Author Topic: The 4% rule is for the stash, not the withdrawal, right?  (Read 3329 times)

AMandM

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The 4% rule is for the stash, not the withdrawal, right?
« on: October 07, 2020, 02:08:22 PM »
Just checking my understanding of the 4% SWR rule.

Suppose I want a retirement income of $40k. Then the 4% rule says I need to accumulate 25 x $40k = $1M. So far so good.

But when I've got that $1M, and I retire, I don't withdraw 4% of the stash every year, right?  I withdraw $40k (adjusted for inflation) regardless of the value of the stash. The idea behind the Trinity study is that the fluctuations in the market mean that some years I'm taking out more than 4% of what I have, and other years I'm taking out less, but historically taking out 4% of the initial amount has (almost) never left anyone bankrupt in less than 30 years.

Is that right?
Thanks!

dandarc

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Re: The 4% rule is for the stash, not the withdrawal, right?
« Reply #1 on: October 07, 2020, 02:13:32 PM »
Yeah - that's what the Trinity Study assumed. Start with that $40K withdrawal, then increase each year no matter what.

I've always preferred to think of that 4% as just a guideline to help determine "could I retire right now?", and the mechanics of withdrawals we actually take will align with whatever our needs are.

reeshau

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Re: The 4% rule is for the stash, not the withdrawal, right?
« Reply #2 on: October 07, 2020, 02:20:20 PM »
Yeah - that's what the Trinity Study assumed. Start with that $40K withdrawal, then increase each year no matter what.

I've always preferred to think of that 4% as just a guideline to help determine "could I retire right now?", and the mechanics of withdrawals we actually take will align with whatever our needs are.

Correct.  It's a nonsense answer to take out more than you need to--the 4% rule should not be leading you to hedonic adaptation.  It does allow somewhat for withdrawals greater than that in the early years, but there is danger in that this is only based on historical information--your first years could set a new historical low!  By the time your portfolio has some further years of growth under its belt (Assuming you retire at exactly 25x) then you will be much lower than the "current" 4%, and therefore will have built a margin of safety.

This is why people plan for withdrawal rates of under 4%, or take other measures against risk in the first years.  Exactly how much safety you need depends on how well you sleep at night, either way.

triple7stash

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Re: The 4% rule is for the stash, not the withdrawal, right?
« Reply #3 on: October 07, 2020, 03:35:33 PM »
Another question to rift off the OP...

Does the trinity study assume you withdraw a lump sum to live off every year cone Jan 1 (in this example 40k each year in Jan)? Or does it assume you withdraw on a monthly or weekly basis totaing 40k per year?

I imagine if you withdrew monthly that would give you another margin of safety as you are earning additional months of compounding.

secondcor521

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Re: The 4% rule is for the stash, not the withdrawal, right?
« Reply #4 on: October 07, 2020, 09:27:35 PM »
Another question to rift off the OP...

Does the trinity study assume you withdraw a lump sum to live off every year cone Jan 1 (in this example 40k each year in Jan)? Or does it assume you withdraw on a monthly or weekly basis totaing 40k per year?

I imagine if you withdrew monthly that would give you another margin of safety as you are earning additional months of compounding.

The original Trinity study is here: 

https://www.aaii.com/files/pdf/6794_retirement-savings-choosing-a-withdrawal-rate-that-is-sustainable.pdf

The above was done on an annual basis so it would be a $40K lump sum once a year.

They later did an update where they looked at monthly returns, which you can read here:

https://www.researchgate.net/publication/228707593_Sustainable_withdrawal_rates_from_your_retirement_portfolio

Their conclusion was that the monthly aspect didn't really change the results all that much (except for a reduction in the safety of high WR%s, which are mostly not of interest to people here).

In the second paper they note that the withdrawals were done at the end of the month, which leads me to believe that in their original paper they made annual withdrawals at the end of the year.  So in the original paper, a person who retired with $1M on January 1, 2020 would withdraw their first $40K on December 31, 2020, and in the second paper the retiree would withdraw their $40K/12 on January 31, 2020.  Other tools and researchers have pointed out that this isn't exactly realistic and have done the withdrawals at the beginning of the period.
« Last Edit: October 08, 2020, 07:42:23 PM by secondcor521 »

blurkraken22

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Re: The 4% rule is for the stash, not the withdrawal, right?
« Reply #5 on: October 08, 2020, 12:17:29 AM »
The danger of the 4% rule is from sequence of returns risk, which is to say: what if I need to sell in a deep bear market in the early years and lose a large percentage of my portfolio.

Example: You save $1M, poop happens, then suddenly your portfolio is $0.5M, but you still need $40k to live on, so now to fund year one you've sold 8% rather than 4%.

Millennial revolution describes this problem in some detail and has a few strategies to try to reduce said risk. I recommend buying your book if you don't have financial strategy figured out yet. It's called Quit Like a Millionaire. See the following blog posts for the details:

I investigated the yield shield this year and found that high yield was pretty much non-existent within asset classes I was willing to purchase. I couldn't find anything (looking at REITs and corporate bonds) that was going to yield above 3.5%. As such, it seems to me that the best insurance is to keep your first year entirely in cash before retirement and hope the bad bear market recovers quite a bit within 12 months.

Don't put yourself in the situation where you have no choice but to sell a big chunk of assets regardless of market conditions. Better to convert a fair bit to cash or money markets while you feel comfortable with market levels. The whole issue declines dramatically in importance over time because in most scenarios other than the worst case your returns are far above 4%.

ericrugiero

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Re: The 4% rule is for the stash, not the withdrawal, right?
« Reply #6 on: October 08, 2020, 09:07:37 AM »
Just checking my understanding of the 4% SWR rule.

Suppose I want a retirement income of $40k. Then the 4% rule says I need to accumulate 25 x $40k = $1M. So far so good.

But when I've got that $1M, and I retire, I don't withdraw 4% of the stash every year, right?  I withdraw $40k (adjusted for inflation) regardless of the value of the stash. The idea behind the Trinity study is that the fluctuations in the market mean that some years I'm taking out more than 4% of what I have, and other years I'm taking out less, but historically taking out 4% of the initial amount has (almost) never left anyone bankrupt in less than 30 years.

Is that right?
Thanks!

Yes you are correct.  One thing to keep in mind is that even if you retire at a terrible time and the 4% rule ends up failing in your particular case, it's not a catastrophic sudden failure that you don't have time to prepare for.  The Trinity study shows that 4% of the original balance still works even if you take a little more that 4% of what remains some years and a little less than 4% of what remains other years.  But, if you see your balance dropping over time (ex: 5 years into retirement your portfolio is steadily dropping and is staying below 75%) it's time to adjust.  Practically nobody is going to ride their balance all the way to zero without making some changes to either income or spending.  You should have years of warning before a failure (excluding a catastrophic event). 

One plan that makes a lot of sense to me is to make gradual adjustments.  Start with 4% of original amount.  If your withdraw rate reaches 4.5% of what's left then adjust your spending down or get a side hustle.  If it reaches 3.5% you could bump spending up if desired.  The quicker your make adjustments the less drastic they need to be. 

Sandi_k

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Re: The 4% rule is for the stash, not the withdrawal, right?
« Reply #7 on: October 08, 2020, 03:31:56 PM »
Yes. $40k to start, and the inflation adjusted in year two.

Year One: $40k
Two, with 2% CPI: $40,000 x 1.02 = $40,800
Three, with 1% CPI: $40,800 x 1.01 = $41,208
Four, with 3% CPI: $41,208 x 1.03 = $42,444

and so on.

THE BIGGEST CAVEAT IS THAT THE 4% RULE OF THUMB IS MODELED ON ONLY 30 YEARS OF WITHDRAWAL.

So if you are FIRE'ing, at 40 - your timeline is more like *50* years of withdrawals. So 4% is TOO HIGH a withdrawal rate for that timeline.

CCCA

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Re: The 4% rule is for the stash, not the withdrawal, right?
« Reply #8 on: October 08, 2020, 07:01:04 PM »
yup, you are correct.


My calculator can help elucidate how the 4% actually works and how your stache changes over different historical cycles:


https://engaging-data.com/visualizing-4-rule/

Playing with Fire UK

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Re: The 4% rule is for the stash, not the withdrawal, right?
« Reply #9 on: October 09, 2020, 01:41:04 AM »
yup, you are correct.


My calculator can help elucidate how the 4% actually works and how your stache changes over different historical cycles:


https://engaging-data.com/visualizing-4-rule/

Thanks very much for this, it is an excellent tool.

LightTripper

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Re: The 4% rule is for the stash, not the withdrawal, right?
« Reply #10 on: October 09, 2020, 02:07:02 AM »
yup, you are correct.


My calculator can help elucidate how the 4% actually works and how your stache changes over different historical cycles:


https://engaging-data.com/visualizing-4-rule/

Wow, this is great - thank you for sharing!

Padonak

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Re: The 4% rule is for the stash, not the withdrawal, right?
« Reply #11 on: October 09, 2020, 07:44:37 AM »
You use the Safe Withdrawal Rate rule to decide when you have enough to retire. It doesn't necessarily have to be 4%. Some people go for 3% or less. The consensus seems to be that 3.5% is low enough.

After you retire, nothing stops you from doing the same calculation every year or even every month but the way you do it is you look at your actual expenses vs portfolio size and calculate your current withdrawal rate which will hopefully be much lower than 4%. If the rate is too low (let's say 2%), then you can safely increase your budget or maybe make a big purchase that will reduce your portfolio size but keep the withdrawal rate reasonable. What is "reasonable" depends on you and your risk tolerance. Or you can just keep your very low withdrawal rate, watch your stache grow and then at some point become the richest person in the cemetery.
« Last Edit: October 09, 2020, 07:49:54 AM by Padonak »

AMandM

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Re: The 4% rule is for the stash, not the withdrawal, right?
« Reply #12 on: October 09, 2020, 09:59:08 AM »
Thanks, all!
Glad for the confirmation, and also for the clarifications, especially the reminder that we can adjust income and spending as seems prudent.

Simpli-Fi

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Re: The 4% rule is for the stash, not the withdrawal, right?
« Reply #13 on: October 09, 2020, 11:28:40 AM »
Another question to rift off the OP...

Does the trinity study assume you withdraw a lump sum to live off every year cone Jan 1 (in this example 40k each year in Jan)? Or does it assume you withdraw on a monthly or weekly basis totaing 40k per year?

I recently pulled a lump sum out of an investment account for closing costs in early Aug, when my stache was at an all time high, by the end of Aug it was back within 5k of all time highs again...I was shocked but it made me think that we need enough flexibility to be able to watch for opportunities to "sell high" vs. "its the end of the month".

DK

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Re: The 4% rule is for the stash, not the withdrawal, right?
« Reply #14 on: October 09, 2020, 02:45:06 PM »
I know it's always stated to account for inflation, but would you go lower to account for deflation if it happens? eg, started with 40k, we hit a deflation period of 5% somehow, do you then pull out 38k instead?

Also, per percents and inflation - i believe the non-inflation adjusted is 8%, so you could start with 80k in that case, but never increase the amount...although unless you somehow have fixed costs won't really work (maybe pieces, like mtg wouldn't change). also with lower cost index funds, i think 4.5 works instead of 4.

TomTX

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Re: The 4% rule is for the stash, not the withdrawal, right?
« Reply #15 on: October 09, 2020, 03:50:23 PM »
Yes. $40k to start, and the inflation adjusted in year two.

Year One: $40k
Two, with 2% CPI: $40,000 x 1.02 = $40,800
Three, with 1% CPI: $40,800 x 1.01 = $41,208
Four, with 3% CPI: $41,208 x 1.03 = $42,444

and so on.

THE BIGGEST CAVEAT IS THAT THE 4% RULE OF THUMB IS MODELED ON ONLY 30 YEARS OF WITHDRAWAL.

So if you are FIRE'ing, at 40 - your timeline is more like *50* years of withdrawals. So 4% is TOO HIGH a withdrawal rate for that timeline.

I'll disagree here. Nearly 100% of real retirees living on investments don't actually follow the 4% rule - they treat it as more of a cap on withdrawals. If portfolio value is down, they cut spending.

This is an enormous boost to long term viability of the portfolio. Heck, a 5% WR which is cut down to 3.5% when the portfolio is below starting value is more robust than a flat, dumb 4% WR.

secondcor521

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Re: The 4% rule is for the stash, not the withdrawal, right?
« Reply #16 on: October 09, 2020, 04:00:03 PM »
I know it's always stated to account for inflation, but would you go lower to account for deflation if it happens? eg, started with 40k, we hit a deflation period of 5% somehow, do you then pull out 38k instead?

That's how the Trinity study worked, and that's how FIREcalc works.  I assume cFIREsim and @CCCA's tools work the same way.  The point of the approach is to have a constant standard of living.

Also, per percents and inflation - i believe the non-inflation adjusted is 8%, so you could start with 80k in that case, but never increase the amount...although unless you somehow have fixed costs won't really work (maybe pieces, like mtg wouldn't change). also with lower cost index funds, i think 4.5 works instead of 4.

I have no idea what you mean here.  I really doubt a straight $80K withdrawal on a $1M portfolio would survive 30 years historically.  In fact, FIREcalc gives it about a 46.7% chance of working historically.

Investment expenses were not accounted for in the original Trinity study nor its follow on study.  But if you're doing low cost index funds and rebalancing in tax-deferred, there's almost zero cost these days.  FIREcalc gives a 4.5% withdrawal rate an 83.3% success rate historically (assuming all other defaults in the tool).

TomTX

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Re: The 4% rule is for the stash, not the withdrawal, right?
« Reply #17 on: October 09, 2020, 05:06:27 PM »

Investment expenses were not accounted for in the original Trinity study nor its follow on study. 

I consider investment expenses as part of the WR. They're an expense.

secondcor521

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Re: The 4% rule is for the stash, not the withdrawal, right?
« Reply #18 on: October 09, 2020, 05:08:21 PM »

Investment expenses were not accounted for in the original Trinity study nor its follow on study. 

I consider investment expenses as part of the WR. They're an expense.

Yup, me too.  As are taxes, which is the other thing people often ask about.

blurkraken22

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Re: The 4% rule is for the stash, not the withdrawal, right?
« Reply #19 on: October 09, 2020, 08:25:18 PM »
Yes. $40k to start, and the inflation adjusted in year two.

Year One: $40k
Two, with 2% CPI: $40,000 x 1.02 = $40,800
Three, with 1% CPI: $40,800 x 1.01 = $41,208
Four, with 3% CPI: $41,208 x 1.03 = $42,444

and so on.

THE BIGGEST CAVEAT IS THAT THE 4% RULE OF THUMB IS MODELED ON ONLY 30 YEARS OF WITHDRAWAL.

So if you are FIRE'ing, at 40 - your timeline is more like *50* years of withdrawals. So 4% is TOO HIGH a withdrawal rate for that timeline.

I'll disagree here. Nearly 100% of real retirees living on investments don't actually follow the 4% rule - they treat it as more of a cap on withdrawals. If portfolio value is down, they cut spending.

This is an enormous boost to long term viability of the portfolio. Heck, a 5% WR which is cut down to 3.5% when the portfolio is below starting value is more robust than a flat, dumb 4% WR.

I'm on the same page. Unless your retirement is extremely lean you can adjust your lifestyle to reduce spending or increase income (in addition to the strategies I mention above). I remember in YMOYL they mention repeatedly that they did not find their living expenses inflating over time. Inflation calculations cover an ever-changing basket of goods that includes a shift in spending toward new luxury products that are probably 90% unnecessary.
« Last Edit: October 09, 2020, 08:28:09 PM by blurkraken22 »

DK

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Re: The 4% rule is for the stash, not the withdrawal, right?
« Reply #20 on: October 10, 2020, 07:12:04 AM »
I know it's always stated to account for inflation, but would you go lower to account for deflation if it happens? eg, started with 40k, we hit a deflation period of 5% somehow, do you then pull out 38k instead?

That's how the Trinity study worked, and that's how FIREcalc works.  I assume cFIREsim and @CCCA's tools work the same way.  The point of the approach is to have a constant standard of living.

Also, per percents and inflation - i believe the non-inflation adjusted is 8%, so you could start with 80k in that case, but never increase the amount...although unless you somehow have fixed costs won't really work (maybe pieces, like mtg wouldn't change). also with lower cost index funds, i think 4.5 works instead of 4.

I have no idea what you mean here.  I really doubt a straight $80K withdrawal on a $1M portfolio would survive 30 years historically.  In fact, FIREcalc gives it about a 46.7% chance of working historically.

Investment expenses were not accounted for in the original Trinity study nor its follow on study.  But if you're doing low cost index funds and rebalancing in tax-deferred, there's almost zero cost these days.  FIREcalc gives a 4.5% withdrawal rate an 83.3% success rate historically (assuming all other defaults in the tool).

hmm, i thought i came across that in a chart either gocurrycracker or madfientist put out....maybe kitces.....but a quick search didn't find it. thanks for the correction.

Much Fishing to Do

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Re: The 4% rule is for the stash, not the withdrawal, right?
« Reply #21 on: October 10, 2020, 11:21:27 AM »
Yes. $40k to start, and the inflation adjusted in year two.

Year One: $40k
Two, with 2% CPI: $40,000 x 1.02 = $40,800
Three, with 1% CPI: $40,800 x 1.01 = $41,208
Four, with 3% CPI: $41,208 x 1.03 = $42,444

and so on.

THE BIGGEST CAVEAT IS THAT THE 4% RULE OF THUMB IS MODELED ON ONLY 30 YEARS OF WITHDRAWAL.

So if you are FIRE'ing, at 40 - your timeline is more like *50* years of withdrawals. So 4% is TOO HIGH a withdrawal rate for that timeline.

I'll disagree here. Nearly 100% of real retirees living on investments don't actually follow the 4% rule - they treat it as more of a cap on withdrawals. If portfolio value is down, they cut spending.

This is an enormous boost to long term viability of the portfolio. Heck, a 5% WR which is cut down to 3.5% when the portfolio is below starting value is more robust than a flat, dumb 4% WR.

Totally agree.  Using a blind 4% you most of the time die with more than you started with, and using a blind 4% retiring in 2000 led to some sweating in 2009 (even for those with just a 30 year time horizon, as you still had 21 years to go) as you were at that time drawing like 9-10% of a 80/20 portfolio.  In other words, using a blind 4% is both too risky and too conservative...which to me says you just can't go blindly.  For anyone who is not leanFire I think starting at 5% is fine, you just know you have to be willing to put the guardrails on if things go poorly.

THis is definitely not a mark against the 4% rule's use, I think you need to know you could comfortably live off of 4% when you retire or you;re not FI yet
« Last Edit: October 10, 2020, 11:23:48 AM by Much Fishing to Do »

Sandi_k

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Re: The 4% rule is for the stash, not the withdrawal, right?
« Reply #22 on: October 10, 2020, 12:01:48 PM »
Yes. $40k to start, and the inflation adjusted in year two.

Year One: $40k
Two, with 2% CPI: $40,000 x 1.02 = $40,800
Three, with 1% CPI: $40,800 x 1.01 = $41,208
Four, with 3% CPI: $41,208 x 1.03 = $42,444

and so on.

THE BIGGEST CAVEAT IS THAT THE 4% RULE OF THUMB IS MODELED ON ONLY 30 YEARS OF WITHDRAWAL.

So if you are FIRE'ing, at 40 - your timeline is more like *50* years of withdrawals. So 4% is TOO HIGH a withdrawal rate for that timeline.

I'll disagree here. Nearly 100% of real retirees living on investments don't actually follow the 4% rule - they treat it as more of a cap on withdrawals. If portfolio value is down, they cut spending.

This is an enormous boost to long term viability of the portfolio. Heck, a 5% WR which is cut down to 3.5% when the portfolio is below starting value is more robust than a flat, dumb 4% WR.

Totally agree.  Using a blind 4% you most of the time die with more than you started with, and using a blind 4% retiring in 2000 led to some sweating in 2009 (even for those with just a 30 year time horizon, as you still had 21 years to go) as you were at that time drawing like 9-10% of a 80/20 portfolio.  In other words, using a blind 4% is both too risky and too conservative...which to me says you just can't go blindly.  For anyone who is not leanFire I think starting at 5% is fine, you just know you have to be willing to put the guardrails on if things go poorly.

THis is definitely not a mark against the 4% rule's use, I think you need to know you could comfortably live off of 4% when you retire or you;re not FI yet

Agreed. I never said follow it blindly. And the research *is* clear that MOST of the time, you end up with a large pot of money using 4% OVER 30 YEARS.

My point is:

- If it's indeed RE, you need to know the research supports 30 years; a longer term means you need to think about it.

- That inflation is already built into it.

- And that the amount will vary each year based on that formula.

Knowing those caveats, you can plan your own path. Reduce discretionary expenses in bad years. Delay getting a new-to-you car. Reduce travel, or do more DIY. All of these things make it personal.

But IMO, it's irresponsible to plan on a 50 year term with a 4% or more WR, not knowing about the ideas of guardrails and what the Trinity Study actually concluded.