In earlier posts I’ve covered how much it takes to retire, the safe withdrawal rate (SWR), and one method of increasing the safe withdrawal rate. Today I wanted to cover the method I use to increase my SWR significantly without taking on any more risk. Sounds exciting huh? Well, maybe to a retirement calculating geek like me…..
The answer to increasing SWRs in retirement is flexibility, in particular flexibility in spending. As I wrote in how to implement the SWR, the annual adjustments in spending are based of the first year’s withdrawal and are then adjusted for inflation. You never look at the current portfolio value. This has its pros and cons. A pro is it keeps you from making short term decisions based on a year or two’s investment returns. A big con is that it can be gut wrenching to increase your spending (to keep up with inflation) in the midst of a large portfolio decline. Imagine adjusting your withdrawals up for inflation in early 2009 after the disaster year for investments in 2008. It’s easy to say ‘trust in history’, ‘this SWR has always worked in the past’, its quite another thing to actually do it.
There is a better way. That way is to have flexibility in your retirement spending. Recall that the SWR implementation always aims to keep your spending the same adjusted for inflation, year after year. Most retirees are capable of having some flexibility in their spending plans. Or as I will show it pays to have that flexibility. What if you could spend less in bad years and spend more in good years? Would that change the success of the SWR method or even allow a higher SWR? The answer is yes to both questions. Lets take a look at the data. The data is from the same source I used in previous SWR posts, William Bengen, a leader in this field. The table below shows the effect on the SWR by having the flexibility to adjust your spending down by 5%-20%, and up by 5%-20% of your initial withdrawal.
First thing to note from the table is the limiting factor is how much you can reduce your spending in down investment years. When things are going great we can increase spending quite a bit. Makes sense. For example, if you can adjust your spending down by 5% in a given year, then your initial SWR goes from around 4.4% to 4.9%. If you adjust your spending down by 10% then your SWR goes to 5.16%. These are significant increases to retirement spending just by maintaining some flexibility in spending. And these SWRs have 100% success rates. As we did with the stable spending SWR, what if we took a little more risk and were willing to tolerate less than 100% success rates. Personally I think 90% success rates are good enough. Here is the result for a -5% spending plan.
So, with a flexible spending plan that cuts retirement spending by a maximum of 5% in a given year and takes on a 90% chance of success I can increase my SWR to 5.75%! How many more people would be able to retire safely if they knew this? Staying flexible sure has its rewards. Just to drive the point home – for a retiree with $40K per year in spending, this increase in SWR means having a retirement portfolio of $700K versus $1M for a 4% SWR!
Or, for the real conservative risk averse types like me, living on a 4% SWR but knowing in the back of your mind that you could easily live on a 5.75% SWR just makes retirement so much more relaxing and stress free.
Finally, I like to talk about how realistic this is. I personally think reducing spending by 5% in a given year is quite realistic and think I could do 10% or more if needed. However, I purposely designed it that way. One of the many reasons my wife and I chose the RV lifestyle was exactly this. There are so many options to reducing expenses while RV’ing, like dry camping, camp hosting etc… that it makes a plan like this easily achievable. On the other hand, I understand that many retirees are already on a pretty bare bones budget and this flexible spending plan may not be an option. I general I think this type of plan is particularly useful for those who are considering retirement and the original 4% SWR is just on the hairy edge of being achievable or not. For those retirees, or even people working toward retirement, this type of plan can make all the difference in the world.
Full Disclaimer - Nothing on this site should ever be considered advice, research or the invitation to buy or sell securities. These are my personal opinions only.