Latest / The Financial Freedom Podcast with Fexingo: Quitting Your Job, Living Off Investments, Independence / How Early Retirees Manage Sequence Risk With a Flexible Spending Rule
Transcript
- Lucas: So you've saved up a million dollars, you retire at 45, and you're planning to follow the classic 4% rule — withdraw $40,000 the first year, adjust for inflation each year after that. What could go wrong? Luna: I'm guessing you're about to tell me a lot, actually. Lucas: Well, the short version is sequence of returns risk. If the market drops 30% in your first year, your portfolio falls to $700,000, but you still withdraw $40,000 — that's now 5.7% of your remaining balance. Do that for a few more bad years and your portfolio can get crushed beyond recovery. Luna: Right, and that's the classic problem. But what if instead of a fixed inflation-adjusted withdrawal, you just take a fixed percentage of whatever your portfolio is worth each year? Lucas: That's exactly what I want to talk about today — the flexible spending rule, sometimes called the percentage of portfolio rule. Instead of saying 'I'll take $40,000 this year,' you say 'I'll take 4% of whatever my portfolio is on December 31st.' So if the market drops, your spending drops proportionally. Luna: And if the market booms, your spending goes up too. That sounds a lot more sustainable. Lucas: It is. In fact, researchers have shown that a fixed percentage rule never fails — mathematically — because you can never withdraw more than you have. The downside, of course, is that your spending is volatile. If the market drops 50%, you're cutting your spending in half. That's a brutal lifestyle adjustment. Luna: So it's a trade-off. Guaranteed portfolio survival versus unpredictable income. Lucas: Exactly. And this is where the nuance comes in. For someone retiring at 65 with a 30-year horizon, the classic 4% rule actually works most of the time. But for early retirees with 50 or 60 years ahead, the failure rate gets scary. A percentage of portfolio rule gives you that long-term safety, but you have to accept spending swings. Luna: And those swings can be really painful in a bad bear market. I mean, imagine you've been living on $50,000 a year, then suddenly you're supposed to live on $30,000. Lucas: Right. So the conversation among early retirees today is about how to blend strategies. You might use a percentage rule as your base, but keep a cash buffer of one to two years of expenses. That way, when the market drops, you don't have to cut spending immediately — you draw from the cash buffer while you wait for the market to recover. Luna: So the cash buffer smooths out the worst of the volatility. That makes sense — you're basically giving yourself time to adjust. Lucas: Exactly. And that's actually a very common approach in the FIRE community. The idea is you set a spending rule like 'take 4% of your portfolio, but if that's more than 20% below last year's spending, use cash reserves to bridge the gap.' It's a guardrail. Luna: I've also seen rules where you take a fixed percentage but cap the annual increase or decrease. Like, you can't cut more than 10% in any one year, even if the market tanks. Lucas: Yeah, that's called a 'floor and ceiling' approach. You set a minimum and maximum change from one year to the next. It's a way to keep spending from being too chaotic, while still letting it adjust over time. Luna: And I think this is where the behavioral side really matters. If you're an early retiree, you're probably already pretty good at managing your finances. But it's one thing to know the math, and another to actually live through a 30% spending cut. Lucas: Absolutely. And that's why I think the flexible spending rule is so powerful as a concept, even if you don't use it strictly. It forces you to think about what you would actually do if the market drops. Most people, when they run their retirement numbers, assume they'll just cut spending — but they never really model what that looks like. Luna: Right. Like, can you actually cut your travel budget by 50%? Can you defer that home renovation? It's not easy. Lucas: No, it's not. And I think that's why a lot of early retirees end up with part-time work or side hustles — not because they need the money, but because it gives them a buffer against those spending cuts. They treat it as a variable income stream. Luna: That's a good point. And it brings us back to the idea that retirement planning isn't just about the withdrawal rate. It's about having multiple levers to pull. Lucas: Look, I think the biggest takeaway for today is that the fixed 4% rule is a useful starting point, but it's not a law. For early retirees especially, a flexible rule — whether it's a pure percentage or a more nuanced version with guardrails — can actually be safer and more realistic. Luna: And you can always adjust. The beauty of a flexible rule is that it forces you to stay engaged with your portfolio and your spending, which is probably a good thing anyway. Lucas: Exactly. And honestly, conversations like this — really thinking through the mechanics of your withdrawal strategy — are exactly the kind of thing that can make a huge difference over a 50-year retirement. If this kind of detailed financial thinking has helped you, whether it's through our show or other resources, it's worth noting that listener support is what keeps these ad-free conversations going. Luna: Absolutely. We don't run ads, and we want to keep it that way. If you find value in episodes like this, you can support the show at buy me a coffee dot com slash fexingo. Lucas: And even a small contribution helps us keep the lights on — or in our case, the cabin porch lights. Anyway, back to spending rules. One thing I wanted to highlight is that the research on flexible rules goes back decades. The original Bengen paper that gave us the 4% rule actually acknowledged that if you make spending flexible, the safe withdrawal rate goes up. Luna: Right, I've seen that. When you allow spending to vary with market conditions, the starting withdrawal rate can be 5% or even higher without increasing failure risk. Lucas: Exactly. Because the rule itself adjusts. So if you're willing to accept some variation, you can actually spend more on average over your retirement. That's a big deal. Luna: It's almost counterintuitive. By being flexible, you end up with more spending power over the long run. Lucas: Yes, because you avoid the worst-case scenario of depleting your portfolio early. And you also benefit from the good years — when the market is up, your spending goes up too. So over a long retirement, the average spending under a percentage rule can actually be higher than under a fixed rule. Luna: That's a really compelling argument. So the question becomes: can you live with the year-to-year volatility? Lucas: And that's really a personal question. Some people prefer the predictability of a fixed income, even if it means a slightly higher chance of running out of money. Others would rather have the security of a rule that guarantees their portfolio will last, even if it means adjusting their lifestyle in bad years. Luna: And I think the combination approach — percentage rule plus cash buffer — is a great middle ground. It gives you the long-term safety without the immediate pain. Lucas: Exactly. And that's what we're seeing more and more early retirees adopt. They keep one to two years of expenses in cash or short-term bonds, and then they use the percentage rule for the rest. When the market drops, they spend from the cash buffer and don't touch the portfolio until it recovers. Luna: It's like a shock absorber. And it also gives you time to adjust your spending gradually if a downturn is prolonged. Lucas: Right. So let's say the market drops 30% and stays down for two years. In year one, you spend from your cash buffer. In year two, you might start cutting discretionary spending because you know the buffer is running low. By year three, if the market hasn't recovered, you've already adjusted your lifestyle. Luna: And that beats the alternative of being forced to sell stocks at the bottom. Lucas: Exactly. So the flexible spending rule isn't just about math — it's about giving yourself a framework to make those adjustments rationally rather than reactively. Luna: I think that's a great note to end on. Thanks, Lucas. Lucas: Thanks, Luna. See you next time.