Alternatives to the 4% rule | Vanguard Methods explained | FIRE

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What are the alternatives to the 4% rule, especially to achieve FIRE. In this video we look at some of the methods put forward by Vanguard to determine your withdrawal rate. Irrespective of whether you're seeking to achieve Financial Independence or just understanding your pensions, I explain what affects how much you can withdraw over time.
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16 май 2021

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Комментарии : 45

@roberthansen9558 2 года назад

This is excellent. While the 4% rule is sound, it isn't applicable to most situations. For example, if you are delaying SS or retiring early, you have to plan on withdrawing more in the beginning and less when SS starts. In some cases, you may need to withdraw 8% or even 10% in the beginning, but then this drops to 2% or 3% after SS kicks in. The problem with this is that at 8% or 10%, if your retirement starts at a particularly bad time for the market, you can crush your savings fast. That is where the 4% came to be. At 4% your are mostly guaranteed to survive a bad stretch in the market. But if you limit yourself to 4% at the beginning, then you are wasting your younger years. But, with this dynamic approach, you can plan a larger budget in the beginning, and if the market doesn't cooperate, the plan adjusts accordingly, keeping your savings intact, and still allowing more than the 4% rule. I have modified Vanguard's formula somewhat by using absolute values for the floor and ceiling, rather than percents. In my case, my discretionary budget allows quite a bit of leeway, so my floor is a comfortable budget, while my ceiling is that plus extra for more travel etc. I then adjust the % of portfolio to withdraw each period and limit it between that floor and ceiling. End result is that I am able to push for the budget I want (the ceiling) but pull back if the market isn't cooperating. I have back tested this against prior market trends, back to 1950, and it doesn't fail. Btw, the difference betwee the 4% rule and and say a dynamic 4% rule is that with the original 4% rule, you take 4% of your BEGINNING portfolio amount and stick with that throughout retirement, adjusting for inflation each year. The dynamic version takes 4% of your CURRENT portfolio amount, so it changes each period. You also adjust the dynamic version for inflation as well. As the Vanguard paper shows, in a strong market the dynamic version provides a higher budget and slightly less left (but plenty) at the end (to leave to family). In a weak market the dynamic version provides a slightly lesser budget but leaves more at the end. The issue with the fixed 4% budget is that it either leaves nothing at the end or a lot at the end. Also, it doesn't work well if you want to start off taking 8% or 10% in the beginning.

@IncomeBoost42 2 года назад

Brilliantly said and great strategy. Even more impressive is that you back tested against the market data, very similar to how the original 4% rule came from! I am personally creating a special emergency fund for my early retirement years in case a recession happens. I don't want to start retirement with a few years of low-budget misery. However, I may need to work a year longer, to build make up for that fund. So, that's not for everyone either. Great post, pinned!

@roberthansen9558 2 года назад

@@IncomeBoost42 Yeah, I added a year to mine as well, to give me more leeway. My original plan, 8% withdrawals in the beginning, 2% to 3% at 70 and thereafter, looked fine on paper with an assumed 6% return, but it failed in back testing during some of the worse times (like the 1960's). A sequence of returns issue. I made it to 70, but my portfolio took such a beating that my budget was greatly reduced after that. I had always realized I would vary my budget in response to market conditions, but my original attempts were clumsy. This paper gives a very nice way to do it and the average budget is close to what my original budget was without blowing up my portfolio.

@DaddyDebt 3 года назад

I love the idea of dynamic withdrawal rate for FIRE

@IncomeBoost42 3 года назад

It's not as simple as the 4% rule but never running out of money is quite tempting isn't it 😍

@jasenjacobsen4197 2 года назад

I think a target income, balanced against a 4% rule sounds about right. That is, plan a target income & grow your portfolio until a 4% withdrawal rate can satisfy it. Or, when retirement time comes, you use the portfolio you have to determine your income. Then, you stick with 4% withdrawal rate. Some years 4% will be more than your targeted income - you stash that into short term savings or bonds; it gets removed from the portfolio used to calculate 4%. Some years 4% will be less than the targeted income and you dip into the "escrow" funds to make up the shortfall. If the market does really well for an extended period - say 5 years - that escrow account may grow large and you dip into it for some big purchases - a new car, fancy vacation. But beware that lean times are coming and the portfolio may underperform for a few years, too.

@IncomeBoost42 2 года назад

Great point, especially on keeping a buffer - all too often one can get caught out by a recession and having to cut back. In some sense, once you retire you need to buff the emergency fund and keeping a 4% benchmark with surplus saved is indeed a great way to prepare. Thanks for watching!

@e-spy 2 года назад

thanks for this, as I have been stunned at the standard 4% rule and worried I will run out of money. But not retiring is not an option. I stay at work, I will die with the way they make you work. So I need my current retirement savings to live on. I have a year's expenses saved up and a house so close to being paid off, retirement is around the corner! I will have to support myself for 3 years till SS is available. I think I can do that, and then my SS will be nearly enough to live on with my current expenses. So I like the method where you never run out of money, lol!

@IncomeBoost42 2 года назад

Nice approach. Rent is a big component of expenditure, so it's great that you're not going to have to pay rent or make mortgage repayments soon. The reason why the dynamic withdrawal rate works with a 100% success rate is that when the market is down, you're withdrawing 4% of your current portfolio value which is a lot less than usual (as opposed to a fixed 4% of the initial portfolio value). Withdrawals during a market downturn is what hurts your portfolio the most and hence why in my recent "Emergency fund" video I suggest enough savings to cover for a couple of years and an expenditure reduction emergency plan. If you don't touch your portfolio during the downturn, it has a massive positive impact not only on your portfolio survival rate but also by how much your portfolio grows. As you know, compounding works on your previous balance! So it seems you're in a great place with your savings and SS covering almost all your expenses!

@jameswalker590 2 года назад

The way I understand the 4% rule is that you take 4% from your portfolio the FIRST year of retirement. Each additional year you will add inflation. This makes it so you never touch your principle.

@IncomeBoost42 2 года назад

Absolutely correct! Situations where you "touch the principal" occur when your portfolio grows less than 4% and you still withdraw the same original 4% amount (for example withdrawing during a recession) - and that has a detrimental impact on the survival rate of your portfolio. This is why I really like the idea of having a solid emergency fund to ride through those tough periods instead of endangering the portfolio.

@rodc4334 2 года назад

No. In a crash when stocks are down 50%, taking out anything touches principle. Unless you simply stop spending anything out of your savings until the market full recovers, you will be spending principle. You could chose to only spend out of bonds, but that would still be spending down principle unless you stick to a very low withdrawal rate and even then only if bonds are paying more than inflation.

@igt2173 Год назад

@@IncomeBoost42 what if during recesion we withdraw 2% ...atleast index funds will give a return above inflation rate right?

@IncomeBoost42 Год назад

@@igt2173 Index funds are not guaranteed to give you positive returns all the time and during a recession, it’s very likely that your portfolio value will fall as well. Ideally, you want to avoid withdrawals when your portfolio has lost significant value. This is because if you withdraw $100 that would have been e.g. $150 previously. One way people avoid these detrimental withdrawals is by having savings to buffer for a period e.g. 1 or 2 years. Having this buffer funds in a savings account gives you interest but you may still need to top up occasionally to adjust for inflation. But that way, you won’t need to sell stocks when the markets are down.

@SammifromMiami Год назад

Any comments on using part of retirement savings to purchase say, a 5 year certain annuity at age 62 that would be equal to one’s Social Security payment at age 67, then can draw SS at age 67? This would be a bridge from age 62-67. This would also allow one to work part time if one chooses without giving back any of the SS because of the penalties for working before full retirement age.

@IncomeBoost42 Год назад

Thank you for a really interesting question - I didn't know much about the US-specific rules but it got me to do some research and I think this is worth a video of its own. But here's the jist of it (and not financial advice): if you retire at 62, you'll indeed need to plug in a 5 year gap until Full Retirement Age (FRA) of 67. Now, the benefit is that you get an extra 30% payout. However, when you factor the cost of putting a lump sum into an annuity that basically removes any future compounding with it - it is quite detrimental. For example to get $1k/month at FRA, you would need a 5-yr fixed annuity which would cost about 55k. That compounded at 6% over 15 years, i.e. until Average Life Expectancy (ALE) of 77, would have generated 135k. With waiting until FRA, you'd get an extra 300 a month for 10 years until ALE, which sums up to 36k. So you win 36k and lose 135k potentially. And yes, shockingly, the US life expectancy is actually 77 and falling! Of course, the annuity guarantees you an income during that period whereas your portfolio may not, but there are strategies to reduce volatility in a portfolio e.g. including bonds or even better in some circumstances - a retirement emergency fund, which is what I recently covered in my videos. Feel free to check them out!

@ericj9011 11 месяцев назад

How about filling that gap with a TIPS bond ladder, instead? Would be interesting to compare the numbers.

@czeital Год назад

Good video thanks however I couldn’t work out where the inflation rate was factored into vanguards dynamic method? Thanks

@IncomeBoost42 Год назад

Great question! So the pure dynamic withdrawal rate does not account for inflation directly. But assuming your portfolio outgrows inflation, then your withdrawals will be higher in real (inflation adjusted) value. If not, then in real terms your withdrawals won’t have as much purchasing power. So, a critical assumption for all portfolio success, irrespective of methods, is growth exceeding inflation rate, at least in the long run. Now, the issue the pure dynamic spending is that one year you could withdraw 40k and the next it could fall to 20k. Hence, a more stabilised version may be preferred, hence the vanguard dynamic floor/ceiling method. But here, one should be careful with the ceiling which should be set at a rate greater than inflation rate. Otherwise, even if your portfolio outgrew inflation, you would be capping the withdrawals below the real desired income level. The 5% ceiling in this example assumed that inflation was way lower, like 2%, but with high inflation rates, the floor and ceilings need to be adjusted accordingly. Hope that makes sense.

@czeital Год назад

@@IncomeBoost42 Thanks -it does thanks. It will be interesting to see if Vanguard release any updated figs or simply see current high inflation as temporary and stick with these example figures.

@muffemod 8 месяцев назад

Easily watchable on 2x speed.

@kbmblizz1940 2 года назад

Common sense tells us when there is a bad year for investors, e.g. 2008-2009, we naturally cut back our discretionary expenses. If one's budget won't allow that, maybe should keep working or live a lower cost lifestyle.

@IncomeBoost42 2 года назад

Well said. Thanks for watching!

@derekwells9550 2 года назад

4% is easy math, who wants complicated algorithms when you retire,

@IncomeBoost42 2 года назад

It is a very easy rule and hence why it’s popular. Nevertheless, it’s good to bear in mind its weaknesses as well, particularly be careful during recessions. That’s not to say complicated models are better neither because they can bring more effort, stress and worry which is counterproductive in retirement. So there’s definitely an element of convenience, practicality and personal choice at play when choosing your withdrawal rate. Thanks for watching

@rodc4334 2 года назад

If you want simple and safe take 1% every 3 months. Yes it will go up and down, but if you really need every last dollar of the so-called 4% rule you simply are not ready financially to retire. It is crazy to set an income plan and expect to not adjust over 30 years! Life is way too uncertain for that. The 4% rule is only for making plans in pencil: what you might be able to take out in the future, not what you necessarily are going to be able to take out in the future. The good news is you are flexible and cut back your withdrawals in down markets, in the long run you will likely be able to take more than the 4% rule on average. But today you cannot plan on that, because sometimes the markets (stocks or bonds) are lousy for long periods of time.

@MrGoodaches 2 года назад

Apparently all the vids about 4% Rule and a few alternatives are totally ignoring 401K, 403B, and IRAs. By no later than age 72 the US IRS dictates your RMD by age. The fractions, based on your remaining statistical life expectancy, are initially nearish to 4% but as you get older the denominators get smaller equating to percentages that climb to 10% within a realistic life expectancy and then accelerate towards 50% after that. So considering that the majority of retirement savings are in tax deferred accounts and most will only have a decade of retirement before the size of distribution is mandated by RMD, discussion of 30 year horizon of 4% Rule (or alternatives) seems pointless. It seems to me that some vids should address a 10ish year plan that arrives at age 72 with an adequate amount so that from 72 on the RMDs meet spending or tax objectives for the remaining lifetime. Is there something I’m not understanding?

@IncomeBoost42 2 года назад

You captured the complexity of optimal withdrawal rates. On one end of the spectrum, the east side, you have rule of thumbs like the 4%, which is catchy but a bit flimsy. On the other end of the spectrum, you have the more complicated but more robust solutions. These might include stress testing the portfolio of investments under different futures, fully utilising tax wrappers, social security and tax allowances to minimise tax and also dynamically adjusting your withdrawal rate to changes in the markets and life expectancy. The modelling can get complicated and hence why people may prefer to settle somewhere in between. Nevertheless, I would say that it’s important to recognise the strength and weaknesses of each spectrum.

@rodc4334 2 года назад

No one says just because a required withdrawal says take more than 4% you must spend it. You can take from a 401K or whatever and plow it back into a taxable account. You can even put it in a very low tax or no tax account. For example put it into treasury bonds, and reduce the bonds in your 401K. All RMD do is make sure you start paying deferred income taxes. The 4% rule has a lot of problems but this is not one of them. To your point though, the 4% is predicated on someone who needs to plan out 30 years. If one is healthy and retires at 50, need to plan out about 45 years so 4% rule was never meant to apply even as an estimate and they better plan for less. If one retires at age 75, and needs to only plan out about 20 years, then the 4% also does not apply and that person could expect to take more.

@rtj6874 2 года назад

My withdrawal rate? 0%. Why? I will be living 100% off dividend income and not touching my principal such that not only can I live off dividends, but will be producing more than I need to live on and thus can continue to DRIP thus growing the snowball even more.

@IncomeBoost42 2 года назад

Nice! There’s something about receiving dividends that feels good and it’s easier than selling part of your portfolio and withdrawing. For example £100 in dividends or £100 in capital gains are theoretically the same but to me, the dividends feel better. It’s psychology I guess! One thing to bear in mind though, is once your dividend income and portfolio reach a certain value it might be more tax efficient to sell some shares instead (and refrain from investing in income stocks). This is because capital gains allowances are greater than dividend allowances (£12,300 vs £2,000) and with capital gains you can ‘choose’ when and how much tax you want to pay by selling accordingly. Then you can get the best of both worlds. And those reduced tax payments mean a few cocktails 🍹 by the beach 🏖 !

@rtj6874 2 года назад

@@IncomeBoost42 Ahh, I am in the US, dividend income up to $40000 pay zero taxes and from $40000 to $451000 you pay 15%.

@IncomeBoost42 2 года назад

Ah right, I see. I'm not too familiar with the US tax system, but from what I read, they are very similar in how they are treated. That seems very favourable compared to the UK. We pay 0% up to £12,750 ($17,264), 20% from £12,570 - 50,270 ($17,264 - 69,045) , 40% from £50,270 - £150,000 ($69,045-206,025) and 45% above £150,000 ($206,025).

@danielkirkland3366 2 года назад

@@IncomeBoost42 all you got to do is invest through an stock and shares ISA Then you will pay zero tax on returns, capital gains or dividends

@IncomeBoost42 2 года назад

@@danielkirkland3366 Great point, with ISA you don’t have to worry about tax. Remember though, you may sometimes also want maximise your tax free allowances first before you dip into your isa (as you may want to let it compound a little further) Chris Bourne shows a great example of this with an example of £70k withdrawal tax free ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-di-AoEKCmlY.html

@bubbafatas2588 2 года назад

No method is precise! Buy high yield funds, LPs, reits, select stock funds, etc etc and live off the dividends and never run out and earn 6- 8 %

@IncomeBoost42 2 года назад

Good diversification is key!

@Wasteoftime10 3 месяца назад

Until a crash and recession comes, and your principle decreases by 65% and the same time the dividends are also cut by 50%.

@rodc4334 2 года назад

This is kind of stupid. The 4% was never intended to be an actual plan that one sets in motion and never reconsiders for 30 years. It is just a back of the envelop estimate of what you might expect at more or less a minimum. 90% or more of the time you will be able to do better. But in a deep recession no one is going to blindly spend all they once thought they could because you may never recover if you spend down to far in the crash. This is just common sense. Every one keeps tabs on how they are doing and adjusts as needed.

@IncomeBoost42 2 года назад

Indeed, however you may be surprised by how many people like the simplicity of a rule of thumb at the risk of overlooking critical aspects. The 4% rule is even more prevalent among the FIRE community. I mention this in my other video about why the 4% rule is wrong, particularly on how things have changed from the time the study was conducted.

@rodc4334 2 года назад

@@IncomeBoost42 If some FIRE person plans on the so-called 4% rule as an actual plan that is crazy. Likely they talked themselves into believing the FI when they are not, and decided to RE but will soon enough need to find a new job! They need 40 or more year perhaps, not 30. Right now bond yields are super low, stock price to earnings (maybe best measured as P/E10) are near historic highs. Even so one might average 4% (of starting balance + inflation) if they can cut spending when stocks tank, rebalance by selling bonds to buy stocks at low prices. If they want something really simple, they could take 1% every 3 months and let their income fluctuate. That would never have them go broke, likely increases with inflation on average. But it requires actually being FI, that is to say have enough money they can very easily their fixed expenses so the fluctuations simply effect things like vacations, how nice a car they drive. But I know I am preaching to the choir! 😀 Hopefully it will helps some viewer some day.

@rodc4334 2 года назад

@@IncomeBoost42 Wow, the FIRE group really should know better. Interestingly enough back around 1990 people like the legendary investor Peter Lynch was saying 10% and advisor William Bengen knew that was bunk, but to say that he needed to be able to say what was sensible. He did a simple little study with some simple assumptions to get a ball park estimate. His little study said 3% was really too conservative. 5% was ok sometimes but not always so really not that safe. 4% worked almost always. So something like 4% under simple conditions was the ballpark answer. Then over time people made 4% into something it was never supposed to be. Someone who retires early and needs their money to last 40 or more years better be smart about it!

@IncomeBoost42 2 года назад

@@rodc4334 Thank you for really nailing those points. The study was at a time when bond yields and S &P 500 returns were high. Vanguard’s Forecast returns over the next decade, show a substantial slowing down of expected returns from the US between 2-4%.Check it out: advisors.vanguard.com/insights/article/amidyearupdateonoureconomicandmarketoutlook At this rate, 4% withdrawal for FIRE is a terrible strategy. I blame those RU-vid ads selling get rich quick schemes to retire early 😅

@Wasteoftime10 3 месяца назад

From 1929 to 1992, the capital appreciation of the stock market adjusted for inflation was exactly 0%. Thats 0% for 63 years. So much for 90% of the time you can do better than 4%.