If you want to build above-average wealth, you need to be dynamic in thought and in action. The world is ever-changing, which is why you should stay flexible.
Those who remain rigid will suffer the consequences: less money, fewer friends, less meaning, and lower levels of happiness. If you don’t believe me, identify the unhappiest person you know. Chances are high they are set in their ways.
Being able to see the other side of an argument is a beautiful thing! It is absurd not to acknowledge another person’s point of view. Maybe if more of us did, there would be no more wars. That would be nice.
In finance, everything is yin yang. A negative is often counterbalanced by a positive. In this current environment with high inflation and high interest rates, your dynamic safe withdrawal rate in retirement can now increase.
Let me explain why.
The Importance Of A Dynamic Safe Withdrawal Rate In Retirement
The dynamic safe withdrawal rate formula is the Financial Samurai Safe Withdrawal Rate formula. It is a guide that changes with the times.
Safe withdrawal rate = 10-year bond yield X 80%
When the 10-year bond yield declined to 0.59% at the start of the pandemic in 2020, the dynamic safe withdrawal rate formula implied a 0.48% withdrawal rate. In my proper safe withdrawal rate post, I rounded it to 0.5% to make the math easier.
With a lower safe withdrawal rate, an individual could invest more or accumulate more cash during times of great uncertainty. Seems logical as the stock market was plummeting. Unfortunately, many readers who worship the 4% rule went apoplectic at the suggestion of being dynamic.
With the 10-year bond yield now rising to ~3.5%, your dynamic safe withdrawal rate now rises to ~2.8%. Hooray! You are free to withdraw at a higher rate if you wish because bond yields, dividend yields, real estate yields, savings rates, and other types of income-producing assets will likely also be rising.
In a high interest rate environment, it’s actually easier to generate more passive income. Sure, your capital values might be getting crunched during a bear market.
But at least you can generate more cash flow. And cash flow is more important than net worth to live your desired life. Net worth comes and goes. As we saw in the 2022 bear market, funny money valuations can disappear in a hurry!
Risk Asset Returns Are Tied To The Risk-Free Rate
Some people misunderstood my formula and thought that retirees must only own a 100% bond portfolio in retirement because of my use of the 10-year Treasury bond yield as a key variable. This is incorrect and my safe withdrawal rate post explains why.
But to summarize here, the 10-year Treasury bond yield is the risk-free rate of return. And risk assets can be priced based off the risk-free rate plus a risk premium.
Equity Risk Premium = Expected Market Return – Risk-Free Rate
Expected Market Return = Risk-Free Rate + β (Equity Risk Premium)
- β → Beta
Logic dictates you would not invest in a risk asset if it didn’t provide a greater potential return than the risk-free rate. Therefore, as the the risk-free rate rises and falls, so too does the expected market return and expected risk premium.
Examples Of Why The Risk-Free Rate Is Important When Investing
To understand new things, it’s helpful to go through formulas and talk out scenarios. With these two examples, let me try to explain one more time why the risk-free rate is important when investing.
1) Real Estate Investing And the Risk-Free Rate
With the risk-free rate currently at ~3.5%, you would not buy a property with an expected market return of 3.5% or less. Why? Because you could lose money. Further, it takes time to manage a physical rental property. Therefore, you look for the highest expected market return above the risk-free rate of return, which equals the equity risk premium.
Some real estate investors, especially in big coastal cities, will purchase real estate with cap rates (similar to net rental yields) at less than the risk-free rate of return. This usually means they are cash flow negative. They invest this way because they are banking on capital appreciation to more than compensate for their negative cash flow.
This strategy works great in a bull market, but puts the real estate investor at greater risk of foreclosure during a bear market compared to a cash flow positive investor.
As the risk-free rate goes higher real estate investors will refuse low cap rate properties, leading to market softness. Investors will look for higher cap rate properties and properties they think will return a higher percentage to maintain their equity risk premium. As a result, more capital should flow to the Sunbelt region where cap rates are higher.
But of course, the variables are dynamic. The equity risk premium could certainly compress as well as investors accept lower expected market returns.
Personally, the less I have to do, the lower the return I’m willing to accept. As a result, I’m fine with earning 7% in a private real estate fund that requires no work versus 10% with managing a physical rental property.
The point of these formulas is to help you think more rationally as situations change.
2) Investing In Corporate Bonds And The Risk-Free Rate
Corporations issue bonds to raise capital for operations and acquisitions. When interest rates are low, corporations tend to issue more bonds because the cost of capital is lower and vice versa.
With the risk-free rate at ~3.5%, a corporation would need to issue bonds with a coupon rate higher than 3.5%. Otherwise, it may have a hard time attracting capital since investing in corporate bonds has risk. Corporations could default on their bond payments or go bankrupt.
If you are a retiree, you start getting excited at investing in all types of bonds because coupon rates are going up. Whether the bond issuer is a corporation or a municipality, it must raise its coupon rate to stay competitive with Treasury bonds.
If you believe inflation and interest rates will decline and the market hasn’t yet priced in this likelihood, then you are even more excited to buy bonds. The corporate bond you purchase yielding 5% today will look much more attractive if the risk-free rate drops to 1.5% in one year versus 3% today. Therefore, the corporate bond will appreciate in value.
Personally, I’m buying as much Treasury bonds as a I can while they are yielding above 4%. 3-month to 1-year Treasury bonds look the most attractive.
Proper Safe Withdrawal Rates In Retirement Chart
To make things easier to understand, here is my proper safe withdrawal rates in retirement chart. It is based off my dynamic safe withdrawal rate formula of 10-year bond yield X 80%. With the 10-year yield at close to 3%, if you are retired, withdrawing around 2.4% is reasonable.
Of course, depending on your situation and retirement philosophy, you are free to withdraw at a much higher or lower rate if you wish. In general, I’ve found guides to be helpful. Then it’s up to us to tailor our decisions.
Raising Your Withdrawal Rate With High Inflation And Negative Returns
Does it make sense to raise your safe withdrawal rate in retirement if risk assets are declining, inflation remains elevated, and a recession may be on the horizon? After all, raising your safe withdrawal rate reduces your wealth quicker.
The answer depends on your timing, risk tolerance, your ability to generate supplemental retirement income, and what is more important to you. Conventional wisdom says to be more conservative and lower your safe withdrawal rate in retirement. But that is if you’ve started with a high withdrawal rate in the first place.
If you are willing to invest more when we know times are bad (e.g. lower withdrawal rate and buying stocks and real estate in 2020), then logically, you should be willing to spend more when times are good or not yet that bad (e.g. after a 60%+ increase from a recent stock market bottom, only a 10% – 15% correction, real market still steady).
To me, it is better to enjoy your money rather than see it disappears in a bear market. If you don’t spend your money when things are still good, then you most likely won’t spend your money when things are bad. As a result, you will more than likely die with too much money.
Retirees Should Care More About Income Than Net Worth
As a retiree, your main focus is on generating enough income to live your life without having to work. Therefore, you like it when interest rates rise because it increases your risk-free and at-risk investment income.
Of course, you still care about your net worth. However, what you should care about more is how much income your net worth is generating.
Even if your net worth temporarily declines by 25% in a bear market, so long as your net worth is generating a similar amount of income, you are OK. But if your income declines by 25%, you may have to reduce your lifestyle. And living your best lifestyle is the end goal.
The risk to your investment income is during a protracted bear market. If a bear market lasts for much longer than a year, chances increase dividend payout ratios may be cut, property rental yields may decline, and bond yields may also decline. The double whammy of declining principal values and declining investment income hurt retirees the most.
In such a worst-case scenario, the recommendation is to be dynamic by lowering your safe withdrawal rate and/or generating some type of extra income. But the beauty of the FS Safe Withdrawal Rate formula is that it will automatically generate a lower recommended safe withdrawal rate in such a scenario!
Therefore, you don’t have to overthink things. My dynamic safe withdrawal rate formula reflects economic conditions as they change.
Why I’m Increasing My Safe Withdrawal Rate
Personally, I’ve decided to increase my safe withdrawal rate from 0% to 1% for the next 12 months. Since 2012, my dynamic safe withdrawal rate has been 0% since I live off passive income.
I also have active online income I generate, which mostly gets reinvested income-producing assets. If all goes well, I’ll increase my safe withdrawal rate to 2% the following year and then reassess.
Let’s say I have a $10 million retirement investment portfolio, the ideal net worth amount for retirement based on a massive survey. I would withdraw $100,000 to spend and donate over the next 12 months.
So long as the 10-year bond yield is at 2.5% or greater, starting in month 13, I will withdraw $200,000 a year ($10 million X (2.5% X 80%). The withdrawal plan is regardless of whether we are in a bear market or bull market.
Three Reasons For Increasing My Safe Withdrawal Rate
The first reason why I’m increasing my safe withdrawal rate is because I’m 45 and entering decumulation mode. I’m determined not to die with too much money. Otherwise, I’ll feel like an idiot who improperly allocated his time and energy.
The second reason why I’m increasing my safe withdrawal rate is because reported inflation is still above 6%. Instead of letting my cash sit there, depreciating in value, I’d rather spend it on some goods or services today. For if I wait too long, such goods and services will cost even more money.
The final reason for spending more is because I’m curious to see what a sudden 40% increase in annual spending feels like. I want to experiment to see if it makes our family happier or not. Further, I want to see if I can actually overcome my frugality.
So far, I’ve just reinvested the majority of my passive and active income to generate more passive income. But we’ve hit our ideal passive income goal for three years in a row. So there’s no point in reinvesting more.
Be Dynamic In More Parts Of Your Life
Following a dynamic safe withdrawal rate will help you live a more peaceful retirement under ever-changing conditions. It’s similar to my dynamic pay down debt or invest formula. The formulas help keep you in check when you may be sure what to do.
Blindly following a fixed withdrawal rate percentage, especially the 4% Rule from the 1990s is not the best choice in today’s environment. There’s a reason why you’re texting and no longer writing letters to friends and family.
In addition to retirement withdrawal strategies, you may also consider being more dynamic in other areas of your life. Here are some examples:
- Get good at a sport, musical instrument, or type of art
- Meet new friends outside of your socioeconomic level
- Meet new friends who are different in sex, race, culture, beliefs
- Learn another language
- Read all types of history
- Take up a new hobby
- Interview someone outside your circle
Personally, I’m practicing Mandarin and strumming my old Martin acoustic guitar again. Further, I plan to get on podcasts with people outside of the personal-finance community this year. It would be nice to talk to people who don’t all think index fund investing and budgeting are the best and only ways to get rich.
A Dynamic Safe Withdrawal Rate Is The Way To Go
I hope this post has better explained why I believe my dynamic safe withdrawal rate formula is superior to sticking to a fixed withdrawal rate in retirement over time.
If you haven’t let go of a steady paycheck yet, then do a test drive by living off various withdrawal rates. You might discover you’re fine with a much higher withdrawal rate. Or you might feel that drawing down principal feels too terrible. As a result, you will find fun ways to generate supplemental retirement income to keep your withdrawal rate low.
The truth is, you won’t know how you will really feel about drawing down capital until you no longer have a job. Therefore, expect the unexpected!
I’m hopeful all of you will see the wisdom in being dynamic. And if not, that’s perfectly fine too.
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Reader Questions And Suggestions
Retirees, are you excited that interest rates are going up so you can receive more retirement income? Are you following a dynamic safe withdrawal rate? If not, how are you spending your money during this rising interest rate period?
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Paul Lutes says
I would love for you to do an article on order of withdrawal — such as when you have 401k vs brokerage vs Roth, what is the best order to withdraw funds from these accounts.
I get why you want to take into account the risk-free rate, but to base the SWR primarily on it seems like it’s leaving out many more important factors. Remember that typically, the risk-free rate drops when the Fed drops its federal funds rate in order to induce economic growth and activity. Also, much of the money in existence is essentially created as debt, which gets cheaper the lower rates go. This is why we saw rapidly rising asset prices during this last decade+ bull market when rates were so low.
I don’t remember the studies off the top of my head, but I’ve read some about how withdrawal strategies based on market fluctuations actually tend to outlast fixed spending strategies. Generally speaking, you can withdraw and spend more money when returns are high, and less when returns are low or negative. The idea is to buy low and sell high.
The problem with your chart based on risk-free rates is that it’s likely the inverse of such strategies. You’re suggesting that it’s better to reduce spending and hold assets when rates are low and prices are high, but then spend more (at least in percentage terms) when the risk-free rate is high and asset prices are low. Count me among those who think that really only works if you hold your portfolio in cash and buy strictly bonds when the risk-free rate is high. I just don’t see how or why most people should go about implementing such a strategy.
Financial Samurai says
“ I don’t remember the studies off the top of my head, but I’ve read some about how withdrawal strategies based on market fluctuations actually tend to outlast fixed spending strategies.”
Please dig up these reading and share.
What is your safe withdrawal rate in retirement? Or are you still working?
I’m always interested in hearing what people are actually doing with their money when they don’t have day jobs, not what they think they will do.
Personally, I’m increasing my SWR bc my income is going up as interest rates increase.
Bill Bengen is 70% in cash and continues to make money as a consultant.
For those of you who follow the 4% rule, do you feel like suckers yet?
Safe withdrawal rate planning must account for RMDs (Required Minimum Distribution), which will set an ever-increasing withdrawal rate floor after age 72.
After 72, the RMD rate increases yearly, with only the first 3 RMD years under 4%. By age 90, the RMD is 7.87%. This income is taxed, and can bump up Medicare premium brackets, capital gains tax brackets, and social security taxes.
Just curious, when you say “I’m fine with earning 7% in a private real estate fund that requires no work versus 10% with managing a physical rental property,” is it really a valid comparison? If you have 50% to put down on a 500K mortgage and earn 10% return (50K), it’s much much more than earning 7% on just your 50K investment (3.5K). I’m really drawn to passive RE investment, but I keep coming back to this question.
Financial Samurai says
It’s exactly what it is, whatever variables you would like to use.
You can say the 10% return is the cash on cash return or the levered return. It’s whatever situation you want. Things also go down in value as well, so you would have to incorporate the potential losses.
Hi Sam – great work again.
I would love to see you write an article on what we are seeing in the stock market right now. I have been through the internet bubble and the financial recession of 09-10. This feels different. There were very legit reasons for what we saw – concept companies with no earnings, and then the overlending.
What we are seeing now in primarily the tech sector feels like some great opportunities, but am I missing something? SHOP from 1700-400? This isn’t just a COVID company like say a ZOOM. I run a business and we aren’t stopping DOCU (330, now 81) in the return to work. This is a new reality for signatures. Granted there was overshooting and euphoria in the runups, but seems now we are entering overselling territory.
So do you see this as a overreaction to rising interest rates/inflation cause we haven’t seen this for so long, or a legitimate reaction. Would you venture into any legit tech stocks right now? Are we seeing a throw the baby out with the bathwater situation? Feels like that to me. But of course always hardest to buy when the fear is high.
Just would love to hear your thoughts with your trading background in the financial industry.
Financial Samurai says
I’m buying and I’m appreciative of the opportunity. Then again, I’ve been buying consistently since 1998, so it’s nothing new.
When do you look at the 10-year yield to see how much you’re going to spend for that year?
It was closer to 1.6% at the start of 2022, so now that it’s 2.76% you increase spending?
Financial Samurai says
I look at it daily because it is one of the investments I track on my phone.
But in terms of spending habits, I adjust at most once a quarter.
Manuel Campbell says
I understand your formula better with your explanation. Essentially, you estimate an amount that will never decrease your net worth solely with the withdrawals.
I also thought the 4% rule was too agressive. If I redo the calculation with your formula, I would fall almost exactly on your number, at 2.6%. Which makes me much more confortable.
However, I might have to adjust my expense number due to very high inflation. I still don’t know how much inflation will affect my spending. And I don’t want to reduce my consumption due to inflation. Also, I was considering a 0.5% “cushion”, which I might be better to forgo according to this formula.
Anyway, withdrawing less makes me much more confortable. Markets are still highly volatile and it’s still not clear how the events of the last two years will pan out. I prefer to be more conservative than having to reduce my spending in the future due to unforeseen event in the economy. It’s always easier to increase spending than reduce it…
Scott H says
Funny fact:I also am withdrawing 2.6% from my retirement accounts. The reason? That’s what the bank said I needed to withdraw to qualify for my mortgage. I had retired, and my wife was between jobs, so we needed to withdraw that amount to qualify. We moved to Arizona, and the extra money has helped with costs of a new home. Now, I’m working part-time to keep me busy. My wife is employed now, and I’m not losing sleep withdrawing 2.6% :)
Yes! Dynamic is such a key concept. I do believe we need to be dynamic with our finances, investing, and retirement plans. I haven’t made drastic changes in my finances but I do make tweaks and adjustments depending on market conditions, inflation, economic trends, and the like.
Having a dynamic mindset is also very beneficial in life as you mentioned. Sometimes I can get rigid in my thinking and those have definitely been the times I experienced the most stress and unhappiness.
I think there should be an age component in the formula. What’s the point of withdrawing so little if you’re 80 years old? Conversely, you probably should be a lot more conservative in your 30s. In general, I think it’s good to be flexible and adjust accordingly.
4% is a good target to shoot for when you’re still trying to get there. It’s just an easy round number to calculate. Once you achieve that goal, I think most people would be more conservative and revise the withdrawal rate downward.
Financial Samurai says
True, however, introducing more variables will make the formula and the concept even more complicated. And the more complicated things are, the less people will understand and the less impact my message will have. Already, many people do not understand how returns are related to the risk-free rate. No matter how many times I try to explain it, I still can’t get the message through to some people.
As a financial writer who is trying to help, there is a balance I must try to maintain between financial analysis and comprehension.
And every person situation is different, which is why I’m going down the rabbit hole with multiple variables gets to be too complicated.
For example, in your situation, what is your safe withdrawal rate?
You might say your rate is 0% because your wife has continued to work for 13 years after you retired. But you might say your safe withdrawal rate is 10% a higher because you can afford to spend more money because your wife is working and you have online income.
What is the proper answer and why? Hard to come up with a formula for your situation. But my formula is applicable to all.
How do you plan on spending the extra money to determine if it makes you happy? Give it a fair shot! lol I feel like that typically entails upgrading a “forever home,” buying a new ride or traveling, but you strike me as someone that already travels when you want regardless of an uptick in spending.
Financial Samurai says
My goal is to spend more money on food, travel, and vacations. For example, I ordered a bone-in ribeye from Morton’s Steakhouse on Uber Eats the other day. Also ordered some mushrooms and key lime pie! Total cost was about $135, when I could have spent $20 and gotten something else.
Just got to take baby steps. Don’t go from beater car to Ferrari! Besides, an extra $100,000 a year can’t buy a Ferrari anyway.
How about you?
I don’t know. It’s hard to get out of the stealth mindset. I would like to upgrade the primary residence but timing with interest rates would be suboptimal. Already bought my wife a much deserved nice new ride which was different for a guy that typically keeps vehicles forever. Having her drive around a 14-year old Honda seemed a little extreme even in stealth mode. lol
Financial Samurai says
True. Safety too.
Oh yeah, I also donated $120 to Feed The Children a couple days ago after reading an article about the drought in Somalia. I wanted to pair up my extra consumption and donation.
This way, more people are benefitting. Feels like a good plan.
I think if you have surplus you don’t think about spending down money buy percentages. You spend the money on things and activities that are fun and make you happy. Chances are if you keep your overhead and debt as low as possible you will have plenty of money to do the things you want and buy the things you want and your net worth will grow anyway because you probably won’t spend like crazy anyway. I give myself permission to go on a cruise every year. Once you have all the things you want you probably won’t be thinking about getting more stuff. My wife says you don’t own things but things own you. Anyway you will have plenty of money. Not to worry.
“If you don’t spend your money when things are still good, then you most likely won’t spend your money when things are bad.”
This is absolutely. And a lot of people who are used to saving and investing have fallen trap to this hoarding mentality.
I’m doing my best to consumption smooth as well. Your formula makes sense and it was shocking to see people go berserk over suggesting something different than withdrawing at 4%.
* Don’t understand finance
* Still have a day job and are just guessing
* Or something else