Tag: fixed percentage strategy
The simplest retirement plan ever.
Jason 0 Comments Career after Retirement Retire Wealthy
there are a lot of complex strategies out there when it comes to withdrawing your money in retirement we've already gone over some of them such as the Guyton clinger rule but not all strategies have to be that complicated to work well sometimes the simplest strategy is the most brilliant of all and today that's what we're gonna talk about we're gonna be talking about two of the simplest retirement spending strategies out there we're gonna discuss their pros and cons as well as who should be using them let's get started but before we get going be sure to LIKE this video if you haven't already as it really does help out the channel a lot and subscribe with notifications on for more money related videos like this one every single week so the strategies that we're gonna be covering today are very similar to one another in that they are both known as fixed withdrawal strategies they are the fixed dollar withdrawal strategy and the fixed percentage withdrawal strategy let's start with the simpler of the two the fixed dollar withdrawal strategy the fixed dollar withdrawal strategy is exactly what it sounds like you begin by withdrawing a certain dollar amount from your nest egg every single month and keep that amount constant throughout your entire retirement it literally doesn't get any simpler than that say if John were living on this strategy in retirement he has a 1 million dollar nest egg and wants to be able to live on $40,000 a year he withdraws $40,000 in that first year of retirement does the same thing in the second and so on and so forth in other words there are no adjustments for inflation using this method to analyze this strategy let's look at the four factors of retirement which for those who are new to this channel our income risk stability and buying power income measures how much money is coming in the door each month as well as when that money is coming in its measured this way because not all retirement spending strategies are systematic and linear with their income growth and none of us know how long we're gonna be in retirement so we tend to put more of a priority in having abnormally high income years in the earliest portion of our retirements since we don't know if we'll ever get to the later portions risk is the likelihood of outliving your money stability is graded by how often you experienced anything that would be considered an undesirable change in your income from one year to another this could come in the form of a freeze on the growth of your income or just a decline in your income from near to the next and buying power is defined like it always is it's a measure of how much your money can actually get you at any given time and is largely tied to inflation the fixed dollar strategy is generally considered to be a little stronger on income and risk in comparison to other popular strategies like the 4% rule but it does suffer in terms of stability and buying power the reason for this is simple as long as your initial withdrawals aren't too high you're relatively unlikely to outlive your money using this strategy and you may actually be able to live at a higher standard of living at least initially than you would have in other similar strategies like the 4% rule in fact going all the way back to 1950 if John had had that one million dollar nest egg invested in something like the S&P 500 he would not actually outlive his money during any 20 30 40 or 50 year retirement as long as he would true no more than fifty four thousand dollars a year or forty five hundred a month so even things like the housing crisis in dot-com crash didn't cause him to run out of money so this does grant John a higher standard of living initially than the 4% rule would have because of course with a 1 million dollar nest egg the 4% rule would only allow him to draw $40,000 a year to live on though eventually like I said the inflation effect would catch up with him using the fixed dollar approach and that's where this strategy does tend to fall short it's not meant for longer retirements because while John may be able to handle living on $54,000 a year particularly if he's retiring debt free with a paid off home it becomes increasingly difficult to do that as the years go on due to the inflation effect historically speaking inflation has averaged somewhere between 2 and 3% per year in the United States if we assume that our personal average inflation rate in retirement is nearer the top of that scale well at 3 percent per year then John's $54,000 a year income will get him the equivalent of what $40,000 would buy him today in just 10 years time in 20 years his money would only be able to buy him about what twenty nine thousand nine hundred dollars would buy him today and his money would be worth the equivalent of twenty two thousand two hundred and fifty dollars sixteen thousand five hundred and fifty dollars and twelve thousand three dollars a year in 30 40 and 50 years respectively just because of the effect of inflation so just for a minute let's imagine that John had decided to follow the financially independent retire early movement but instead of using the 4% rule which helps to protect your buying power over longer term retirements like those in the fire community are aiming for John decides to use the fixed dollar withdrawal method assuming everything else stayed the same John would retire at the age of 30 with a $54,000 a year income and a 1 million dollar nest egg again at the age of 30 that would be perfectly fine for him however the average life expectancy for people living in the u.s.
Is about 79 years old as of 2019 and it's possible that that number will continue to grow as technology and medicine continues to advance so assuming he doesn't die young it isn't out of the question that he would have a near 50-year retirement and be living on the equivalent of about $1,000 a month when he's aging and his medical costs are at their highest as you can imagine that wouldn't be an ideal situation for John and that's why this strategy generally isn't the best idea for longer term retirements but for the right person in terms of the four factors of retirement the fixed dollar strategy is above average and income and risk but below average instability and buying power in comparison to the 4% rule the fixed percentage method works very similarly to the fixed dollar method except that you're withdrawing a certain percentage of your nest egg every year as opposed to a certain dollar value this strategy also doesn't adjust for inflation but it does at least adjust with the value of your portfolio and depending on what you're invested in and what initial percentages you choose this method may work out all right say John just wanted to withdraw a 4% of his investments each year in retirement since the value of his investments were $1,000,000 when he retired he would withdraw $40,000 in his first year that would leave him with nine hundred and sixty thousand dollars left over if his investments went up by 10 percent that year the value of his portfolio would be somewhere in the neighborhood of a million and fifty six thousand dollars at the start of his second year of retirement since he's withdrawing four percent of that he would live on forty two thousand two hundred and forty dollars in that second year assuming inflation was three percent during that first year of his retirement his buying power would have actually gone up if he had merely adjusted his withdrawals for inflation like he would have if he were using the actual 4% rule he would have withdrawn 40 1200 dollars in his second year or about a thousand and $40 less than he did using the fixed percentage withdrawal method in this scenario the downside that I'm sure a lot of you already see is that the reverse can also happen say that the following year john's investments fell by 20% bringing the value of his nest egg down to about eight hundred and eleven thousand dollars and forcing him to withdraw thirty two thousand four hundred and forty dollars in the third year of his retirement that would be significantly less than the forty two thousand four hundred dollars that John would have withdrew in that third year using the actual four percent rule so as you can see depending on the situation stability is something that this strategy could have a very low score in given that the value of a nest egg especially if it's invested in something like stocks can grow or shrink by 20 30 or even 40 percent from one year to the next the bright side of course is that you have a very low risk of running out of money theoretically it's actually zero if you're able to follow this strategy to a tee and I specifically say theoretically because like many things it's only gonna be true up to a certain point if we take it to a logical extreme we can break this down say if John had $10,000 in his nest egg and he wanted to live on fifty percent of that nest egg for the next five years in theory he'd be fine and he'd never run out of money because he'd always be withdrawing fifty percent of whatever that nest egg is but how many of us are gonna be able to live on five thousand dollars a year that would be what he'd be withdrawing that first year and of course it would be even less the second year if his investments stayed flat his second years withdrawals would be half of five thousand dollars or twenty five hundred dollars and I don't know many people that are living on two hundred dollars a month but the point is if you're willing to take the hit to the stability of your income in retirement you can usually safely squeeze out a little more than four percent of your nest egg each year in a typical retirement using this strategy you just have to be prepared to see the average raw dollar income that you receive shrink as you go further into your retirement to illustrate this let's say that John withdrew 10% of his nest egg each year assuming he had that one million-dollar nest egg he would start out with a six-figure income however if he ended up living longer than he planned on he could eventually find himself living on what would only be generously described as a shoestring budget for example in the simulations I ran covering the various retirement lengths starting from 1950 onward assuming John had invested in the S&P 500 he would have had a median monthly income of about $6,500 a month in 20 and 30 year retirements which when adjusting for inflation would be about $3,600 a month in 20 years scenarios and twenty seven hundred dollars a month in thirty-year scenarios but that number did shrink a lot as the retirements got longer for example in 50 year retirements his average median monthly income was about forty four hundred dollars which again doesn't sound bad but when we look at the final few years worth of his monthly withdrawals we find that it's actually about $2,300 a month on average which is considerably less than the six-figure income he started with and of course that $2,300 a month was what he was actually withdrawing almost 50 years from now once we adjust for inflation over that time it may not even buy John what $1,000 a month would buy him today so similar to the fixed dollar withdrawals your buying power could be taking a significant hit if the initial percentages you set in this strategy are too high in summation the fixed percentage method scores reasonably well though not elite when it comes to income particularly when used in early retirements it does great in terms of risk again assuming you're not too aggressive with your initial percentages but is questionable with stability and below average in terms of buying power so in the end who should use these strategies now I'll admit I am personally biased here I believe there's very few people who should realistically be using these strategies as their primary method it's mainly limited to those with very short expected retirements so that their buying power doesn't become too damaged over time and even then ideally only by those who are also approaching that same retirement with little to no debt because especially with the fixed percentage method you'll often need to be pretty flexible with your spending from your year but for those who aren't retiring early and will have no more than nine or ten years that they expect to be retired they have little debt to speak of and want something very simple to follow when figuring out how much of their money they should withdraw each year one of these strategies could work out well it gives you some advantages in terms of income without significant increases in risk but what are your thoughts do you agree with my assessment of the strategy or do you think that I'm missing something do you think another strategy would work better for people in that situation let me know in the comments section below but that'll do it for me today once again if you haven't already be sure to LIKE the video as it really helps the channel a lot and if you want to learn more about various retirement planning strategies be sure to check the links on the screen for my videos on how to safely spend money in retirement as well as protect your nest egg and as always thanks for watchingRead More