How does the 4% swr work in real life?

[67walkon]

I understand the 4% concept. My wife, a long retired banker, understands it to. But how does it work for you guys?

Assume Mr. and Mrs. Thrifty retire when Mr Thrifty hits 62. Assume they have $2,000,000 million in savings/401's, etc. Assume the Thrifties have their money invested in some municipal bonds, dividend paying stocks and some corporate bonds, yielding an over all cash flow of $90,000 a year, or 4.5% total return. The Thrifties have saved up enough cash to have $90,000 put away.

In year 1, under the 4% SWD method, would they spend $80,000, or 4% of the nest egg? Or would they be able, should they choose to do so, take the $80,000 plus the $90,000 cash flow?

During year 1, the value of the next egg could go up or could go down. More than likely it would go down. But it could go up. So at the start of year 2, do the Thrifties then pull down 4% of the then value, plus what is left of the $90,000 cash flow since some assets were sold?

OR, do the Thrifties just take the 4%, or $80,000 in year 1 and let the $90,000 cash flow just go into the kitty? If that's how it works, year 2 would result in the Thrifties taking out $83600, because they would also take 4% of the $90,000 cash flow they left in there.

Seems to me that if the second option is the right way to do the 4%SWR, you will never run out of money unless you consistently have returns of less than 4%.

So how does it work?

 

[Midpack]

This is what I've always read to be the original WR...

Conventional wisdom states that, when it comes to retirement planning, the 4% “safe withdrawal rate” (SWR) rule is the platinum standard. That rule, dating back to William Bengen’s 1994 article in Journal of Financial Planning, says that a new retiree can safely withdraw 4% of their savings in the first year of retirement and adjust this amount for inflation in subsequent years.* Bengen found that this strategy is safe in the sense that the strategy will not lead the retiree to exhaust all of his or her remaining assets for at least 30 years.

IOW, you withdraw 4% of your nest egg in the first year, and then withdraw the same amount plus inflation in year two, ad infinitum (your withdrawal increases by 3% or whatever inflation is each year). In theory you never reconsider your portfolio performance again after year one, that's all baked in to the historical data (as is the cash flow you project in your example), though I doubt anyone would actually ignore actual returns/nest egg balance.

 

[youbet]

In the classic 4% + inflation scenario that's tested vs. historical data with the FireCalc tool, you spend 4% of the original FIRE portfolio amount the first year. The next year you increase that amount of spending by the first year's CPI. The third year you you increase the second year's spending amount by second year's CPI. And so on and so forth.

FireCalc testing also assumes some AA and if your's is different, then don't expect FireCalc to have any relevance to whatever you're doing.

Many folks modify that classic scenario and you can use the search feature to find many discussions on the various methodologies.

 

[Alan]

Seems to me that if the second option is the right way to do the 4%SWR, you will never run out of money unless you consistently have returns of less than 4%.

So how does it work?

Seems to me that you have it figured out.

I'm just coming to the end of year 2 but because of unplanned, unexpected, infusions of cash in year 1, I've re-invested most of the dividends and interest in my ER savings in the first 2 years as I didn't need to take them.

 

[Katsmeow]

In the hypothetical given you would take out $80000 the first year. The second year you would take out $80000 adjusted for inflation. Each year you take out $80000 but adjust it for inflation.

Theoretically how much is taken out is not affected by how much your investments earn during the year. As a practical matter, people do pay attention to that. If investments had a 20% loss each year for a couple of years, I suspect it is relatively rare to simply continue taking out an inflation adjusted 4% each year.

 

[youbet]

As a practical matter, people do pay attention to that. If investments had a 20% loss each year for a couple of years, I suspect it is relatively rare to simply continue taking out an inflation adjusted 4% each year.

Or, perhaps more important for nervous folks, NOT increasing your spending by the full amount of the CPI following years of high inflation.

 

[rescueme]

How does the 4% swr work in real life?

IRL, it hasen't (at least for me).

I retired at age 59, with no pension nor intent to take SS till age 70 (for the benefit of my DW).

That means that I'm living on my portfolio for a period of seven years (till I can claim 50% of DW's SS) and eleven years until I can claim my SS.

Sure, I have an SPIA for a part of my current income, but that required a substantial withdrawl of my retirement portfolio. It's not the same as a defined benefit (e.g. pension) plan, supplied by a private company or government entity.

I've been retired 4.5 years, and I've exceeded that "magic 4%". However, at the time I turn 70 (in six years), my WR drops to around 3% and I don't exceed that 4% rate till I'm in my early/mid-80's (if I'm still alive), even with the "excessive" withdrawls I've made since retirement.

That 4% makes some assumptions, not applicable to most folks on this forum; that is that you retire (at 65?) with your SS, pensions, etc. "in place". That has not been my actual experience.

Just some considerations, based upon a "real life" situation, since you asked...

 

[HFWR]

The 4% SWR is based on total return; i.e. growth + dividends. So, taking out the dividends/interest earned plus 4% would be MORE THAN 4%...

No double dipping!

 

[Rustward]

FireCalc testing also assumes some AA and if your's is different, then don't expect FireCalc to have any relevance to whatever you're doing.

Not sure "assumes" is the correct word here. The AA is specified on the "Your Portfolio" tab. The specification does have a default, but the specification can be changed.

 

[donheff]

OP said he and his wife understand the 4% SWR concept and then describe something else. Midpack and Youbet described the 4% SWR concept. It envisions talking a fixed amount year 1 and then adjusting that amount by inflation. Thus the withdrawer's life style is "guaranteed" for 30 years. In most scenarios, the expectation would be for principal to grow over time (thus supporting the increasing withdrawals due to inflation). If any of us here are actually following that method it is impossible to answer "how does that work for you guys," unless we are ancient and near the end of our run - for anyone else we would have to wait and see if everything is different this time . OP's Method 2 is truly guaranteed to avoid ever running out but involves a lot of year to year volatility. 4% after a 50% down year leaves you with half your previous year's spending.

Most of the talk I hear around the forum involves people choosing a hybrid. For example, starting out with an first year withdrawal that translates to conservative rate (e.g. 3%, 3.5%, maybe 4%) and raising the initial sum only as needed (hopefully less than inflation) with plans to cut back a bit during a downturn (using Guyton or some similar method). Most of us pursuing such an approach hope that 10 years down the road or so it will become evident that we are likely on a path that matches one of the better Firecalc scenarios. If so, we can relax and splurge a bit. If not, we hope we left enough wiggle room to retrench... It is important to note that such a hybrid approach is NOT the conventional 4% SWR described in the literature. Nor is OP's method 2 a conventional 4% SWR.

 

[REWahoo]

Here's a classic thread on the subject from the forum FAQ's:http://www.early-retirement.org/forums/f28/explain-the-4-withdrawal-rate-19234.html

 

[67walkon]

Now I know what retired people do all day! I think I've got it. Now I just need $2,000,000. But I'm close.

 

[rescueme]

Now I know what retired people do all day! I think I've got it. Now I just need $2,000,000. But I'm close.

Uh, I would stay at w*rk if you have less than $2M in retirement assets.

That's what I would have done ...

BTW, to live the "good life" in retirement means you need to have more than "just enough". That's not good enough for me (or DW)...

Not to "down" those that retire on a shoestring; it's just not our way...

 

[haha]

I understand the 4% concept. My wife, a long retired banker, understands it to. But how does it work for you guys?

Assume Mr. and Mrs. Thrifty retire when Mr Thrifty hits 62. Assume they have $2,000,000 million in savings/401's, etc. Assume the Thrifties have their money invested in some municipal bonds, dividend paying stocks and some corporate bonds, yielding an over all cash flow of $90,000 a year, or 4.5% total return. The Thrifties have saved up enough cash to have $90,000 put away.

In year 1, under the 4% SWD method, would they spend $80,000, or 4% of the nest egg? Or would they be able, should they choose to do so, take the $80,000 plus the $90,000 cash flow?

That would be a delightful plan indeed, a perpetual motion machine that creates income on the fly. Your wife is a banker?

 

[67walkon]

She was a banker a long time ago.

It's impossible to tie down all the variables and often I fear I'm erring on the conservative side way too much. Right now, with a kid in college and about 6 years to go on a mortgage, we live on about $130,000 a year, maybe a little more if we've saved a lot that year and get some extra income. Our basic expenses, excluding the principal and interest on the mortgage and college expense are under $100,000. That allows a nice, but not extravegant life style with 2 houses, one of which is mortgage free. We get a little over $95,000 a year for another 7 years on a very well secured payout on an asset sale; nothing is guaranteed, but in a year or two, the collateral will be worth more than what is owed us. We have some commercial properties we are trying to sell and they would bring in $1 million, after expenses, if they sell for the listed prices. I'm assuming they will sell for 50% to 75% of the listed prices sometime in the next few years and would be very happy with 75%. One has been generating income that we weren't really using, but that stops at the end of this year. My plan is to work semi part time until we get the two properties sold, or at least the more valuable one. We can easily live off the $95,000 pay out and the $50,000 we are currently getting in interest from bonds. I'm basically working from this point on to carry the two properties until we sell them. Realistically, I need to make $50,000 to $75,000 working part time, and I think I can do that easily, so we'll continue to add to savings. The only mortgage we have is a relatively small one on our main house and it's gone in 5 or 6 years, which is before the $95,000 payment stops. It'll work, but until I get rid of at least one vacant property, I'm not going to completely quit work. It's a nice safety net.

Right now, we have too much real estate, with $2,500,000 or more in equity and about $1,500,000 in investment assets. The principal balance on the payout is around $500,000, but that isn't liquid either. Our total debt is $136,000 on one of the houses. No car loans, no credit card debt, nothing else. If things really get tight in retirement, we'll just sell one of the houses, but we shouldn't have to if we don't want to. We have a pretty strong balance sheet, but tend to live way, way below what we could. All of our friends would be stunned to know we've got a net worth in excess of $4,000,000. The things we like to do are pretty inexpensive and both of us like to do things ourselves rather than pay people. It's just the result of a generally pretty good earning career, a couple of inherited properties, and not throwing money away on silly stuff.

But I don't know if I'll ever get over the need to save something every check or every year or whatever. I'll have to work at it.

 

[Rich_by_the_Bay]

Now I know what retired people do all day! I think I've got it. Now I just need $2,000,000. But I'm close.

To put a finer point on it, we put about 2-3 years worth of expenses aside in CDs and MMFs and do the actual withdrawal from that "allowance" account. Because of that slush fund we have some ability to wait out down markets before selling shares when prices are low; there are also quite a few years in short term bonds and the like. I figure we could go well over about 13-15 years or more without selling a share of stock for income; realistically we would probably rebalance every few years when earnings are good.

 

[W2R]

+1 to everything that has been said so far. I direct any dividends to cash which then can be used for withdrawals.

 

[TromboneAl]

We use midpack's system. I just plug the year's inflation value into my spreadsheet and it tells us how much to spend. When we spend too little ( which has happened each year) the remainder goes in the "fun money" column.

 

[martyb]

We use midpack's system. I just plug the year's inflation value into my spreadsheet and it tells us how much to spend. When we spend too little ( which has happened each year) the remainder goes in the "fun money" column.

I think I like this one....

 

[youbet]

Not sure "assumes" is the correct word here. The AA is specified on the "Your Portfolio" tab. The specification does have a default, but the specification can be changed.

I agree. Bad choice of words on my part. Indeed, FireCalc uses a user specified AA. That's what I meant, but, sputter - sputter, not what I said.

What I was thinking of was that when FireCalc executes its algorithm, it assumes (there's that word again) some value for "AA" and that value is either the default value or a user specified value.

Anyway..... the point is that if you don't carry an AA through retirement similar to what you tested with, your original FireCalc test results won't apply to your situation.

 

[Nords]

I understand the 4% concept. My wife, a long retired banker, understands it to. But how does it work for you guys?
So how does it work?

I'll tell you a secret.

The only ER who religiously follows the 4% SWR system is the hapless Y2K ER on Raddr's board. That's because he's not a real human being so he doesn't vary from the program for any reason whatsoever.
Raddr's Early Retirement and Financial Strategy Board • View topic - Hypothetical Y2K retiree update

Us real humans have lumpy expenses (new roof, fantasy vacation, kid's college) or we shrink our spending during bear markets.

What we really do is use the 4% SWR as an indicator of when our portfolio is likely to provide us with 30 good years. Then we ER and spend our time contributing to threads like this one.

It's impossible to tie down all the variables and often I fear I'm erring on the conservative side way too much.
But I don't know if I'll ever get over the need to save something every check or every year or whatever. I'll have to work at it.

Exactly. You just keep working until you figure out all the variables to your personal satisfaction. Or at least until you can no longer work.

Some people don't enjoy their jobs very much and quickly figure out the ER solution. Others apparently enjoy working more than they enjoy working on ER problems.

 

[Brett_Cameron]

..... Others apparently enjoy working more than they enjoy working on ER problems.

I love it!

 

[obgyn65]

According to the SWR method, you need to take up to 4% of your nest egg in year 1 (in your case $80,000). You do not spend $90,000 on top, which would represent 8.5% withdrawal in total for the the first year.

In year 1, under the 4% SWD method, would they spend $80,000, or 4% of the nest egg? Or would they be able, should they choose to do so, take the $80,000 plus the $90,000 cash flow?

 

[arebelspy]

The only ER who religiously follows the 4% SWR system is the hapless Y2K ER on Raddr's board. That's because he's not a real human being so he doesn't vary from the program for any reason whatsoever.
Raddr's Early Retirement and Financial Strategy Board • View topic - Hypothetical Y2K retiree update

Wow that thread is terrific.

What does FIRECalc say inputting the parameters of Y2K ER's scenario?

 

[ERD50]

Wow that thread is terrific.

What does FIRECalc say inputting the parameters of Y2K ER's scenario?

I didn't read the whole thread, but it does look interesting. Anyone know if the spreadsheet for the table in this post is available? If not, it would be pretty easy to reverse-eng the formulas.

Raddr's Early Retirement and Financial Strategy Board • View topic - Hypothetical Y2K retiree update


As I understand it, FIRECALC already has those numbers in it. However, for you to 'experience' a 1999-2010 data-set, you need to set your portfolio life to 11 years. A default 30 year life will not include the most recent 29 years.

Bottom line, it demonstrates that a 4% starting from a bubble is aggressive.

-ERD50