The financial planning problems that is toughest to plan is when a lot of the variables that goes into the planning are tight.

And also when we have a lot of constraints and scripts.

Back when I need to work with a limit of $500,000 in wealth, I had to consider whether it is feasible if my annual expense is $24,000/yr. (you can read more about it in this article)

This works out to a 4.8% initial withdrawal rate (24k/500k).

Depending on how much you know about the literature of retirement, this would seem very feasible or very not feasible to you.

In hindsight, that withdrawal rate is rather high that if one were to withdraw a constantly inflation adjusted $24,000/yr, there is a high chance the person would run out of money.

To make 4.8% initial withdrawal safe, you will need to:

1. Ensure you have a high rate of return, perhaps more than 10%/yr
2. Research, then create a flexible rules based withdrawal plan, and have some sensible austerity with it

Both requires more effort. #1 is a very tall ask based on my experience.

To implement the above, I found that the financial assets/solutions that could be used to implement also becomes limited.

For example, your investments total return (capital gains + dividend/interest/rental income yield) needs to be at least 10%. That eliminates a lot of traditionally low yielding instruments. You will probably need to invest in an active fund, perhaps Eric Kong’s Aggregate Asset Management. They are confident of a 5% initial withdrawal rate.

In financial planning, you probably need a good planner who is competent enough to know all the variables and constraints, put them together, and make your plan work. Good planners in the world of planners are rather rare. Good planners focused in retirement is even more rare.

The Retirement Dilemma to fulfill a $20,000/mth Expense

Contrast my situation to Person B, that requires at the very least inflation adjusted $20,000/mth to fulfill her monthly expense.

And the person B have a $10 mil net worth.

Person B will draw down an initial $240,000 / $10,000,000 = 2.4% withdrawal rate.

By all standards, the probability the person B’s wealth can last for 60 years despite drawing an inflation adjusted $20,000/mth is very high.

Person B’s rate of return on her wealth need not be exceptionally high.

She does not need some rules based flexible spending plan.

Most importantly, the financial products available to implement for her is a lot:

1. Private property can have a net rental yield of 2.2% to 2.4% with inflation adjusted growth
2. Government bonds average around there, so you could implement a bond ladder
3. You can put part of your portfolio in lower yielding REITs (5%) which have a higher prospect of growth. They also tend to have better managers.
4. You could put part of the portfolio in quality companies that distributes a 2.5% to 4% dividend yield, with a low payout ratio. This leaves enough room for growth.
5. Annuity could yield that amount (and more) to form a safe income floor

She would probably need a good planner as well, but her planner would have a much easier time with her case.

I think, when I was running through my case, there is that lingering thought in my head whether what you know in theory matches up to the reality. This is because, in my case, my margin for error is very small. If my plan is not very robust, I will get a shock next time.

In person’s B plan, there is much more room for error. Even If she withdraws a little more, or 50% more, her withdrawal rate would be 3.6%. It is still safe in a lot of historical 30-50 year scenarios.

Expense Optimization often Trumps Pushing Portfolio Returns

Why did I compare my situation with a person that is rather well off?

I want to bring to your attention the advantage of someone having a larger net worth versus someone who thinks he had just about enough.

She has more room for errors in her plan, more available and suitable financial products.

But most of all, she does not need that high of a return.

There is often that debate of whether you should budget or cut your expenses, or you should focus on earning more.

This has been debated to the death.

And some would take the middle ground of saying you should do both.

If we are to be strict about it, and limit earning to how much you can earn from your financial assets, then the debate will be tilted.

A person can double down on his job, on his business to earn much more than he does now, but when it comes to achieving alpha in your investment performance, it is different.

If you put in more effort, it does not mean that you will be rewarded with higher investment returns.

Only probably a handful, can deliver superior than market average returns.

And so if you have a withdrawal rate of 5-6%, that might mean you have to gain access to, or have seriously dope capital allocation and investment skills.

Your plan becomes weaker because only a handful of people could execute this well (unless you use some flexible variable withdrawal strategy, take on more volatility by having more equities, which may or may not always worked well for you), so its rather dead on arrival.

To compound to the problem, a lot of people, due to their need for that 5-6% withdrawal rate, spend a lot of effort to attempt to generate that higher rate of return.

In the end the effort that they spend versus the reward, is asymmetric.

If not pushing portfolio returns, would expense optimization give us better gains?

I would contend that, a lot of people come into planning thinking how they spend in the recent past is how they would spend in retirement.

This might not be well optimized:

1. when your children are independent, the dependence on your income changes
2. your perception about your frequency of holiday travels might be wrong
3. you over estimate your consumption ability over time
4. you believe that your life style would not change

What you need for your expenses might be rather different.

If you right-sized your expenses, your initial withdrawal amount might increase the success rate of your plan.

The toughest clients would probably be those that came in with a 6-7% initial withdrawal rate and throw a ton of inflexibility to the financial planner.

They need $36,000/yr and they want you to make $600,000 in liquid invest-able assets work. They wish to preserve the capital for the next generation.

They cannot bear to see any volatility in their portfolio.

They think what they need, is what their spending is like now.

I think they need a financial miracle or $300,000 to $400,000 more.

If you realize that instead of $36,000/yr, what will keep you satiated, satisfied about life, would cost you only $24,000/yr, you might just need to accumulate $100,000 more to have a very robust plan, then the financial miracle you thought you need previously.

Knowing what you want, Right Sizing your Expenses, Figuring Out the Right Retirement Scheme and Accumulating More

A lot of the problems with their existing financial independence plan can be improved by refining the above 4 things.

For example, it took a while more, from going through life, for me to learn about the reality of different schemes of life, and know that I would probably not want to be permanently not working.

I realize that there may be some folks like myself that wishes to alleviate that fear of not able to survive if you do not have a job, or to depend on others.

To alleviate that fear, cost much less than the $24,000/yr I originally envisioned.

click to see larger image

In my December post on my annual expenses, I listed the estimated expenses to just not fear about survival or dependence on external factors so much.

It cost about $11,880/yr.

If the net worth stayed at $500,000, then the initial constant inflation adjusted withdrawal rate would be 2.3%.

Your mileage may vary, based on what you really want. It might be the case, after right sizing your expenses, figuring out the scheme of financial independence you prefer, you have to accumulate more.

If you define what you really want, optimize your expenses, and figure out the most suitable scheme of life, you might find yourself living a life with satisfaction that is higher than the Person A in my example, if Person A didn’t know that working might give her more life satisfaction.

What I Considered as “Cheating”

There is going to be a bunch of people that will come at me and debate that there are so much expenses that you can optimize.

That is fair enough. And in a lot of what I advocate, I contend that your expenses might go up instead.

I have certainly benefit from earning more.

If I were to retire today, I would certainly have a lower initial withdrawal rate on my investable assets due to not stopping at $500,000. That was a good exercise, but with $200,000 more and keeping to the plan (4 more years), I would have more buffer, the plan is safer, the margin for error is higher.

However, we cannot always use going back to work as an excuse if we are evaluating whether it is better to earn more returns or optimize expenses.

So the following are the assumptions, if we are pitting the 2 against one another:

1. No cash inflow from main job
2. No cash inflow from side gigs
3. The expense go up consistently annually, by adjusting for inflation
4. You earn more by investing better, shifting to some other financial assets

In real life, these cheats are available to you, and thus for those flexible, financial competent folks, they will make your plan more concrete.

Summary

I took my inspiration for this article from this week’s great piece of work by Morgan Housel.

The biggest return talks about the difficulties of finding more sources of energy, versus the improvement in the efficient use of energy. The use of energy have improved dramatically, and despite the talk of shale, wind turbines and solar panels, what gives the biggest returns have been the improvement in efficiency. And Morgan lays out how this relates to investing.

If we have the same assets and I can earn an 8% annual returns, and you can earn 12% annual returns, but I need half as much money to be happy while your lifestyle compounds as fast as your assets, I’m better off than you are. I’m getting more benefit from my investments despite lower returns.

There are investors who grind 80 hours a week to add 10 basis points to their returns when there are two or three full percentage points of lifestyle bloat in their finances that can be exploited with less effort. Outperformance is amazing when it can be achieved, and some can achieve a lot of it. But the fact that there’s so much effort put into one side of the finance equation and so little put into other is an opportunity for most people, companies, and countries.

The initial withdrawal rate explains the advantage of the very wealthy over you.

However, it also means that you can have some of that advantage if you are able to know what you want, the kind of life you wish to save up for. You can have that same low initial withdrawal rate.

And sometimes, you might be happier than the richer person because you know what keeps you satisfied and gives joy more than someone who have much more resources.

I realize something as I was running through the numbers.

I thought with $10 mil, the initial withdrawal rate for $20,000/mth will be like 1% and that would mean it is really comfortable if you are very wealthy.

Not so.

My perception was wrong. And this is not the first time I perceive numbers wrongly.

Thus, sometimes it is good to work out the number with the assistance of a friend, just to see the numbers in reality.

$10 mil could be made up of $4 mil in property value where you live, leaving $6 mil in investable assets. Based on $6 mil, the initial withdrawal rate becomes 4%.

It is not super safe anymore.

If you right size your expenses well and have a 3% initial withdrawal rate, you can be in a better position than someone with much more money.

I write about more retirement planning, financial independence stuff in number 6 below.

Do Like Me on Facebook. I share some tidbits that is not on the blog post there often.

Here are My Topical Resources on:

1. Building Your Wealth Foundation – You know this baseline, your long term wealth should be pretty well managed
2. Active Investing – For the active stock investors. My deeper thoughts from my stock investing experience
3. Learning about REITs – My Free “Course” on REIT Investing for Beginners and Seasoned Investors
4. Dividend Stock Tracker – Track all the common 4-10% yielding dividend stocks in SG
5. Free Stock Portfolio Tracking Google Sheets that many love
6. Retirement Planning, Financial Independence and Spending down money – My deep dive into how much you need to achieve these, and the different ways you can be financially free

I got a chance to read my friend Ivan Guan’s book Fire your retirement.

For those who have not come across his content, you can read his financial sharing at SG Money Matters. Ivan have been writing for some time, introducing us to tax saving strategies and good plans for retirements.

FIRE stands for financial independence retirement early. And this topic is close to Ivan’s heart for him to write about it.

This is possibly the first book on FIRE in Singapore on this topic (you can get the book here).

This is a light read and I think it sought to connect with those who are not so numbers focus, but about the qualitative aspects of life and money.

So here I will pick out some bits and pieces that I find interesting.

Crafting your mission statement

I seldom understand what do we do when we create a mission statement. And here Ivan explains that the mission statement should do two things.

The first is to keep you motivated when the going gets tough and secondly, to help you make the right choice.

For someone who have walked this path I think I can relate to his second point. You are going to have some really tough choices and often the overriding factor is whether it is what will fit your plan.

Do you chase returns when you should be risk managing?

I think the mission statement helps.

Ivan gives a good example for the first one. One of the tough work we do is the stuff we do for a new born baby. That is on top of our day job and other things in life. But we do it because it is our mission.

The Different Financial Trolls

One of the interesting aspects about blogging is dealing with trolls and Ivan puts a slant to how you could be trolled upon financially.

External financial trolls. You will faced many folks that have differing views, but some of their comments and gesture would affect you. Ivan explains that friends and family members can be some of the biggest ones. Sensible financial concepts, and the concept of FIRE is easily confused, misinterpreted, and when these folks try to talk you out of it, there are some emotional and monetary challenges there.

Ivan explains that why couples need to go for divorce counselling is because a big contributor of divorce is due to financial trolls.

Internal financial trolls. Ivan reckons that the internal trolls are more problematic. And I have to agree that it is.

The internal trolls are the part of you that will say:

1. I will never be able to retire
2. I’ll start saving next month
3. Surely the government will do something about this

Internal trolls are manifested from your self doubt, procrastination and rationalization.

These are the products from your family, education and the success & failures you experienced

The Income Generating Asset Concept

Ivan explains that the duration of retirement should be extended due to our life expectancy or that we desire an earlier retirement age. Thus, your wealth needs to last for a longer duration.

Ivan’s way of looking at financial assets that are required in retirement is Income Generating Assets (IGA).

The criteria to be an IGA is:

1. Generate predictable income
2. Generate positive cash flow every year after you retire
3. Do not need active management.

I think these are interesting criteria, and I would think many underestimate #3.

I think predicable cash flow is easy to get.

If you have 1 mil, you can just sell units slowly to get the cash flow. It is whether your predictable cash flow would last for the duration you need.

Ivan categorize the income that you could get into three categories:

1. Bonus income
2. Variable income
3. Guaranteed income

And in the book, he sought to link the financial assets to the kind of income.

The one that you should be based on should be mainly guaranteed income.

One popular solution out there, which is based on CPF and a passive portfolio of exchange traded funds is not recommended by Ivan.

The main reason is related to the future growth of Singapore. For more, you can check out his book for more in depth explanation.

Another big reason was that most wealth builders are not wired to make sound investing decisions.

The way to secure more guaranteed income is through retirement plans. Ivan shared his original reservations about these plans, if you viewed them from the rate of return perspective. However you will not find a lot of things that fulfills the IGA parameters.

Summary

The books is a short read and I think it imprints how Ivan look at this topic of financial independence retire early.

It will be a good book to let your peers see what is the big deal about this path you are taking without going into the mambo jumbo that I usually go into.

Do Like Me on Facebook. I share some tidbits that is not on the blog post there often.

Here are My Topical Resources on:

1. Building Your Wealth Foundation – You know this baseline, your long term wealth should be pretty well managed
2. Active Investing – For the active stock investors. My deeper thoughts from my stock investing experience
3. Learning about REITs – My Free “Course” on REIT Investing for Beginners and Seasoned Investors
4. Dividend Stock Tracker – Track all the common 4-10% yielding dividend stocks in SG
5. Free Stock Portfolio Tracking Google Sheets that many love
6. Retirement Planning, Financial Independence and Spending down money – My deep dive into how much you need to achieve these, and the different ways you can be financially free

2 days ago, I wrote an article exploring the timing of retiring during a financial meltdown and explain the immense advantage of not drawing down the wealth during that period.

Since then, I received an email from a long time reader, perhaps pointing out some things that I do not get so well.

Since he is also a retiree, he presents his perspective how retirement can be better structured.

His reply to my post:

I felt compelled to discuss this issue.

Having retired at age 60, XX years ago, the philosophy is not how many years the amount of money will last. We should plan it to last in perpetuity.

Your article based on American literature of Karstan from Early Retirement Now reflects just that. It is contradictory to our Asian culture whose belief is to plan and extend wealth in perpetuity not in 30 years but also for inheritance.

Let me show your readers how.

With a million in hand, through some fortune of CPF, gratuity or pension or some divine intervention, one should put the money away for at least a year. It depends on your financial maturity in managing wealth.

If it is from sudden windfall, the period must be longer to calm oneself, and accumulate financial knowledge on managing this windfall. If the sum is from expected events example, pension, gratuity, stocks bonus etc, usually these recipients are capable persons who are able to manage their own money.

Once the dormant period is over and hopefully accumulate enough knowledge and maturity, one is less likely to squander the wealth.

Suggested Method to preserve wealth in perpetuity in Singapore: bid your time to purchase an investment property. As Warren Buffet suggested, invest in the National economy. In Singapore, a million is not going to buy any freehold today. Even if it is a 99-year leasehold, one should fetch a returns of 2-3% returns, I.e. $20-30k per annum. Couple with CPF Life payout monthly, one should have sufficient for basic living. This would leave the preservation of capital, the property or income machine generator as you put it. The home is also a good inflation hedge.

By then, most of life’s burdens would have been fully paid off: home loans, children expenses.

I think if I were to summarize the main points are:

1. Kyith got it wrong about how many years the money would last. It should be to plan the money to last till perpetuity
2. American concepts do not work so well in Asian culture
3. You should incubate your wealth in cash for one year, where you spend that one year beefing up your competency
4. To preserve your wealth, get a freehold property. The property will throw out a 2 to 3% return which is enough for basic living. Supplement that with CPF Life Payout. You should be debt free and burden free by then.

Here are my thoughts.

The Misinterpretation of the Safe Withdrawal Rate

I think it is not whether these western concepts if workable or not workable. The withdrawal rate that is discussed is just mathematics.

The withdrawal rate is like the internal rate of return. The internal rate of return indicates return performance, factoring in time, and measures against opportunity cost.

The withdrawal rate measures paying out inflation adjusted cash flow over a period of time.

Be it a dividend stock portfolio, a passive exchange traded fund portfolio, an investment property portfolio, a unit trust portfolio, an annuity portfolio, it is almost the same.

The withdrawal rate just gives you a basis of comparison.

In the best case scenario, we will always want our money to last till perpetuity. However, for that to happen, you would have to ensure you spend in a very cautious manner so that it will not be depleted.

The solution my reader gave is to base your retirement on a freehold property providing a 2-3% yield for basic living expenses.

That is basically like drawing down 2-3% of your wealth, if your entire net worth is in that freehold property.

Essentially, what my reader is talking about IS that western concept of the safe withdraw rate but an Uber conservative one where the safe withdrawal rate is between 2 to 3%.

There is nothing wrong with this western concept but whether you can relate what you have with it.

In the end everything can be related back to the safe withdrawal rate.

I would clarify one thing that I may not have explained: What is deemed as safe, depends a lot on the long term volatility of the overall portfolio of financial assets.

If my reader wants something safe, and relatively perpetual, I contend that property might not be it.

He should form a 30 year government bond ladder that yields an average of 1.6%:

• the principal is protected
• its yields will go up over time if future inflation/yield is higher
• the assets are easy to understand

By doing this, it will give you a withdrawal rate of 1.6% of your wealth.

You can form a portfolio of stocks, bonds, properties and insurance plan, and eventually you will need to decide upon how much you are going to systematically withdraw from this portfolio.

And you will arrive at a withdrawal rate.

But how safe is your withdrawal rate?

Could the $1 million Freehold Property Solution work if your Annual Basic Expense is $50,000?

I could probably provide some really perpetual solutions:

• the property solution my reader mentioned
• the bond ladder solution
• inflation protected bonds
• annuity
• dividend paying insurance plans

However, would those solution provide that withdrawal rate that you require?

If your annual basic expense is $50,000, and your wealth is $1 mil, your withdrawal rate is 5%. Those solutions provided is not going to provide you a cash flow that is close to $50,000. They could provide perhaps somewhere half of it.

So what is the solution here?

1. Accumulate more
2. Shift to other financial assets that allow you to take a larger withdrawal rate

This is just mathematics. I don’t think you would like solution #1.

Doing solution #2 will impact that perpetual requirement you desire.

I think my job here is to let everyone see the complexity of this problem.

The solution is always to have a near 1.5% withdrawal rate:

1. Put in a portfolio of deposits, high grade short term bonds
2. Spend only 50-70% of your freehold net rental income
3. Bond ladder
4. Spend only 50% of the dividends of a portfolio of very high quality listed business that yields 3%/yr

But you would need to accumulate 3.33 mil.

You will then proceed to ask Kyith the philosophical question:

I was born into this world, I spend my whole life to accumulate 3.33 mil and now you tell me I can only spend a miserly $50,000/yr, just so that my next generation can still have this wealth machine. Is this really worth it?

My answer is: You decide. I have shown you the mathematics. I am not going to tell you how you want to spend your money.

There is a spectrum between YOLO and being ultra conservative. You got to figure out where you stand, at this juncture of your life.

If your money cannot even last X number of years, what are the chances it will last to perpetuity?

Having explained the link between the withdrawal rate, the cash flow needed to meet your annual expenses, let us address how long the money would last.

As we lower the withdrawal rate that we spend, the money will last closer to perpetuity.

The reason why we explore a safe withdrawal rate is because, we have to take care of a sensible spending amount. We have to find that sweet spot.

And thus, we explore whether the money will last 30 years, 40, 50, 60 years.

If it last 60 years, most likely, your next generation will get it.

However, if the amount does not last X number of years, we won’t even need to consider perpetuity.

Suppose there is a surge in expenses and your tenant just vacated

If your net worth is in one property, you cannot readily liquidate part of it. The most logical solution to that is, since your property is paid off, you could probably secure a line of credit that you can tap upon should there be a surge in expenses.

However, that would invite some increase risk exposure.

One single property do not allow you to liquidate your capital gains, or capital for that matter.

Given this, having financial assets such as bonds, bond funds, equity, exchange traded funds would allow you to do that if required.

I am not sure why its such a good idea to concentrate your cash flow based on a single tenant. Would that be a higher risk, or that you have more volatile cash flow, but the cash flow is more diversified.

Summary

After studying this problem for some time, I felt that looking at it from the withdrawal perspective makes the most sense.

It allows us to have a common denominator to compare, while other solutions do not.

What my reader discussed is more of the nuts and bolts of implementation. That is important. You cannot just discuss the withdrawal rate, and not talked about the implementation. After all, in order to have that rate of return, at that kind of volatility, you need to implement it well.

As a person that is rather conservative, I do get the need for wealth to be preserved, even during spending down.

Its just that I believe the withdrawal rate explains a lot of things if you know it pretty well.

Do Like Me on Facebook. Join my Email List. I share some tidbits that is not on the blog post there often.

Here are My Topical Resources on:

1. Building Your Wealth Foundation – You know this baseline, your long term wealth should be pretty well managed
2. Active Investing – For the active stock investors. My deeper thoughts from my stock investing experience
3. Learning about REITs – My Free “Course” on REIT Investing for Beginners and Seasoned Investors
4. Dividend Stock Tracker – Track all the common 4-10% yielding dividend stocks in SG
5. Free Stock Portfolio Tracking Google Sheets that many love
6. Retirement Planning, Financial Independence and Spending down money – My deep dive into how much you need to achieve these, and the different ways you can be financially free

Today’s Sunday post is on trying to plan the timing of your retirement, to coincide with certain financial market events.

I think its interesting that we are discussing this when the global stock markets are down quite a fair bit.

Pension Partners has a pretty good summary of how the equity markets around the world are handling it.

And as someone planning when you should pull the trigger, how should your game plan be?

I think there are a few tactics that we should navigate through these situation, but my focus today is on whether it is a better idea to plan your retirement to be before, in the midst of, or after a severe market meltdown.

This would not be construed as advice, and I am just sharing what I came across, and perhaps after reading this,  you can offer your critical take on this.

Ranking the Biggest Retirement Risk to Wealth

There are a few concerns about retirement but for the sake of this topic, let us limit to talking about the problem of whether your money could last long enough.

And every time there is a market draw down, as a retiree, you have the inclination to go to cash, be overweight in bonds, or just be very light on equity.

Now, this would prove to be difficult because, if you are reviewing from a single year perspective, this could be a correction, could be the first year of a deeper bear. What you are worried about is the latter.

Before that it might be worth ranking some of the worse problems that might cause you to have not enough annual income to meet your expenses for the duration you need.

I group them as the following 4, in ranking order.

1. Negative Sequence of Return Risk. This is number one because some of the historical data in the past is very befuddling. For those who are not aware what is sequence of return risk, you can read my deeper explanation here. Basically, if the market sequence you get in the last few years of accumulation plus the first few years in retirement is not very favorable, it has massive impact on how long your wealth would last.

Essentially, you are doing reverse dollar cost averaging. In accumulation, dollar cost averaging works in your favor. In retirement it works against you because, when the markets are down, you are taking out even more of it. By taking out more, the wealth has less to return to near its original state.

Karsten from Early Retirement Now did some splendid data testing here. He highlighted 3 specific 30 year period in the past that proves that even if your rate of return is good, it doesn’t mean you cannot have a better safe withdrawal rate.

The safe withdrawal rate, is the initial percentage of your wealth you can withdrawal, based on a lot of historical market cycles, that would allow your wealth to last for that specific duration you need.

So in the example above, a 5.72% SWR (safe withdrawal rate), means that if you are retiring tomorrow, and have $1 mil, if you withdraw $57,200 for the first year to spend, and increase that subsequently by the inflation rate, your money should last for 30 years.

From the data December 1968 is the one with negative sequence (observe the 0 to 10 year period). While the rate of return is higher than the October 1955 period,  the October 1955 period have a vastly higher safe withdrawal rate.

The rate of return of October 1955 is 56% of the December 1968 rate of return!

To put things into perspective, the sequence of return for March 1979 was the opposite of 1955 (the negative years happen in the last decade instead of the start), the rate of return is roughly similar, but you can draw out $92,120 in annual income and the money would have last.

So hence this is the biggest problem.

2. Stagflation and Escalating Spending. The previous case study would have shown us which period that is the most problematic. That’s right, a high inflation environment, probably ranks higher than deflation period. This is based on the historical data strictly.

The 1970s high inflation period proved to be harder to navigate then the deflationary period.

So why are they so notorious?

I think the main reason is that the dynamics of the safe withdrawal rate, which is a form of constant inflation adjusting spending.

One of the goals is to preserve the purchasing power of your spending in retirement. So be it deflation or inflation, your annual withdrawal is adjusted upwards.

This is a good system for planning purpose (because you know that if you have a relatively safe withdrawal rate at the start, it preserve a lot of spending power) but when executing mechanically, it can be a real problem.

The problem in high inflationary scenario is that you are forced to adjust the annual amount you take out by a lot, to preserve that purchasing power.

And your equities might not be growing very well as compared to the increase in inflation.

The net effect is that, you withdraw a lot more and your wealth depletes faster.

3. Low rate of return. A few problems can aggregate into this one. Essentially, this is a problem when your rate of return is too low. This can be due to the way your portfolio is constructed.

Traditionally, as you get closer to your retirement, it is strongly advised to reduce your equity allocation. With that, your overall portfolio rate of return is also reduced.

Your rate of return can also be lower if:

1. The future bond rate of return is lower. This is based on the strong correlation that current bond yields is indicative of future bond returns (which is at a historical low)
2. Based on equity valuation. There is a strong correlation that a high overall valuation would mean a reversion to the mean for equity returns

All this points to the high likelihood that future overall return is lower.

The danger here is that, if your wealth requires you to last longer, the rate of return might not be able to keep up with your withdrawals.

This is more prevalent if you are planning for early retirement, and your wealth need to last for 40 to 60 years.

4. Deflation and Bear Markets. This is the last one. Instead of losing purchasing power, it is likely you faced a severe cut in the value of your wealth.

Our current scenario fits potentially this situation (or it could be nothing if we recover next year!).  Bear markets look pretty dangerous, but I ranked it lowest because if you taken care of the sequence of return risk, and low rate of return and perhaps stagflation, you probably taken care of this.

Solutions to these Main Challenges

The point of listing out these 4 challenges is to make you see that, your urge to move to cash, specifically to address #4, will solve one problem, but might expose you to 3 other higher priority challenges.

For each of these challenges, there are specific solutions. I will summarize them here:

This article will not go through these solutions, but the idea is, you probably need a good idea on a general market cycle where you are at.

With that in mind, there are specific solutions to it.

The most common solution is lame but probably the most true: Accumulate more assets!

However, you need to figure out how much more.

If this sounds very complex, then the solution is to find a competent, trust financial planner that gets these kind of stuff, to help you through that 30 to 60 year retirement.

With that, let us point out a specific different in choosing when to retire.

The Three Advantages of Working over Not Working

When you are not working:

1. you do not save money or add on to your net worth
2. instead of someone else paying your annual spending, you are paying for it through your net worth
3. your employer might take care of your healthcare insurance to a certain extent

As such, it is a double whammy in retirement.

#3 is not felt so much in Singapore due to the way our healthcare system is setup, but in United States, its a big thing. Europe is probably better than us in this area, but it might be harder to build up the net worth due to high taxes. So it is never even.

If you are working, these risks are addressed by your employer and perhaps why your timing of pulling the plug might be a pretty big deal.

A lot of people frown on the typical solution to retirement problems is to work longer.

However, you cannot deny the math. #1 and #2, will really amplify your results if you just delay for 3 to 5 years.

Working in a Financial Meltdown or High Inflation Times Alleviate the Sequence of Return Risk

If you still have a job in a financial meltdown, then you prevent the reverse dollar cost averaging problem.

When you are spending your net worth, there are less assets to “grow back to its original state”.

However, if you manage to keep your job, these challenges are delegated to your employers.

I think if you get your timing so right that you end up working in a high inflation scenario, it might make a bigger impact then recessions because of the crazy rise in cost of living.

I think in either scenario, those who are frugal would have an easier time managing things.

However, it is much easy if your daily necessities stayed constant or become lower, compare to them rising by a lot. This is one cost that you cannot escape and cannot frugal your way out of.

If you are able to work, until you know that it is a bigger financial meltdown, you could delay, endure this tough period, knowing that once this is past, the chances of your wealth lasting a 30 to 60 year duration is much higher.

Finding Any Job to Do

I think if you like or can take your current job, that is alright.

However, there are peers that really cannot stand working at their current company.  In this case, what is the better course of action?

I think we have to be pragmatic here. The reason you do not like about your job, might not be the same reason you want to retire.

And depending on the level of your net worth, it might make more sense to try and seek a better opportunity elsewhere. The net worth would allow you to take risk.

If you failed to find the job, then you might go into that temporary or full retirement mode (this is where we see the beauty of having a cash cushion, but essentially, cash cushion is no different then just having a larger net worth).

The idea here, is to specifically address the negative sequence of return risk, by hedging with work.

And to alleviate that, taking on a lower grade job, or lower pay job, improves the situation because any amount delegated to the employer, reduce the strained on your net worth.

It can be Challenging to Time This Well

If you have been investing, you would realize it can be quite difficult to tell whether a market draw down, actually becomes a full blown one.

Similarly, what could very well happen is that this is just a deeper corrective move.

So you might end up shifting your retirement just to do this hedge.

However, you could probably gauge the chances that you would be retiring in the midst of a starting bear market:

1. how was the CAPE levels, relative to in the past?
2. how was the equity markets in the past 4 years?

Since a lot of things are cyclical, we know that the average equity run lasts for 4 years and average meltdown lasts for 1.5 to 2.5 years, using this to plan might be helpful.

This current United States equity run have been abnormally long. However, on the emerging market front, it has been more volatile.

If we have just been through a really good period, then perhaps access if you could continue working for some time more.

If you continue to work for some time, and the meltdown doesn’t come, its not entirely wasted because in the mean time you have built up a bigger net worth.

The additional net worth, would mean that your initial withdrawal rate is much lower, indicative that your net worth should have a higher success probability to last the duration you need.

 If you have a Rather Safe Current Withdrawal Rate, Just Retire if you Wish

Of course, a lot of whether you can just heck care all these planning depends on answering the question how much you have currently.

These planning is required, if you are anxious whether the net worth you have is adequate enough.

If you have a $10 mil net worth, and you spend $25,000/yr next year, I think you do not have to think so much.

If you have $700,000 in net worth then maybe you wish to find out the mileage of your $700,000.

The way to gauge is by sensing roughly what is your current withdrawal rate going forward.

In the table above, we see a spectrum of withdrawal rate from 6% to 2%, versus an example of wealth accumulated. Based on the historical research we carried out on how risky is the withdrawal rate we can rank the withdrawal rate in terms of how risky it is.

For each withdrawal rate, and its riskiness, there are certain lifestyle schemes that it might fit.

A person spending $25,000 a year and have $10 mil would have a withdrawal rate of $25,000/10,000,000 = 0.25%.  If you refer to the scale, its not even on it because it is so low.

If a lady spends $25,000 a year and her current net worth is $700,000, her withdrawal rate is $25,000/$700,000 = 3.57%. Based on historical data, 3.5% is not always safe in all 30, 40, 50, 60 year periods, but in some cases, you could consider retiring.

Whether it is enough would depend on your luck haha.

It is situations like this that for some risk seeking folks, they would take the plunge, but for those really really conservative ones, they would just err on the safe side.

Then what we discuss today, could be applicable.

Suppose the couple can add $35,000/yr to their net worth. Delaying for 3 years, when the net worth is down 20%, could bring their withdrawal rate to ($25,000 x 1.03^3)/($700,000 x 0.80 + $35,000 x 3) = $27,318 / $665,000 = 4.1%.

While the withdrawal rate is higher, due to the reduction in net worth due to the bear market, averting the negative sequence of return risks by working during the 3 years, may greatly avert the couple to negative sequence, making 4.1% safe.

If we sensibly evaluate our withdrawal rate annually, you can have an idea if your retirement plan is going to be out of wack.

A Last Word on Sequence of Return Risk and Having a Bond Tent

I think not everyone have a choice there that your job is still around during recession.

I would think that doing this is more applicable for the civil servant friends where things can be more sturdy than in the private sector.

Since sequence of return risk is a big shit, setting up a bond tent might alleviate it, together with full time work, or part time work. (Read Kitces article on the Bond Tent here)

I do note that the most crucial period is:

1. the 3 to 5 years before retirement
2. the 3 to 5 years after retirement

If you had not reduce your equity allocation during #1, and your net worth gets cut by a lot, that might inadvertently means you have to delay retirement (if your withdrawal rate is high, but if your withdrawal rate is like 1-3% even after that, this does not affect your plan that much)

In times like this, it might be worthwhile to review your financial assets as a portfolio, to see if they are aligned to your objectives, be it wealth accumulation or wealth de-accumulation.

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1. Building Your Wealth Foundation – You know this baseline, your long term wealth should be pretty well managed
2. Active Investing – For the active stock investors. My deeper thoughts from my stock investing experience
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