So on one of my recent videos, I got a comment asking how long you would last historically
with various withdrawal rates such as a 5% or 6% safe withdrawal rate as opposed to the
usual 3% or 4% that I talk about in these videos.
Because while I'm sure that some of you are hoping to or already have retired early not
everyone is going to go that route.
So if you have a more normal retirement say 20 to 30 years would you actually be able
to withdraw more than 4% safely in retirement?
And in addition to that, given that the market has, from what we've been told by the media,
been doing worse since the turn of the millennium than it ever has in its entire history is
the 4% rule which was based on a study done before the turn of the millennium still safe
to use as a general rule of thumb?
Those are some of the questions we’re going to be hopefully answering today because in
today's video we're going to be talking about safe withdrawal rates and figuring out are
they actually that safe?
Hey everyone Daniel here and welcome to Next Level Life a channel where you can learn about
investing, debt, retirement, and many other financial topics besides, because, let’s
face it, the school's aren't going to teach it for us.
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So a couple of things I do want to point out before we get started.
The first is that past results do not indicate future returns, but until we see what the
future returns are the past results are the best, and really only, thing we have to go
off, so that’s what we’ll be using today.
The second thing is that expense ratios and taxes are going to vary depending on what
and where your money is invested in as well as how you withdraw it in retirement.
If you want to learn how to better manage your money in your post-working life you can
check out my financial Independence and retirement playlist or my investing playlist where I've
already had videos discussing those topics but because of how many variables there are
with that those factors have not been explicitly taken into account here.
A third thing that I want to mention is that in the interest of keeping this short and
sweet I will not be taking into account things like bonds or other Investments options that
one may have, nor any other forms of income such as social security, side hustles, and
interest on other savings outside of retirement savings, at least in the initial examples.
The bright side is that if you do have these things they will likely increase your chances
of success in comparison to what you will see here.
The last thing I want to mention is the assumptions that are being used here.
For example, dividends are being paid and reinvested annually at the end of each year
and averaged 1.7% for the S&P 500 and Dow Jones industrial average scenarios.
I used 1.7% because it's roughly in the middle of what the dividends for index funds on those
indices have been historically.
Dividends for the NASDAQ scenario will be 0.9% since that is again roughly average for
indexes that track the NASDAQ.
The annual expenses in this scenario are $36,000 and will be increased by 2% each year for
inflation.
I used 2% each year for inflation because we don't know what future inflation is going
to be and this is the alternative that the 4% rule allows if you're not able to adjust
each year for the actual inflation.
And the entire net worth of the individual will be dumped into the index fund on the
day they retire in each of these scenarios.
This was mainly done because I can only get data from so far back so it's almost impossible
to figure out what their net worth would be in some of the very old scenarios assuming
they invested consistently for their entire careers I mean we're going back all the way
to like 1928 in this video so say you had a 40-year career and retired in 1928 when
you started working in the 1800's it's hard to get reliable data from that far back.
So this is not going to by any means be a perfect case study and I don't think you should
look at it as such.
I'd just look at this as an exercise in seeing historically what may have happened had someone
followed each of these safe withdrawal rates.
The idea being to give us a general feel for what might happen in the future using these
rates, under these assumptions, and whether or not we're comfortable using these rates
given the past results.
But with those caveats out of the way let's get started.
So what I did was gather all the historical price data from the S&P 500, Dow Jones industrial
average, and NASDAQ composite threw them into a spreadsheet and figured out over various
retirement time periods, in this case, every single available 20, 30, 40, and 50 year time
periods how often someone would have run out of money had they had their money been invested
in those indexes.
For both the S&P 500 and Dow Jones industrial average I started testing in January of 1928
using a 3%, 4%, 5%, and 6% safe withdrawal rate and here were the results.
Using the 3% safe withdrawal rate John still had money left over 97% of the time under
a 20-year retirement, 95% of the time under a 30-year retirement, 94% of the time under
a 40 year retirement, and 92% of the time under a 50 year retirement using both the
S&P 500 and the Dow Jones.
Using the 4% safe withdrawal rate John still was very successful, though there was a little
bit of a difference between the two indexes this time around.
For the S&P 500 under a 20-year retirement, John still had money remaining at the end
in 95% of the cases.
Under the 30, 40, and 50 year scenarios he succeeded 93% of the time, 91% of the time,
and 87% of the time respectively.
For the Dow Jones, he succeeded with money to spare 95%, 93%, 89%, and 82% of the time
under the 20, 30, 40, and 50 years scenarios respectively.
So admittedly not quite as good as the S&P 500 but he’s still succeeding over 80% of
the time even in the 50-year retirement scenarios, with absolutely no income or other savings
to help safeguard his investments during down markets.
Once we get to the 5% and 6% safe withdrawal rate we see the numbers get a little shakier
as you can see from the success rates listed in this chart.
So judging by these numbers, a 3% or a 4% safe withdrawal rate for any retirement that
will last under 40-years looks to be a fairly safe bet with all of the success rates for
the S&P 500 being over 90% in both cases and the Dow Jones having the lowest success rate
of 89% under a 40 year retirement using the 4% rule, however once you start getting above
4% safe withdrawal rate, the numbers do start to look a little uncertain with the Dow dropping
below a 70% chance of success in a 40 year retirement using a 5% safe withdrawal rate
and going all the way down to a 38% chance of success under a 50 year retirement using
a 6% safe withdrawal rate.
But one thing that I noticed particularly with the 3% and 4% rules is that almost all
of the failing scenarios came right at the beginning, when someone retired in the late
1920s or in other words when they threw all of their money into the stock market at its
peak right before the absolute, hands-down, worst stock market crash we have ever seen,
the great depression.
So I wondered what would happen if we looked at it from a more recent point of view?
Say that in the interest of comparing apples to apples with the NASDAQ we started in February
of 1971 which is when the NASDAQ began.
Under that scenario we can't actually do a 50-year retirement because the NASDAQ hasn't
actually been around for 50 years so instead of the 20, 30, 40, and 50 year time span we're
going to use a 15 year, 20 year, 30 year, and 40 year retirement time spans this time
around.
Using these retirement lengths will allow us to see what happens if someone was investing
their nest egg during the heights that preceded the Dotcom crash and housing crisis.
The results?
The S&P 500 and Dow Jones both posted perfect 100% scores in all four retirement length
scenarios for both the 3% and 4% safe withdrawal rates.
The S&P 500 actually also posted perfect scores under the 5% safe withdrawal rate for all
four times spans as well with the Dow just barely missing out on perfection with the
40-year scenario using a 5% safe withdrawal rate with a success rate of 97%.
Under a 6% safe withdrawal rate the S&P 500 had success rates of 96%, 97%, 91%, and 69%
under the 15, 20, 30, and 40-year scenarios respectively.
The Dow Jones posted success rates under those same rules of 100%, 97%, 85%, and 65%.
The NASDAQ posted success rates of 100% for all four time spans using a 3% safe withdrawal
rate, and 100% for the 20, 30, and 40 year scenario's using a 4% safe withdrawal rate,
but thanks to investing the entire retirement nest egg right before the huge price drop
the NASDAQ experienced during the Dot Com bubble, it only managed to succeed in 98%
of all 15-year retirement scenarios.
Using a 5% safe withdrawal rate a NASDAQ had a 97% success rate using during all 15-year
retirement time spans and was again perfect during the 20, 30, and 40 year time spans.
And, finally, under a 6% safe withdrawal rate we see the numbers start to drop a little
bit more with success rates of 94%, 98%, 94% again, and 80% under the 15, 20, 30, and 40
year time spans.
The reason the 20-year retirements were slightly more successful than the 15-year retirements,
in this case, came down to when the money was invested and when dividends were paid
out.
In reality, this likely wouldn’t be the case since most of us are going to be investing
our money consistently over time and not investing it as a lump sum on the day that we retire.
So I chalk that quirk up to a weird case of math, timing, and the limitations of this
exercise.
But, anyway, what this suggests to me is that barring the absolute worst that we have ever
seen happening again in the stock market somewhere down the line we're probably going to be pretty
darn safe using either a 3% or 4% safe withdrawal rate.
At the very least I think we will have a reasonable expectation that we won't outlive our money
under the conditions put forth by the 4% and 3% rules.
The 5% and 6% safe withdrawal rates may work for some shorter retirements but it's a little
shakier and I probably wouldn't recommend it if you can avoid it and instead use one
of the more conservative withdrawal rates.
But as I said this is not a perfect case study and it doesn't necessarily go into all of
the things you could do to supplement your retirement in order to increase your odds
of success.
So while they weren't calculated into these figures let's talk about a few things you
can do to increase your odds of not running out of money once you leave the workforce.
The first thing that you can do in order to increase your chances of successfully making
it through retirement without running out of money is to diversify your investments
between stocks and bonds in order to increase your passive income a bit through the bond
coupons and to help balance out some of the years where stocks are performing really poorly
by withdrawing more of your money from bond funds that are performing better.
For an example on the difference, this can make let’s look back at John’s scenarios
from before.
Say if John, instead of investing all of his money into an S&P 500 index fund, decided
to split up his investments between his S&P 500 fund and a Vanguard bond index fund (let’s
go with their total bond market fund so that we can be well diversified), with 75% of his
nest egg going into his S&P 500 fund and the last 25% going into his bond index fund.
If we run the experiment again, this time starting from January 1987 since that’s
when Vanguard’s bond fund was created, we see that John has money left over at the end
of his retirement in 92% of all 15-year scenarios, 94% of all 20-year scenarios, and 100% of
the 30-year scenarios using a 6% safe withdrawal rate and assuming he only invested in the
S&P 500.
However, if he split his money between stocks and bonds he ends up having money left over
at the end of his retirement in all of the 15 and 30-year scenarios and 99% of all 20-year
scenarios using a 6% safe withdrawal rate.
He actually succeeds in all 15, 20, and 30-year scenarios with both strategies when using
a 3%, 4%, or 5% safe withdrawal rate during this time span.
A second thing that you can do in order to increase your chances of successfully making
it through retirement without running out of money is to create multiple streams of
income.
This could be through some sort of small freelancing gig that you have going on, on the side or
a business that you run part-time, or some other form of passive income.
Whatever the case may be, having another source of income to draw from in times when your
investments aren’t doing as well as you’d hoped can make a significant difference in
your chances of financial success in retirement.
Let’s again go back to John’s example from the beginning of the video.
John has all of his investments in the S&P 500 and is bringing home $500/month from his
side hustle.
Going all the way back to January 1928 we see that, using a 3% or 4% safe withdrawal
rate never leaves John with even a 10% chance of outliving his money under the 20, 30, 40,
or 50-year retirement scenarios.
On average, his side hustle income is improving his chances at success by 1% to 3% compared
to when he didn’t have any side hustle income.
But the real interesting point comes with the higher withdrawal rates.
Previously, at a 5% safe withdrawal rate John had success rates of 93%, 87%, 79%, and 69%
under the 20, 30, 40, and 50-year retirements.
However, with the side hustle income taken into account, his chances at success balloon
to 95%, 92%, 90%, and 86%!
The difference becomes even starker when looking at the 6% withdrawal rates scenarios.
Without a side hustle, John succeeds 85% of the time for 20-year retirements, 68% of the
time for 30-year retirements, 50% of the time for 40-year retirements, and 43% of the time
for 50-year retirements.
But with the side hustle income, he succeeds 93% of the time for 20-year retirements, 84%
of the time for 30-year retirements, 73% of the time for 40-year retirements, and 62%
of the time for 50-year retirements.
That’s quite a big difference if you ask me!
A third thing that you can do in order to increase your chances of successfully making
it through retirement without running out of money is to first try out semi-retirement.
By this, I essentially mean to work part-time for a year or two as you transition into retirement
life.
This will have a couple of benefits:
First is that it will allow you to maintain that comradery you have with your co-workers
(social interaction is something that tends to be a little less frequent in retirement,
at least when you first retire, especially if you are retiring early).
Second is that it’ll allow you to figure out what you want to be doing in retirement
once you no longer have work to fill your days.
This is definitely something that you need to think about and plan for!
I can say from personal experience that it should not be underestimated.
And, of course, the third benefit that this will have is it’ll allow you to save a little
bit more, while simultaneously shortening the amount of time that your savings will
have to last you in full retirement, which will obviously increase your chances for success.
But that'll do it for me today once again if you enjoyed this video be sure to smash
that like button if you haven’t already, subscribe, and hit that Bell next to my name
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I generally upload every single Monday, and if you have a friend that would be interested
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out there and start our own Financial revolution.