Do you know how much money you need in order to be able to retire?
It’s a question that many people are asking themselves every day and if you’ve seen
my video on the 4% rule you already know one of the most popular answers that will be given
in response to that question.
If you haven’t, then, in short, the 4% rule suggests that you need roughly 25x your annual
expenses saved in order to have a reasonably good chance of not running out of money once
you leave the workforce.
However, while I do believe that on the whole, the 4% rule is a good starting point and a
solid rule of thumb to use as a guide, it isn’t by any means the only answer to the
question.
And depending on your situation and goals, it may or may not even be the best one.
Today we’re going to be asking whether or not it’s possible to withdraw more than
4% of your money every year in retirement when we look at another popular retirement
withdrawal strategy known as the Guyton-Klinger Method.
We’re going to be talking about what the Guyton-Klinger Method is, how to use it, the
rules associated with it, as well as the potential pros and cons associated with it in comparison
to other retirement withdrawal strategies.
Let’s get started.
Hey everyone Daniel here and welcome to Next Level Life a channel where you can learn about
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So the Guyton-Klinger Method of retirement withdrawals is another retirement withdrawal
strategy similar to the safe withdrawal rate method, often known as the 4% rule that I’ve
covered in previous videos.
Although, the Guyton-Klinger Method is a little bit complicated compared to the other retirement
withdrawals methods because it has quite a few rules that need to be followed in various
situations.
So let’s start by going over those rules.
Buckle up this is going to get pretty complex.
The first rule of the Guyton-Klinger Method is known as the withdrawal rule.
Interestingly, the Guyton-Klinger Method actually begins very similarly to the 4% rule, with
you setting a certain percentage as your target withdrawal rate for each year of your retirement,
however, unlike the 4% rule (which adjusts for inflation each year, regardless of other
external factors) you will only adjust your withdrawal amounts for inflation in the years
where your portfolio’s total return was positive.
If your investments lost money in the previous year, then you will have no adjustment for
inflation and you do not make up for missed inflation adjustments in the following years
if your investments are making money again.
Additionally, the maximum adjustment that you can make each year for inflation is 6%
each year under the original rule (although some studies have chosen to ignore this).
So if inflation causes costs to rise by 8% one year
and your investments are performing well enough for you to adjust for inflation, you can only
increase your withdrawals by 6% the following year.
This means that, under those circumstances, you will lose some of your buying power following
this rule as it was originally written.
The second rule of the Guyton-Klinger Method is known as the capital preservation rule.
This rule seeks to ensure that you aren’t withdrawing too much of your nest egg that
you run the risk of outliving your savings.
It basically states that if at any point, your withdrawal rates increase beyond 20%
above what your initial target was set to in the withdrawal rule, then you will lower
your current year’s withdrawal by 10%.
The third rule of the Guyton-Klinger Method is known as the prosperity rule.
This rule is basically the reverse of the capital preservation rule as it seeks to ensure
that you aren’t withdrawing too little of your nest egg that you run the risk of drastically
lowering your standard of living over time.
It basically states that if at any point, your withdrawal rates decrease beyond 20%
below what your initial target was set to in the withdrawal rule, then you will increase
your current year’s withdrawal by 10%.
And I should mention that whenever either of these last two rules are triggered, the
adjusted withdrawal becomes the new base withdrawal that we use in all following year’s withdrawal
calculations.
These may seem a bit odd, but it’ll make more sense in a minute when we get to see
them used in an example.
For now, just think of these two rules like financial guardrails, which help prevent the
value of your nest egg from falling off the edge of a financial cliff and maintains the
majority of your original standard of living through the ups and downs of the market over
time.
I should also note that, according to Jonathan Guyton and William Klinger, the capital preservation
and prosperity rules don’t necessarily have to be followed in the final 15 years of your
planned investment period, though due to the uncertain nature of retirement lengths (none
of us know for sure how long we’ll live after all), many people still do follow these
rules as an added safety measure.
The fourth, and final, rule of the Guyton-Klinger Method is the portfolio management rule, which
is basically just a rebalancing formula with the main idea being that you should withdraw
money from the gains of your nest egg in order of best to worst performance over the previous
year and move any excess gains you may have into a cash account for next year’s withdrawals.
Technically, the full rule is a little more comprehensive stating that you should withdraw
your money in the following order: First, any equity asset classes that are considered
overweighed from the prior year-end.
Second, any overweighed fixed-income assets from the prior year-end.
Third, any cash you may have accumulated.
Fourth, any remaining fixed-income assets you may have.
And, finally, fifth, withdrawals from remaining equity assets in order of best to worst performance
from the prior year.
Additionally, if at all possible, no withdrawals are taken from any equity assets following
a year in which that equity had a negative return.
Instead, you would withdraw from cash or fixed-income assets.
So that’s the full rule, but the main idea is roughly to draw money from overweighed
assets first and move any excess you have to cash so that it can be used to help fund
withdrawals in future years.
Based on my research for this video, it seems as if this last rule has some controversy
surrounding it.
It is pretty complicated and based on the majority of the studies that I found at least
it doesn’t even necessarily always significantly improve the success rates when it comes to
not outliving your money.
So some have suggested that it’s more trouble than it’s worth, but I’m mentioning it
because it is technically still part of the strategy.
As I said, this method is a bit more complicated and may sound a bit confusing without an example
so let’s take a look at one to see this method in action.
John has $1,000,000 saved to start his retirement.
The first thing that he needs to do if he’s following the Guyton-Klinger Method is to
set his initial target withdrawal rate.
Let’s say that John’s target withdrawal rate in retirement is 5% that would mean that
in his first year of retirement he would withdraw $50,000, leaving him with a nest egg of $950,000.
It would also mean that we would have to check and make sure that John’s yearly withdrawals
are not lower than 4% of his nest egg (since that would be a 20% reduction in his initial
target withdrawal rate of 5%) or higher than 6% (since that would be a 20% increase in
his initial target withdrawal rate) of his nest egg in any given year in order to make
sure he’s following both the capital preservation and prosperity rules of this method.
Now let’s assume that John’s investments grow by 10% over the course of that first
year, bringing the value of his nest egg up to $1,045,000 at the start of his second year
of retirement.
Since his investment return was positive in his first year of retirement, he would be
allowed to adjust his initial withdrawal amount of $50,000 for inflation in year 2.
Let’s say that inflation was 3% during John’s first year of retirement.
This would mean that, after adjusting for inflation, John would withdraw $51,500 to
live on for the year.
But remember, each year we need to make sure that John’s withdrawal amount is never lower
than 4% of his total nest egg or higher than 6% of his nest egg.
So we take his withdrawal of $51,500 and divide that by his current retirement nest of $1,045,000
and we see that he is withdrawing about 4.9% of his nest egg.
That’s well within the financial guardrails we set for ourselves using this method so
we’re good to go.
John withdraws $51,500 from his investments following the portfolio management rule and
we look forward to year 3.
John’s investments perform very well in his second year of retirement, rising by 20%,
and his real return is pretty good too, with inflation for the year being only 2%.
This means that John’s nest egg is worth $1,192,200 before making his next withdrawal
and his withdrawals would increase to $52,530 at the start of his third year of retirement.
John is still within those financial guardrails but it’s getting close to the point that
we’d need to make an adjustment.
And thanks to some more phenomenal investment performances in John’s third year of retirement,
he is going to finally going to need to make some adjustments to his withdrawals.
With a 25% return on investment and a 3% rate of inflation, John has had his best year yet.
His nest egg is now $1,424,587.50 before making his withdrawals and his next withdrawal is
set to be about $54,100.
This withdrawal would be a shade under 3.8% of the value of his nest egg, which means
we’ve fallen below our 4% financial guardrail and have triggered the prosperity rule.
This means that John will increase his anticipated withdrawal by 10%, which would bring his actual
withdrawals for the fourth year of retirement from $54,100 all the way up to about $59,500.
This actually brings us back up above the 4% financial guardrail and gets us back on
track.
And remember that whenever the prosperity or capital preservation rules are triggered,
we use the new and adjusted withdrawal, in this case, $59,500, as the new base withdrawal
for future inflation adjustment calculations.
So, if John’s investments continue to perform well and he gets to adjust for inflation next
year, he’ll be adjusting based on $59,500, not the $54,100 that he was originally going
to withdraw before the prosperity rule came into effect.
But, unfortunately for John, that’s not going to happen this time because with the
ups in the market eventually come the downs and John’s not likely to sustain returns
of better than 20% forever.
He learns this the hard way when the market tanks the following year, losing a whopping
30% of its value and bringing John’s nest egg down from $1,365,000 after he made his
withdrawal last year to $955,500 before making his next withdrawal this year.
And remember, that since John lost money this past year, there are a couple of rules that
are going to be triggered.
The first is that he can’t adjust his withdrawals for inflation, regardless of what inflation
is that year and he won’t be able to make up for it in future years.
This means that his anticipated withdrawal of $59,500 isn’t adjusted for inflation,
but since his investments lost so much value in such a short amount of time, his now actually
above the upper financial guardrail of 6%.
Therefore, he will need to adjust his withdrawal down by 10% to get himself back on track.
This means that his actual withdrawal for his fifth year of retirement will be about
$53,550.
Let’s say that inflation was 5% during year 4 of his retirement and 2% in year 5 with
his investments growing by 15% in that fifth year, recovering at least some of his losses
from the previous year.
So let’s pause for a minute and look at the situation for John.
In his first five years of retirement his investments averaged a return of about 8%,
and after taking into account his withdrawals the value of his nest egg stayed pretty steady
despite having a year where the market tanked by 30%, which is pretty encouraging for those
worried about running out of money in retirement, especially considering that we started off
with a withdrawal rate of 5% instead of the more conservative 3% or 4% that we usually
hear about.
However, I regret to say that not all is sunshine and rainbows in this scenario.
John’s anticipated withdrawal to start off his sixth year of retirement would be about
$54,600 under the Guyton-Klinger Method, but this is where we see the first potential con
to using this method.
Under a different retirement withdrawal strategy such as the safe withdrawal rate, we would
be adjusting our withdrawals for inflation every year regardless of market performance,
as opposed to only when our returns are positive and as a result our withdrawals would be higher
than they were in John’s example, all else being equal.
Assuming that John was following a 5% rule (as opposed to the more traditional 4% rule,
for no other reason than to just to keep things consistent between the two methods) and the
returns and inflation he experienced stayed the same, John would be withdrawing nearly
$58,000, which translates to about $280 a month in extra income for John compared to
what he had using the Guyton-Klinger Method.
So as you can imagine, depending on the performance of the market John’s buying power could
slowly erode due to these freezes, reductions, and inflation over time at least in comparison
to something like the safe withdrawal rate strategy.
The other side to that coin, though, is if he’s withdrawing more under this 5% rule,
wouldn’t his nest egg be worth less than it was under the Guyton-Klinger Method, all
else being equal?
Well, as it turns out, no.
At least not with the numbers used in this example, but they are very close.
John’s net worth under the 5% rule after this 5 year period would be $1,037,900 while
it was $1,037,300 under the Guyton-Klinger Method.
Though I will admit that this is likely misleading due to the small sample size (we’ve only
looked at a 5-year time span after all).
If all else is equal, and John is withdrawing less money each year using the Guyton-Klinger
Method than he is using the safe withdrawal rate, then eventually the value of his nest
egg using the Guyton-Klinger Method will surpass the value of his nest egg under the safe withdrawal
rate.
So while the Guyton-Klinger Rule does also give you a reasonably certain chance of not
outliving your money, arguably more so than a safe withdrawal rate that uses the same
initial percentages, it may do so at the risk of noticeable cuts to your buying power, at
least in less than ideal times.
So the question you need to ask yourself is which of the 4 factors of retirement withdrawals
do you value most?
Which do you value the second and third most?
And which do you value the least?
I’ve already covered these factors in depth as well as tips on how you can improve them
in your retirements earlier on this channel and I’ll link to it in the description below,
but the factors are: Maximizing withdrawals (especially early in retirement), limiting,
or completely eliminating the possibility of running out of money, avoiding undesired
changes to your income stream (namely reductions of it or freezes on it), and maintaining your
purchasing power.
Answering these questions for yourself is what will ultimately help you to decide whether
this retirement withdrawal strategy is the best strategy for you.
But that'll do it for me today once again if you enjoyed this video be sure to smash
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