If you’re increasing your safe withdrawal rate for retirement now, you’re likely making a mistake. You might be inadvertently top-ticking the market as the Fed embarks on what is likely a multi-year rate cut cycle.
One of the main reasons the Fed is cutting rates is due to growing weakness in the labor market. Inflation has also slowed down, prompting the need to make rates less restrictive to prevent a recession. So, by raising your safe withdrawal rate, you’re actually putting yourself at greater financial risk. Strangely enough, some retirement researchers are advocating for this exact strategy as you’ll read below.
Let’s break down why this is happening and why I still stand by my dynamic safe withdrawal rate approach. For context, I left my 13-year career in finance in 2012 and haven’t had a day job since. My wife retired in 2015, and she hasn’t returned to work either. I’d classify us as semi-retirees.
A Dynamic Safe Withdrawal Rate Is The Way To Go
I’m a strong advocate for adopting a dynamic safe withdrawal rate in retirement. Relying on the outdated 4% rule from the 1990s doesn’t make sense in today’s rapidly evolving world. Just like we no longer use corded dial-up phones, why would we stick with a safe withdrawal rate recommendation from 40 years ago?
In 2020, as the pandemic unfolded, I urged people to rethink their approach to safe withdrawal rates. Instead of adhering to a fixed rate, I introduced the concept of a dynamic safe withdrawal rate, which adjusts to 80% of the 10-year Treasury bond yield.
When the 10-year yield dropped to 0.62% during the flight to safety, this meant reducing the safe withdrawal rate to about 0.5%. Some people were outraged, claiming a 0.5% withdrawal rate was unreasonable. “That would require saving 200X your annual expenses to retire early!” they exclaimed.
While extreme, these were extreme times. In periods of great uncertainty, it makes sense to REDUCE capital drawdowns to preserve your financial health as investments lose value. Alternatively, by lowering your withdrawal rate to 0.5%, you could redirect your cash flow into discounted assets, positioning yourself for future positive returns.
Need to Do a Better Job Getting My Point Across
One issue I realized with some of the critics of my dynamic withdrawal strategy is that they don’t think dynamically themselves. They’re stuck in a static mindset, which doesn’t work when the world around us is constantly changing. When you fail to adapt to shifting variables, you risk being left behind. Instead of bending, you more easily break.
Another problem is that many didn’t grasp the concept of the 10-year bond yield as the risk-free rate of return, which is fundamental to all investment decisions. As someone with a background in finance and an MBA, this seems obvious, but it’s irrelevant if readers don’t understand it.
I wasn’t suggesting investors go all-in on bonds, as some misinterpreted. Rather, I was urging people to consider the risk-free rate before making any investment decisions. If you’re going to take on risk, you must demand a premium above the risk-free rate. Otherwise, why bother ever taking risk?
An Investment Bonanza Since Introducing a Dynamic Safe Withdrawal Rate
What frustrated me more than the insults was my failure to effectively educate the most vocal critics.
Now, over four years later, those who understood and applied the dynamic withdrawal strategy have done incredibly well. In contrast, those who clung to the rigid 4% rule like zombies may not have fared as well.
Imagine how much more wealth was accumulated by investing in stocks and real estate in 2020 and 2021, simply by reducing your withdrawal rate to 0.5% instead of sticking to 4%. That extra 3.5% was put to work. The gains in both the S&P 500 and the median home price index were substantial.
Those who approached posts like How to Predict a Stock Market Bottom Like Nostradamus and Real Estate Buying Strategies During COVID-19 with an open mind either took action or stayed the course while others veered in less optimal directions.
From a mental health perspective, those who were able to make financial adjustments were able to navigate a difficult time with more confidence. In turn, they felt more secure and happier.
Of course, investing in risk assets always carries uncertainty. I’ve lost money before and will continue to lose some in the future. But by following a retirement withdrawal framework grounded in math, logic, and real-world experience, you can reduce anxiety and build more wealth than those who just wing it in retirement.
Raising Your Safe Withdrawal Rate Now Is Top-of-the-Market Thinking
What’s fascinating is that just as the Fed embarks on a multi-year interest rate cut cycle, some retirement experts are raising their recommended safe withdrawal rate. Talk about top-ticking the market!
Here’s an article from Barron’s discussing this trend:
“It’s time to throw out the 4% rule and give your retirement paycheck a raise. New research indicates that a 5% withdrawal rate is ‘safe’—although how you invest and tap your portfolio is critical to keep the cash flowing.”
In a new research report, JP Morgan believes a 4% withdrawal rate is too conservative, and recommends 5% instead. David Blanchett, 42, Head of Retirement Solutions at PGIM DC, who argues that the 4% rule is too conservative and inflexible.
Blanchett, who has studied withdrawal rates for years, believes 5% is a safe rate for “moderate spending” through a 30-year retirement. “It’s a much better starting place, given today’s economic reality and people’s flexibility,” says Blanchett. I have never heard of PGIM DC.
The Inventor Of The 4% Rule Is Raising His Withdrawal Rate Too
Even more intriguing is that William Bengen, the creator of the 4% rule, is also revising his recommended safe withdrawal rate. He mentioned in Barron’s that in his upcoming book, he may endorse a rate “very close to 5%.”
As someone who has written traditional books, I know they take over two years to complete. Now, just as the Fed is preparing for rate cuts in the coming years, we see the idea of a nearly 5% withdrawal rate emerging. This is backwards thinking or at least thinking that is stuck when rates were higher.
A 5% withdrawal rate would have made sense back in October 2023, when the 10-year bond yield surpassed 5% and long-term Treasury bonds were yielding 5.5%. However, times have changed, and as rates—and potentially returns—trend lower, we must adapt accordingly.
The Potential for Lower Returns Going Forward
Vanguard has pointed out that the U.S. stock market is roughly 32% overvalued, based on the cyclically adjusted price-to-earnings (CAPE) ratio. Higher valuations typically signal lower expected returns. In Vanguard’s 10-year forecast, they expect U.S. equities to return only about 3.5% to 5% per year. You can see more details, including Vanguard’s bond forecasts, by clicking the chart below.
Meanwhile, J.P. Morgan projects U.S. stocks to return around 7.8% annually over the next 20 years, with bonds expected to yield 5%. 7.8% is roughly a 2.2% decrease from the 10% compound annual return the S&P 500 has provided since 1926. Therefore, increasing your safe withdrawal rate by 25% (from 4% to 5%) seems illogical. Lower expected returns typically warrant a more conservative withdrawal rate to ensure your savings last throughout retirement.
J.P. Morgan’s projected 5% annual bond return aligns with historical averages. Their assumption of a 2%–3% inflation rate suggests bondholders will likely receive a 2%–3% spread for taking on additional risk.
Different Investments For Different Risk Profiles
The truth is, no one knows what future returns will be, especially since most retirees don’t have all their assets in stocks or bonds. Vanguard, J.P. Morgan, and others will likely change their forecasts every year.
You could go with a traditional 60/40 stock/bond portfolio or a more conservative 20/80 split. But if inflation spikes again, as it did from 2021 to 2023, you might underperform. Alternatively, you could go with a more aggressive stock portfolio and experience a significant drop, like the 20% decline in 2022.
Therefore, it’s smarter to use a dynamic safe withdrawal rate as a guide to make better spending decisions in retirement. If you’re unsure or need a second opinion, consult a financial advisor. They see clients with diverse financial goals regularly and can provide valuable insights.
Unlike retirement researchers who are gainfully employed with benefits, you don’t have that luxury to pontificate once you leave work for good. If you end up losing a ton of money right before you want to retire, you might not be able to. And if you end up losing a lot of money during retirement, then you might have to go back to work.
Big Difference Between Retirement Research and Practice
Bill Bengen and other retirement researchers do excellent work. They help us think about saving for retirement and spending down our wealth. The more research and discussion about retirement planning, the better!
However, there’s a big difference between being a retirement researcher with a steady paycheck and a retirement practitioner who doesn’t have those benefits. I’ll take it a step further and say there’s an even bigger gap between a retirement researcher and an early retiree, who is too young to withdraw from tax-advantaged accounts and too young to collect Social Security or have a pension.
You can research and propose retirement strategies all you want, but you only truly grasp retirement when the steady paycheck and benefits are gone. Retiring is one of the most psychologically challenging transitions to face. As a result, being a little more conservative is better than being a little too aggressive.
After you retire, you’ll likely be consumed by doubt and uncertainty for an unknown period. You might even force your spouse to work longer just to keep your worries at bay! You can do it honey! Just 10 more years.
Whether you want to die with nothing or leave a small fortune for your children is entirely up to you. Everybody’s retirement philosophy is different. But since there’s no rewind button in life, it’s crucial to plan your retirement carefully.
Most people wing it when deciding how much to withdraw and spend. What I offer is a practical, adaptable approach that adjusts withdrawal rates based on shifting economic conditions. As a result, you’ll have more confidence to navigate the complexities of retirement.
Retirement will be different from what you imagine. Stay flexible!
Reader Questions And Suggestions
Do you think retirement researchers are upgrading their safe withdrawal rate assumptions near the top of the market? If so, why do you think they don’t take into consideration that inflation, interest rates, and returns are now falling? In such a scenario, wouldn’t reducing your safe withdrawal rate assumption make more sense? What is wrong with my dynamic approach?
If you have over $250,000 in investable assets, you can schedule a free appointment with an Empower financial professional here. Complete your two video calls with the advisor before October 31, 2024, and you’ll receive a free $100 Visa gift card. It’s always a good idea to get a second opinion about how your investments are positioned.
