Retirement, this is what most are striving for in the personal finance community. More specifically, early retirement at that with the help of something called the Safe Withdrawal Rate.
I was inspired by a 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).
Bill Benger 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.
What does this mean in real numbers?
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 ridiculously high over this time period of 30 years.
I had a few thoughts when I read this.
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. Simply put, 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 at the end of 30 years, he will be running out of money during a period of time where lifestyle expenses can be very high).
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 and condo developers want to buy it from them) then I suppose it’s not that bad because this retiree can always do a reverse mortgage or sell the home and downsize.
However, if it was $850,000 30 years ago and at the age of 95, I had less than $50,000 to my name, I would be worried (if I was still cognitively intact enough to be worried).
With that amount ($50,000) you can’t even pay for more than half a year of a fancy 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.
A retirement home in Vancouver, from what I have heard, can be $10,000 a month or more. That’s five months of retirement home for $50,000 at 95.
Of course, there is the consideration of government assistance like the pension plan, defined benefit pensions, and other retirement funds. And there are publicly funded long term care homes as well which do not cost $10,000 a month.
Again though, who knows if in 30 years time CPP will still be a benefit provided by the government, especially given the situation where we are in billions of dollars deficit from pandemic spending.
Now that we know what the safe withdrawal rate is all about, what is Never Touch Your Principal?
what is never touch your principal?
Never touch you principal means never spending what you have accumulated and never using your original capital investment.
It means using what you have accumulated to your advantage and just living off the cash flow of dividends and distributions generated from your investment portfolio. Without drawing it down year by year.
So if you had the $850,000 investment portfolio and you had a 3.5% dividend yield, that would be $29,750 in annual dividends received. You would not draw down and withdraw money from your original $850,000 but just use the dividends taken from the money tree (your investment portfolio). As you can imagine, doing the never touch your principal method would take more time and money to accumulate compared to the safe withdrawal rate method.
At that point, obviously $29,750 in dividend income would only cover 3 months of fancy retirement home living, but I suppose it would be prudent to start selling the portfolio at that time to pay for added expenses. The $850,000 portfolio would have grown to something much larger at this point with decades of capital appreciation and not drawing it down.
I am opting for the strategy of Never Touching Your Principal instead of the 4% Safe Withdrawal Rate with my retirement savings because:
- I don’t want to run out of money in retirement, especially in the latter years of retirement. This is when there are expensive things to pay for, should be be a live-in caregiver, or a retirement home, or extra support in the form of meals, or a part time caregiver.
- I would like to make sure there’s some money leftover as inheritance for my children or grandchildren at that point. That being said, I might want to spend like crazy in my later years in life. Who knows what the future will hold, but I do know that I would like to at least have 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 if I stop working at 45!). I am hoping for early retirement at age 45 (but am open to working part-time or other gigs to supplement, I would like to keep my brain working in semi-retirement).
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 safe withdrawal rate 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) movement emphasize financial independence because it provides freedom. In my option, never touching your principal provides freedom as well from the burden of not having enough money in retirement.
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 $35,000 to $40,000 in dividend income for myself. Dividends are like ocean waves, they are soothing and are consistent (except when they are cut, ha).
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.
For a more in-depth look at retirement projections, check out this post.
What do you think about the safe withdrawal rate?
Am I being too conservative by not wanting to touch my principal?
GYM is a 40 something millennial writing about personal finance since 2009 and interested in achieving financial freedom through disciplined saving, dividend and ETF investing, and living a minimalist lifestyle. Before you go, check out my recommendations page of financial tools I use to save and invest money. Don’t forget to subscribe for a free dividend yield spreadsheet and the free Young Money Bootcamp PDF.