Question about Adjusting for Inflation with 4% Rule

[FindingForward]

I just go by the Dec 31 value each year and don’t inflation adjust. Much simpler. Withdrawal amount varies each year as it is dependent on portfolio performance the prior year and note that the withdrawal can shrink after a bad year. FIREcalc also models this method and calls it % remaining portfolio.

I was more comfortable with this approach compared to the more well known inflation adjusted 4% (or whatever). I don’t need a fixed inflation adjusted amount every year - my spending is highly discretionary and I have a lot of flexibility.

I have used this approach for many years.

i like this the best - simple enough for my non-spreadsheet, non analytically gifted mind.

 

[ERD50]

Originally Posted by audreyh1 View Post
I just go by the Dec 31 value each year and don’t inflation adjust. Much simpler. Withdrawal amount varies each year as it is dependent on portfolio performance the prior year and note that the withdrawal can shrink after a bad year. FIREcalc also models this method and calls it % remaining portfolio.

I was more comfortable with this approach compared to the more well known inflation adjusted 4% (or whatever). I don’t need a fixed inflation adjusted amount every year - my spending is highly discretionary and I have a lot of flexibility.

I have used this approach for many years.

i like this the best - simple enough for my non-spreadsheet, non analytically gifted mind.

This may work for some, but strikes me as odd.

I would have to adjust my next year's spending based on my EOY portfolio balance? Might work for others, but I find that very stifling. What if that is the year I have some opportunities that would fit within my long term budget, but a short term budget based on the last EOY balance wouldn't cut it? That opportunity may not exists next year. The whole idea of a conservative WR is that you can ride the dips w/o adjusting spending.

FindingForward, it's not complicated. Take that first year withdraw $ amount, write it down on a piece of paper. At the EOY, find the inflation rate for the past year. Multiply you first year withdraw $ amount by the inflation rate. Write that down. Repeat at the end of each year.

You don't need to be a slave to that number, but if you exceed it some years, you might want to look at cutting a bit in some other years to balance it out.

Or, you could re-run the model, and if it sayd you are good to spend more now (because portfolio is up), you are good. If it says you should spend less, you can (historically) ignore it - the initial inflation adjusted value accounted for these dips and you can ride them out,

-ERD50

 

[Al18]

I’m not including inflation in my yearly spending plans - period. As someone who spent their working career LBYM, I think you’re looking at the wrong indicator for spending. I retired 5 years ago and based on balanced investing, I’m up 400K since retiring. There’s enough growth to buy a new Corvette for cash without blowing up my retirement plan. That will more than double my yearly % pulled from investments - I don’t care.

 

[LateToFIRE]

Been interesting seeing the various approaches to WD strategy. I haven't quite settled on one yet, as retirement is still only a months new. And I probably won't settle into an approach for another couple years, as will take 2-3 years to sort through a variety of liquidity events and repositioning living situation.

But, what I have planned towards is to basically maintain a similar standard of living we had pre-retirement, albeit with modified housing situation, and some added BTD expenditures such as greater frequency of vacation/sunbird travel. I've gotten comfortable that our plan has a lotta "fluff" in it with 50% discretionary spending, so there is a lot we can do if we encounter a worst case situation and get nervous.

So, I don't really plan to follow any prescriptive formulas other than try to keep WD's inside ~3.5% of portfolio which looks very doable. If I do that, then with a small amount of good luck, it seems we should expire with considerably more than we started with (or at least as much on an inflation-adjusted basis). Reading many of the stories here from those of you who've been FIRE's awhile seems to confirm my thinking.

 

[SecondCor521]

So, I don't really plan to follow any prescriptive formulas other than try to keep WD's inside ~3.5% of portfolio which looks very doable. If I do that, then with a small amount of good luck, it seems we should expire with considerably more than we started with (or at least as much on an inflation-adjusted basis). Reading many of the stories here from those of you who've been FIRE's awhile seems to confirm my thinking.

It likely works just fine as long as the market doesn't swoon in the early years - the frequently-commented-on-lately SORR and you don't mis-budget severely.

Most of the people who are already FIREd here - including me - either retired at an opportune time such as 2016, or retired at an inopportune time but it was so long ago that SORR has been forgotten. And remember, people who retired early and it didn't work out probably don't post much about their lack of success.

Using the 4% rule, it's not that hard to retire at an opportune time, if you think about it.

There was a thread over on the MMM forums (which seems to trend younger and still working) about "did the 2020 class pick the worst time to retire?" with the usual angst about maybe the future will be worse than the past.

There were threads here back in 2008-2009 that were similar. Some folks tightened their belts and were OK. Some people went back to work for a bit, and they were also OK. Some people pulled all their money out of the market and waited to get back in; they were less OK I think.

 

[LateToFIRE]

^^^
Thanks for the historic perspective. Indeed, friends who retired in the 2010's all seem to be pretty relaxed about the financial part of the experience, and I suspect most have higher balances than when they started. The 2020's will be an interesting time to retire - we're either at the peak before the hammer comes down, or we're gonna slowly glide along with the positive momentum. I gave up trying to predict the stock market a long time ago. Alls I know for sure is it usually goes up more than it goes down - IF you can wait it out for decade or more.

 

[Dtail]

I just go by the Dec 31 value each year and don’t inflation adjust. Much simpler. Withdrawal amount varies each year as it is dependent on portfolio performance the prior year and note that the withdrawal can shrink after a bad year. FIREcalc also models this method and calls it % remaining portfolio.

I was more comfortable with this approach compared to the more well known inflation adjusted 4% (or whatever). I don’t need a fixed inflation adjusted amount every year - my spending is highly discretionary and I have a lot of flexibility.

I have used this approach for many years.

This approach can also be modified in Firecalc to effectively use the Bob Clyatt 4/95 methodology.

 

[ERD50]

.... There were threads here back in 2008-2009 that were similar. Some folks tightened their belts and were OK. Some people went back to work for a bit, and they were also OK. Some people pulled all their money out of the market and waited to get back in; they were less OK I think.

And some of us did nothing, continuing with a conservative withdrawal rate, unchanged. And we seem to be doing fine.

-ERD50

 

[Dtail]

The last group to have a 30 year retirement without their money lasting to the end using the 4% inflation indexed withdrawal methodology was the retirement group starting in 1966.

 

[audreyh1]

This approach can also be modified in Firecalc to effectively use the Bob Clyatt 4/95 methodology.

Yes, Bob Clyatt is offered in FIREcalc.

 

[LateToFIRE]

The last group to have a 30 year retirement without their money lasting to the end using the 4% inflation indexed withdrawal methodology was the retirement group starting in 1966.

I thought the 4% rule was designed to survive exactly this type of SORR situation?

 

[ERD50]

I thought the 4% rule was designed to survive exactly this type of SORR situation?

The study (and FIRECalc - see the 'defaults') is based on a 95% success rate.
From FIRECalc results, with defaults:

FIRECalc Results

Your spending in every year after the first year will be adjusted for inflation, so the spending power is preserved.

FIRECalc looked at the 123 possible 30 year periods in the available data, starting with a portfolio of $750,000 and spending your specified amounts each year thereafter.

Here is how your portfolio would have fared in each of the 123 cycles. The lowest and highest portfolio balance at the end of your retirement was $-300,739 to $4,259,606, with an average at the end of $1,421,948. (Note: this is looking at all the possible periods; values are in terms of the dollars as of the beginning of the retirement period for each cycle.)

For our purposes, failure means the portfolio was depleted before the end of the 30 years. FIRECalc found that 6 cycles failed, for a success rate of 95.1%.

So historically, with 4%, there are 5% failures.

You can change the settings for 100%, and you'll get something around 3.3%.

Some people feel that with all the other uncertainty, that 95% is 'good enough' - I feel the opposite - with all the other uncertainty, I want as much certainty in this as I feel I can reasonably obtain. But you can take that to the point of never retiring.

At some point, it is a leap of faith.

-ERD50

 

[latexman]

My question is, when you "adjust for inflation," are you using an average figure (e.g., the average inflation rate over the past 30 years) and adding that same percentage each year, or are you using the then-current rate of inflation (and thus changing the percentage each year)?

I think the correct answer is the former, but I want to make sure. Thanks.

I think it's the latter, use the previous year's inflation and changing the % each year. To me, an easy way will be to glom onto SS's COLA % every year about mid-October. It's reported widely, readily available, and discussed to death all over the www, even here.

 

[LateToFIRE]

The study (and FIRECalc - see the 'defaults') is based on a 95% success rate.
From FIRECalc results, with defaults:



So historically, with 4%, there are 5% failures.

You can change the settings for 100%, and you'll get something around 3.3%.

Some people feel that with all the other uncertainty, that 95% is 'good enough' - I feel the opposite - with all the other uncertainty, I want as much certainty in this as I feel I can reasonably obtain. But you can take that to the point of never retiring.

At some point, it is a leap of faith.

-ERD50

Thanks for the clarification.

 

[audreyh1]

This may work for some, but strikes me as odd.

I would have to adjust my next year's spending based on my EOY portfolio balance? Might work for others, but I find that very stifling. What if that is the year I have some opportunities that would fit within my long term budget, but a short term budget based on the last EOY balance wouldn't cut it? That opportunity may not exists next year. The whole idea of a conservative WR is that you can ride the dips w/o adjusting spending.

-ERD50

It’s pretty simple. In the big picture the annual withdrawal does drive our spending. Over many years it has been generally driving it up. I don’t have a hard rule to spend all in one year either. If there are future opportunities or planned spending on the horizon some of it can be earmarked for that. In practice the income variations are quite small and my spending has ramped more gradually than my income anyway so it has tended to smooth out nicely.

 

[NoiseBoy]

My favorite resource for understanding the exact process of the 4% "rule" is a page on John Greaney's retireearlyhomepage.com website. I didn't really get the rule until I saw John's tables detailing how the inflation adjusted withdrawals impacted the various portfolio's balances. The website uses hilariously out-dated basic HTML tables, but he continues to post updates including one yesterday. As to sequence of returns risk, John added a table at the very bottom of the page detailing what the returns would be like for someone who retired just before the dot.com bubble burst in 2000. The key take aways for me are that a 60/40 portfolio, which can be as simple as a single fund, holds up really well through good times and bad, and also, it's really good to invest like Warren Buffet!


https://retireearlyhomepage.com/reallife24.html

 

[Lewis Clark]

... But each year we seem to always have unplanned lumpy expenses, a new car, home improvement projects etc and we withdraw additional money from taxable accounts.

That is what I call "planned spontaneity that I expect to be surprised by."

 

[ERD50]

It’s pretty simple. In the big picture the annual withdrawal does drive our spending. Over many years it has been generally driving it up. I don’t have a hard rule to spend all in one year either. If there are future opportunities or planned spending on the horizon some of it can be earmarked for that. In practice the income variations are quite small and my spending has ramped more gradually than my income anyway so it has tended to smooth out nicely.

Well, if you don't spend it, it's not really a 'withdrawal'. You are doing a form of leveling, just maybe not as much as a straight 4% plus inflation (which is really just the guide for what one could historically do). Most of us are using that as a guide I think, not a strict spending level.

It's just semantics, no big deal at all. I'm just trying to be clear about it, mostly for others reading along.

-ERD50

 

[ShokWaveRider]

What if one's SS & Pensions cover 2x one's monthly expenses, like DW and myself? We have not touched our stash (Except to borrow against a SS or pension payment when we need a little extra early).

As a result, we have had a Zero WR up until this year, as I feel we should be spending some as we have no heirs and will start to do so soon as I keep promising myself.

 

[audreyh1]

What if one's SS & Pensions cover 2x one's monthly expenses, like DW and myself? We have not touched our stash (Except to borrow against a SS or pension payment when we need a little extra early).

As a result, we have had a Zero WR up until this year, as I feel we should be spending some as we have no heirs and will start to do so soon as I keep promising myself.

Yes. How many healthy years do you have left? Are there things important to you that you have put off? This is a think outside of the box kind of thing and often means pushing the comfort zone a bit.

 

[audreyh1]

Well, if you don't spend it, it's not really a 'withdrawal'. You are doing a form of leveling, just maybe not as much as a straight 4% plus inflation (which is really just the guide for what one could historically do). Most of us are using that as a guide I think, not a strict spending level.

It's just semantics, no big deal at all. I'm just trying to be clear about it, mostly for others reading along.

-ERD50

Not by my book. Spending and withdrawal are two different things regardless of how often they are conflated.

I have short term funds and the retirement portfolio (long term investments) and manage them separately. The retirement portfolio is managed to a specific target AA including stocks and withdrawn from annually. The short-term funds are invested in short-term fixed income instruments. Each year the withdrawal is added to the short-term funds pile which I can spend whenever and however I want.

And I’m pointing out again that I don’t do the 4% plus inflation method which almost no one here actually does anyway. Regardless my % remaining portfolio method is also modeled by FIREcalc and I have studied it extensively for my AA and investment types and am satisfied with the long term and short term characteristics.

 

[TheWizard]

What if one's SS & Pensions cover 2x one's monthly expenses, like DW and myself? We have not touched our stash (Except to borrow against a SS or pension payment when we need a little extra early).

As a result, we have had a Zero WR up until this year, as I feel we should be spending some as we have no heirs and will start to do so soon as I keep promising myself.

I'm in a similar situation but I call it a negative withdrawal rate, meaning I'm putting additional money into investments most months, on the order of $50K per year.

I spend what I want to spend, just bought a new car.
But I'm also trying to get my Investible Assets up to the next million, as per the other thread started by Street...

 

[brett]

Not by my book. Regardless this is an area of personal choice and by now my experience.

I have short term funds and the retirement portfolio (long term investments) and manage them separately. The retirement portfolio is managed to a specific target AA including stocks and withdrawn from annually. The short-term funds are invested in short-term fixed income instruments. Each year the withdrawal is added to the short-term funds pile which I can spend whenever and however I want.

And I’m pointing out again that I don’t do the 4% plus inflation method which almost no one here actually does anyway. Regardless my % remaining portfolio method is also modeled by FIREcalc and I have studied it extensively for my AA and investment types and am satisfied with the long term and short term characteristics.

We do exactly the same. We pay zero attention to the so called 4 percent rule. Inflation or not inflation adjusted. From a personal financial managment perspective it is meaningless to us.

Our focus is on understanding our spending, managing our resources. We do not need a X% rule to figure it out.

 

[kingle]

The 4% rule says if you have $1m. Your first-year draw is 40k. Then you adjust the 40k for inflation. Not the percent. The amount. I guess the rule figures as you out earn the 40K plus inflation the resulting % draw goes down. WHAT IF, you're greeted with sour markets at the get-go? As one contributor mentioned, this could be a hell of a strain on a portfolio in a bad market. I back tested Vanguard Wellington since 1929 (it's been around that long - get returns on Yahoo finance) with a variety of draw scenarios. THE ONLY ONE that did not end up with portfolio exhaustion was a 3-3.2% draw from the prior year balance or less. This assumes a 60/40 portfolio and market conditions like we experienced 1929 to present. I ran a series of 30 year runs starting in 1929, 1930, 1931, etc. ITS NOT A GOOD ENOUGH SAMPLE. The "lost decade" of 1965-1981 was particularly vexing. This low percentage draw generates variable income. Suggestion would be to save some each year in good years to help on the lean years and flatten out the variability. Stave off the vacation and optional expenses in a bad year if you can.

 

[ERD50]

The 4% rule says if you have $1m. Your first-year draw is 40k. Then you adjust the 40k for inflation. Not the percent. The amount. I guess the rule figures as you out earn the 40K plus inflation the resulting % draw goes down. WHAT IF, you're greeted with sour markets at the get-go? As one contributor mentioned, this could be a hell of a strain on a portfolio in a bad market. I back tested Vanguard Wellington since 1929 (it's been around that long - get returns on Yahoo finance) with a variety of draw scenarios. THE ONLY ONE that did not end up with portfolio exhaustion was a 3-3.2% draw from the prior year balance or less. This assumes a 60/40 portfolio and market conditions like we experienced 1929 to present. I ran a series of 30 year runs starting in 1929, 1930, 1931, etc. ITS NOT A GOOD ENOUGH SAMPLE. The "lost decade" of 1965-1981 was particularly vexing. This low percentage draw generates variable income. Suggestion would be to save some each year in good years to help on the lean years and flatten out the variability. Stave off the vacation and optional expenses in a bad year if you can.

Are you sure you included dividends in the returns (total returns is price change + divs)?

Wellington is already 60/40. If you are implying that you used VWELX as the 60%, and added another 40% of fixed, that is way under-weighting stocks from the typical '4% rule' approach (~75/25). You'd be ~ 35/65, a long way from 75/25.

-ERD50