purchasing power
William Bengen’s Floor and Ceiling Spending Strategy
William Bengen, the financial planner who derived the 4% withdrawal rate, also didn’t use this constant inflation adjusting spending strategy when advising his clients.
“I always warned people that the 4 percent rule is not a law of nature like Newton’s laws of motion,” said Mr. Bengen, who graduated from the Massachusetts Institute of Technology with a bachelor’s in aeronautics and astronautics in 1969. “It is entirely possible that at some time in the future there could be a worse case.”
Mr Bengen’s Floor and Ceiling is a variation of the Vanguard version.
- Ceiling: 20% above last withdrawal amount
- Floor: 15% below last withdrawal amount
The main difference is actually how wide Mr Bengen’s recommendation is. Because it is so wide, the strategy leans closer to the Constant Percentage Spending Strategy.
From the Annual Withdrawal % of Starting Portfolio Value, we see that the withdrawal percentage is much more stable. The downside is that, your spending steps down by a lot.
However, this strategy got it right due to the conservative stance that, if you have less you should be stepping down your spending.
Guyton and Klinger’s Guardrail Decision Rules
The researchers Guyton and Klinger did some Monte Carlo simulation with past USA stock exchange data, simulating the failure of the investment portfolio with different allocations such as 50%, 65% and 80% stocks.
They came up with a set of fixed rules to adjust the withdrawal spending of the investment portfolio, depending on the portfolio performance.
The rules are:
- Portfolio Management Rule: A cash reserve is set aside to cover spending needs. We can look at this cash reserve as a 1 year liquid cash set aside for next year spending. This is similar to our simulation, where we withdraw the spending amount 1 year before instead of just before we need it
- Withdrawal Rule: This rule is only applied if annual withdrawal % of current portfolio value is higher than the initial withdrawal rate. In negative return years, spending for the year stays the same. In positive return years, the spending moves up with inflation. In the future, the spending do not try to catch up with lost purchasing power due to previous years stagnation.
- Capital Preservation Rule: Cut 10% of spending if the annual withdrawal % of current portfolio is 20% higher than the initial withdrawal rate. This is when the portfolio decreases in value. This rule is applied if there are more than 15 years you need the money to last
- Prosperity Rule: Raise 10% of spending if the annual withdrawal % of current portfolio is 20% lower than the initial withdrawal rate. This is when the portfolio decreases in value. This rule is applied if there are more than 15 years you need the money to last
There was a 5th rule called Inflation Rule, where if inflation exceeds 6%, your spending increases at that rate. This was dropped.
In the above illustration, we try to explain the Guyton decision rules in implementation.
We set the inflation rate at 3%, the percentage threshold for both the prosperity rule and capital preservation rule to 20%. When any of the prosperity rule and capital preservation rule is hit, the recommended spending amount is adjusted by 10% up or down.
Our initial withdrawal % is 5%. The Prosperity Annual Withdrawal Threshold is therefore fixed at 6% and Capital Preservation Annual Withdrawal Threshold is fixed at 4%.
We evaluate previous year’s recommended spending amount in Year 1, in this case $25,000.
We multiply this amount by the inflation rate to get $25,750.
To get the Annual Withdrawal Rate, we divide by the starting portfolio value, which is $285,000, after it being ravaged by a -40% draw down. The annual withdrawal rate is 9.04%.
This is higher the Annual Capital Preservation Withdrawal Threshold of 6%. This will mean we adjust the previous year’s spending amount down by 10% to $22,500.
Due to the bad sequence of return, for subsequent years, the annual withdrawal rate is always exceeding the annual capital preservation withdrawal threshold of 6%. So the annual spending keeps being adjusted down.
- Able to start of with a higher initial withdrawal rate
- It teaches the owner and family the boundaries in spending decisions they need to be aware of
- The rules are more human understandable
- Allows you to be flexible to choose the threshold for capital preservation and prosperity rules
- Prosperity Rule allows spending to catch up with inflation in exceptionally good sequence of returns
- In normal growth markets, there is still inflation adjustments
- In normal growth environments, spending does not get reduced
- Spending power may stagnate in prolong bad sequence of returns
Zolt’s Target Percentage Adjustment (TPA)
Another financial planner came up with a variable withdrawal method.
His premise is based on his experience that:
- People can forgo some lost in purchasing power
- People don’t want to see their spending amount reduced
- People want a higher withdrawal sum to work with
So he came up with the target percentage adjustment.
I find that it is very similar to Guyton’s rules, as he also studied how that work and came up with his own method
The basic idea is
- If the annual withdrawal % is less than the initial withdrawal %, you either do not increase spending with inflation, or make 1 – 3% adjustment
- If the annual withdrawal % is more than the initial withdrawal %, you increase the inflation percentage
I believe you can see the similarities. For more of Zolt’s TPA, you can read his paper here.
The idea is this: Suppose your portfolio is $500,000 and then your initial withdrawal spending % is 5%. So for the first year, the proposed spending amount for next year is $500,000 x 5% = $25,000. Since it is the first year, we spend $25,000.
During the year the stock market went down 40%. The market value of the portfolio was hit. Your next year proposed withdrawal amount should be $25,000 x 1.03 = $25,750 (up 3% inflation).
However, because the markets are down, based on Zolt’s TPA, you need to make a 1%, 2%, 3%, or full adjustment. What this means is that
- 1% means you take 25750 x (1-0.01) = $25,492
- 2% means you take 25750 x (1-0.02) = $25,235
- 3% means you take 25750 x (1-0.03) = $24,977
Notice any of them are higher than the previous year spending of $25,000. The 3% essentially is no adjustment for inflation.
We lose purchasing power, but we also be more prudent by not increasing the spending amount.
The example we went through is a progression of this table. The only increase in spending amount was in year 2 where previous year the market was up 30%. However, compare to Guyton and Klinger’s rules, there is no capital preservation rule and in this current case study of severe economic depression, not reducing the spending amount cause the portfolio to deplete by a lot, even though we are not taking any inflation increase in spending (3%-3% = 0%)
- Able to start of with a higher initial withdrawal rate
- The rules are simpler than Guyton and Klinger, which have more ruless
- Spending power may stagnate in prolong bad sequence of returns
So Which Method of Spending Should you Choose?
- All of the spending method have their strong suits and their bad points
- Your wealth accumulation capabilities are different from others
- When you would like to be financial independent or secure is different from others
- How much buffer for running out of money you wish would also differ from person to person
- How long you wish the wealth machine to last also differs from other people’s situation. The longer would mean a bigger sum of money, or if you have less you would need one that may entail going back to work
For my situation:
- Prefer to accumulate $500,000 in wealth which allows me to spend an initial spending rate of 5%, with $25,000 that covers my basic survival needs
- I would like to have financial security today (which I have)
- I do still have government enforced savings coming in at age 65 in the form of an annuity
- I can work with running low on money, since I would still be working in a job that aligns my interest, or less working hours that covers my rich life or basic survival (will supplement the other)
- My $500,000 wealth machine will need to grow and sustained for 40-50 years
Given this permutation, and a high initial spending rate, I prefer to adopt a variable withdrawal spending plan that draws the idea from Guyton and Klinger’s decision rules.
I have worked out the following work flow:
The objective of this work flow is to write out a fundamentally sound way that I would withdraw my wealth from my wealth machine. This is so that I can understand all the pivots or variable decisions that I need to make, and make them in a sound manner.
Your spending strategy may be different from mine, and it may be a good idea to write them out so that things become clearer.
Spending Failure – Its Academic and in Real Life we make Variable Decisions when we see Signs of Failure
The original research done on safe withdrawal rate is rather rigid, in that, it describe a low probability of success as an outright failure.
However, Micheal Kitces, a person in this field that does a lot of work, would like us to frame failure differently:
Yet if that’s the reality, then consider what happens if we actually call it a probability of adjustment, instead of a probability of failure. When we frame the outcomes as failures, the nature response from clients is to think up terrible images of what failure might look like, and then seek to avoid it at all costs. But when we frame the outcomes as “adjustments” it leads to very different – and much more productive – conversations instead, such as “How big would the adjustment be? When would I have to make the adjustment? How will I know when it’s time to adjust?”
In other words, framing “probability of failure” rates as “likelihood of [needing] adjustment” instead changes the context of the conversation. When we say “you have a 10% probability of failure” it conjures up a 1-in-10 chance of catastrophe. When we have a 10% “probability of adjustment” and then explain the adjustment might simply be “you’ll need to sell your vacation home” or “you’ll need to tap your home equity with a reverse mortgage” or “you’ll need to cut your spending by 15% to get back on track” it’s far less scary. It goes from a chance of catastrophe to a chance of simply executing a plan for adjusting to get back on track.
And notably, it’s not just the probability of failure that’s misnamed. It’s also the probability of success, which is more like a probability of EXCESS. It’s the likelihood of having excess money left over, and sadly makes no distinction about how much will be left over! A Monte Carlo analysis in traditional retirement planning software treats having $1 left over the same as $1M and the same as $10M – they’re all “successes” – yet clients would react to this very differently. When you call it a probability of “excess” it again raises the question “how much of an excess are we talking about?” and a more productive conversation. – Financial Independence in lieu of retirement , and other phrases that should be banished from retirement planning
Think about it.
If you see a recession coming, usually that will be associated with deflationary prices. The morale around is poor. Your wealth machine(s) value takes a hit.
You would be more conservative with how you spend your money. The luxurious rich life spending would be cut down.
You would be making variable withdrawal decisions without you realizing it.
The work flow I draw out is just a way of putting the work flow we went through out so that we could just go through the motions.
In the worse case, if we see our wealth machine cut its value by 50%, we will be adjusting to something closer to a constant percentage spending strategy.
The significance here is that after reading this article, you are equipped to know:
- why you need to adjust
- what is the repercussion if you failed to adjust
- what are the pros and cons of various methods
The proponents of the 4% withdrawal rules may have a good case if they live in USA and invest in USA.
For the international wealth builders following that very passive premise lures your mind into a safe feeling, when in reality, the assumptions are all false for your circumstances.
To make things worse, many that believe in the rules said:
- they would spend lower
- they would go back to work
That in itself, are making a spending decision that depends on variable situation.
I believe knowing how to pivot will galvanize our resultant plans and learning from the work of many of these retirement researchers have helped us immensely to come up with a good spending plan.