Maximizing Your Retirement Income: The 4% Withdrawal Rule & Retirement Withdrawal Calculator

Oct 10, 2023 | 401K, ETFs, Feature, Investment Portfolios, Investments, IRA, Mutual-Funds, Newsletter

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Regular AAC (Asset Allocation Composite), SAA and TAA portfolios are always rebalanced on the first trading day of a month. the next re-balance will be on Wednesday November 1, 2023. 

As a reminder to expert users: advanced portfolios are still re-balanced based on their original re-balance schedules and they are not the same as those used in Strategic and Tactical Asset Allocation (SAA and TAA) portfolios of a plan.

Maximizing Your Retirement Income: The 4% Withdrawal Rule & Retirement Withdrawal Calculator

Retirement planning can be daunting, especially when it comes to determining how much money you can withdraw from your investment portfolio each year without running out of funds. This is where the concept of safe retirement withdrawal rates comes into play. But what exactly is a safe withdrawal rate, and how can you ensure your retirement income will last for at least 30 years?

At MyPlanIQ, we have studied and monitored several popular safe retirement withdrawal rate strategies. In this newsletter, we will first revisit this concept, review the latest data and then introduce our retirement withdrawal calculator that can be very useful for those who like to explore various strategies on various funds and portfolios in various periods. 

The Origins of the 4% Rule

A safe annual retirement withdrawal rate refers to the amount of money you can withdraw from your investment portfolio each year without depleting your funds too quickly. In general, a safe withdrawal rate is one that can guarantee income for at least 30 years. This assumption is based on the income being purely from an investment portfolio that includes stocks, bonds, and/or real estate.

The concept of a safe retirement withdrawal rate is not new. In fact, it dates back to the early 1990s when financial planner William P. Bengen introduced what has become known as the “4% rule.” This rule suggests that retirees can safely withdraw 4% of their investment portfolio each year without running out of money for at least 30 years.

The 4% rule is based on historical market data and assumes a portfolio mix of 50% stocks and 50% bonds. Bengen conducted extensive research on stock and bond returns over the past century and found that a 4% withdrawal rate would have provided sufficient income for a 30-year retirement period.

A more challenging objective is to determine an annual withdrawal rate that not only guarantees a stable income for at least 30 years but also maintains the purchasing power of the investments after 30 years, accounting for inflation. While this is a more ambitious target, it is a desirable option for many individuals who aim to leave behind an estate that retains its original value. A even more ambitious goal is to be able to safely spend your retirement fund perpetually for more than 30 years. 

Retirement withdrawal strategies or rules

Here is the synopsis of several retirement withdrawal strategies:

  • The 4% retirement withdrawal strategy: at the end of every calendar year, withdraw inflation-adjusted 4% for the next year spending. Inflation-adjusted 4% means for the first year, you start at 4%, and then the next year’s withdrawal rate would be adjusted by previous_year_withdrawal_rate*(1+inflation_last_12_month). Inflation is normally defined as using the Federal Reserve CPI for All Urban Consumers data. This approach may provide a consistent income stream, but it does not account for fluctuations in market returns.
  • Floor and ceiling withdrawal strategy: the withdrawal amount is calculated as a percentage of the portfolio total value. The withdrawal amount is allowed to rise or fall with the performance of the portfolio. However, the withdrawal will neither fall below a floor nor rise above a ceiling. In Journal of Financial Planning. May 2001 issue, Bengen suggested this strategy to accommodate more volatile portfolio fluctuations. 
  • Sensible withdrawal strategy: it suggests withdraws at least at a floor percent. But in a good year when investments grow much higher than the inflation, it can allow to withdraw more by setting up a cap such as half (0.5 or 50%) of the amount from the original accumulated floor amount. See Sensible Withdrawal strategy for more details. 

Empirical Data Based on MyPlanIQ’s Portfolio Data

While the 4% rule has been widely accepted as a standard for safe retirement withdrawals, there are some who question its validity in today’s market conditions. To address this concern, MyPlanIQ has monitored several portfolios for more than a decade to see how effective these strategies have performed. 

MyPlanIQ’s study found that the 4% rule is still a valid guideline for retirement withdrawals, but the actual safe withdrawal rate may vary based on individual portfolio allocation and market conditions. For example, portfolios with a higher allocation to stocks may have a higher safe withdrawal rate than those with a higher allocation to bonds since 2000 as in general, stocks have done well. 

Retirement withdrawal portfolio comparison:
Assumption:
  • Initial amount is assumed to be $100,000
  • Period: from 12/31/1990 (for VBINX, 12/31/1992) to 12/30/2022
Ticker/Portfolio Name Total cumulative withdrawal Last annual withdrawal Remaining Value
P Vanguard 500 VBINX Sensible Withdraw 4% No Extra Withdrawal 182,398 8,672 220,488
P Vanguard 500 VFINX Sensible Withdraw 4% No Extra Withdrawal 208,363 9,484 1,228,190
P Vanguard 500 VFINX Sensible Withdraw 4% 428,339 9,484 164,732

A few comments: 

  • The aggressive Sensible Withdraw portfolio has had more than double cumulative withdrawal amount, compared with the pure 4% withdrawal one. However, this comes with a big price: their remaining values (on 12/30/2022) are way too different: the conservative one has 7.4 times more value than the aggressive one! So a good saving goes a long way: double spending or 7 times more wealth at the end!
  • The balanced one (VBINX) has a comparable spending (withdrawal) amount, compared with VFINX. However, its remaining value is also much lower than the VFINX one. 

Certainly, it’s important to note that the data presented above is significantly influenced by past market conditions. Given that our present bull market has extended beyond 14 years, doubling the typical length of a 7-year bull/bear full market cycle, we would like to advise readers to approach the most recent data with caution. What becomes more intriguing is the examination of data commencing from a bull market peak. To facilitate this, we can utilize MyPlanIQ’s recently introduced retirement withdrawal calculator.

Retirement Withdrawal Calculator

The Retirement Withdrawal Calculator calculates or simulates each year’s withdrawal amount and how much remained in an investment for an annual withdrawal rate that’s inflation adjusted. It can take a fund (ETF or mutual fund) symbol (such as SPY for S&P 500 index ETF) desired. You can also enter a stock symbol (for example, a dividend paying stock such as VZ (Verizon Communication) or XOM (Exxon Mobile). Furthermore, you can even enter a MyPlanIQ portfolio symbol in the format of P_xxxxx where xxxxx is the portfolio ID. For example, P_46880 represents ‘Schwab Total Return Bond‘ portfolio (you can find its ID in its URL https://www.myplaniq.com/invest/port/?ID=46880). In essence, the calculator works for any stock, ETF, mutual fund or even a MyPlanIQ portfolio.

Users have the option to experiment with various settings, such as the annual withdrawal rate (with a default setting of 4%) and the starting date. For instance, if we wish to assess how a fund would perform if we initiated our retirement spending at the height of a bull market, we can specify the starting date for comparison purposes. Below, you’ll find two distinct outputs corresponding to two different starting dates for the S&P 500 fund VFINX. We also encourage users to explore other balanced funds (such as the 60/40 Vanguard balanced fund VBINX) or portfolios.

The first one starts retirement withdrawal in 1/1/2008 (a bull market high): 

The second one starts retirement withdrawal in 1/1/2009 (a bear market low):

A few observations:

  • Starting from a bull market peak (2008), even though it has one more year to spend, its cumulative withdrawal amount at the end of 2022 stood at $94k, compared with $145K for the one starting in 1/1/2009! So retiring in a bull market peak can severely affect your spending!
  • Similarly, notice the withdrawal in year 2008: it had only $2.5k. This is because the $100K portfolio at the beginning of 2008 became only $63K at the end of 2008 because of the drawdown or loss of VFINX (S&P 500) in that year! So this retiree must have felt a big squeeze in that year as it really only could spend 2.5% of its money that year (from the beginning $100k point of view)! In fact, its annual withdrawal never caught up with the one starting on 1/1/2009, usually 40% or so lower.
  • The final wealth is also very different: the bull market one is about 63% or 2/3 of the bear market one. 

The above study shows that retiring at the peak of a bull market turns out to be the worst time to retire. This is somewhat counter intuitive. 

Conclusion

Retirement planning requires careful consideration of many factors, including your investment portfolio, market conditions, and retirement goals. A safe retirement withdrawal rate is an essential component of retirement planning and can help ensure your income lasts for at least 30 years. While the 4% rule is a useful guideline, it is important to consider other withdrawal rules and compare and contrast. Furthermore, MyPlanIQ Retirement Withdrawal Calculator can be used to test out various scenarios to better understand how a withdrawal strategy behaves in both good and bad market cycles. 

Market Overview

As mentioned in our previous newsletter two weeks ago, the ongoing increase in yields of long-term Treasury bonds is certainly a cause for concern. Currently, the 10-year Treasury yield stands at 4.78%, which is notably higher than the 4.56% observed two weeks ago. The persistence of these elevated long-term interest rates is exerting significant pressure on business spending and overall growth.

Other notable developments: 

  • the iShares 20+ Year Treasury Bond (TLT) recently suffered one of its most substantial drawdowns from its peak, reaching a maximum drawdown of 42% as of last month (and including this month, its drawdown is now at 44.2%)!
  • The utility sector stocks have had their worst year relative to the S&P 500 index since 1999.

  • Year to date, all of the ‘safe’ S&P sectors have had negative returns:
‘Safe’ or defensive S&P sectors have lost money this year: 
Ticker/Portfolio Name YTD
Return**		 1Yr AR 3Yr AR 5Yr AR 10Yr AR
XLP (Consumer Staples Select Sector SPDR ETF) -7.5% 3.6% 5.2% 8.1% 8.5%
XLU (Utilities Select Sector SPDR ETF) -15.5% -7.0% 1.8% 5.4% 8.4%
XLV (Health Care Select Sector SPDR ETF) -2.3% 6.8% 9.8% 9.1% 11.9%
XLK (Technology Select Sector SPDR ETF) 36.6% 35.8% 14.7% 19.5% 19.8%

Currently, we observe two potential scenarios: either the economy will persist in its growth despite the prevailing high-cost environment, or interest rates will need to rapidly decrease for the markets to achieve stability. It’s important to emphasize that even in the event of continued economic growth, the current stock valuations are significantly less appealing compared to fixed income and cash, both of which are currently offering much higher yields. If you have the opportunity to secure a risk-free return of 5% or more annually, it might not justify the risk associated with stocks, which could potentially yield low or even negative returns in the upcoming years.

As always, we claim no crystal ball and we call for staying the course which is guided by the well defined and sound strategic and tactical strategies:

  • For strategic allocation (buy and hold) investors, ignore the current market behavior. Remember, as we have emphasized numerous times, when you choose and commit to a strategic portfolio, you essentially know and commit that your investment horizon (or the time you need to utilize this capital) is 20 years, preferably much longer, given the current high valuation. As we pointed out, if your investments are those diversified (index) funds such as an S&P 500 index fund (VFINX, for example), you know your money is in some solid ‘business’ that eventually (20 years later and preferably many more years later) will deliver some reasonable returns. As long as you are comfortable with this thesis, you should sit tight and forget about the current gyration.
  • For tactical investors, again, you have to ignore the current market noise. Furthermore, you should follow your strategy rigorously, especially during this time. Human emotion, both optimistic and pessimistic, and human desire, both greedy and fearful, are your worst enemies. This is true time and time again.

Stock valuation has dropped, and now valuation is becoming less hostile. However, it is still not cheap by historical standards. For the moment, we believe it’s prudent to be extra cautious. However, how serious a correction might be, we have confidence in the US economy in the long term and thus in the stocks in aggregate. We just need to manage through interim losses carefully.

We again would like to emphasize that for any new investor and new money, the best way to step into this kind of market is through dollar cost average (DCA), i.e., invest and/or follow a model portfolio in several phases (such as 2 or 3 months) instead of the whole sum at one shot.

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