Latest / The Happiness in Retirement® Hour / Smart Withdrawals: Maximizing Your Retirement Income Without Running Out
Transcript
- Welcome to the Happiness in Retirement podcast, where we help you turn your retirement dreams into reality. Each week, we'll dive into smart financial strategies, lifestyle tips, and expert insights to help you build a fulfilling and secure retirement. Whether you're planning ahead or already enjoying retirement, this is your go-to place for inspiration and practical advice. So sit back, relax, and let's make your golden years the best years. The information provided is for educational and informational purposes only and does not constitute investment advice, and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor's particular investment objectives, strategies, tax status, or investment horizon. You should consult your financial professional, attorney, or tax advisor. Hello, hello folks. Welcome to this episode of the Happiness in Retirement Program podcast. I'm your host, Bill Del Sette. Thank you for joining me today because the road to retirement should be an adventure, not a survival strategy. We have a great program today talking about a subject that you may be familiar with, but Even if you're not, it's something that your advisor certainly is, and that is figuring out a safe withdrawal rate from your portfolio. And this has been a subject there's been a ton of research on, and today we're going to cover three different ways that you can calculate an amount to pull from your portfolio such that you don't have to worry so much about running out of money. And so if you would imagine a world where there is no inflation, and because there's no inflation, if you have $100 today, in 10 years, it will still be worth $100 loaf of bread today that you buy for $2. Plus $2 in the future, and you don't have to worry about prices going up anymore, ever, ever, ever. So your dollars would maintain their purchasing power. Also imagine a world where there's no income tax. So the government doesn't take 30%. of what you earn, or 20%. So you don't have to worry about income tax. And in this great world, if you will, let's assume also that you can get a 7% return on your money fixed, guaranteed, year in, year out, no fluctuation, no market declines. It's just a straight 7% guaranteed forever and ever. No inflation, no income tax, 7% return, and it gets better, you know, when you're going to die, and you're going to die at age 100. and you're going to die in your sleep. Boy, what a great world. In a case like that, the calculation in terms of how much money you would need to save for retirement would be simple, and it would be even simpler to figure out how long that money would last if you knew what your budget was. No inflation, no taxes, no market volatility. What a great world. You live a good long life. Life is easy. Well, that is of course a hypothetical world, and you know as well as I do that that's not the real world. In the real world, we have inflation. Inflation is averaged somewhere in the neighborhood of around 3% a year over the last 100 years. However, that rate can be a lot higher or even lower or negative in certain years. Deflation as it's called. And so what you experience for inflation is going to be different from that long run average by definition. Might be a lot higher, might be a lot lower. So that's something you need to worry about if you want to maintain your purchasing power in retirement and make sure that your dollars continue to go as far as they did 10 years ago or 20 years ago. We also have income taxes, not only federal, but depending on what state you live in, also a state income tax. California New Yorkers, you know what I'm talking about, Connecticut, Vermont, income tax states, or you may live in a low to no income tax state like Tennessee or Florida. But we have income taxes and income taxes are raised and lowered on a whim. Not quite on a whim, but it depends on who's in charge. So we can count on fluctuating income taxes eating into your purchasing power and your money. Finally, it's pretty difficult to find a 7% guaranteed return that will last forever and ever, if not impossible. Interest rates fluctuate. Markets fluctuate. And by the way, I like to say that anything that reduces portfolio volatility reduces return. Nowadays, it seems like everyone's trying to find the investment that doesn't fluctuate. They try and avoid fluctuations in their portfolio, but they shoot themselves in the foot. So avoiding volatility probably isn't a good idea because chances are if you do that, your money may not keep up with the taxes and inflation. In other words, what we call your real return could be negative, meaning even if your portfolio doesn't fluctuate after taxes and the cost of living going up every year, you're still losing purchasing power. So there you have it. This risk, by the way, that we have to deal with, unless we are very, very wealthy and we can afford to have all our money under the mattress, losing purchasing power every year, is called sequence of return risk. And for retirees, it is a big risk. That's the risk that your first few years of retirement are negative and maybe deeply so. And so the sequence of return risk can really impact how long your portfolio is going to last in retirement. So how do we deal with market volatility and taxes and purchasing power? And by the way, mortality risk. What if we live a lot longer than we thought we would? It's the old saying, if I knew I was going to live this long, I would have taken better care of myself and my portfolio. So how do you deal with that? Nowadays, it's not necessarily a bad bet that you're going to live to be 90 or 100 years old. So we need to deal with that and your money's got to last. In a future episode, we're going to talk about the retirement income smile or the go-go, slow-go and no-go years, front-loading your fun in retirement by front-loading how much you take out of your portfolio using what we call income guardrails, subject of another program. although we are gonna talk about income guardrails a little bit, but how do we deal with all of these forces? How do we deal with these things that can have an impact on our portfolio value and therefore how much we can take out when we are financially independent? Well, let's start with the old school approach based on something called the Trinity Study, also a gentleman by the name of William Bengen, B-E-N-G-E-N, if you wanna Google him, wrote an influential article way back in 1993, and he looked at how much retirees could afford to spend each year. Inflation adjusted, getting that raise for inflation, if they had retired in each month since 1926, assuming a 30-year retirement. His initial conclusion over thousands of actual retirement trajectories, or thousands of 30-year retirement paths, on when you retired, what month, what year, thousands of iterations of this. And his initial conclusion was that in the worst case, you can live off 4% of the initial value amount in the first year, adjusted for inflation thereafter, and maybe still have a little bit of money left over. So what you would do, and let's assume that you have $2 million, is you would just calculate 4% of that, or $80,000 a year. using this 4% rule. And then that is the amount you would take from your portfolio every year. And you would adjust that for whatever the inflation rate is or whatever you'd want to use. Maybe it's 3%. So every year you take that original 80,000 adjusted by inflation. And that's it. Sounds good. Fairly safe bet. The problem, and this is a big problem, is that 4% figure was a worst case scenario, which happened to be for all those unfortunate retirees who left work. right at the start of the stagflation period and who experienced the full brunt of the market downturns of the 70s. Do you remember? Are you old enough to remember the lines at the gas stations, gas rationing, things like that? What happened in the early 70s if you were unlucky enough to retire then and have a portfolio? Most people had fixed pensions then. What happened was pretty bad bear market, the 19th for bear market, the market declined by a lot, which is ordinary and necessary. It's what markets do from time to time, but adding insult to injury is inflation was extremely high, the stagflation. So it was a double whammy losing purchasing power at the same time of a big market decline. And so this 4% figure would have helped folks go through that period. But in every other time period, every other 30 year period of time, people could have been more adventurous with their spending. In some cases, up to 10% of that initial portfolio. So as you can see, how much you can take from your portfolio in hindsight, right? You can look back and say, well, you know, this 4% rule was great. I didn't run out of money, but now I have this huge pot of money and I'm 85 years old and I can't enjoy it anymore like I wanted to when I was 60 or 65. So the 4% rule, it is a worst case planning rule and there's been a lot of research since then. Having said that, and by the way, it's based on your portfolio being in a 60-40 stock bond mix, what we call a balanced portfolio. You have to have stock exposure. We think, it's my opinion, most planners, that having stock exposure is necessary so that your money has the chance to grow after taxes and inflation, right? But it's highly dependent on what your return experience is. So a 4% withdrawal, this 4% rule, may protect from you running out of money, but it doesn't protect against you having too much money that you could have enjoyed. Okay. So that's, that's equally important. In my opinion at DelSette Capital, we, we view it as a, not a good thing if you are 90 years old with a few million dollars that you could have enjoyed. in any which way you want, gifting, donating, giving to your kids, more vacation, more travel, more gardening, whatever it may be. So that's the 4% rule. Number one, old school, very old school. Okay, so iteration number two of how to calculate a safe withdrawal rate or potentially safe, the Variable Percentage Withdrawal Method or VPW. in the industry. Instead of a fixed dollar amount, you would draw a percentage of your portfolio each year. And this ensures that you never deplete your savings completely. Think of it like this, okay? We talked about this hypothetical couple having $2 million in a 60-40 stock-bond mix. 60% stock, 40% bonds and fixed income in cash. Same portfolio, but now instead of taking 4% of the initial starting value, why not take 5% of the end of the year or the start of the year balance. So in year one of retirement, you've got your $2 million. Take 5% of that, that's $100,000 in year one. Year two, measure the account value. Let's say that the portfolio has gone up to $4 million. I'm just picking hypothetical numbers, right? And now you can take 5% of that or 200,000. So you see how this works. Now let's go the other way with it. The 2 million is now 1 million. You go through a bear market and then you adjust downward. You have a million dollars, 5% of that is 50,000. So from your starting point of 2 million, $100,000 withdrawal the next year, your portfolio is a million. You drop it in half to 50,000. And if you were to do that, you will never run out of money. It's impossible. Taking 5% of some variable a portfolio value, you're never going to run out of money. It's like the, you know, if you go to swat a fly, and you move halfway to the fly and then you stop, and then you move halfway to the fly and then you stop. When do you hit the fly? Never. It's the same thing with this variable percentage withdrawal strategy. So this isn't bad either, except that again, you could leave a lot of money on the table if your portfolio is going up in value and you're only taking 5% of the value. Okay, so now let's talk about the bucket strategy. Basically, all you do is you divide your assets into different categories, short term or cash, medium term or bonds, and long term or stocks to protect against market swings. And the way that works is basically your long term money, your stock of your portfolio, maybe you set this up so you don't have to touch that for 10 years, okay? So your long-term money can fluctuate for 10 years, you're not going to touch it. But during that 10 years, you have enough in cash and bonds to get you through. And time is your friend in the market, generally speaking. The longer your time horizon, the better your chance of earning a good return in stocks or a non-negative return. I think there have only been two periods, 10-year periods with the stock market. return negative in a 10 year period of time, but that's how it works. So, you know, again, you draw a cash for a year or two or three or four and bonds for another six years. And finally, at the end of 10 years, you look and you go, Hey, our stocks have doubled. And then you start it all over again. Right? Not a bad strategy, not one I personally use. And again it does run the risk that you don't spend enough. So now let's talk about what I consider to be the gold standard of a retirement income withdrawal planning. And that's called the guardrail strategy. The guardrail strategy is relatively new and it does dynamically adjust your withdrawals for both upper and lower portfolio values. So if you were to tell me as my client at DelSette Capital, you've got this $2 million and you want to leave zero behind, you might say, hey, my kids are successful in their own right, and I don't care if I leave anything behind. I wanna spend this money and just really enjoy it myself, but I don't wanna run out of money. So the guardrail strategy, what makes this so compelling is that once we set you up on a monthly or annual withdrawal, and these guardrails are in place, if your portfolio reaches an upper guardrail and hits that number, some value above where it is now, then you get a raise. Isn't that nice? A dynamic adjustment. And if your portfolio hits that lower guardrail, you take a little less and you make these adjustments to your withdrawals dynamically, given your return sequence. If you have right out of the gate, a bad return sequence, you're going to hit a lower guardrail. I'm going to call you up and say, okay, we're going to scale back a little bit, your monthly withdrawals until things get better. And alternatively, If you have a better than expected return sequence in the early years, great. take more out. Or in fact, anytime throughout your retirement, if you hit those upper guardrails, then you should be taking more out, else you could end up with a lot of money left at the end of your life. And unless that's planned, you've left some money on the table. So these guardrails, the guardrails adjust over time, and they can also adjust if you want to leave a legacy at death. We can actually plan around that. This hypothetical couple that has $2 million, If they told me, for instance, that they wanted to leave a million dollars to their kids, then we would just simply tell the system that we use this guardrails approach. We would plug that into the system and it would account for that. They're therefore reducing the amount of monthly withdrawals to account for the fact they want to leave a legacy. So, and you know, again, alternatively, a zero legacy value results in more spending. There have been studies done in this guardrail strategy And it is really, I think, the advent of retirement income planning. So that's it. We have the 4% rule. We have the variable percentage withdrawal strategy. We have the bucket strategy and we have guardrails. Again, we at Del Ceti Capital, we practice the guardrail method most of the time. I'd be remiss if I didn't talk about how your money is invested in retirement. We will go through that in a future podcast. We are big fans of combining the scarred rail approach with a dividend income equity or stock dividend income portfolio. Without boring you with all the details today, we think that is such a great combination because dividends tend to be sticky, meaning they tend to be distributed to their shareholders in good and bad markets. They may be reduced when the bad markets come. But if you have a diversified portfolio of dividend paying stocks, then they at least historically have not been reduced dividends anywhere near what the value of the individual companies that pay those stocks have declined. And by that, I mean, I believe in 2008, when the S&P 500 index lost around 50%, Dividends only declined, the payouts that these largest companies in the United States paid only declined by 20%. And then actually I believe the next year went back up again. So we love dividends. And when you combine those with the guardrail approach to income planning, we think it gives you a really good chance of getting the most enjoyment out of your money. Isn't that what it's for? I used to have an economics professor and he used to say that economics is not about maximizing output, right? Or GDP, gross domestic product. It's about maximizing fun. And that really resonated with me and it does today. So that's why we love the guardrail strategy. We love dynamically adjusting in real time and our clients getting the most enjoyment out of their money. So that's it. That's today's program. Thank you for joining me. If you have any questions about the 4% rule, or guardrail retirement income planning, anything that we talked about today, shoot me an email, billathappinessretirement.com. If you like this podcast, hit subscribe, tell your friends and family members, and we will see you next week. That's it for today's episode of the Happiness in Retirement Program podcast. We hope you found some valuable insights to help you create the retirement you deserve. If you enjoyed this episode, be sure to subscribe, leave a review, and share it with someone who's planning for their future. For more tips and resources, visit happinessinretirement.com or the Del Ceti Capital Management Facebook page. Until next time, here's to a happy, healthy, and financially secure retirement.