Latest / The Financial Freedom Podcast with Fexingo: Quitting Your Job, Living Off Investments, Independence / How to Manage a Variable Withdrawal Rate in Early Retirement
Transcript
- Lucas: So you've saved up your nest egg, you've hit your number, and you pull the trigger on early retirement. Then the market tanks twenty percent in your first year. What do you do? Just keep taking the same four percent? That's the classic advice, but it can backfire. Luna: Right, because if you lock in a fixed withdrawal rate after a big loss, you're selling low and depleting your portfolio faster. That's sequence of returns risk, which we've talked about before. Lucas: Exactly. So a growing number of early retirees are turning to a variable withdrawal rate — specifically, the guardrail method popularized by financial planner Jonathan Guyton. It's a set of rules that adjusts your spending based on portfolio performance. Lucas: Here's the core idea: you start with a fixed percentage, say four and a half percent of your portfolio in year one. Then each year you recalculate based on the new balance, but with caps and floors. Guyton's research shows this can boost success rates significantly. Luna: How do the guardrails actually work? I've seen a few different versions. Lucas: The simplest model has three rules. First, if your portfolio's actual withdrawal rate — the percentage you're taking relative to the current balance — rises above a certain threshold, say six percent, you cut your spending by ten percent. That's the upper guardrail. Lucas: Second, if your withdrawal rate drops below a lower guardrail, like four percent, you can increase your spending by ten percent. And third, you skip inflation adjustments in down years. So you only increase for inflation in years when the market is up. Luna: So it's like a safety buffer. You're not locked into a rigid spending plan — you flex with the market. Lucas: Exactly. Let's make it concrete. Say you retire with one million dollars and decide on a starting withdrawal rate of four and a half percent, so forty-five thousand dollars in year one. In year two, the market drops twenty percent. Your portfolio is now eight hundred thousand. Lucas: If you stuck to a fixed four percent, you'd still take forty thousand, which is now five percent of the reduced balance. But with variable guardrails, you might cut your withdrawal by ten percent, so thirty-six thousand. That's only four and a half percent of the new balance. Luna: That feels painful — cutting spending right after a bad year. But it protects the portfolio from being decimated. Lucas: It does protect it. Guyton's backtests show that this approach can survive the worst historical sequences — like retiring in 1966 or 2000. The key is that you don't cut forever. Once the market recovers, you can raise spending again. Lucas: I'll give a real-world example. Someone who retired in early 2022 with a variable withdrawal plan would have seen their portfolio drop maybe fifteen to twenty percent that year. The guardrail would have triggered a spending cut. But by 2023 and 2024, markets rebounded strongly. Luna: So by 2024, they actually increased spending above their original amount? Lucas: Potentially, yes. If the withdrawal rate fell below the lower guardrail, they got a ten percent bump. Plus inflation adjustments in up years. So they might be taking out fifty thousand dollars by now, while someone on a fixed four percent is still at forty thousand. Luna: That's a real benefit. But I imagine it requires a lot of discipline. Not everyone can stomach cutting spending after a market crash. Lucas: It does take discipline. That's why I think the guardrails work best if you have some flexibility in your budget — discretionary spending you can trim. If all your expenses are fixed, variable withdrawal is tougher. Luna: I have a friend who retired early in 2019. She used a simple four percent rule and was fine through 2020, but in 2022 she was really stressed. She ended up taking a part-time job to avoid cutting spending. Luna: If she'd used variable guardrails, she might have avoided that. Or at least had a plan for when to cut. Lucas: That's exactly the kind of story that makes the case. There's also a more sophisticated version from Guyton and his colleague William Klinger that adds rules for portfolio rebalancing and using dividends. But the core principle is the same. Lucas: Let's talk about the numbers. Guyton tested a starting withdrawal rate of five point two percent with guardrails and found a ninety percent success rate over thirty years. Without guardrails, the classic four percent rule has a roughly ninety-five percent success rate. So you're giving up a bit of safety for more spending potential. Luna: But the trade-off is that you can start with a higher withdrawal rate. For early retirees who need more than four percent, that's huge. Lucas: Right. If your expenses require five percent, the guardrails might make that sustainable. The key is to run your own numbers. Monte Carlo simulations can test different guardrail thresholds for your specific portfolio. Luna: What about the behavioral side? Does the research show people actually follow the rules? Lucas: There's some evidence that retirees who adopt a plan with explicit rules stick with them better than those who just 'wing it.' A 2024 study from the Journal of Financial Planning found that retirees with a written withdrawal strategy were significantly less likely to panic-sell during downturns. Lucas: The guardrails give you a framework. You know exactly when to cut and when to increase. It removes the emotion from the decision. Luna: That's a big deal. I think a lot of early retirees overestimate their ability to stay disciplined in a downturn. Lucas: Absolutely. And that's why I'm a fan of variable withdrawal rates. They're not perfect — no strategy is. But they offer a middle ground between the rigidity of the four percent rule and the chaos of spending whatever you feel like. Lucas: One more thing: you can combine guardrails with a bucket strategy. Keep one to two years of cash for essential expenses, and let the rest of the portfolio follow the variable rules. That way you never have to sell stocks at a loss to pay for groceries. Luna: So the cash bucket smooths out the cuts. You might not even need to reduce spending if you have a cash cushion. Lucas: Exactly. And that leads to a final thought. Variable withdrawal rates aren't about being cheap. They're about being smart. If the market does well, you get to enjoy more. If it doesn't, you protect your future. Luna: I like that framing. It's not deprivation — it's adaptability. Lucas: Speaking of adaptability, I want to mention something that makes episodes like this possible. Our show is ad-free, and that's because listeners who find value in it choose to support us. A couple of dollars a month is genuinely what keeps these going. Luna: Yeah, it's a small thing that makes a big difference. If our money conversations have helped you think about a decision differently, you can find us at buy me a coffee dot com slash fexingo. Lucas: Appreciate it. Now, back to variable withdrawals. I think the most important takeaway is to test your plan before you retire. Run the numbers for different guardrail levels. See how your spending would have fared in past bear markets. Luna: So listeners should actually model a 2022 scenario? Or maybe a 2008 scenario? Lucas: Both. And also a scenario where you have to cut spending for two consecutive years. If you can live with that, then you're ready. If not, you might need a bigger cash buffer or a lower starting withdrawal rate. Luna: So the guardrails give you a roadmap. But you have to be honest with yourself about your spending flexibility. Lucas: Exactly. And that's the kind of honesty that makes early retirement work long term. Thanks for listening, and we'll see you next time.