There are numerous strategies to safely spend your money in retirement.
I’ve already covered one of the most well-known strategies in my video on the 4% Rule (and
we’ll be briefly touching on it again since I know a lot of you weren’t around back
when I originally made that video and it’s also the strategy against which we’ll be
measuring the others), but it is by no means the only strategy that has been put out there
and depending on how deep down the rabbit hole you want to go, it may or may not even
be the best one for you, personally.
Today I’m going to be going over 4 different retirement withdrawal strategies and hopefully
along the way we’ll find one that appeals to you and
your situation.
Let’s get started.
The first and arguably most popular retirement withdrawal strategy that I want to talk about
today is the 4% rule or safe withdrawal rate strategy, which basically aims to get you
to withdraw a certain percentage of your retirement nest egg in the first year of retirement and
adjust your withdrawal every year thereafter to account for inflation.
One bright side to this strategy is that, so long as you stick to a conservative enough
withdrawal rate, you should have a reasonable chance of not outliving your money as I covered
in detail in my video on whether or not the 4% is actually safe.
Another plus to using this strategy is that your buying power will remain the same throughout
your entire retirement.
Say John had annual expenses totaling $40,000 a year heading into retirement and he was
going to follow the 4% rule for his withdrawals in retirement.
This would mean that he would need to have $1,000,000 saved by the time he retires in
order to live on that $40,000 per year.
Over the course of his first year of retirement, he would withdraw his $40,000.
In his second year, he would adjust for inflation (or just increase his withdrawals by 2% each
year if you don’t know what the inflation rate is going to be, which is what many people
do when trying to simulate this strategy).
Say inflation was 3% in his first year of retirement that would mean that in John’s
second year he would withdraw $41,200, which would keep his effective buying power the
same as what it was in his first year of retirement before the inflation happened.
This can go the other way of course if inflation is actually negative over the course of a
year, which doesn’t happen often, but does happen once in a while.
Say if inflation was actually down 2% in John’s second year of retirement.
If he was adjusting for inflation that would mean that he would lower his withdrawal in
his third year of retirement from $41,200 to about $40,400.
In terms of how this strategy is graded using the four factors of retirement (which if you
don’t know are income, risk, stability, and buying power I’ve got a whole video
on them in the description if you want to learn more) in my personal opinion the 4%
rule is below average in income (dynamic strategies that focus on this factor as their primary
selling point are far better in this regard than the 4% rule), roughly average to maybe
slightly below average in risk (though using the 3% rule can improve this score), and strong
in both stability (thanks to its constant adjustments for inflation and lack of freezes
or reductions) and buying power (which is where this rule shines the most in my opinion).
The second retirement withdrawal strategy I’m going to cover today is the fixed dollar
withdrawal strategy.
This is, exactly what it sounds like, you begin by withdrawing a certain dollar amount
from your nest egg every single month and keep that amount constant throughout your
retirement.
Say if John were living on this strategy in retirement.
He still has $1,000,000 saved and still wants to live on $40,000 a year, but this time there
is not adjustments for inflation.
He withdraws $40,000 in the first year of retirement, $40,000 the second, and so on.
When it comes to the four factors of retirement, compared to the 4% rule this strategy is generally
a little stronger on the income and risk side of things while suffering a little more in
the stability and buying power categories.
The reason for this is that, as long as your initial withdrawals are not too high, you
are very unlikely to outlive your money on this strategy, and you may be able to live
at a higher standard of living, at least initially, than you otherwise would have under something
like the 4% rule.
In fact, going all the way back to 1950 and looking all the way to March of 2019, which
is the most recent data I have at the time of this writing, if John had his $1,000,000
invested in something like the S&P 500, he would not actually outlive his money during
any possible 20, 30, 40, or 50 year retirements during that time span as long as he withdrew
no more than $54,000 a year or $4,500 a month.
As I said, this initially will give him a higher standard of living than the $40,000
a year income he would have under the 4% Rule would, though eventually, the inflation effect
would catch up with him.
So in terms of the four factors of retirement, the fixed dollar strategy is above average
in income and risk, but below average in stability and buying power in comparison to the 4% rule.
The third retirement withdrawal strategy that I want to discuss today is known as the fixed
percentage method.
This works very similarly to the fixed dollar method, except that you are withdrawing a
certain percentage of your nest egg every year.
This doesn’t adjust for inflation, but it does at least adjust with the value of your
portfolio.
Say John wanted to withdraw 4% of his investments each year in retirement.
Since the value of his investments were $1,000,000 when he retired he would withdraw $40,000
in year one of retirement leaving him with $960,000 leftover.
If his investments went up by 10% that year, the value of his portfolio would be somewhere
in the neighborhood of $1,056,000 at the start of his second year of retirement and he would
withdraw 4% of that or $42,240.
The downside is that the reverse can also happen.
Say that John’s investments fell by 20% the next year, bringing the value of his nest
egg down to about $811,000 and forcing him to withdraw $32,440 in the third year of his
retirement.
So as you can imagine stability is something that this strategy has a very low score in
given that the value of a nest egg (if it’s invested in something like stocks) can grow
or shrink by 20%, 30%, or even 40% from year to year.
The bright side is that assuming you’re not withdrawing something crazy like 20% of
your nest egg every year, your risk of running out of money is theoretically very low.
And I specifically say theoretically because like many things it’s true only to a point.
If we take it to a logical extreme this can break down.
Say if John had $10,000 and he wanted to live on 50% of his nest egg each year for the next
5 years…
He’d technically be fine in theory, but how many of us are able to live on $5,000
a year?
Not very many, but if you’re willing to take the hit to the stability of your income
in retirement, you usually can safely squeeze out a little more than 4% of your nest egg
each year in a typical retirement, it just means that your average raw dollar income
will shrink the further you go into retirement.
To illustrate this let’s say that if John withdrew 10% of his nest egg each year he
would start out with a six-figure income given his $1,000,000 nest egg, however, if he ended
up living longer than he planned on he could be living on what could only be generously
called a shoestring budget in his later years.
For example, in the simulations I ran covering the various retirement lengths starting from
1950 onward, assuming John had invested in the S&P 500 he would’ve had median monthly
incomes hovering around $6,500 in 20 and 30-year retirements, but that number dropped quite
a bit as the retirements got longer.
In his 50 year retirements, his average median monthly income was about $4,400.
Which admittedly doesn’t sound that bad, but you also need to consider his final few
years’ worth of monthly withdrawals, which were about $2,300 a month on average during
those scenarios which is considerably less than the six-figure income he started with.
Also remember, that’s $2,300 a month possibly as much 50 years down the road.
Once we adjust for inflation over that time period it may not even buy John about what
$1,000 a month would buy him today depending on exactly how far down the road we are.
So buying power could be taking a significant hit if the initial percentages you’re withdrawing
are set too high.
So in summation, the fixed percentage method scores reasonably well, though not necessarily
elite, when it comes to income (particularly early in retirement), great in terms of risk
(assuming you aren’t too aggressive with your withdrawals), horrible with stability
(due to fluctuations in the value of your nest egg), and below average in terms of buying
power (unless you’re too aggressive with your withdrawals, in which case it gets pretty
bad over time).
The fourth retirement withdrawal strategy we’ll be covering today is the dividend
method.
The dividend method seeks to get you to a point where the dividends from your investments
cover all of your expenses.
The plus side to being able to use this dividend growth investing method is obvious when done
right, you don’t have to sell any of your shares of your investments to cover your bills.
The downside is that you are, usually, less likely to experience the kind of rapid stock
appreciation we sometimes get during market booms if the majority, or entirety of your
portfolio is invested in these higher dividend-paying stocks.
This is because companies that are in what investors call the “growth phase” of the
business usually want to reinvest as much of their profits as they can into continuing
to build the business and as a result they don’t usually pay out a portion of those
profits in dividends.
Often, though not always, when a company starts paying a dividend it is because they feel
the biggest part of their rapid growth phase has ended.
That doesn’t mean that they won’t continue to grow as a company, it just likely won’t
be quite as quick of a growth as it was in the past.
But that’s not really the point of this method, we’re not quite as concerned with
stock prices rising or falling because we aren’t selling our stocks in the first place
with this strategy.
The point of this method is to minimize risk as much as possible by investing in well-established
companies that are paying out consistent dividends (hopefully they also have a history of raising
their dividends over time) that will cover your expenses.
As a result, the dividend method scores pretty highly in the risk factor, is generally slightly
below average in income (it’s rare, though not impossible, to find those consistent,
safe, and reliable companies, index, or mutual funds that year in and year out pay much over
4% per year in dividends alone, especially over the long haul that is the typical retirement),
and both stability and buying power varies.
Normally I’d say that stability is decent, though not excellent (dividends do tend to
grow over time, but there are going to be instances where they get cut down particularly
during major crashes.
However since they tend to grow more than shrink it’d consider it technically a net
positive, but this does depend to a certain degree on what investments you choose).
And normally I’d say that buying power is good since dividends growth investments usually
do keep up with inflation, or at least very close to it (inflation has historically averaged
between 2%-3% per year and dividends are usually in that ballpark as well, but again this does
depend on the investments you choose to a certain degree).
So those are 4 more systematic withdrawal strategies that people use to have an income
in retirement, but they are by no means the only ones out there, and depending on your
situation they may not be the ideal ones for you to use.
Next week I’ll be going over 4 more retirement withdrawal strategies that are a bit more
dynamic in nature that may appeal to some of you better if none of today’s strategies
exactly jumped out at you.