See Average Joe Retire

Disclaimer:  Accountants will love this post, everyone else will hate it.

Dick and Jane have left the premises because they have better things to do.  But Syd is still here and in light of this blog’s spirited discussion of the 4% rule (or 3% rule, whichever applies to you), I wanted to illustrate how distributions work over the lifetime of your retirement when you use the 4% rule.

This particular retiree, Average Joe, actually winds up doing better than the worst-case scenario that drives the 3% rule—the result is that he dies with a little money left over, based on the facts I create.  (I could have chosen facts that would result in a better or worse outcome, it doesn’t matter, I’m just trying to illustrate how the withdrawals will work for Joe.)

No one will ever experience a steady growth of exactly the same earnings and inflation rates each year, but I wanted to provide a simple example to show you generally how your retirement withdrawals might look 10, 20, and 30 years down the line when you use the 4% rule:

Joe starts with $1 million.  He experiences exactly a 3.5% inflation rate every year of his retirement, and also a steady 5% return every year of his retirement.  (Remember the 4% rule is that Joe withdraws 4% of his nest egg in the first year and then adjust that dollar amount by the inflation rate each year.  For Joe that’s a 3.5% inflation rate each and every year.)  Here’s how his distribution history would look:

*Dollar Amount of first year withdrawal adjusted annually for 3.5% inflation rate.

 

Here are the two things I'd like to point out:

1)   In the early years Joe's assets keep growing from year to year.  He begins at $1 million and because his earnings are larger than his withdrawals, his nest egg grows to $1.049 million by Year 9.

2)   After that, the inflation adjusted amount of his withdrawals becomes larger than the growth his nest egg generates.  Eventually his nest egg declines to $280,000.

3)   The percentage of his nest egg (final column) that he is actually drawing each year is only near 4% in the early years.  As inflation increases the withdrawal amount it represents a larger and larger share of his nest egg balance.  By year 15 he's actually withdrawing over 6% of his nest egg, and by year 25, nearly 13%.  If he lives long enough, his final withdrawal would be 100% of his assets and he would die with nothing.

No matter what facts you assume, this will always happen, i.e. that when using a flat starting rate, say 3% or 4%, that you adjust for inflation each year, your nest egg will grow for some period in the early years and shrink after that, down to nothing depending on how long you live.

If you tried to keep your actual withdrawal rate at 4% for a long period of time, you would find that a) you can’t buy as much as you used to, and b) you might actually die with a bunch of with money left over.  Which might be ok for those of you with heirs, but I’m trying to bounce that last check.

Related Posts:

    See Dick and Jane Retire

    The Scary Impact of Inflation on Your Retirement Budget

    The Impact of Inflation:  Your Mileage May Vary

 

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Comments

[Jacq]

@new at this - it's not "jump and the net will appear" - it's more of a "jump and make it work". So maybe that means working part time for a year or two to just wind down, take a great trip once every 2 years instead of annually, realize that cutting cable and holding onto a vehicle for a couple of more years isn't a big hardship. You can make it work with what you've got.

At the end of the day, if the time off means more to you than more stuff or a higher standard of living, you just make it work. This seems so blindingly obvious to me and I don't care what kind of ratios anyone spews out to give me a false sense of safety. The safety comes more from knowing you'll make it work if you have to and if you want it bad enough. Just build up a "war/depression rations budget" and know that you'd be okay doing that for a few years if you had to.

But if you want to be a nervous Nellie and cover for every eventuality - then go ahead and do that. Stay at work for another 10 years just to make sure you've covered every eventuality. Whatever makes you sleep at night - it's all good.

"Most things I worry about never happen anyway."
~ Tom Petty

[New at this]

Brian - thanks! Great website. And I guess from Syd's non-answer response, the 5% is just a plug number she used to support her conclusion.

I also found another site, "Free Money Finance" where they cover topics like this. Hopefully they are less about "proving" why they are right, and more open to exploring differing perspectives.

Jacq - I really do envy you. What a great way to live life! I've always been wired to analyze the heck out of something before committing, but if Tom Petty is right , your way makes sense.

[Steve]

I agree with Jacq, there are just so many variables that one has to be flexible. While a portfolio's projected rate of return receives a lot of ink, one variable I rarely see discussed is the rate of inflation. What happens if there's a long stretch of double digit inflation? Not only will stocks get whacked but what you have left will buy much less. Time for plan B...

[New at this]

Steve - great thing about worrying about things like inflation ahead of time, is you can manage your portfolio to anticipate. Example, stocks combat it well and you can stay away from long bonds.

Problem I have with just limiting your research to "It's true because Bengen said so" is that you're left kind naive and vulnerable.

[Retired Syd]

@New: I'm so sorry that I neglected to answer your question about where I got the 5%--I'm having trouble keeping up with all your questions at this point.

I pulled that number out of the clear blue sky. I was trying to show what would happen to a portfolio (how the withdrawals look) under the worst-case scenario (you die with zero). I suppose I should have used a slightly lower return to get it to exactly equal zero, but with a couple of years living expenses left, I thought I got it close enough for the simple thing I was trying to show.

I'm sorry that there was a communication problem here. I should have specifically stated that this is not a return I am saying is in any way historical or reasonable. I thought I was being clear when I said I know no one is ever going to have this exact example, but I was trying to show what it would look like if you lived almost in the worst 30 years, spending down to zero.

Again, I'm not saying this will happen to you. Sorry, I should have said that too. Most people will do better than the worst 30 years, so yes, they are indeed earning a higher rate of return. Whether that will be 6%, 7%, 8% or more, I really don't know. The better rate of return you make, the better your situation will be. I kind of thought most people would have understood that.

Again, I apologize for failing you in so many ways.

[Steve]

@ new, we've all heard stocks are an inflation hedge so many times we actually believe it. The facts say otherwise though:

http://www.dailyfinance.com/2012/03/09/investing-error-stocks-not-inflation-hedge/

[Sightings]

Thanks for this table which I'm printing out and hanging on my wall. Two things about it strike me: 1) It's amazing how much inflation affects the amount of the withdrawals, even at a (relatively modest) 3.5%. And 2) If Joe lives for 3 more years, he's broke -- you have to make a lot of assumptions to make these projections, and if any of them are wrong, they go haywire after 30 years.

Who said retirement would be easy?

[New at this]

Thanks Steve. Interesting opinion. But depending on which equities you buy, ask yourself, what is inflation? It's when prices go up, right. Well, who is raising the prices? Answe, Companies who sell you products at "inflated" prices. Now of course you have to be careful, as companies also buy inputs, that can also go up in price, but in general, equities over the long term do a pretty good job of pacing.

Syd - Actually the mistake is mine. I was thinking you were some kind of finance guru, who had figured out how to answer the holy grail question, "Do I have enough to retire?"

But what I finally understand is your just an average person who happened to read Bengen's article and decided that was enough research to base a life decision on.

I'm jealous of your optimism.

And all this is just fine.

[Retired Syd]

@New: Yep. As it turns out there are a whole bunch of us regular, average people that have managed to figure out how to retire, even without being engineers!