Navigating Retirement: Dynamic Safe Withdrawal Rates In Action

One of my ongoing challenges as a writer is explaining financial concepts in an easy-to-understand manner. With a background in business school and 13 years at Goldman Sachs and Credit Suisse, financial concepts come naturally to me.

Despite writing over 2,500 personal finance articles since 2009 on Financial Samurai, however, some concepts still get misunderstood or provoke readers into a rage. One such concept is my Dynamic Safe Withdrawal Rate, introduced in my post, “The Proper Safe Withdrawal Rate Is Not Always 4%,” in 2020.

Instead of retirees adhering strictly to the “4% Rule,” popularized in the 1990s as a safe withdrawal rate, I advocate for a dynamic approach. This means adjusting withdrawal strategies as circumstances change.

By staying flexible, you increase your chances of staying retired.

A Quick Explanation Of My Dynamic Safe Withdrawal Rate

My Dynamic Safe Withdrawal Rate is calculated as the 10-year Treasury bond yield multiplied by 80%. This percentage is based on the idea that the suggested 4% withdrawal rate from the 1990s roughly equaled 80% of the average 10-year bond yield, which was around 5% at the time.

The concept was simple: if you could withdraw at a 4% rate while earning a risk-free 5%, your funds would never deplete. Therefore, let’s take this logic to the present.

Using the 10-year Treasury bond yield as a variable for withdrawal rates is crucial because it continually fluctuates. This yield stands as a pivotal economic indicator that every investor should monitor. It serves as the benchmark for risk-free returns, influencing the pricing of risk assets. Additionally, the yield curve reflects assumptions about inflation, economic growth, and monetary policy.

However, this is where confusion sometimes arises.

Retirees Have Diversified Portfolios

Some readers mistakenly believe I advocate for a portfolio consisting entirely of 10-year Treasury bonds in retirement, which is incorrect. While living solely off the interest from Treasury bonds could guarantee financial stability, most retirees maintain diversified portfolios. Their investments span across real estate, stocks, bonds, venture capital, alternative assets, and cash.

I am meeting retiree investment portfolios where they are.

Investors strive to find the optimal asset allocation that balances maximizing returns with minimizing risk, considering their financial goals and risk tolerance. Regardless of the allocation, every investment should be assessed against the 10-year bond yield, or the risk-free rate of return. If an investment’s expected return doesn’t exceed the risk-free rate, a logical investor would reconsider its viability.

Furthermore, investors understand that investments rarely achieve their historical averages annually. For instance, stock returns can significantly deviate from their long-term average of 10% since 1926.

As retirees seek predictability and stability, they often opt for portfolios with less volatility.

How Following My Dynamic Safe Withdrawal Rate Turned Out

I understand that some of you may still oppose my Dynamic Safe Withdrawal Rate. It’s natural to feel uneasy about changing the long-celebrated 4% Rule to adapt to today’s different world.

Change can be challenging, especially as we grow older. Heck, there are still people who clean their bums with dry toilet paper when bidets are so much better! But embracing change is essential if we want to maximize our wealth and achieve greater financial peace in retirement.

For context, I’m speaking from experience as someone who hasn’t had a day job since 2012. I also don’t benefit from a working spouse providing additional income or subsidized health insurance since my wife left the traditional workforce in 2015.

I’m not just theorizing about retirement; I’m living it in the best way that I can, which includes earning supplemental retirement income. And from my firsthand experience, you won’t truly understand your risk tolerance in retirement until you and your partner, if applicable, completely rely on your retirement savings.

To better illustrate my Dynamic Safe Withdrawal Rate (DSWR), let me provide a case study of its application since 2020 when COVID hit. This example will offer insights into how this approach has performed in real-world conditions.

Dynamic Safe Withdrawal Rate In 2020

In March 2020, the COVID lockdowns began, sparking widespread market panic. By March 30, 2020, the 10-year bond yield had dropped to approximately 0.59% as investors flocked to the safety of Treasury bonds.

With the 10-year bond yield at 0.59%, your Dynamic Safe Withdrawal Rate would decrease to 0.47%. To simplify, I rounded it up to 0.5%, a figure that triggered some strong reactions from readers.

Typical angry feedback goes something like this: “What?! A 0.5% safe withdrawal rate means I need to save 200 times my annual expenses to retire early! You’re just spreading fear and misinformation!“

Unfortunately, conflicts often arise when one side fails to understand the perspective of the other. The concept of a safe withdrawal rate primarily concerns individuals who are already retired. The goal is to provide retirees with confidence that their savings will sustain them throughout their retirement, especially when they rely heavily on their investments for financial support.

The fear of running out of money looms larger for retirees than for those with a steady income stream. And this fear of running out of money for retirees is precisely why some retirees continue to generate supplemental retirement income.

Discovering Your Temporary Net Worth Target

Indeed, for those still in the workforce, you can invert 0.5% to derive a target net worth for retirement, which would be 200 times your annual expenses. However, it’s crucial to recognize that my Dynamic Safe Withdrawal Rate is constantly evolving with market fluctuations.

Consequently, if you opt to utilize the inverse formula, be prepared for your target net worth to fluctuate accordingly over time.

What I Ended Up Doing During COVID

Experiencing a sense of déjà vu reminiscent of when I launched Financial Samurai in July 2009, amidst the depths of the global financial crisis, I felt compelled to adjust my withdrawal rate. It seemed only prudent to tighten spending and bolster savings, a natural outcome of reducing one’s safe withdrawal rate. With a newborn daughter, a three-year-old son, and a stay-at-home spouse to support, this decision carried significant weight.

Then, on March 18, 2020, I penned a post titled “How To Predict The Stock Market Bottom Like Nostradamus.” In that article, which I hope you’ve all had the chance to read, I posited that 2,400 in the S&P 500 represented the worst-case scenario, advocating for buying opportunities as a result. Additionally, I forecasted a V-shaped recovery in the latter half of 2020.

In order to adhere to my own rationale and summon the courage to invest in stocks amid the market downturn, I found it necessary to adopt a lower safe withdrawal rate. This adjustment not only liberated funds for investment but also provided a substantial cash buffer to weather any further declines in my newly acquired stock holdings.

An Example Of Investing Thanks To A Lower DSWR

If you’re questioning the logic, consider a retiree accustomed to spending $10,000 monthly based on a 4% withdrawal rate. The retiree also has $150,000 in cash and short-term Treasury bonds. With the onset of global lockdowns, this retiree slashes expenses to just $1,250, adhering to a 0.5% withdrawal rate and limiting spending to essential needs.

However, drawing from experience navigating market panics and recoveries, this seasoned investor opts to channel the remaining $8,750, previously earmarked for expenses, into the S&P 500. By maintaining a dynamic safe withdrawal rate pegged at 80% of the 10-year bond yield throughout 2020, the retiree continues this strategy, directing unspent funds into the S&P 500.

Over the span of a year, this retiree funnels roughly $100,000 into the S&P 500 by tightening spending. Additionally, leveraging the confidence gained from dynamically adjusting their safe withdrawal rate, the retiree commits an additional $100,000 in cash reserves to the S&P 500, capitalizing on its potential amidst low interest rates.

Dynamic Safe Withdrawal Rate In Action In 2023

Following the stock market’s appreciation in 2020 and 2021, retirees who tightened spending and ramped up investments found themselves in a more favorable financial position. As the 10-year bond yield climbed to approximately 1.5% by November 2021, retirees cautiously adjusted their dynamic safe withdrawal rate to 1.2% (1.5% X 80%).

However, 2022 witnessed a 19.6% correction in the S&P 500 amidst aggressive Fed rate hikes, pushing the 10-year Treasury bond yield to 4.85%. Retirees were faced with a dilemma to raise their overall withdrawal rate to 3.88% given inflation was making everything more expensive or maintain conservative spending and continue investing; retirees found themselves at a crossroads.

Retirees who remained faithful to the Dynamic Safe Withdrawal Rate (DSWR) found themselves in a win-win scenario as the S&P 500 rebounded by 26% in 2023, while also getting to spend a greater percentage of their retirement savings.

My Actions in 2023

As a pseudo-retiree who decided to pursue his passion for writing, I have supplemental retirement income from Financial Samurai, my severance negotiation book, and now traditionally published books. Although being an author doesn’t pay much, this supplemental income acts as a shield, allowing me to afford to invest more and take more risks in retirement. Alternatively, I could withdraw funds at a higher percentage to YOLO on things I don’t need.

By mid-2023, I felt relieved because we had clawed back most of the stock market losses from 2022. In addition, a house that I wanted to buy in May 2022 was privately being offered at a lower price when the listing agent emailed me in May 2023.

For 3.5 years, I was extremely careful with my spending. Not only did we have a new baby in December 2019, but we also decided to buy a new house in mid-2020 once I realized our old house we bought in 2019 would take much longer to remodel.

With stocks up and real estate prices down since 2022, I was excited to take on more risk by climbing another rung up the property ladder. The 2022 downturn reminded me that there was no point in investing in stocks if you don’t occasionally sell to buy something useful.

So in October 2023, I bought my realistic dream home by selling stocks and Treasury bonds. The source of funds was roughly 65% stocks and 35% Treasury bonds. Although I would miss earning a 5%+ annual risk-free return on my Treasuries, I wanted the house more. Besides, there was a chance home prices could catch up with the S&P 500.

How To Think About The Dynamic Safe Withdrawal Rate Today

With the 10-year Treasury bond yield hovering around 4.5%, my Dynamic Safe Withdrawal Rate guides for 3.6%. As a retiree, you need to do a financial checkup to see if the latest DSWR makes sense. Everybody’s situation is different.

On the one hand, a high DSWR indicates the economy is robust and inflation remains high. Therefore, spending a greater amount in retirement makes sense. On the other hand, a high DSWR today means the economy may slow down in the future, therefore, caution is prudent.

But here’s the thing. If the economy does indeed slow down and inflation does settle down to the Fed’s long-term target of 2-2.5%, then the DSWR will also come down. As a result, you may naturally decide to spend more money in retirement.

Don’t Need To Forecast The DSWR To Alter Spending

You can certainly try to anticipate where the DSWR is going and be even more conservative than what the DSWR suggests. However, the whole point of the DSWR is to help guide your spending as economic conditions change. If you are overly conservative, you will more than likely fail to spend down enough wealth before you die.

So you see, my Dynamic Safe Withdrawal Rate is just a guide to help you make more optimal decisions going forward. It is not a rule.

Personally, the latest DSWR indicates I can spend a similar amount of money in 2024 as I could in 2023. However, the issue is, with such low liquidity post my house purchase, I’m on a mission to save as much as possible to feel more financial security.

Final Takeaways Of My Dynamic Safe Withdrawal Rate Guide

As a Financial Samurai reader, my goal is to help you think more critically about issues to make the most optimal decisions possible for building wealth. Keep an open mind when reading financial concepts because there is no 100% right or wrong way of doing things.

The world is becoming more connected, and financial markets are growing more volatile over time. One of the primary goals of my DSWR is to remove EMOTION from your financial decision-making process.

The same principle applies to my Debt And Investment Ratio formula when deciding how much of your cash flow to allocate to paying down debt or investing. It is also a dynamic formula that encourages you to logically pay down more debt as interest rates increase and vice versa.

If you want to feel better in retirement, consider the following:

1. Find something you enjoy doing that earns supplemental retirement income. This way, you’ll have something meaningful to occupy your free time and help protect your finances during difficult times.
2. Be dynamic in thought and action. Just as you wouldn’t continue with the same approach if it’s not yielding results, you shouldn’t stick to the same spending pattern in retirement regardless of the economic environment.
3. Recognize that circumstances far above or below trend are usually temporary. Therefore, it’s essential to understand where you are in the economic cycle and adjust your strategies accordingly.
4. Stay humble by acknowledging that we cannot consistently predict the future. Consequently, we must stay vigilant with our finances, diversify, and be prepared to adapt when necessary.
5. Don’t confuse brains with a bull market. Your net worth will likely far surpass any amount you could have reasonably spent when returns are strong.

Reader Questions And Suggestions

If you still vehemently disagree with my Dynamic Safe Withdrawal Rate formula, feel free to express your dissent! Share your reasons for disagreement, and provide examples if possible. If you are retired, how did you alter your withdrawal rate or spending since COVID began?

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