The 4% Safe Withdrawal Rate (SWR) vs Never Touch Your Principal (NTYP)
Retirement, this is what we are all striving for in the personal finance community. And early retirement at that.
I was inspired by a recent post from Liquid Independence’s blog about Revisiting the 4% Safe Withdrawal Rate. I think that although the 4% Safe Withdrawal Rate (SWR) has been tested and it works, with the assumption of a 30 year time horizon, I would rather not opt for this strategy and instead am gunning for the Never Touch Your Principal (NYTP) method.
what is the 4% Safe withdrawal rate?
As Liquid Independence mentioned, it was coined in 1994 by a financial advisor by the name of Bill Benger (who is now retired), who calculated that retirees could safely withdraw a maximum of 4% (well, according to him now, 4.5%) from their tax advantaged retirement investment portfolio starting in the first year of retirement and ending 30 years later, with the assumption that starting in retirement, there is a 50% stocks and 50% bonds asset allocation.
So someone retiring at the age of 65 with a $850,000 portfolio can safely withdraw $34,000 annually (4% safe withdrawal rate) from their investments to last them until the age of 95. This is with the assumption that inflation isn’t too crazy over this time span.
First of all, I was quite surprised that the Safe Withdrawal Rate rule which is so ubiquitous in the personal finance community is only a little over 20 years old. That’s not even tested as 30 years haven’t elapsed since it was coined by Bill Benger.
I don’t know about you, but if I am 95 and still alive I would be worried about running out of money (because at that age with the Safe Withdrawal Rate, he will be running out of money). If this aforementioned retiree had amassed a $850,000 investment portfolio and had owned a house in Vancouver (you know, now worth over $1.5 million, or even $6 million if they lived on a big street near the Canada line) then that’s okay because this retiree can always do a reverse mortgage or sell the home and downsize. But if it was $850,000 30 years ago and at the age of 95 it is less than $50,000 I would be worried. WORRIED. With that amount you can’t even pay for a fancy schmancy retirement home in Vancouver where you get fresh flowers in the lobby and fresh flowers on your dining table and an aperitif prior to your meal, which according to Seniors Zen can cost over $5000 a month.
Of course, there is the consideration of government assistance like the pension plan and other retirement funds. Again though, who knows if in 30 years time this will still be a benefit provided by the government?
what is never touch your principal?
It doesn’t mean not physically and literally touching your school principal or your child’s school principal, which is likely not recommended in any case, but never touching you principal means never spending what you have accumulated. It means using what you have accumulated to your advantage and just living off that. Without drawing it down.
Financial Samurai wrote a post about the Ideal Withdrawal Rate For Retirement Does Not Touch Principal. Instead he recommends using the S&P 500 dividend yield which is 2.2%. This ensures that you won’t be touching your principal. I’m a little impatient and it will take me quite some time to reach a portfolio that sustain myself on a 2.2% dividend yield. Probably take another 5 years compared to using a higher dividend yield.
I am opting for the strategy of Never Touching Your Principal with my retirement savings because:
- I don’t want to run out of money in retirement, especially in the latter years of retirement.
- I would like to make sure there’s some money leftover as inheritance for my children (if I decide at that point to gift an inheritance), you know, analogous to dangling a carrot for them to pay some attention to me in my old age (I am kidding!!)…or I can always have the option to spend my portfolio in haste in the very last few years of life. Who knows what the future will hold, but I do know that I would like that option especially when I am vulnerable and older.
- I want to retire earlier than age 65 and therefore the 30 year time horizon will not be applicable for me, it will be much longer than 30 years (hopefully I will live longer than 75!). I am hoping for early retirement at age 45 (but open to working part-time or other gigs to supplement, I would like to keep my brain working). That being said there are plenty of early retirement/ financial independence folks who have retired at the age of 35 with $1,000,000 in capital who are planning to use the SWR option. I think a lot of them are supplementing with other streams of passive investing or income, such as starting an online business/ monetizing their blog.
People in the FIRE (Financial Independence Retire Early) camp so emphasize, financial independence provides freedom. In my option, never touching your principal provides freedom.
my never touch your principal target
With the aim for NTYP in mind, I would like to create a dividend portfolio that would generate at least $40,000 in dividend income for myself. Dividends are like ocean waves, they are soothing and are consistent. With a 3.5 % dividend yield (my current yield is about 3.2% from my dividend portfolio) that would mean amassing a portfolio of $1,143,000. My long term goal is to reach $1,000,000 net worth by age 40, and hopefully I can have a seven figure investment portfolio at that time, at the latest by age 45. By the age of 45, my parents and in laws will be in their 80’s which is usually when health care needs are more. As mentioned in My Reason for FIRE I would like to have the option of taking care of them if needed, taking them to appointments so that I am not sandwiched between full-time work, school age children, and aging parents.
Readers, what do you think about the safe withdrawal rate? Am I being too conservative by not wanting to touch my principal?