How do you withdraw 4% from your portfolio when you enter FI?

[Asgard01]

Hi all,

I want to test my knowledge of withdrawing an income from my portfolio when I reach FI In 5 years time at 32.

Right, let's say that it is 5 years from now. My money has grown at a real 5% rate per year which would be nice. This is from my mix of 80/20 stocks bonds and some 60/40 stocks bonds funds (vanguard). I have reached my target of $233707 which gives me all my basic necessities and bills at 4% withdrawal rate $779 a month.

In the past, I assumed that you took the dividends from this which may be 4% but forgive my lack of knowledge, my funds only give around 1.7% dividends and I have read that the higher yielding funds often do not grow very well. Am I  right or wrong in thinking that every month I workout what 4% of my total amount is, divide this by 12 and then sell that amount of my stocks/bonds fund.
I can then draw 5% or more to account for inflation etc after the first year.

My next question is as there is pretty much always inflation, does that not mean I would always be withdrawing 5-6% after year 1 in the same way each month - 5.5% of total (1.5% inflation) divided by 12 then sell this amount of stocks/funds. I would repeat this every month from then on.

If the market was in a bad year or couple of years then I would be best to stick to 4% without accounting for inflation and if there was a bull market then I could even withdraw 7-8%. By doing this, it would be likely that my money would last 30 years. Depending on how markets go up and down relative to my retirement, I could withdraw a higher amount and still not touch my principle or I would have to withdraw a lower amount of say 3% which could slowly eat into principle but should keep you going for 30years. Depending on how lucky you get with timing your retirement, you could get a way with a higher withdrawal rate. And finally the higher your stocks percentage, 40, 60 or 80%. The more likely you can draw that 4% continuously.

Thanks for your time,

Chris

[Asgard01]

Any takers :). I got a message from a forum user saying he tried to post to this thread but it would not let him?

[Roland of Gilead]

You really can't draw more than 4% just because the market has had a good year because you are depending on the average real return to be 4%.  You are going to need 4% to live during the lean years and it is the extra earning that happened in the good years that you didn't spend which will get your portfolio through the bad times.

[bikebum]

My understanding of the 4% rule is the first year you withdraw 4% of your portfolio. Each year after that, you withdraw the same dollar amount but adjust it for inflation. So you are not withdrawing 4% of the remaining portfolio each year; if you did the amount you withdrew would go up and down with the market.

[dude]

My understanding of the 4% rule is the first year you withdraw 4% of your portfolio. Each year after that, you withdraw the same dollar amount but adjust it for inflation. So you are not withdrawing 4% of the remaining portfolio each year; if you did the amount you withdrew would go up and down with the market.

Yes, this.  4% is the initial withdrawal amount.  Each year after that, you adjust that figure (the dollar amount, not the percentage) by the rate of inflation for the previous year (measured by the CPI).  For example, with a $100,000 portfolio, the initial withdrawal is $4,000. If the CPI for that year is 3%, then in Year Two, you withdraw $4,120 ($4,000 * .03).  If it's 3% again in Year Two, then in Year Three, you withdraw $4,243.60 ($4,120 * .03), and so on year after year.

If you are invested in a total market index fund, the your dividends are re-invested into the fund, so yes, you are selling shares monthly (thus using both capital gains and dividends in essence).  There is the very real issue of this being a reverse dollar cost averaging approach, i.e., you are selling more shares when prices are low.  So it's wise to have options for adjusting your withdrawals in bad times (by, for example, having a cash reserve fund on the side, or getting a part-time job, or selling bonds instead of equities if you have that option).

[Asgard01]

The idea of selling my shares/bonds every year for 30-50 years seems to me like I will run out and that the basic 4% rule would not apply. I don't know how that 4% rule was performed or checked during the people checked. Would they have been spitting out dividends in an income portfolio of say 1.7% then selling their bonds at 2.3% a year! loosing 2.3% of your bonds/shares just seems to me like you will lose out ultimately unless the shares you do have perpetually keep rising ultimately which I guess is what the stock market hopefully will do albeit a couple steps back before going forward now and then.

I want to be overly paranoid as I don't like the idea of running out of money before life, even if I took 3% I would be selling 1.3% of shares/bonds every year. When I first got into this, I assumed that my interest would just be spit out like regular savings, I know that dividends are close to this but much lower in percentage terms and you only get the rest of the percentage gains if you sell your shares.

I feel confused about this now, tut.

Chris

[Roland of Gilead]

Please Google the words "Stock split"

[Asgard01]

Please Google the words "Stock split"

Are you just referring to the value of shares? It seems that if dividend income does not meet the 4% target and I have to well shares! as in am not buying any new shares, those are finite and constantly shrinking if I keep selling them. It seems that eventually I will have no shares. I am sorry if I am misunderstanding this.

Chris

[marty998]

You don't have to withdraw 4%. If the $$$ you need to live off are less than 4% then go with that. If the $$$ you need to withdraw are more than 4%, then yes you should be paranoid about running out of money.

Makes sense to me to think of it that way.

We have it different down here. Most companies pay 4-5% dividends + refundable tax credits, so most retirees never have to sell their capital if they have a diversified dividend portfolio.

[Roland of Gilead]

Please Google the words "Stock split"

Are you just referring to the value of shares? It seems that if dividend income does not meet the 4% target and I have to well shares! as in am not buying any new shares, those are finite and constantly shrinking if I keep selling them. It seems that eventually I will have no shares. I am sorry if I am misunderstanding this.

Chris

A dividend is just one way a company can return money.  They can also issue stock splits during growth phase (so you have double the shares) and later the shares may grow in value as the company prospers and return to their pre-split value.  It may be that the company also buys back shares which makes the shares you own more valuable.

Say you have 10 shares valued at $10 each, the company splits and now you have 20 shares worth $5 each.  A few years later the company has grown and has bought back 10% of the outstanding shares plus increased profits, so your 20 shares are now worth $10 each again.  If you sell 5 shares for income, you still have more shares than when you originally started investing.

[gooki]

I intend to sell 1% of my stocks every quarter.

[Asgard01]

I think Its fair to say I have been too optimistic with all of this. I have taken 5% real growth average as a given for future returns and even if this occurred, as I could pull the trigger on FI in 5 years which feels very tangible. It is now coming to my attention that I could end up with a loss at the end of 5 years for all anyone knows. I may increase my portfolio in the long long term but at the 5 year scale, who knows.

This has also of course made me think about withdrawal, it seems that 3% maybe more of an aim but that would delay my FI for years. It's a bit frustrating but I should of knew all this really. It's just that 4% rule was drilled into me as if it was a real fact. I could get 3% from a UK CASH ISA, no inflation but still almost 100% safe. I will need to think about this some more, my confidence has been shattered a little with my latest readings and understandings. Pulling FI trigger at your basic FI level assuming 4% which you could not be flexible on as this is for minimum living seems far too risky! I know you could supplement it with part time work! business ventures etc.

Ponders....

Chris

[RetiredAt63]

I am there now.  I am withdrawing the mandatory minimum from my RRIF (3.7% this year, 3.85% next year, 4% at 65) - the amount I have to take out goes up each year.  At this withdrawal rate my RRIF is still increasing in value.  At some point, as the withdrawal rate keeps going up my total value will start going down, since the rate is aimed at the fund being emptied by the time someone dies of old age (20% withdrawal rate at 94 and over).  If I could stay at 4 % forever, I would be fine.

The effect of withdrawals may also be dependent on what is in your portfolio, I am in more conservative, dividend-yielding investments.  I am not looking at stock gains, those fluctuate too much for someone at my age.

[DoubleDown]

Some more study on the subject will likely go a long way in helping you understand how you can turn your total investments into income for your retirement. The "4% rule" is just a simulation of how well an imaginary stocks/bonds portfolio can survive a certain span of years, based on historical periods in the past. It is definitely not safe to retire and follow any set percentage withdrawal without understanding the mechanisms for generating income, survivability of different kinds of assets, geographical differences based on the country you live in, and so on.

If you investigate ways to generate income from your assets (ideally without depleting those assets over time), then I suspect all the mystery will go away and you'll have a lot more confidence in making it all work. You won't have a crystal ball with perfect foresight, but you'll know what needs to be done and able to make the best choices for your own circumstances. Some common approaches for generating passive income include:

1. Converting some portion of your assets into a fixed, permanent annuity to cover your basic living expenses. Typically this is done by purchasing an annuity from a company, hopefully finding good rates and a solid company that you have confidence will stay around to hold up their end of the bargain.

2. Generating cash flow through investment real estate (i.e., collecting rents).

3. Collecting dividends from stocks.

4. Periodically converting stocks and bonds into cash (that is, selling them), and rebalancing your portfolio to follow a desired asset allocation. A good strategy is to have about two years of living expenses in cash so that you can weather any market downturns and not to have to sell in a down market in order to cover your living expenses. As you convert a portion of your portfolio to cash, rebalance your portfolio.

5. Collecting social security or pensions in old(er) age.

[Michread]

Try watching this: http://www.morningstar.com/cover/videoCenter.aspx?id=641676&SR=EVZ128

[someguy]

A dividend is just one way a company can return money.  They can also issue stock splits during growth phase (so you have double the shares) and later the shares may grow in value as the company prospers and return to their pre-split value.  It may be that the company also buys back shares which makes the shares you own more valuable.

Say you have 10 shares valued at $10 each, the company splits and now you have 20 shares worth $5 each.  A few years later the company has grown and has bought back 10% of the outstanding shares plus increased profits, so your 20 shares are now worth $10 each again.  If you sell 5 shares for income, you still have more shares than when you originally started investing.

I don't think you understand stock splits.  A stock split is completely neutral from an individual investor's perspective.  You're confusing it with share buybacks, which DO increase the value of the shares by reducing the float.  The two concepts are completely separate. 

[Fitzy]

Try watching this: http://www.morningstar.com/cover/videoCenter.aspx?id=641676&SR=EVZ128

Thanks for the video link!

[Roland of Gilead]

I don't think you understand stock splits.  A stock split is completely neutral from an individual investor's perspective.  You're confusing it with share buybacks, which DO increase the value of the shares by reducing the float.  The two concepts are completely separate.

No, understand them very well.  Yes they are neutral.  The OP was asking how he might get 4% from his portfolio when his bonds and dividends don't pay 4%.  I was trying to point out other ways a portfolio can grow.  A stock split during growth plus share buyback in later years is a very common way your stock portfolio increases in value.

[Jags4186]

Not to judge but I really recommend you save a little more and have a cushion rather than call it quits on $779/mo.  That's nothing and should you encounter any problem you would be ill equipped to deal with it.

[Asgard01]

Not to judge but I really recommend you save a little more and have a cushion rather than call it quits on $779/mo.  That's nothing and should you encounter any problem you would be ill equipped to deal with it.

To be honest jags4186, I am rethinking whether I even want to achieve FI in the sense of not working anymore, escaping the rate race for good, kick it back at home with the 1 can of beer I can afford a week hehe. I am concentrating more on finding happiness and some peace of mind in the here and now instead of putting this on a pedestal and thinking/idealising what life will be like afterward.

I am thinking that achieving financial independence will be a goal still, but retiring as it were in my early thirties is out of the question now. I still want to contribute to society at the level of working and creating, doing etc. I just like the idea of being able to cover myself if anything happened, like the idea of being able to change jobs if I don't like things, take a pay cut to do things I prefer, eventually go part time perhaps etc. the idea of stopping working altogether has lost its allure as of late, this could change though I'm sure hehe :)

I have freed my mind up a little from obsessing over purchases, and having to pay for such and such, I am not wasting money on things that provide little gain or use but neither am I so concerned about hitting bang on 50% of savings, or bang on such and such. I budgeted to tightly and I am realising this now. I have relatively small outgoings but I have added in more 'unexpected outgoings' money if which I only had $1200 a year. I also had $0 big purchases (more than $150) and $0 for holidays. I feel like I would become like my father and be a Scrooge at this rate so I am changing that.

I think for myself and my own needs, I was being too extreme, concentrating too much on the numbers and changing from 23 years, to 20 years, to 13 years, 10, 8 and now 5. I think I would rather push this back to 8 years. I wasn't even happy with the prospect of 3 years which would of been possible if I kept my part time job of helping my disabled friend and living on bare minimum. I guess I prefer a life with a little more flexibility with regard to spending, and less strictness, penny watching etc.

I may be back to chasing FI though when I go back to work on Tuesday :)

[danclarkie]

Let's be frightfully honest.
$779/month is not a retirement income anywhere in the western world.

Just because you can eek by at the moment on $800 a month does not mean that is the income you need in retirement.

Living on $800/month would not be retirement. It would be a financial prison sentence.

I know that Jacob from ERE lives on less than this, but the reality is that this model is certainly not applicable to 99.999% of people.

$800 might sound fine, until you need a root canal treatment, or you need some eyeglasses in old age (Even in the UK these are not covered).

I'm 26.
I lived in Berlin from 20-25 and worked with a bunch of interns that would take home around $500 a month.
You can live off of it, if you are a 20 something kid, sure.
But it is not a wage you can retire on, raise a family on, grow old on.
Even then, you are reliant upon employer healthcare.

Different strokes for different folks, but I lived in a squat in Berlin and would eat at Volksküche on a regular basis.
It's not a lifestyle I can see any smart person holding for 40-50 years in retirement.

All too often, people assume their current lifestyle will be how they always live, with no emergency costs, no inflation, no family or financial dependents.
This is a recipe for financial ruin. No mistaking.

Realistically, as a single man with no dependents, I am projecting a stash of $1.25MM for FI giving SWRs
4% $50k.
3% $37.5k

Allowing for inflation, the $37.5k is around $27k in 2014 dollars. I feel this is the minimum I could retire on and potentially raise a family if I were very conservative and had a paid off house.
Without a paid off primary residence, the stash comes closer to $1.5MM giving SWRs:
4% $60k
3% $45k

The idea of retiring on $779/month, at 4% SWR, for the rest of your life, is at best naive and at worst ruinous.

Measure twice. Cut once.

[Asgard01]

Thanks for your comment Danclarkie.

Jacob from ERE supposedly has lived in $583 ($7000) or less or over a decade has he not?

Your point rings true however especially for me, especially if I were to want children which I do etc. the idea of pulling the FIRE trigger at that amount which covers all my outgoings now and then never working again would not be very wise however there is somethings you are not considering or aware of.

- I don't intend to reach FI and completely stop working, I intend to work part time for fun money and to save unexpected outgoings money. I intend to play out the idea of semi-retirement instead. I may even carry on full time but with FI change my job, career into a calling with solid financial backing that results in no fear of taking time to find work without having work for a while.
- secondary, I have $18,000 in cash that I am not adding into my calculations, this will be for such emergencies, unexpected outgoings etc for the first few years.
- thirdly, I am in a situation whereby when I am between 50-60, I will inherit a fair whack of money, probably doubling my portfolio or more. I usually do not like to include this in any of my planning for obvious reasons but it's likely to happen so it's in the back of my mind although I prefer to be comfortable in the knowledge that I will look after my own FI and this like social security, will only be a potential top up. I mention this as it will mean I need the money to last 30 years.

I have to say though, I don't think I would need masses of savings for emergencies, outgoings. Most people I know including my mom during my upbringing live paycheque to paycheque and have zero or little savings and they have managed there entire lives on a regular amount of money without any real problems. Perhaps we were just lucky...

It's worth noting again that I don't want to retire completely with no income from work, if I did I would probably choose my comfortable FI  amount that would take 8 years to get which would give me $1100 a month. Even with this, I could choose to do some part time work if times got tough.

Chris

[hobbes1]

Another approach would be to save up the requisite amount of money you need to retire on a set income: $800/month x 12 months x say...30 years = $288,000.00
As you go along, invest the savings into bond fund(s) that will yield 3-4% or better (a few come to mind: VWAHX, VWEHX, FNMIX, FLBAX) and have generally low expense ratios.

When you have accumulated your $288k for example, you begin to live on the yield, never touching the principle. Thus, $288k x 0.04 = $960/month in a check to you. I'm new here but I've seen a lot of posts on withdrawing from stock/bond portfolios and selling stocks to fund withdrawals. Seems to me that it makes more sense to shoot for steady income monthly with no need to sell the underlying portfolio. Hope this helps.

[danclarkie]

Another approach would be to save up the requisite amount of money you need to retire on a set income: $800/month x 12 months x say...30 years = $288,000.00
As you go along, invest the savings into bond fund(s) that will yield 3-4% or better (a few come to mind: VWAHX, VWEHX, FNMIX, FLBAX) and have generally low expense ratios.

When you have accumulated your $288k for example, you begin to live on the yield, never touching the principle. Thus, $288k x 0.04 = $960/month in a check to you. I'm new here but I've seen a lot of posts on withdrawing from stock/bond portfolios and selling stocks to fund withdrawals. Seems to me that it makes more sense to shoot for steady income monthly with no need to sell the underlying portfolio. Hope this helps.

I want to live in your world where inflation doesn't take 3% out of my purchasing power each year.

In the above scenario you would need to draw down into the principal each year and would deplete your nest egg in the course of 25-33 years assuming that it grew at 3%-4% which is broadly in line with inflation.

Generally speaking, your portfolio needs to beat inflation by 4% a year if you wish to withdraw 4% a year and life off of it without touching the purchasing power of the principal.

If your portfolio grows in line with inflation and you take 4% out of it each year, then it will run out in 25 years.

You can't eat your cake and have it too.

[wtjbatman]

Another approach would be to save up the requisite amount of money you need to retire on a set income: $800/month x 12 months x say...30 years = $288,000.00
As you go along, invest the savings into bond fund(s) that will yield 3-4% or better (a few come to mind: VWAHX, VWEHX, FNMIX, FLBAX) and have generally low expense ratios.

When you have accumulated your $288k for example, you begin to live on the yield, never touching the principle. Thus, $288k x 0.04 = $960/month in a check to you. I'm new here but I've seen a lot of posts on withdrawing from stock/bond portfolios and selling stocks to fund withdrawals. Seems to me that it makes more sense to shoot for steady income monthly with no need to sell the underlying portfolio. Hope this helps.

Research dividend growth investing. The goal, once you are out of the accumulation phase and into the income phase, is to never touch the principal while living off the (growing) dividends you receive from the stocks you own. Unlike a bond fund, your dividends will grow 8-12%, well above inflation, meaning your purchasing power doesn't erode. Odds are it will continue to grow even as you are collecting the dividends.

http://www.dividendmantra.com - Dividend growth investor in the accumulation phase
http://www.dividendgrowthinvestor.com - Another good DGI blog
http://www.seekingalpha.com - Fantastic crowd-sourcing stock research site, large section containing dividend focused articles

[hobbes1]

@wtjbatman and danclarkie: yes, you make valid points. however, maybe i misread the the intent of the OP; it seemed to me the poster wanted to know how to achieve a steady stream of ~$800/month. a bond fund(s) will do this. will it keep up with avg. inflation? maybe not, although, the yield on the bonds will fluctuate up and down over time as well.

here are some interesting MMM articles as well:

http://www.mrmoneymustache.com/2012/05/29/how-much-do-i-need-for-retirement/
http://www.mrmoneymustache.com/2011/10/17/its-all-about-the-safety-margin/
http://www.mrmoneymustache.com/2012/05/14/first-retire-then-get-rich/

IMHO, it's always prudent to have alternate sources of income. While I personally like the bond fund idea, it's not our only means of income. Others will have a different idea. For me, one thing I personally wouldn't do is put all (or even a majority) money into stocks or stock funds and hope for ever increasing dividends and stock growth. Dividends fluctuate up and down on a per stock basis (not to mention the risk of having significant assets tied up into a single stock or a few stocks) and stock funds tend to (as far as I've been able to see) have pretty low yields. Different strokes for different folks, right?

Anyway, as pointed out earlier, living on $800 in a Western country will not be easy but more power to the OP if he can pull it off! :)

[Bateaux]

I don't really think I can live on less than $5,000 per month unless I have a total lifestyle change.  I really don't trust the 4% withdrawal rate.   I plan on using a 3% withdrawal rate. Even to make 3% will require investment in stocks.  My strategy is and has been index funds from vanguard.  The market as a whole in my opinion is the safest long term bet.

[Ozstache]

I don't really think I can live on less than $5,000 per month unless I have a total lifestyle change.  I really don't trust the 4% withdrawal rate.   I plan on using a 3% withdrawal rate. Even to make 3% will require investment in stocks.  My strategy is and has been index funds from vanguard.  The market as a whole in my opinion is the safest long term bet.

Do you realise that your requirements calculate to needing a $2M stash to retire? Unless you're earning a huge income and saving most of it, you're going to spend many decades working to build up to that level of stash. Ironically, your lifestyle desires may end up cramping the overall quality of your lifetime!