A good rule-of-thumb to estimate whether you have accumulate enough to retire or not is based on a magical 4% Safe Withdrawal Rate.
This percentage was first came out based on the research of Bill Bengen in the 1990s. Back then, he became a financial planner not too long ago and his client have a problem of figuring out
- How much they need to accumulate so that they can retire?
- How much they can spend monthly or yearly so that they would not run out of money?
- How to structure their portfolio?
His research was borne out of necessity but it became a rule of thumb that many in the Financial Independence Early Retirement (FIRE) space use to determine how much they need to build up towards.
This week, there were two good interviews on this subject.
Bill Bengen, now having sold off his financial planning practice, happily retired, spoke to Michael Kitces on his podcast. Karsten from the great blog Early Retirement Now spoke to Morningstar’s The Long View.
If you are someone who is accumulating towards FIRE, or financial independence, or retirement, you can gain good insights from these two interviews.
I treat these interview as a quick way to gain concise thoughts from thought leaders who have done either a lot of research, or are very experience practioners.
While they cannot go too in-depth as compared to their writings, you can hear certain important things that they emphasize on that would have been lost in the many articles they have written over the years.
Some interesting points I gathered:
- Bengen held the view that in today’s low-inflation environment, we might be able to withdraw as high as a 5% initial withdrawal rate and things would be OK
- Both Karsten and Bengen highlight the strong correlation between market valuation and what is a safe initial withdrawal rate to withdraw
- Bengen highlighted that you could withdraw more if you have pension sources
- Bengen is quite an active manager for his client’s portfolio
- Karsten specifically talks about what made portfolios fail to last long in negative sequences
- While he is an advocate of a diversified, index portfolio, Karsten also dabbles in uncorrelated investments such as private equity real estate and options writing
Here are my notes from the two interview, with time stamp. Let me know your takeaway.
- 2:30: “We cannot diversify our career as much as our portfolio.”
- 3:40: There are people taking a slower approach to FIRE but Karsten also have friends that like their normal lives but now are reaching out to find out more about this FIRE movement
- 6:20: There is some truth that 4% Safe Withdrawal Rate is too optimistic
- 8:10: At the same time, the withdrawal rate study factors in some seriously poor sequence such as 1929 and 1960s. If you reduce your withdrawal slightly from 4% to 3.2%, things will turn out okay.
- 9:20: If you have a longer spending period, your initial withdrawal rate needs to be lower. It is just amortization math. But the surprising thing is how little lower you need to move it. It is not like instead of a 30-year retirement, you have a 60-year retirement, you would need to move your initial withdrawal rate from 4% to 2%. It will be around 3-3.3%.
- 11:20: Using Shiller CAPE or Earnings yield and use market valuation to time the initial withdrawal rate to use. There is a strong correlation that those lowest safe initial withdrawal in history are also periods where market valuations are high
- 15:15: What if markets stayed overvalued for a prolonged period of time? By withdrawing based on a CAPE earnings yield percentage, if the markets remain overvalued, your portfolio value goes up, the absolute amount also goes up, which means that you could spend more money. It is more flexible compared to a static 4% safe withdrawal rate.
- 17:10: Is there a concern over low bond yields? Bond yields have been low before in the 1960s (and this is part of the safe withdrawal rate study)
- 19:30: Why Karsten does not like the Required Minimum Distribution approach. The main reason is that it is very rigid and not a very scientific approach. Nothing in life is as linear. In contrast, the Boglehead’s Variable Percentage Withdrawal (VPW) is a good tweak.
- 23:30: How to tackle a sequence of return risk for people with long retirements. If you have a longer period, the period of vulnerability to sequence risk also increases. Typically you can wait 10-15 years in a 30-year retirement to know your portfolio is able to survive well. For a 60-year retirement, you have to wait until 45 years later to know you are out of the woods. Some solutions
- Just be flexible. Jobs and side gigs.
- Have enough diversification in asset type at the start of your retirement so that it diversifies the volatility at the start of your retirement e.g. short-term cash, bonds. Sequence risk is selling volatile assets at the worst possible time and if you have enough uncorrelated assets that you can sell and get cash flow instead of selling the volatile assets, then it helps.
- Micheal Kitces’ Bond-tent or Rising Equity Glidepath. Don’t use Target Date Fund. The glide path is so that your equity allocation is at the lowest during the lowest point in the bear market and then you pick it up.
- 28:00: It may be tough for clients at 80 years old to remain in high equity allocation. Karsten explains that you might want to use the rising equity glide path or take your equity allocation up only if you face a bear market or a negative sequence at the start of your retirement. If not, don’t rely on it so much, just have a normal allocation. Don’t do these blindly.
- 31:45: Why holding a basket of dividend stocks do not work. When you go high yield, you are being concentrated and you lose traditional high-quality safer bonds. Your dividends don’t hold up forever. Just focus on total return.
- 35:50: What kind of assets does Karsten recommend as passive assets for retirement. Private equity multifamily real estate. Sell very short-dated S&P 500 put (not passive). His majority would be passive unit trust.
- 39:00: Tackling US Health Plan and social security
- 44:00: Having an active network in retirement.
- 7:30: Why Bill Bengen choose to be a Fee-Only adviser when it was not fashionable to do it (the 1990s)
- 19:00: Why did Bengen start researching on the 4% withdrawal rule. No one could answer him the question of how much to save for retirement, how much to spend in retirement.
- 22:43: How did he get close to the magical 4% number
- 25:00: People criticizing his 4% rate was too low in a 7% a year balance fund return world. Now people are criticizing his 4% is too high.
- 27:30: Bengen emphasizes that people need to be aware that the 4% withdrawal rate is a worst-case scenario and you cannot just rely on the worst-case. Given what he knows now, instead of the 4%, he would recommend a 5.25 – 5.50% withdrawal rate today in a low-inflation environment.
- 29:50: When Bengen introduced small-cap stocks, he realizes the safe withdrawal rate is close to 4.50%
- 33:30: How Bengen implements 4% with clients. It was ideal for him because they have a massive bull market during that period.
- 36:10: He wishes that financial planning software can benchmark a client’s current withdrawal rate against some historically poor sequences and warn clients before this.
- 37:40: Opinions on Monte-Carlo vs 4% withdrawal rate
- 42:00: Bengen explains how he implemented different withdrawal rates for clients. Start at 4.2%. For some with inheritance, he may start at 5.25%
- 45:00: Did September 11 affect things? (answer no. The 1960s and 70 sequence was worst)
- 49:00: What are the reasons for him to retire?
- 51:00: Bengen got his clients successfully out of the GFC. But he was unsuccessful in getting clients back in.
- 62:40: How Bengen looks at the 4% rule today and how tactically he will shift his portfolio. Bengen believes that we should look at the relative inflation and market valuation at the time you retire to judge what is a safe initial withdrawal rate for yourself. At this moment we believe is closer to 4.75 to 5%.
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