One of the things I like is discussing with still working people the right withdrawal rate in retirement. I’d love to hear about all their money plans for after they leave a steady paycheck. The debate isn’t really a debate, because most of the time I’m just listening so I have something to revisit in the future.
You see, I used to be one of those people who thought I knew what life would be like after work. I had all these estimates of how much money I would spend and what I would do with all my free time. However, as I got older and gained more experience, my views on retirement have evolved.
While it has been mainly a bull market since I left work in 2012, we experienced a correction in 2018, a 32% crash in March 2020 and now a correction again in 2022. The NASDAQ has already technically entered a bear market. The S&P 500 may not be too far behind.
It’s hard to know what you don’t know. Therefore, it is wise to be open to the unexpected. Writing about different points of view is enlightening, but if you are a gambling man you should try to bet with people who don’t have that much information or are overconfident with 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 attorney who disagreed with my correct safe withdrawal rate in retirement. Let’s call him Jack.
My main thesis is that the 4% rule is dead. Further, whatever withdrawal rate you think you will use once you retire, it will not happen. Instead, you pay a much lower rate for the first few years because you are so used 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 letter of resignation. Over the past three years, he made between $700,000 and $1,100,000. The more he worked, the more he earned.
Unfortunately, that was Jack’s problem. He could only make a lot of money if he put in hours. There was no influence whatsoever in his profession. If he stopped working, he stopped making money.
With two children aged 14 and 16, he felt bad working for more money instead of spending more time with them. Soon his sons would go to college and lead their own lives. He kept thinking he would regret choosing more money over his family. Hence, he decided to quit with a net worth of ~$6 million.
I encouraged him to try and negotiate a departure, as he intended to quit anyway. What’s the downside? But he didn’t want to. Instead, he wanted to “walk away on his terms,” even if negotiating a departure involves putting control in the hands of the departing employee.
With $4 million of his $6 million total net worth in stocks, he felt he had the right net worth allocation. His net worth also included ~$500,000 in bonds, ~$1.4 million in stock in a $2.5 million home, and $100,000 in cash. He planned to make a return of 5% – 8% and withdraw at an annual rate of 4%.
Unfortunately, the S&P 500 corrected by more than 10% within two months of filing his resignation. In addition, about $1 million of its $4 million equity exposure was in individual growth stocks that fell 40% on average.
Instead of retiring with a net worth of about $6 million, Jack’s net worth fell to about $5.1 million at one point. Retiring near the top of the market is one of the 10 worst times to retire.
So what did Jack do with his withdrawal rate?
Zero percent withdrawal rate
The risk of lower or negative returns early in a period when withdrawals are made from an investment portfolio is known as sequential return risk. It’s too early to say for Jack. However, returns could remain lower or stable for the foreseeable future.
Jack therefore decided not to withdraw any money at all from his investment portfolios, including no dividend income. So what did Jack use to fund his expenses, estimated at about $13,000 a month after taxes?
He used his money. But after going through $30,000 of his $100,000 stash, he started to feel uneasy. At his current pace, he would run out of money in six months. Further, with his net worth nearly $1 million since he tendered his resignation, he began to worry that he had made a crucial mistake.
Solution for Preserving Capital
The last thing he wanted to do was withdraw $160,000+ from his investment portfolio that was being hammered. He couldn’t use his money 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.
Income is starting to come 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 additional income.
Jack is relieved that income is coming in again. He uses his income to pay for his living and to buy various stocks. He just couldn’t bear not to invest after seeing so much carnage in some of his property so far.
Despite earning $36,000 a month and working 25 hours a week, Jack has fooled himself into thinking he’s retired. Not only does he think he’s retired, he tells his friends he’s retired.
You see, if you work 50+ hours a week and earn $72,000 a month, working half the time feels like a walk in the park on a sunny day! It’s funny how everything is relative in life and in finance, isn’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 will not spend as long as possible on my pension money when I retire. Selling something after a correction feels terrible. Instead, I would much rather work part time and start contributing to my investments again!
Your withdrawal rate will not be what you think it is
I share Jack’s story to illustrate how situations are different from what you imagine. We can crack our numbers all we want, but our number of financial independence is not real if we don’t take action to improve a sub-optimal situation.
In Jack’s case, he thought his $6 million financial independence figure was real, so he announced his resignation. But after only a month into retirement, he realized he might have underestimated how much he needed.
His net worth was equal to about 38X his annual expenses and between 7 – 12X his annual gross income. It made sense for Jack to think he was financially independent, since 25X annual expenses and 10X gross annual income is the often accepted minimum threshold to be considered financially independent.
In Jack’s case, however, piling up 50X annual expenses or 15X annual gross income was probably more appropriate for his situation. He was used to earn a lot of money and lead a good life.
The loss of a fixed income and an abrupt decline in investment returns were too drastic for his financial situation. So logically he did something about it.
Be flexible with your secure payout percentage
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 make more money to stop the bleeding. In a bull market, we can increase our withdrawal rate since our investment returns are so great.
Jack’s situation is not unique. Instead, it’s perfectly rational. And as long as Jack thinks he’s retired while working 25 hours a week, that’s all that matters. At least Jack has found the right work-life balance where he may no longer want to retire in the traditional sense.
My latest payout percentage
In my case, I see my stock burning to the ground as I continue to buy the dip with my cash flow. Instead of investing so much in risky assets, I reduced investment amounts because I would also like to increase my cash reserves. While inflation is reducing the purchasing power of my cash, increasing cash still feels good in times of uncertainty.
Since I’m not retired (these posts don’t write themselves), my withdrawal rate is also zero percent at the moment. It just feels so wrong to sell stocks after they’ve been corrected.
Here is a hilarious chart where I buy the dip in VTI as it continues to fall. What a downer. But I plan to continue buying this taxable brokerage account as it has a time horizon of over 20 years. There are no commissions, so buying small positions is easy. Furthermore, it feels good to take some action through dollar charges.
My original goal was to retire again sometime in 2022, but now I’m in doubt.
Maybe I’ll just keep doing what I’m doing and say I’m retired while I’m at work. After all, I spend less than 12 hours a week writing. It’s all the other things that have to do with owning a website that aren’t so much fun. So if Jack can believe he’s retired and working 25 hours a week, maybe I can too!
I really want to reduce my hours and spend more time living up to it now that COVID has abated. I have almost reached my maximum net worth goal. Now my plan is to focus on de-accumulation while I’m still healthy.
The disadvantages of early retirement that no one likes to talk about
The Ideal Net Worth Before Retirement: $10 Million
Readers, if you’re retired, what’s your withdrawal rate during this latest correction/bear market? Have you changed your withdrawal rate or economic activity? How can we encourage salaried people to be more open to different retirement perspectives?
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This post Your withdrawal rate during retirement will fall in a bear market
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