The End Game

Safe withdrawal rates and asset management in retirement

I really enjoyed watching The Queen’s Gambit (Netflix series about a fictional female chess player in the 60s) last week. In chess, there are roughly three periods of play: the opening, which is highly structured; the mid-game, which is more chaotic and allows for inspired genius; and the end game, which should be played ‘like a machine’.

In the same way you could say that investing could also be broken into three periods: getting started, the accumulation period, and the spending period in retirement.

To get started, people need to get to grips with their spending, start saving, learn about investing, open broker accounts, and start investing.

During the accumulation period they need to save and invest, get comfortable with their investing style, and continue doing this for decades.

But what about the final phase? What does that look like?

RetireJapan aims to help people get to grips with their finances, so we end up talking about insurance, credit cards, real estate, tax, investing, cars, and a whole range of other topics.

But the end goal for all of us is retirement. We hope to have a comfortable retirement on our own terms, so what can we do to get there? And what do we do when we make it?

A site member sent me a link to this interesting article about safe withdrawal rates last week.

Most people don’t think about safe withdrawal rates (SWR). Most people I meet are not even thinking about retirement. But the readership here is above average in this regard. So let’s assume you have saved and invested diligently and find yourself facing retirement with a fairly nice nest egg. How much of it can you safely spend each year?

Most people work off the ‘4% safe withdrawal rate’ popularised by Bill Bengen as a way to ensure you don’t run out of money during a 30-year retirement based on historical data. According to his theory, you should set your initial annual withdrawal from your portfolio at 4%, then increase it based on inflation every year.

In the linked article, Bengen updates the rule using stock valuations and inflation to give a wider range of safe withdrawal rates, most of which are higher than 4% (ranging from 4.5 to 10%). With a 10% safe withdrawal rate, I could retire tomorrow.

Sadly I am slightly more paranoid than Mr Bengen and will not be using his approach for my own retirement in a few years’ (decades’?) time, interesting though I find it.

Instead I am planning to do some variation of the following:

This is more conservative than the 4% rule, because the withdrawal does not increase with inflation, but remains a flat percentage of the portfolio. If the portfolio gets smaller the withdrawal also gets smaller and cannot deplete the portfolio (although it can get too small to be useful if things go wrong).

If all goes to plan our cash bucket should also grow over time, allowing us to give it away or spend more on ourselves if we feel like it. If things go badly we can make a new plan, and either way we should be able to keep most of our portfolio in reserve.

Having state pensions is an important part of the plan, as they give us an income floor that would pay the rent and buy food regardless of what happens with our investments. That is why it is important to pay into nenkin and any other pensions you are qualified for.

How about you? Have you given the withdrawal phase (retirement) any thought?

21 Responses

  1. My wife has also recommended I watch “The Queen’s Gambit” but I’ll have to wait until I am in the US over the holidays in a home with Netflix access.

    You might be interested in the Michael Kitces interview with Bill Bengen:
    https://www.kitces.com/blog/bill-bengen-4-percent-rule-safe-withdrawal-rates-historical-returns-research-book/

    I had read several of Bengen’s original research about “Safemax” but didn’t realize that (as becomes clear in the Kitces interview) he didn’t actually use this as rule and on top of that he is a market timer and never practiced a buy-and-hold index portfolio approach with his clients. He mentions in passing to Kitces that he is at about 15% in equities right now.

    I was interested in your four bullet point approach to withdrawal strategies in retirement with a bucket funded by pension income, dividends from the portfolio and 5% sales of portfolio value each year. It will depend on the composition of your portfolio (i,e, whether it is filled with lower or higher dividend securities) but taking dividends and a 5% sale is like a 7-8% fixed drawdown, at least into the cash bucket. Is that what you intend?

    1. Very good point! I probably needed to provide more detail, although to be fair this isn’t the most definite of plans. I think we’re at least a decade or two from starting to draw down our investments, and considering I only started doing this twelve years ago I get the feeling our situation could change quite a bit by then 🙂

      My portfolio (and to some extent, my wife’s too) is made up of two tiers: most of it consists of cheap index funds like eMaxis Slim all-country. The remainder is made up of dividend stocks. I don’t plan to ever sell the dividend stocks, so the ‘sell 5%’ bit only applies to the index funds.

      I’m still hoping the dividends will fund most if not all of our living expenses in retirement, but we’ll see how that works out!

  2. I’m a bit confused as withdrawing 5% of your portfolio each year seems to be more, not less, aggressive than the 4% rule… unless I’m missing something in your logic. Assuming the portfolio size is sufficient to cover living expenses at 4%, introducing some flexibility with the annual withdrawal rate (i.e. adjusting lower, to 3-3.5%) to reflect the other sources of income would make sense.

    BTW, there’s a great discussion on the Morningstar Long View podcast on this very topic … TLDR/L conclusion is that the traditional 4% rule was devised from an assumed 30 year horizon, so a combination of going down a little on the rate (particularly in the early years), and maintaining flexibility in the rate depending on how the portfolio is performing, goes a long way to making your portfolio last long enough. With the other sources of income you describe, you could likely make that happen.
    https://www.morningstar.com/podcasts/the-long-view/78

    1. The safe withdrawal rate is calculated assuming you increase the withdrawal amount by the rate of inflation each year. It’s really 4% x (initial balance) x (multiplicative sum of inflation rate since start) in any given year. At current <2% inflation rates it takes around 10 years for 4% to act like 5% of the initial rate but in the past that inflation component has made a bigger difference.

      1. Yes, exactly. By withdrawing a fixed percentage of the portfolio, this guarantees the portfolio will never be fully depleted, although if things go wrong this fixed percentage might end up being too small to be useful…

      2. I see what you’re saying here, (and I may have missed something) but I was always under the impression the research that arrived at 4% already factored in inflation … thus negating the need for the retiree to add to it in the manner you describe. If you were withdrawing a fixed certain dollar amount (rather than a %) then I could see that adjustment being necessary though.

        1. And thus rather than the formula being “4% x (initial balance) x (multiplicative sum of inflation rate since start)”, it should simply be 4% x (current portfolio balance). Focusing on the “initial balance” will always imply a fixed dollar amount.

          1. Unfortunately that is not how the ‘4% rule’ or similar safe withdrawal calculations work.

            The purpose of establishing a safe withdrawal rate is to guarantee a certain level of income. For most people, they will actually need this going forward.

            So if someone had a million-dollar portfolio and they needed 40,000 dollars a year to maintain their lifestyle, the 4% rule tells them they can take out 40,000 dollars adjusted for inflation for at least a 30-year period.

            If it were just a flat 4%, and they experienced a stock crash that reduced their portfolio by 50% in the second year, they might not be able to get by on 20,000 dollars.

            I agree that a flat percentage might be easier to use, and am thinking of using one myself, but that is not what the broader community is talking about 🙂

        2. The 4% Safe Withdrawal Rate used in the studies does factor in inflation in the sense that if you don’t adjust by inflation (or deflation) the SWR actually fails during the Great Depression because it relied an decreasing the amount withdrawn in the 1930’s because of deflation.

  3. Thanks for the clarification Ben. I think I was simply thinking of the Trinity study (which did consider inflation in their safemax calculations), while you are talking more about how withdrawals would work in the real-world, where there actually is a dollar amount the retiree would need to withdraw to meet their needs, which then need to be adjusted for inflation. Clear now!

    1. I think the Trinity study said the same thing though:

      “The rule refers to one of the scenarios examined by the authors. The context is one of annual withdrawals from a retirement portfolio containing a mix of stocks and bonds. The 4% refers to the portion of the portfolio withdrawn during the first year; it is assumed that the portion withdrawn in subsequent years will increase with the consumer price index (CPI) to keep pace with the cost of living.”

      https://en.wikipedia.org/wiki/Trinity_study

      I think the only people who can disregard inflation in their withdrawals are those who have their basic living expenses covered by other income (pensions, etc.) or those whose portfolio dwarfs their spending needs. I’m kind of hoping to be in both of those categories 😉

      1. Thanks for the feedback. Went back to re-read the Trinity study… on pg.19 it gets into inflation and it does cite CPI adjustments, and Table 3 includes those adjustments.

        As such, my understanding is that the 4% SWF has a built-in, passive sort of inflation protection, because the 4% is under the actual (inflation-inclusive) return, and thus your principal should theoretically continue to grow with inflation…. and by extension the amount you withdrawal with your 4% should adjust accordingly. But it’s a theoretical projection using assumed constant rates of future returns based on historical data, so it obviously doesn’t deal effectively with you “50% drop in a year” scenario, which is a real-world concern.

        https://web.archive.org/web/20150702114906/http://incomeclub.co/wp-content/uploads/2015/04/retirement-savings-choosing-a-withdrawal-rate-that-is-sustainable.pdf

        Anyway, apologies if I’m starting to sound pedantic as that isn’t my intention. I think we’re arguing two sides of the same coin as it is anyway, so will leave it at that.

        And I also second the Queen’s Gambit! Great show.

  4. I’d love to know what stock you purchase to increase your dividends. I’ve mostly stuck to index funds that don’t pay out that much.

  5. With regards to investing once you reach retirement, have you read “Living off your money”? (https://www.amazon.com/Living-Off-Your-Money-Retirement/dp/0997403403) My brother-in-law suggested this book and I’m still working my way through it but so far it’s been a good read. I like the data-based approach to his thinking as it’s something an IT professional like me can relate to. Most people think about saving/investing enough to get to retirement but don’t think about how to manage their money once they get there. I am guilty of this as well so it’s been interesting to read about the strategies defined in this book.

  6. These percentages all sound fine and dandy. However, has anyone factored in the possible problems of when your health starts to fail? Certainly in Japan, even if you’re fully paid up in the National Health system, health costs skyrocket the older you get, especially if you need serious surgery and/or long convalescence. How do we budget for that? Or is there a really good private health insurance deal that I don’t know about?

    1. For older people copays go down to 20% or 10%, and there is also a cap on how much you have to pay per month, or per illness (based on income). Due to these protections, medical bankruptcy is less likely in Japan, although you can take out private insurance if you are worried.