One of the things I enjoy is debating with still employed people about the appropriate withdrawal rate in retirement. I like hearing about all their money plans for after they leave a steady paycheck behind. The debate is not really a debate as I mostly just listen so that I can have something to revisit in the future.
You see, I used to be one of those people who thought I knew what post-work life would be like. I had all these estimates about how much money I'd spend and what I'd do with all my free time. As I grew older and more experienced, however, my views about retirement have evolved.
Even though it's been mostly a bull market since I left work in 2012, we did experience a correction in 2018, a 32% crash in March 2020, and now another correction in 2022. The NASDAQ has technically already entered a bear market. The S&P 500 may not too far behind.
It's hard to know what you don't know. This is why being open to the unexpected is wise. Writing about different viewpoints is insightful. However, if you are a betting man, you should seek to make bets with people who don't have as much information or are overconfident about the information they have. Over time, you will make a lot of money.
Let me share with you a conversation I had with a recently retired lawyer who used to disagree with my proper safe withdrawal rate in retirement. Let's call him Jack.
My main thesis is the 4% Rule is dead. Further, whatever withdrawal rate you think you'll use once you retire won't happen. Instead, you'll withdraw at a much lower rate in the initial years because you're so accustomed to saving and investing.
Retired At A Bad Time
On December 22, 2021, Jack, a 50-year old partner at a law firm, gave his two-week resignation notice. For the past three years, he had been earning between $700,000 – $1,100,000. The more he worked, the more he made.
Unfortunately, that was Jack's problem. He could only make big money if he put in the hours. There was no leverage in his occupation whatsoever. If he stopped working, he stopped making money.
With two kids ages 14 and 16, he felt bad working for more money instead of spending more time with them. Soon his sons would attend college and live their own lives. He kept thinking he'd regret choosing more money over his family. Therefore, with a net worth of ~$6 million, he decided to call it quits.
I encouraged him to try and negotiate a severance since he planned to quit anyway. What's the downside? But he didn't want to. Instead, he wanted to “walk away on his terms,” even though negotiating a severance is all about putting control in the hands of the departing employee.
With $4 million of his $6 million total net worth in stocks, he felt like he had the proper net worth allocation. His net worth also included ~$500,000 in bonds, ~$1.4 million in equity in a house worth $2.5 million, and $100,000 in cash. He planned to earn a 5% – 8% return and withdraw at an annual rate of 4%.
Unfortunately, within two months after handing in his resignation, the S&P 500 corrected by over 10%. What's more, ~$1 million out of his $4 million stock exposure were in individual growth stocks that declined by 40% on average.
Instead of retiring with about a $6 million net worth, at one point in time, Jack's net worth declined to about $5.1 million. Retiring near the top of the market is one of the 10 worst times to retire.
So what did Jack do with regards to his withdrawal rate?
Zero Percent Withdrawal Rate
The risk of receiving lower or negative returns early in a period when withdrawals are made from an investment portfolio is known as sequence of returns risk. It's too early to tell for Jack. However, returns could continue to go lower or flat-line for the foreseeable future.
As a result, Jack decided not to withdraw any money from his investment portfolios at all, including any dividend income. So what did Jack use to fund his expenses, estimated at about $13,000 a month after tax (down from ~$20,000 a month)?
He used his cash. But after going through $30,000 of his $100,000 stash, he started feeling uncomfortable. At his current pace, he would run out of cash in six more months. Further, with his net worth declining by almost $1 million since he handed in his resignation, he began to worry he had made a critical mistake.
Solution To Preserving Capital
The last thing he wanted to do was withdraw $160,000+ from his investment portfolio that was getting hammered. He couldn't use his cash to buy the dip either. Instead, he left his portfolio alone and found a better idea.
Jack reached out to his old law partners and asked if he could go back to work! However, instead of billing full-time, he asked if he could bill part-time. The senior partners said yes because Jack had valuable clients and connections. The partners didn't want him to leave in the first place.
The Income Starts Pouring In Again
With Jack's old job back, he started billing at a rate of $600 an hour for 25 hours a week. He gets to keep 60%, so $360 an hour X 25 = $9,000 a week in extra income.
Jack is relieved to have income coming in once more. He uses his income to pay for his living expenses and buy various stocks. He just couldn't bear not to invest after seeing so much carnage in some of his holdings so far.
Despite making $36,000 a month and working 25 hours a week, Jack has tricked himself into thinking he's retired. Not only does he think he's retired, he tells his friends he is retired.
You see, when you're working 50+ hours a week and making $72,000 a month, working half the amount of time feels like a walk in the park on a sunny day! It's funny how everything is relative in life and in finance, ain't it?
And when I asked Jack to tell me what his withdrawal rate in “retirement” is now, he told me it was 0%. He said,
“I'm not going to touch my retirement funds in retirement for as long as possible. Selling anything after a correction feels terrible. Instead, I'd much rather work part-time and start contributing to my investments again!
Your Withdrawal Rate Won't Be What You Think It Is
I share Jack's story to illustrate how situations are different from what you imagine. We can crunch our numbers all we want, but our financial independence number is not real if we don't take action to improve a suboptimal situation.
In Jack's case, he thought his financial independence number of $6 million was real so he announced his resignation. However, only a couple months into his retirement, he realized that maybe he had underestimated how much he needed.
His net worth equaled about 35 – 38X his annual expenses and between 7 – 12X his annual gross income. It made sense for Jack to think he was financially independent given 25X annual expenses and 10X annual gross income is the often-accepted minimum threshold to be considered financially independent.
However, in Jack's case, accumulating 50X annual expenses or 15X annual gross income was probably more appropriate for his situation. He was used to making big bucks and living the good life.
The disappearance of a steady income and an abrupt drop in investment returns were too drastic for his financial situation to handle. Therefore, he logically did something about it.
Be Flexible With Your Safe Withdrawal Rate
The great thing about most of us is that we have the ability to adjust our withdrawal rate as we see fit. In a bear market, we will tend to lower our withdrawal rate and try to earn more money to stop the bleeding. In a bull market, we may increase our withdrawal rate given our investment returns are so great.
Jack's situation is not unique. Instead, it is completely rational. And so long as Jack thinks he's retired while working 25 hours a week, that's really all that matters. At the very least, Jack has found the appropriate work life balance where he may no longer want to retire in the traditional sense.
Given times and conditions are always changing, the best thing retirees can do is follow a dynamic safe withdrawal rate. Instead of rigidly following a safe withdrawal rate, follow my formula so you can change with the times.
My Latest Withdrawal Rate
In my case, I'm watching my equities burn to the ground as I continue to buy the dip with my cash flow. However, instead of investing as much into risk assets, I've reduced the investment amounts because I'd also like to boost my cash reserves. Even though inflation is reducing my cash's buying power, increasing cash still feels good in times of uncertainty.
Given I'm not retired (these posts don't write themselves), my withdrawal rate is also currently at zero percent. It just feels so wrong to sell stocks after they've corrected.
Here is a hilarious chart of me buying the dip in VTI while it keeps on dipping. What a bummer. But I plan to continue buying in this taxable brokerage account as it has a 20+-year time horizon. There are no commissions so buying small positions is easy. Further it feels good to take some action by dollar-cost averaging.
My original goal was to re-retire some time in 2022, but now I'm having second thoughts.
Maybe I'll just continue to do what I'm doing and say I'm retired while working. After all, I spend less than 12 hours a week writing. It’s all the other stuff involved with owning a website that isn’t as enjoyable. Hence, if Jack can believe he is retired working 25 hours a week, maybe so can I!
I very much want to reduce my hours and spend more time living it up now that COVID has waned. I've almost reached my peak net worth goal. Now my plan is to focus on de-accumulation while I'm still healthy.
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Readers, if you are retired, what is your withdrawal rate during this latest correction / bear market? Have you changed your withdrawal rate or economic activity? How can we encourage gainfully-employed people to be more open to different retirement perspectives?
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