I don’t know what percent of my portfolio I withdraw. I take 90% of my dividends, reinvest the other 10% and get a pay raise every month.

Sounds like a smart move!

The Captain

1 Like

“When and how did the “4% withdrawal” become the MAGIC number? Why not 5%? Why not 3%?”

Long time ago.

The famous Trinity Study and others analyzed portfolio returns over 30 year periods to determine the appropriate ‘safe withdrawal rate’ from a portfolio that was 50% bonds/50% stock index.

They produced ‘curves’ showing the max rate you could safely take with high probability and survive ‘the worst 30 period in history’. Thus the 4% rule was hatched.

You can do your own analysis using FireCalc and other financial planners.

If you are living off dividends, they are typically 2-2.5% of their value, so you are likely taking less than 4% a year from your portfolio if all dividend paying stocks.

If your time horizon is shorter than 20 years, then you can take more - like 5%.

Put another way, if you don’t spend about 4% of your assets, your heirs likely will after forking over a chunk to the IRS/states in inheritance taxes on estate if it grows too big.
Otherwise, your heirs will get to spend it.

t.

t

4 Likes

Long time ago.

The famous Trinity Study and others analyzed portfolio returns over 30 year periods to determine the appropriate ‘safe withdrawal rate’ from a portfolio that was 50% bonds/50% stock index.

Thanks for the info!

1998 is not all that long time ago!

Trinity study

In finance, investment advising, and retirement planning, the Trinity study is an informal name used to refer to an influential 1998 paper by three professors of finance at Trinity University.[1] It is one of a category of studies that attempt to determine “safe withdrawal rates” from retirement portfolios that contain stocks and thus grow (or shrink) irregularly over time.[2]

“The 4% Rule” refers to one of the scenarios examined by the authors. The context is one of annual withdrawals from a retirement portfolio containing a mix of stocks and bonds. The 4% refers to the portion of the portfolio withdrawn during the first year; it is assumed that the portion withdrawn in subsequent years will increase with the consumer price index (CPI) to keep pace with the cost of living. The withdrawals may exceed the income earned by the portfolio, and the total value of the portfolio may well shrink during periods when the stock market performs poorly. It is assumed that the portfolio needs to last thirty years. The withdrawal regime is deemed to have failed if the portfolio is exhausted in less than thirty years and to have succeeded if there are unspent assets at the end of the period.

https://en.wikipedia.org/wiki/Trinity_study

The 4% rule sounds like a variation on the Kelly Criterion (1956), the max you can bet without going broke.

Kelly Criterion

After being published in 1956, the Kelly criterion was picked up quickly by gamblers who were able to apply the formula to horse racing. It was not until later that the formula was applied to investing. More recently, the strategy has seen a renaissance, in response to claims that legendary investors Warren Buffett and Bill Gross use a variant of the Kelly criterion.

https://www.investopedia.com/terms/k/kellycriterion.asp

The Captain

1 Like

Denny When and how did the “4% withdrawal” become the MAGIC number? Why not 5%? Why not 3%?

AFAIK, 4% was not and is not recommended as a magic number.
It’s a guide, a useful Rule of Thumb for planning.
As such (a Rule of Thumb) it’s not a hard number, and sometimes 3% or 5% (or 1% or 10%) is a better “fit”.

It’s just a starting point for planning.

As a Rule of Thumb, IMO, the SWR, that each person uses, MUST have error bars on either side.
So I agree: don’t fall in love with magic numbers!

I wrote that a 4% SWR on \$1M is \$40,000 before taxes.
If the portfio is the ONLY income, then that’s a rather mean buying power. Personally, I don’t want to live on \$32k/year, as my sole spending power.

4% SWR on \$2M is \$80k before taxes, and ABOUT \$65k after taxes. Incidentally \$65k is ABOUT the median family income a couple years ago.

Income and Poverty in the United States: 2020
https://www.census.gov/library/publications/2021/demo/p60-27….

Median household income was \$67,521 in 2020, a decrease of 2.9 percent from the 2019 median of \$69,560 (Figure 1 and Table A-1). This is the first statistically significant decline in median household income since 2011.

With a \$2M portfolio, one could almost equal the median family income, using a 4% SWR?
4% SWR is a useful planning tool.

ralph

AFAIK, 4% was not and is not recommended as a magic number.
It’s a guide, a useful Rule of Thumb for planning.
As such (a Rule of Thumb) it’s

Now that I know where the 4% number came from (thanks to telegraph) I can relate to it but when used like the article that started this thread, it IS a magic number – or click bait.

Can You Really Retire with \$5 Million? Yes, Here’s How

I can not only retire on \$5 Million but start a charity and have some left over!

Since 1971 the S&P 500 has delivered a CAGR of 7.65%. By taking out 4% per year by 2042 the port will be worth \$9,645,25. Put half in bonds and you are shooting yourself in the foot. Just put the \$5 million in an S&P 500 index fund.

The Captain

``````
**Year   Portfolio  Withdraw                 Gain**
**4.00%                7.65%**
2022   5,000,000   200,000   4,800,000   366,985
2023   5,166,985   206,679   4,960,305   379,241
2024   5,339,546   213,582   5,125,964   391,906
2025   5,517,871   220,715   5,297,156   404,995
2026   5,702,151   228,086   5,474,065   418,520
2027   5,892,585   235,703   5,656,882   432,498
2028   6,089,379   243,575   5,845,804   446,942
2029   6,292,746   251,710   6,041,036   461,868
2030   6,502,904   260,116   6,242,788   477,293
2031   6,720,082   268,803   6,451,278   493,233
2032   6,944,512   277,780   6,666,731   509,706
2033   7,176,437   287,057   6,889,380   526,729
2034   7,416,108   296,644   7,119,464   544,320
2035   7,663,784   306,551   7,357,232   562,498
2036   7,919,730   316,789   7,602,941   581,284
2037   8,184,225   327,369   7,856,856   600,697
2038   8,457,553   338,302   8,119,251   620,759
2039   8,740,010   349,600   8,390,409   641,490
2040   9,031,899   361,276   8,670,623   662,914
2041   9,333,537   373,341   8,960,196   685,053
2042   9,645,249   385,810

``````
2 Likes

If you invested in the SP500 in 1966,

the real return on your investment for the next 20 years was ZERO due to inflation

https://awealthofcommonsense.com/2014/06/1966-1982-stock-mar…

While the SP500 delivered 6.8% annual increase, the average inflation was 6.8%.

IF you were withdrawing 4% a year, inflation adjusted, after 20 years…well…

and most of that gain came from re-invested dividends. (in a taxable account, you’d pay tax on that gain each year too!) making your return even less.

–"Many smart people in the industry are predicting lower investment returns over the next decade or so. Who knows what will happen, but it makes sense to prepare for that possibility.

One of the most interesting scenarios over the next few years would be if the economic recovery really takes off, the job market improves and wage increases ultimately cause lower stock market returns. In that situation everybody is confused and many investors are left extremely frustrated.

We’ll never see another environment exactly like the 1966-1982 period, but we will definitely see periods of underwhelming market performance. "

If the tax bill passes, corporations will pay more taxes, and have less to pay out in dividends or dividend increases.

Companies stressed might even chop or eliminate dividend payments.

t.

1 Like

Since 1971 the S&P 500 has delivered a CAGR of 7.65%. By taking out 4% per year by 2042 the port will be worth \$9,645,25. Put half in bonds and you are shooting yourself in the foot. Just put the \$5 million in an S&P 500 index fund.

There is a bit more to it. The SWR is 4% of the initial portfolio value, adjusted each year for inflation. That way you can maintain the same lifestyle through retirement. As it turns out, there were two critical start periods that lead to portfolio failure: 1929 (obvious what happened there) and 1966-68 when low stock and bond returns combined with future high inflation that would have killed a portfolio. In most other scenarios, you wind up filthy rich at the end of 30 years.

You can test all sorts of portfolios (stock and bond combinations) here:

https://firecalc.com/

This one is easier to use, but not as powerful:

https://cfiresim.com/

But no matter the inputs, the SWR doesn’t vary much from 4%. And of course, as Ralph says the 4% SWR is necessarily backward looking. No one knows what the future holds. So while the 4% SWR isn’t “real” it is also invaluable as a starting place for planning purposes.

P.S. firecalc was created by a former TMF poster named dory36 who modeled it on work done by intercst.

cfiresim grew out of the Mr. Money Moustache forums, partially based on work by Nords, who was also a former TMF poster.

5 Likes

Captain:

Year Portfolio Withdraw Gain
4.00% 7.65%
2022 5,000,000 200,000 4,800,000 366,985
2023 5,166,985 206,679 4,960,305 379,241
2024 5,339,546 213,582 5,125,964 391,906
2025 5,517,871 220,715 5,297,156 404,995
2026 5,702,151 228,086 5,474,065 418,520
2027 5,892,585 235,703 5,656,882 432,498
2028 6,089,379 243,575 5,845,804 446,942
2029 6,292,746 251,710 6,041,036 461,868
2030 6,502,904 260,116 6,242,788 477,293
2031 6,720,082 268,803 6,451,278 493,233
2032 6,944,512 277,780 6,666,731 509,706
2033 7,176,437 287,057 6,889,380 526,729
2034 7,416,108 296,644 7,119,464 544,320
2035 7,663,784 306,551 7,357,232 562,498
2036 7,919,730 316,789 7,602,941 581,284
2037 8,184,225 327,369 7,856,856 600,697
2038 8,457,553 338,302 8,119,251 620,759
2039 8,740,010 349,600 8,390,409 641,490
2040 9,031,899 361,276 8,670,623 662,914
2041 9,333,537 373,341 8,960,196 685,053
2042 9,645,249 385,810

No, NO, NOOOO

you did not include inflation at used 4% inflation number?

At 7% inflation (that seen 1966-1982…)

your money would be worth half as much after 10 years (Rule of 72)

after 20 years, worth 1/4 of original amount.

Imagine gas and food bills then.

If you retired in 1966, 505 index, 50% bonds, you made it to 30 years with zero left in your portfolio

t.

you did not include inflation at used 4% inflation number?

No, I did not. Increasing the withdrawal by 7% annually the \$5 million port is exhausted in 26 years.

The Captain

1 Like

Swooping in to say that Nords had a small consulting role in the creation, but largely it was a reverse-engineered version of firecalc that had extra features added on from crowdsourced user input… created by me a current Fool.

-Lauren

5 Likes

There are 11 million households in the US with more than one million in assets.

There are perhaps 20% of earners that make a very good living in the US.

The issue of \$5 million in pop literature. Just throwing something out their for anyone to feed on while reading.

In addition, those in that position most likely have two Social Security checks each month, so there’s an additional \$72K each year – which should pay for the property taxes and utilities.

DB2

1 Like

Hey Lauren! Thanks for the clarification. I didn’t mean to slight your contribution, just highlighting the early TMF connection.

Suffice to say the modern FIRE movement was made possible by giants like intercst, Nords and you! Along with many others, of course.

1 Like

My rule of thumb: save 15 pct. annually, retire comfortably within your means in 30 to 35 years. A lifetime of living on 15 percent less than you earn will give you a comfortable retirement within your means.

3 Likes

I just explained it briefly in another post here - Withdrawal rate in these times - #6 by MarkR

Thanks!

Maybe using the phrase ‘magic number’ was not the clearest way to express my dislike for this ‘meme.’ There is nothing wrong with the numbers themselves, it’s their consequences that trouble me. In your referenced post you said

If people believe you, and the industry does, the above becomes a dictum. Everyone is advised not to take out more than 4%. The problem is that every portfolio has an owner with distinct characteristics, age, gender, family, wealth, health, risk tolerance, income sources, and so on.

A 4% straitjacket for everyone is not a good idea. It stifles creativity. Same for the 60/40 rule and many more. Let me illustrate with my portfolio. I no longer have any income stream so I need a portfolio that generates income. As I noted previously I do it with covered calls. 2022 results so far (approximate, conflating euros and US\$, ignoring stock capital gains or losses from option trading). The income has allowed my port to beat NASDAQ by almost 2 to 1 despite having hard hit ‘high risk’ securities

``````           YTD
Income    13.35%
Withdraw   8.30%
``````

My point is that ‘magic numbers’ are interesting data points but should not be taken as commandments handed down from on high. There is too much variety among investors to do so. Portfolios should fit like well tailored clothes.

The Captain

This is completely untrue! The 4% rule of thumb is for a 60/40 portfolio for 30 years, nothing more, nothing less. All it says is that 4% out of a 60/40 portfolio would have withstood beginning withdrawals in 1929 and in 1966. That’s essentially it.

If you’re retiring at 75 and expect to live max to 95, you only need 20 years and the safe withdrawal rate is likely higher. If you are ill and expect to live only another 10 years, you can, and should, withdraw more. If you receive social security and/or pensions, that amount is off the top and when calculating what you need, you can withdraw more because you can accept a slightly higher risk of failure. If you have a wealthy family that will take care of you if you run out of money, you can withdraw more than 4%. If you “feel lucky”, you can withdraw more than 4%. Every one of these things you listed is taken into account.

It says nothing about people who have the skills to regularly double the nasdaq returns. Similarly, someone who has the ability to serve on corporate boards, and attend meetings a few time a year, and earn a bunch of money from it. People who have skills that can earn them extra money, will have more money than 4% drawn out of a typical 60/40 portfolio (or 3.93% drawn out of an 80/20 portfolio, or a 1.67% drawn out of a 0/100 portfolio, etc).

2 Likes

I don’t doubt that the above is the intention but, is that was the neophyte investor hears, what he understands? I certainly was confused!

The Captain

Oh, it’s far far FAR worse than this! The neophyte, and even the typical, investor is giving away a quarter to a half of their annual income to the company managing their retirement money. If you take a 4% withdrawal rate, and you pay 1.33% in management/etc fees (and this is very common just using run of the mill mutual funds), then you’re giving away a third of your annual income to them. Some people even pay 2% total annual fees, that’s HALF!

1 Like

Thanks!

The Captain

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