Retirement Income Planning – Safe Withdrawal Rates

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Hello everyone. My name is Greg Phelps. I am the president of red rock wealth management here in Las Vegas, Nevada. I am also your host, the retire wire blog and podcast and webinars series. And excuse me just about everything else you want to find regarding retirement planning and an investment education. So today I’ve got a great topic that I want to go over with you, and it’s a very important topic for all of us, because the topic is retirement income spending, but more specifically it’s on what is your safe withdrawal rate? I mean, you worked and saved and scrimped and pinch pennies and invested and took risk with your money, your entire working life. How much can you actually spend out of that nest egg that you built up over so many decades? And it’s a very, very important question. So before I go ahead and get right into that, I’d like to ask you no matter where you’re watching this, whether it’s Facebook or YouTube live or where you’re listening to the podcast, please go ahead and rate review and subscribe.

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I’d really appreciate it. It only takes a few seconds and it helps me deliver you more great retirement planning, education and content. So let’s go ahead and let’s dig right in. So retirement income planning. What we’re going to discuss today is how much can you spend in retirement? How do you solve that problem of what can you spend? And most importantly, how do you solve that problem is in how much to spend without dying broke, because that’s one thing you don’t want to do in retirement. You don’t want to die broke. In fact, I believe it’s the the second most common fear for retirees after the fear of public speaking. And so I’m not going to focus so much on the public speaking fear, but I will focus on the worry about retiring broke. And we’re going to give you some ideas on how to avoid that fear and enjoy that memorable in that purposeful retirement that you’ve always dreamed of.

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We’re going to talk about what is your safe withdrawal rate? How much can you spend without having that worry. We’re going to talk about sequence of returns, risk, which frankly, we’re going to spend a lot of time on that because it’s a very critical concept for all retirees to understand. And if you don’t get it, and if you don’t plan for it, your retirement could be catastrophic. And that’s the last thing that you want retirement. Your golden year should be fun and exciting, and you should have confidence that everything you’ve done in your plan and you’ve executed on is working for you to the best of your finances, ability and sequence of returns. Risks can really knock you off track. So we’re gonna spend a lot of time on that. We’re going to talk about the 4% rule and what that is and what that means to you.

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And then we’re going to talk, talk about a few ways that you can adapt the 4% rule to your situation and actually enjoy retirement a little bit more just by thinking a little bit differently. I mean, wouldn’t, you rather spend a little bit more money and still have that great level of confidence that you’re living your dream retirement and not worry about dying broke. So we’re going to talk about some adjustments that you can make that will actually help you spend more money and still have the confidence to do it. So let’s go ahead and dig right in. Well, we’re going to tackle this question of how much can I spend on retirement? One of two ways, typically people think about retirement as, Hey, I’ve got my IRA, my 401k, my investment accounts. Maybe they’ve got some real estate and savings in the bank and they’ve got all of these assets.

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And these are the assets. I just mentioned that you, you worked your entire life. You worked decades for you, scrimped, you saved you pinch pennies. You put your money in your 401k, religiously and funded your IRAs and built up a nice savings account. You did all of these things, but then it comes down to well, when I retire, how much of those nice things, the assets that I accumulate can I enjoy and not worry about dying broke? So that’s one way to approach the question of what can I spend in retirement and what is my retirement spending income plan look like? That’s one way the other side of the coin actually is the opposite way. And some people, especially pre-retirees, you’re not there yet. They will actually say, Hey, when I retire, I want to buy that vacation house. I love to travel overseas. I definitely love fancy red Lamborghinis and fine dining.

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Forget about it. That is all me. So that is the other way. The other side of the coin that you can look at this. I know what I want to spend, but I just don’t know how much I need an assets to be able to spend it and not worry about dime broke. So two sides of the same coin, just different ways to look at it. Now let’s get into how retirement spending was done traditionally. So if we take a look at back in the fifties and sixties and in the fifties and sixties, the way that you got your retirement income is you pretty much saved up and you bought some bonds. We’ll just for the purposes of this discussion, we’ll assume government bonds and those government bonds. It was actually a physical bond. It was actually a sheet of paper. And that sheet of paper had coupons on it.

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And you would take those coupons and you would just clip them off. When they mature, they had dates on them. You would clip them off. You’d take them down to the bank, give them to the teller. And the teller would say, here’s your money? Here’s your retirement income. Now, the thing about bond coupons is it’s a stated rate of return. So if that, if that bond says 5%, then that’s what you’re getting in. A bond is a debt obligation of the government. So they promise when you loan them your money to buy the bonds that they’re going to give you these coupons. And they’re also going to give you your money back at some point in time. So it’s a very stable source of income and it worked great in the fifties and sixties because inflation was relatively tame. The bond coupons, you could sustain your purchasing power relatively well.

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And that worked great up until the 1970s. What happened in the 1970s? Well, your bond coupons that you were clipping and taking down to the bank, the purchasing power got absolutely devastated from outrageous inflation rates. I mean, we had cumulative double digit inflation rates, your purchasing power. It fell by more than 50%. So if a Coke was a quarter by the end of the seventies, a Coke was 50 cents. So your purchasing power got decimated. And as you clip these bond coupons and took them to the bank, the tellers give you the same amount of money. It only went half as far in the seventies. And so that’s why in the seventies, people said, well, wait a second, clipping the coupons isn’t working, I’m running out of money because costs more, which is also another huge risk that retirees face is the loss of purchasing power.

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That and sequence of returns risk are more important, I think, than the stock market crashing. Yet, most people are worried about the stock market crashing. So I digress your purchasing power got crushed. You had to figure out a better way to do it. So people turned to stock dividends. What does that mean? And we’re typically topic talking about large blue chip companies. So they’re not really aggressive high risk companies. They still have a lot of fluctuation, a lot more in bonds, but they pay you a dividend. And that dividend is your part of the company’s profits. And they’re going to pay you typically on a quarterly basis. Now, why did they switch to dividends? Well, dividends basically will outpace, or it will keep pace with your purchasing power, power erosion in an opposite fashion. So effectively an easier way to look at this is as inflation increases, your dividends will increase as well.

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Why? Because that Coca Cola so that Coca-Cola, let’s just say instead of being 25 cents, now it’s 50 cents. Well, Coca-Cola made twice the profit as well. Their profit margin, even though their costs went up, their profits stayed the same. They were able to deliver that inflation, combating dividend to you. So your, your income went up constantly. And that way you didn’t have to worry about paying for that Coke when it was 50 cents, because you had more income to use to pay for it. So that was a fantastic thing. It actually worked so well that, you know, by buying these high quality dividend paying stocks and keeping your capital intact, you’d actually worked so well that in the eighties, people found out well, Hey my, my dividends actually outpaced inflation by about a point, which is great. You had more money to spend than inflation was eroding from your purchasing power.

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Not only that stock prices doubled in the eighties, but people took a step back and they said, well, wait a second, I’m dying or I’m close to death. And I’ve got all of this money because all of my big blue chip companies, my, my stocks, they all went up. I did it fantastically. Well, all I spent was the dividends. Where’s the problem here. I want to spend it. It’s my money. I saved. I worked for it. I took the risk. I don’t want to leave behind exorbitant amounts of money for my heirs, or some people may, may want to do that. So then we take a look at, well, why don’t we spend capital gains also, why don’t we take some of those shares of stock and sell some throughout retirement. So now you’re spending your bond coupons, you’re spending, you’re spending your stock dividends and you’re spending capital gains.

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You’re selling off little bits of shares, and you’ve got a very nice mix of income sources. Plus you’re probably going to have social security and pension income possibly, but you’ve got this nice mix of S of income sources, and now we’re diversifying the income mix as well. But the problem became again, how much can I spend from all of these things? There’s nobody, there’s no fixed rule that says you’ll be able to spend X amount of dollars because returns vary economic cycles vary. And so thankfully with the advent of computers and the spreadsheet in the eighties and early nineties, we can now actually calculate and historically back test different portfolios, different amounts of income and bond and interest, income, and different amounts of capital gains. And we can, we can actually analyze and say, well, here’s how much you could spend in different time cycles, different years and not run out of money.

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Thank you, spreadsheets. So that’s where we, we entered into the eighties and nineties, and now all of a sudden we can calculate these things and make sure that we don’t spend too much and run out of money. So let’s look at an example of, of how this works. Well, let’s talk about a 60 year old retiree is going to live 30 years. We’re going to talk about a 30 year retirement throughout inflation on average, throughout history, around 3% or last a hundred years around 3%, much lower recently, but stocks, if you look at any Ibbotson chart, they’ve got an average return of about 10% per year. So we’re going to use that bonds about half of that at 5%, that gives you a 60% stock S and P 500, we’re using and 40% bond long-term government bonds we’re using. It gives you a blended portfolio return of about 8% on a million dollars.

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So then the question we’re going to say, we’re starting with a million dollars and the question becomes, how much can I spend of that million dollars and not run out of money? And what we find is that starting with your million dollar portfolio and starting with your $60,000, we just came up with that number by running the spreadsheet $60,000 per year in cashflow, in retirement income. And we’re growing that retirement income that cashflow at 3% per year with the inflation rate, you end up dying and you’re spending $150,000 per year. That’s what, $60,000 over a 30 year retirement with 3% inflation takes $150,000 to buy the same thing. That’s 60,000 did 30 years ago. And what happens at the very end? Well, the portfolio grows a little bit and then it kind of Peters out. And at the end, when you’re age 90, it kind of goes to about zero.

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So you don’t run out of money. You spend everything you got, and that’s the 60%, or excuse me, 6% or $60,000 withdrawal rate. So you would look at that and say, well, my safe withdrawal rate must be 6%. Not necessarily. There are many ways, bad returns, higher inflation. There are many ways that your portfolio can actually crash a lot earlier. And that’s a scary concept because if you crash before you’re dead, you’re risking that drive across town to borrow money from your kids. So you can buy a burger or pay your rent. And nobody wants to do that. So if you have bad investment results, not just even investment results, the 6% is a linear. Even every year. If you have bad investment results, you could crash early. If you have great investment results, you end up basically leaving behind a lot of money.

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So these are decisions that you’re going to have to make, and you’re going to have to kind of analyze and figure out what’s the right amount for you. With your bad investment results, you can increase savings rate. You can re you can actually reduce your savings, your spending rate. You can actually push off your retirement date. So your retirement period is shorter, or frankly, dilators, excuse me, die sooner. So you can do those four things. Those are your choices. They’re the only choices you have. If your portfolio isn’t doing so well now, conversely, if your portfolio is doing fantastic, you can actually retire a little bit earlier. You can live a little bit longer. You can save a little bit less so you can spend a little bit more. So these are the choices and the trade-offs, but we’re starting with a 6% withdrawal rate because on a linear fashion with returns coming in equally every year, that’s what you could spend on a million dollars and basically come close to bouncing the check for your casket,

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But that’s

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Hypothetical. That’s linear. That’s not reality. That’s not the way that the world works. Returns are not linear. So we’re going to take a look at just a very simple, very similar, but very simple concept. What if the first two years your stocks, your 10% return went to zero. So you actually, instead of making 10% of your stocks on your stock investments, you had zero. And what if the last two years we’re gonna look at two different scenarios? What if your stocks are in 20% early? And then the last two years they earned zero. So you have two scenarios. One is, stocks are in zero the first two years, and then they are in 20% at the end. The other is, they are in 20%, the first two years, and then they earned zero at the end.

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Let’s

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Take a look at that. So first we’re going to talk about two really nasty years early. Your stocks are basically flat. You are nothing. You take kind of a hit because you’re still spending that 60 grand and your portfolio is going down because you didn’t earn anything on your stocks. What happens is you end up running out of money about six years too soon. Now you have the same average annual return. Your return on the portfolio is still at 8%. Your, your, your stock return for that 30 years, it’s still 10% on average. You just had two years with nothing upfront. And two years with 20% on the back, the problem is the 20% returns on the back. You don’t have any money to enjoy them. It doesn’t help you at all, but the 20%, or excuse me, the 0% returns on the first two years actually crushes your portfolio.

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And you’re still spending the same amount of money. As you can see, you end up spending 150 when you die. Roughly that starts off as a $60,000 retirement income. It’s not so good. Now let’s take a look at what happens with we get two good years early. Well, now you take a little launch, upwards, your portfolio actually sores a little bit, and now you’ve got the two bad years on the back end, but it doesn’t affect you. It doesn’t affect you because you had the sequence of returns. Be very, very positive upfront. You had those returns of 20%, 20%, and then average a 10 for your stocks. And then, and then at the end of your life, you have 0%, 0%. So yeah, you didn’t do so well on the end, but you certainly did really good upfront and it more than made up for it because now you’re dying with the portfolio.

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That’s actually about, even to what you put in, you literally are maintaining about what your principal is because you got those two good years early, you were able to sustain and leave a lot of money behind as your legacy. So it’s critical to understand the concept that your returns, when they come early are they’re compounding exponentially really over your retirement. It’s critical that you understand this and you model this in your retirement planning, because if you’re not ready for it, and you’re just spending the same $60,000 every year, you might actually have to die six years early or take that drive across town to borrow some money from your kids. Nobody wants to do that, especially not me. Another thing that affects how much you can spend in retirement is the actual inflation rate. Now we talked about 3% going back through history and that’s relatively realistic.

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It hasn’t been that high lately. We’ve had a very low inflation rate environment, but assuming we get 3%, what does that do? Because your portfolio runs the same, but your income while it started at 60, actually expands quite a bit more. So when you die, you’re spending $180,000 per year. So what does that do? Well, your portfolio crashes and burns at about age 87. So you’ve either got a die three. You’ve either got to die three years early, or you can borrow money, or are you going to make some changes? You retire a little later, you know, so you save a little bit more and you spend a little bit less. So that’s just a half a point in inflation tick up. And that really put a hurt on your retirement plan because you ran out of money too soon. Now, if you look at what, if inflation is actually better and lower than expected, well, that’s fantastic.

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You end up spending about a only 130,000 the year that you die and your portfolio actually holds its own. By the time you die, your portfolio is worth. It’s still about half of what it was when you started with a million dollars. So what we’ve learned from this is inflation has a big factor on how much you can spend on retirement or how long your money will last. And so it’s very, very important to model these different potential inflation adjustments into your retirement plan and to understand how they work. Okay. So let’s take a look at what exactly is your safe withdrawal rate. If you’re a 60 year old who lives 30 years into retirement and you retire in 1969, and why did I pick 1969? Because the numbers are fantastic. You’re going to love this. So if you came to me and I said, Hey, if you retire at age 60 in 1969, you’re going to get for the next 30 years of your life, over 12%, almost 13% on your stock investments.

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You’re going to get more than 9% on your bond investments. And we’re using the S and P 500 and long-term government bonds for these indexes. These are actual numbers and your 60 40 stock bond portfolio earned over 11% while inflation basically was around five, five and a quarter. And these are your real returns over here after inflation. So if I said to you, Hey, you’re going to get 11. And a quarter percent inflation is only going to be five, this 30 year timeframe, you would say, yes, Greg, that sounds fantastic. Put it to work for me. Just tell me what I can spend. Okay, well, let’s take a look at what can you spend? Well, if we start off in 1969, and we have that 11 and a quarter percent return on our portfolio, the numbers work out where you can spend about $72,000 a year at the beginning or 7.2%.

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That’s a lot more than the 6% we already talked about, or 4% obviously. So you can spend about $72,000 a year to start off about a thousand dollars more a month. By the time you die, you ended up spending about $320,000 that last year of life. And that actually your portfolio takes a nice little rise until it Peters out in that 30th year, which is 1999. Everything looks fantastic. And you say, Greg, that’s fantastic. Start sending me the $72,000 right away. Give me the inflation increases every year. And I would say, excellent. That sounds good. Actually, I wouldn’t say this. You’re going to see why in a second here, because let’s take a look. Let’s take a look at what really happened over this timeframe. So what you’re looking at, here’s the real world because returns aren’t linear and the sequence of returns risk is very, very real and very, very powerful.

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In 1969, you had, you started off, you retired, you had a loss of 8% that took you about four years to recover from because you remember you’re drawing $72,000 a year, plus the inflation. And for the record, you’ll notice this inflation line is actually not linear because we used exact inflation measured by the CPI for that timeframe. So we literally saying $72,000 a year, what was inflation last year? Let’s give you a raise. And then that would be increased by the following year’s inflation. So you took you about four years to recover, which kind of stunk. And then all of a sudden you have the 73 74 bear market, which was disastrous. Your stocks crashed about 45%. And because they crashed about 45%, the amount of money that you’re drawing that $72,000 grown for inflation now becomes 16% of your overall portfolio. What’s left after the crash.

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Anyways, this is devastating because we’re not talking about a 6% safe withdrawal rate and safe is all relative. We’re not talking about a 6% withdrawal rate or 7.2 or a four. We’re talking about 16% of the portfolio, and that is devastating to this retirees. It only took another five or so years. And then you basically ran out of money, 12 years into retirement. You ran out of money. So if you retired in 69, you basically ran out of money at age 81. And at age 80, excuse me, in, in 1981. And in 1981, that was the, basically the bottom. That was the bottom of the nasty bear market and stocks soared after that. But you had no money left. You were making that drive across town to borrow money. And so stocks soared by about 14% a year, all the way out through 1999. And the point is, it doesn’t matter how great the average annual return is.

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If you’re not around to enjoy it. And in this case, the sequence of returns wiped you out early on in retirement, spending that $72,000 a year, 7.2%. It should have worked, but it didn’t, it failed absolutely miserably. So let’s take a look at the opposite. What if you got the same returns and the same average annual return that 11% 11 a quarter percent, but you’ve got them in reverse. So literally you started off in 1999, you retired and you got that return in that inflation. And then 98, you got that returned in that inflation in 97. And so on all the way through the nineties, all the way back through the eighties, you had some pretty good returns until all of a sudden, if I said to you, by the way, the last 10 years of your retirement inflation is going to skyrocket. It’s going to go from 2% per year to 12% per year.

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And by the way, you’re going to see the biggest bear market history has ever seen really. And your stocks are going to get crushed by 45% and you won’t even be alive to see them rebounds. You would say, no, I don’t want that. I don’t want that volatility when I’m 80, I don’t want that risk when I’m 80, I don’t want those high inflation rates and those bad returns and rightfully so. I wouldn’t want him either, but let’s take a look at how that actually panned out. See the sequence of returns was so good early in your retirement, that you had more than enough money to overcome the nasty sequence or the nasty returns at the end of your life then. And that was a whole decade that wasn’t very good, high inflation, bad returns. So let’s take a look at your portfolio starts here at the same million dollars.

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It creeps up almost a one point in time. This would be in the early eighties, late seventies right there, right around there almost two $11 million over $10 million. Now, now you’re going to have that bad decade and that bad decade, you’re going to see some pretty big losses and a lot of volatility and a lot of high inflation. And your $10 million is going to end up at about $8 million. Now that’s going to be nerve I’m. Sure, because you just lost 20% of your portfolio. Your kids, your grandkids have 20% less of your assets to enjoy that’s nerve wracking, but along the way, you started off at that $72,000 in income. And you spent the last year before you died $320,000, you spent everything that you wanted to, and it was because of the sequence of returns that you got good returns. First, that you ended up dying with $8 million and got to spend everything you wanted.

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And your kids are very thankful and grandkids are thankful as well. So while we’re retiring, 69 to 99 was horrible. 99 to 69 in reverse was fantastic. Even though the last decade of your life, you had nasty inflation and horrible market returns. So here’s what we do know. We know that the sequence of returns is absolutely critical and it can crush your retirement if you are not prepared for it. That’s why different strategies like asset liability matching, check out my retire wire blog for that or, you know, bear buckets or setting aside different types of ladder bonds can help you protect against that early in retirement nastiness. Your early returns are definitely compounded over time, and it just has kind of this exponential effect either for the positive or for the negative and volatility has a big impact as well. We’re only talking about a very simple 60, 40 portfolio.

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We want to keep the volatility low and your returns high. So the question is, what, what do you need to figure out? Well, you need to figure out how much money do you want to have left when you die. You need to figure out what, what rate can you pull money out of your portfolio and have that amount left? So some people want to bounce the check for their casket. Other people want to leave money to loved ones or charities. And then finally, if volatility is good, returns are good, but volatility is bad. What type of portfolio makes the most sense for you and your retirement planning? So these are the things that we need to talk about now. And that’s where the safe withdrawal rate study came in by bill bangin back in the mid nineties, when I started in the industry in 95, 94 anyways that’s where he, his study has a lot of validity and actually helped planners like me figure out what these numbers are.

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So I want to stop for a second real quick and give credit to bill bangin for his original work. Also a couple other what I would consider mentors in the industry Michael Kitsis and Dr. Wayfair, I’ve done a lot of work on safe withdrawal rates. And so they deserve a lot of credit on this. But these are my numbers. These are my calculations. And what I did here to find out what the safe withdrawal rate is, is I took a portfolio of 60, 40 S and P 500 long-term government bonds. I rebalanced it every year and I looked at different years. So if you would have retired in 1926, your safe withdrawal rate is let’s just say it’s around seven and a half, almost 8%. If you were to retired in 1950, your safe withdrawal rate is a little bit higher than that.

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It’s a little bit over eight. And so that takes the actual inflation, the actual sequence of returns. And it says, okay, if you retired in 1950, you could have started with 8% per year, and then taking an actual inflation raise every year for the actual inflation. And you would not have ran out of money. You would, well, you would have basically come very, very close, but you would have had a dollar left or so when you died. So how do we find the ultimate maximum safe withdrawal rate? Real simple. We look at the lowest bar in this chart, cause that’s the worst sequence. And by the way, we’re talking about 1920s. I just took a lot of work to calculate by the way 1926, all the way up through roughly 1989, 1990, the reason we had to stop there, it goes, we need, we need a 30 year retirement.

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So it’s 1989 because we needed that 30 year period to analyze the results. So as you can see here, the worst withdrawal rate, I come up with a different number, Mr. Bangin in his study, he came up with 4.15%, I believe, which was rounded. And it just became the 4% rule. I actually came up a different number. I came up with 3.7, 8%. That is your ultimate safe withdrawal rate. If you had a 60, 40 portfolio and grew your income with inflation, going back to 1926, because even in the worst cycle, you wouldn’t have run out of money. Now it’s very highly likely you will end up dying with a lot of money because the average withdrawal rate is around 6%. So you could say, I’m going to take the 6% and have my $60,000 of income. And that sounds fantastic, but you’ve got a 50% chance of running out of money or dying broke.

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Some people are okay with that. Other people are not, most people are not okay with that. So there’s withdrawal rates as high as over 11% and as low as 3.78, the ultimate safe withdrawal rate is going to be down there closer to four. And in my case, the way that I calculated these numbers was 3.7, 8%. So what we learned from bill being in study and my recreating this using my own data and own index information is the average withdrawal rate could be about six, six and a half percent, but you’re very likely flip a coin. If you’re going to run out of money. The 4.1% would be the quote unquote safest withdrawal rate. I guess you could say, because in his study that was the worst cycle of 30 year retirements, where you could have still spent 4.1 and not run out of money.

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My number was 3.7. Keep in mind that 4% number is a third lesson spending, then the average. So that’s a big, big chunk of money you’re taking off the table to make sure you don’t die. Broke. Now the optimal portfolio balance is about 40 to 70% stocks. Why is this optimal? So as I was, as I was raising my boys, I have twin boys as I was raising my boys and I’m coaching their baseball. I’m teaching them to hit, hit the ball and the sweet spot of the bat. The nice fat part, you hit it way out in the end. You’re going to get an errand shot. If you don’t too high, it’s going to pop up too low. It’s going to bounce on the ground, hit it too close to the handle, and it’s going to not go anywhere. You might dribble one to third base.

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And so let’s practice hitting on the sweet spot. So this 40% to 70% stocks is really like the sweet spot. And if you have less than 40% stocks, according to the studies, then you’re going to have a big problem with inflation because you won’t have enough earnings, power to combat inflation. Inflation’s going to eat you alive. If you have more than 70% in stock, your volatility could easily eat you alive because your sequence of returns, risk becomes very, very volatile and much greater impact on your long-term retirement income planning. So the safe withdrawal rates, the allocation for most of our retirees is around 55 to 65% in stocks, the rest in bonds. It just seems to be the quote unquote sweet spot in it. And basically the studies have kind of bared out that information. Now the 4% rule is great, but it does have some inefficiencies or deficiencies, I guess you could say.

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So let’s talk about those real quick. The first one would be fees. If you’re paying an advisor to manage your portfolio, to help you with your planning and so forth, that’s going to reduce your safe withdrawal rate because that’s money. That’s going to the advisor and not into your pocket. Now it’s very important to note that the advisor should be adding alpha and alpha is a term fancy wall street term for manager added value. So that’s somebody who’s actually working for you and making, making sure that they’re adding as much return with as little risk as possible and maximizing your planning and making sure you’re minimizing your taxes. Now, the way that we look at it, if we’re adding value over and above the fees you pay, it’s a net positive, regardless fees on their own or a negative alpha will always be up.

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Well, there’s always going to be a positive because by definition it’s manager added value taxes are always going to be a negative because you’re paying money to the government and keep in mind the money that we’re talking about, the income rates, the 60,000 on a 6% withdrawal, for example, that is effectively your, your gross return. If you have to pull that out of an IRA, taxes have to come out of or gross cashflow taxes have to come out of that $60,000. So keep that in mind, taxes are always going to be a drag time. Horizon is interesting if you, if you retire at 70 and you’ve got a 20 year timeframe to plan for, you can spend more because you’ve got a shorter window of potential, bad sequence of returns or volatility. If you retire at 50 and you’re going to live 40 years, you’re going to spend a lot less.

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And the gap between those two, the Delta is actually quite substantial. It’s exponential in a way. So, so your time horizon has a big factor. If your retirement is going to be shorter, you can spend more diversification is a huge factor as well. A simple portfolio, 60% stocks, 40% bonds is not diversified. It is just a two asset class portfolio. You’re going to be more volatile than if you add it in international stocks and real estate, commodities different types of bonds and so forth. So diversification will reduce your volatility. It should increase your returns, if not, at least keep them the same, but the reduction of volatility is very powerful as well. So that is going to be a positive. Also the diversification factor spending flexibility. I’m going to talk about in a second. It’s so important. I want to spend more time on it.

(31:52):

Same thing with risk tolerance now, valuation and tactical management. If you retire at a point in time and where stocks happened to be overvalued by whatever measure, don’t use your gut, please. And I would caution you not to think too heavily into this, but if stocks are apparently overvalued, your upside is less in the near term. I remember those first few years are very, very important. Your downside is more and you might have to reduce your safe withdrawal rate because you’re, you’re retiring and starting to spend at a time when things are inflated and your upside is less conversely, if you retired in 2008, you can increase your safe withdrawal rate because everything’s already depreciated. So, so the valuation of the market when you’re going to retire is very important as well. Tactical management is kind of interesting as well, that that would be an allocation adjustment.

(32:43):

So if you started with 60% stocks, most people would say, well, as I get older, I should invest a hundred minus my age in stocks. So if I’m 70, I should have 30% and basically reduce your allocation to stocks. The studies show actually a static portfolio at 60 40, and never changing. It has much higher rate of success with your safe withdrawal rate. Even though it’s counterintuitive, you would think, well, I don’t want as much risk the older I get it’s counter-intuitive. I realize that, but the studies have shown that a static 60, 40 for the rest of your life is better than reducing your risk. And technically speaking, if you look at a lot of the math out there that Michael Kitces did, if you actually increase, I know it sounds crazy. It’s very contrarian to what most people want or think if you actually increase your stock allocation throughout your retirement, your returns are actually better.

(33:32):

Your safe withdrawal rate is actually better. And why is that? Because your risk is lower on the first part of your retirement. And it goes up gradually over your retirement where it ends up higher, but as we just showed you the sequence of returns with higher volatility and higher risk is at the end. So it doesn’t have as much of an impact. So, so you’re actually better off increasing your risk over retirement. Then we’re then reducing it. It’s a whole nother webinar that I’ll do at some point in time. And finally, how much money do you want to leave behind and your safety margin? So there’s a lot of wiggle room in this withdrawal rate formula. I mean, you’ve got inflation that you can’t control. You’ve got spending variances, different things that happen throughout your retirement taxes. You can’t predict and, and your returns are going to be, you know, volatile to some extent, whether it’s highly volatile or less, highly volatile is just depending on the market and what the market delivers.

(34:24):

So there’s a lot of wiggle room to increase or decrease your safe withdrawal rate. And sadly, we just can’t predict the future. So, I mean, if we could, I don’t have a crystal that I do have a crystal ball, actually it’s right there. It doesn’t work though. I haven’t got it to work yet. If we had a crystal ball and we knew what was going to happen, it would be a lot easier to, to tell you exactly what your safe withdrawal rate is. And we can build you the perfect plan. So let’s talk about spending flexibility because the most important thing I think for you to take away from this is sequence of returns. Sequence of returns is very, very critical. And there’s a lot of things that can derail your retirement, but let’s talk about two ways or yeah, two ways. I think they go hand in hand where you can actually improve your retirement enjoyment just by thinking differently.

(35:09):

And so, for example, in Begin’s study, he noticed you could increase your safe withdrawal rate by 10 to 15%. If you were willing to have a mindset of changing your retirement spending in bad markets. So this is the way that I’m going to do it when I retire, if I retire. But effectively, what you’re, what you’re saying is I wanted to buy that yacht in three years. And then if the market’s not good, the next two years, I might not buy that yacht for, you know, six years from now, three years past then. So I’m adjusting my spending because the market results recently were not good. And conversely, you can do the opposite market results are good. You can move that spending up. So it’s having spending flexibility. I look at it kind of like this, if you’re going down the freeway and you’re taking a turn on a bridge and there’s no guardrail, that’s pretty scary.

(36:00):

But once you have that guard rail up, you feel a lot better about driving over that overpass, right? Or like bumper lanes on a bowling alley. And if you think about what what that means is you just have to be willing to adjust your spending. So this other couple of planners who are guiding and Claire giving credit where credit is due, they said that your safe withdrawal rate could be as high as 5.2%. If, if you’re willing to adjust your spending by 10%, if your withdrawal rate increases more than 20%, or you can actually take a pay raise by 10%, if your withdrawal rate decreases by 20%. So for example, your million dollar portfolio, your $40,000 spending, right? If your portfolio drops, let’s just say it drops a to 833,000 here. I did the math on this ahead of time. I cheated. So it drops to 833,000.

(36:51):

Now your withdrawal rate is 4.8%. So your withdrawal, your initial withdrawal rate is now 20% higher than it was cause you got a lower portfolio to draw from. So you would actually decrease your spending by 10%. Conversely, if you’re $40,000 of spending and your million dollar portfolio, your million dollars goes up to 1.2. Now your spending rate fell by more than 20%, you get to increase your spending. So it’s basically like these guard rails on the freeway. They keep you in the lane and make sure you don’t fall into the ditch. So I love this concept, but this concept frankly, works really, really well with the risk tolerance concept as well. And, and there are certain clients that will look at the glass half full instead of the glass half empty in terms of their retirement income planning and their chances of not outliving their money.

(37:42):

And what I mean by that is what we do with our clients is we mapped together all their assets, income, expenses, liabilities, all that stuff. And we look at the rest of their future. And then we say, how can we improve it? And are they going to be able to live the retirement of their dreams without worrying about dying broke? And so what the Monte Carlo does, it’s part of the planning process is it basically takes a thousand different sequences of returns because we know the sequences are so important and it randomized them. So year one, you’re in 5%, year two, you lose three year, four year in 20 and year five, you earn eight. And so on and on and on random returns, a thousand different trials. So a thousand different sets of random returns. And it says out of those thousand different trials, how many of them are successful?

(38:28):

Meaning this sequence will let you live the life you want, and at least have a dollar left when you die. And we’re not talking about real estate assets or anything else we’re talking about just your, your investment capital that you’re going to use to live on in retirement. Those other assets are separate in the plan and it’ll say, well, in this case, based off of this plan, you’ve got an 83% chance. And you’re right in that green zone, which is where you want to be. You got an 83% chance of having at least a dollar left when you die. And that sounds fantastic to most people. And these red lines down here are your failures. However, so those are the 17% of the times that you run out of money when returns were bad, typically early on, or possibly they were bad in years where you need it, large withdrawals.

(39:14):

So if you need a large withdrawal or any withdrawal, when the market’s now you’re pulling out more shares, you’re liquidating more shares at lower prices. You can’t recover from it in retirement because once you retire, you can’t earn it. Again. Those of you who follow me, you see, I say that all the time. So there are other clients, however, who are perfectly fine with a 50% chance of success. Now it’s very few, it’s the minority. I will say this, but when you tell them really, you know, you’re going to have a 50% chance that you’re going to die, broke and 50% chance that you’ll have at least a dollar or more. And they’ll say, that’s great. I’m okay with that. That means I can flip a coin and 50% of the time, I’m fine, but you’ve got a whole more failures with that 50% chance of success.

(39:57):

Now, why do people have this risk tolerance? Quite frankly, it’s because they’re just, they’re willing to make adjustments. And that’s why I say this goes hand in hand with the spending flexibility. I think if you’re willing to make the adjustments and you’re willing to say, Hey, whatever goals I have in my plan, I can put them off. I can spend less. If we have bad returns for three years, that following two or three years, I’m going to spend 10, 20% less. If you’re willing to do that, it can have a great impact on your retirement, especially early on retirement. When you want to, what I call front-load and have the most fun when you’re in your sixties and early seventies, when you want to travel and enjoy life. So the risk tolerance and the retirement spending flexibility is absolutely fantastic. So that kind of leads me into why everybody really needs a plan.

(40:45):

I cannot, for the life of me fathom by anybody would retire without a retirement plan, because the plan is going to map out those things, the assets, the income, the expenses, which the expenses are your goals, that’s your, your goals and your dreams for the future, how much you want to spend and how, you know, we want to spend it when you want to spend it, do you want the yacht or you want the travel or whatever it may be. That’s important to you. And we break these down into needs, wants and wishes. So we get very, very into the granular detail where your needs are. Things like keeping the power on and putting gas in the car, your wishes, or your wants are things like the fancy dinner and the fancy purse and the fancy car. And you’re, you’re really, your wishes would be leaving a legacy for the kids or an Alma mater, something that is lower on the totem pole.

(41:26):

The root, the reason, the reason we break them down is because we can show you well, based off of this, you can accomplish your needs, but only 50% of your wants or different types of planning scenarios. So it’s a really fun process. I love going through it. When people see these things, their face lights up. So we map all these things together, assets, income, expenses, and liabilities. And then we basically go back to this 83% and we say, okay, here’s your plan? How do we make it 83? How do we take this 83% chance of success and make it an 86 or 90? And that comes in different ways like investment planning and asset location, Roth conversions, and, and watching out for the Medicare Irma penalty, when you’re, when you’re doing your IRA distributions and Roth conversions and so forth, there’s a lot of ways that you can improve a plan and get you a higher chance of success, and then hopefully be able to enjoy and live that retirement dream that you always wanted for the last several decades while you were working your fingers to the bone and saving and investing.

(42:25):

And that’s really what a plan is. And that’s why everybody needs to have some plan, even if they only do it once before they retire. Everybody needs to have some sort of plan in place to help manage these variances and the sequence of returns, risk and the different occurrences. So that is the discussion for today. Retirement income planning, specifically on your safe withdrawal rates, how much you can spend. And again, we looked at that from two sides of the coin. How much do you have to have to accomplish the dreams that you want? Or how much can you spend based off of what you have? So we, we know that sequence of returns risk is, is potentially devastating. Watch out for that in your planning. The 4% rule is absolutely fantastic. It’s very robust, but there’s a lot of limits. And we talked about the adjustments of fees and taxes and diversification and retirement flexibility spending and so forth.

(43:13):

The, the 4% could be as low as three. It could be as high as six. It could be any number in between. It could be much higher than six if you only have 10 years to live. So there’s a lot of variances. Only a real plan can tell you what your true spending rate could be, the money Carlos stuff, the, the planning and the analysis is absolutely fantastic. I highly encourage you to get with your financial planner and get a plan done. It’s probably some of the best money you’ll spend before you retire. So I just want to say, thank you so much for spending a little bit of your day with me. I hope you found this educational and entertaining and, and and enjoyable. And at least at the very least, I hope that you learned a couple things in the process, because if it helps you kind of mentally wrap your head around what you’ll be able to retire on, you got a million dollars and your safe withdrawal rate is 4%.

(44:02):

And, you know, you got $40,000 coming. Well, then you got social security on top of that at 20,000, maybe you can start to package together your retirement income streams. And that’s just a fun part of what we do. And if I’m part of a mapping out your retirement finances over your lifetime. So if you did find it enjoyable again, please rate, review, subscribe, wherever you’re watching on Facebook live or YouTube live, or listen to the podcast or, or whatever. I’d really, really appreciate it. Also go check out on retire wire, download 16 of the worst 111 retirement planning mistakes you could ever make and how to turn them into gold lines. You can get with gold mines. You can get it for free on retire, wire.com. You can’t miss it. It’s a book that I just published on Amazon. So there’s 16 of the tips there for you for free. And thank you very much. And here’s to your best retirement ever. Cheers.