Latest / The Financial Freedom Podcast with Fexingo: Quitting Your Job, Living Off Investments, Independence / How Early Retirees Use a Variable Percentage Withdrawal Strategy
Transcript
- Lucas: So we talk a lot on this show about the 4 percent rule — the idea that you can withdraw 4 percent of your portfolio in year one, adjust for inflation, and have a high probability of your money lasting 30 years. Luna: Right, it's the default starting point for most early retirees. Lucas: Exactly. But it's a static rule — it doesn't adjust for how your portfolio is actually performing. And for someone retiring at 40, 30 years might not be enough. So today I want to look at a dynamic alternative: the variable percentage withdrawal strategy, or VPW. Luna: I've seen this mentioned on the Bogleheads forum. It ties your spending to your portfolio's current value, right? Lucas: Yeah, that's the core idea. Each year, you withdraw a fixed percentage of your remaining portfolio. The percentage depends on your age and asset allocation, and it's designed so you never run out of money — because as your portfolio declines, your withdrawal shrinks proportionally. Luna: But if the market drops 30 percent, your spending drops 30 percent too. That's a huge cut to your lifestyle. Lucas: It can be. And that's the trade-off. But the flip side is that in good years, you get to spend more. Let me give you a concrete example. Say you're 45 with a $1 million portfolio, 50 percent stocks, 50 percent bonds. According to the VPW table, your withdrawal percentage for that age and allocation is about 4.8 percent. Luna: So year one you'd take $48,000. Lucas: Correct. Now imagine the market goes up 10 percent that year. Your portfolio grows to $1,052,000 after the withdrawal. Next year, you apply the percentage again — now the table says 4.9 percent because you're a year older — so you withdraw about $51,500. Luna: So your spending grows when the market grows. That's nice. Lucas: But if the market drops 20 percent that first year, your portfolio falls to $800,000 after the withdrawal. At age 46, the percentage is still around 4.9 percent, so you'd withdraw about $39,200. That's a cut of about 18 percent from the prior year. Luna: Ouch. That's tough to stomach if you've built a lifestyle around $48,000. Lucas: It is. And that's why VPW isn't for everyone. But early retirees have a few advantages here. First, you have a long time horizon — you can afford the volatility. Second, you can combine VPW with a cash buffer or a bond tent to smooth the really bad years. Luna: How would that work in practice? Lucas: Let's say you keep two years of expenses in cash or short-term Treasuries. In a down year, you skip the VPW withdrawal from stocks and bonds and instead draw from your cash buffer. That gives the market time to recover before you start selling again. Luna: So you're still spending the same amount, but you're pulling from a different bucket. Lucas: Exactly. And then when the market rebounds, you can replenish the cash bucket with some of your excess withdrawal. The VPW forum on Bogleheads has a whole thread on this — they call it 'bridge withdrawals'. Luna: It sounds like VPW requires more active management than the 4 percent rule. You can't just set it and forget it. Lucas: That's fair. You do need to check the table each year and recalculate. But once you've done it a couple of times, it becomes a routine. And the payoff is that you never have to worry about running out of money — because mathematically, you're always withdrawing a percentage of what's left, you can't deplete it to zero. Luna: Unless you live to 120, I suppose. Lucas: Even then, the withdrawal percentage gets very small. At age 100 with a 50/50 portfolio, the VPW table suggests about 7.5 percent. But by then your portfolio is likely much smaller, so the absolute amount is modest. The strategy is designed so that your spending gradually declines in your later years, which aligns with how many retirees actually spend. Luna: That's an interesting point. A lot of people spend less in their 80s and 90s anyway. Lucas: Right. So VPW naturally adjusts for that. Let's talk about the numbers for a 40-year-old. At age 40 with a 50/50 portfolio, the VPW percentage is about 4.5 percent. At age 65, it's about 5.4 percent. At age 80, it's about 6.7 percent. So the percentage rises over time, but because your portfolio has likely been drawn down, the dollar amount may not increase. Luna: So you're spending a bigger chunk of a smaller pie. Lucas: Exactly. Now, one common criticism of VPW is that it ignores Social Security. But you can incorporate it: treat Social Security as a bond-like income stream and reduce your portfolio withdrawals accordingly. The Bogleheads VPW spreadsheet actually has a field for that. Luna: If I'm retiring at 40, I'm not getting Social Security for 30 years. How do I handle that? Lucas: You can use a technique called 'delayed Social Security' — basically, you treat your future Social Security as a bond, and you mentally subtract its present value from your portfolio. But that gets complicated. A simpler approach is to just run VPW on your portfolio alone, and then add Social Security income on top when it starts. Your total spending will jump up at that point, but that's fine. Luna: I like the simplicity of that. One thing I worry about is the psychological aspect. If I'm in a down year and VPW tells me I can only spend $35,000, but my neighbor using the 4 percent rule is spending $50,000, that would be hard to watch. Lucas: It would. But remember: the 4 percent rule can fail in a bad sequence. VPW never fails — it just gives you less when the market is down. And if you have a cash buffer, you can smooth out the worst of it. Plus, early retirees often have side hustles or part-time work they can fall back on. Luna: True. So VPW seems like a good fit for someone who's comfortable with math and doesn't mind adjusting their lifestyle year to year. Lucas: I think that's exactly right. And for the person who wants to maximize their spending over their lifetime — rather than leave a huge inheritance — VPW is hard to beat. It's actually mathematically optimal for spending everything, because it adjusts to market conditions. Luna: Let's talk about a specific period. How would VPW have done during the lost decade of the 2000s, from 2000 to 2009? Lucas: Good question. We actually covered the 4 percent rule during that period in episode 122. But for VPW: if you started in 2000 with a $1 million portfolio, 50/50, age 45, your first-year withdrawal is $48,000. After the 2000-2002 bear market, your portfolio might have fallen to around $700,000 by 2003. Your withdrawal that year would have been about 4.9 percent of $700,000, or $34,300 — a 29 percent cut from the peak. Luna: That's brutal. But after that, the market recovered, so your spending would have recovered too. Lucas: Right. By 2007, your portfolio might have grown back to $1.1 million, and your withdrawal would have been around $54,000 — higher than where you started. So you had a few lean years, but then you caught up. Luna: And with a cash buffer, you could have kept spending at $48,000 during the lean years, then replenished later. Lucas: Exactly. And that's actually the strategy recommended by the Bogleheads: keep two years of expenses in cash, use VPW for the rest. If you do that, you essentially eliminate the sequence of returns risk. The worst-case scenario is that your cash buffer gets depleted, but then you're back to VPW which naturally adjusts. Luna: I can see this being really appealing for someone who wants to be more hands-on. If today was actually useful to you, the way these stay ad-free is listener support — buy me a coffee dot com slash fexingo. Just a quick mention because keeping this independent matters. Lucas: Yeah, totally. And that support really does make a difference for us. So back to VPW — one thing I want to emphasize is that VPW doesn't guarantee a minimum income. If the market crashes 50 percent and stays down for years, your spending could get very low. That's why some retirees pair VPW with a floor from Social Security or a pension. Luna: Right, VPW handles the variable part, and the floor covers your basics. Lucas: Exactly. Another variation is to use a 'guardrails' approach: you set a floor and a ceiling for your spending, and only adjust when withdrawals fall outside that range. That's a hybrid between VPW and a fixed rule. Luna: I like that. It gives you some stability without being completely rigid. Lucas: One more thing: VPW works best when you have a diversified portfolio. If you're all stocks, the volatility is too high. If you're all bonds, the withdrawal percentages are lower. A 50/50 or 60/40 split is typical. And you should rebalance annually to keep your allocation consistent. Luna: So the takeaway for me is: VPW is a powerful tool if you're comfortable with math and want to maximize spending, but it requires a cash buffer or other income floor to handle the worst-case scenarios. Lucas: That's a great summary. And I'd add that for early retirees, VPW's flexibility is a huge advantage. You're not locked into a fixed withdrawal rate that might be too conservative or too aggressive. You adapt to what the market gives you. Luna: And you never run out of money. Lucas: Never. So if you're thinking about early retirement and you like the idea of a dynamic strategy, I'd recommend checking out the VPW spreadsheet on the Bogleheads wiki. It's free, it's detailed, and it lets you run your own scenarios. Luna: I might try that for my own planning. Thanks, Lucas. Lucas: You're welcome, Luna. And thanks to everyone listening. We'll be back next time with another tool for your financial independence journey.