5% the Hard Way

Reaching a 5% withdrawal rate with a dividend strategy is easy. You never sell any shares and you manage cash flows. Reaching 5% with a liquidation strategy, where you sell shares, is difficult. This is how you do it.

Fixed Income

Look at the TIPS Table (button on the left). It shows that you can reach a 5% (plus inflation) 30-year withdrawal rate with 3% TIPS. Just because you cannot buy 3% TIPS is not a problem. Corporate bonds yield more than 1% above treasuries. You should be able to withdraw 5% plus inflation for 30-years with corporate bonds by themselves.

Variable Withdrawals

Using the Scenario Surfer, I found that you can almost reach a 5% (plus inflation) withdrawal rate if you vary allocations. This is with a combination of the S&P500 and 2% TIPS. Simply substitute corporate bonds or preferred stock and you will exceed 5% easily.

Fixed Allocations

Using fixed allocations (i.e., rebalancing) is a horrible idea. It takes away the upside. Look at the 30 Year Safe Withdrawal Rates (Year 30 SWR button on the left) with 3% TIPS. At today’s valuations (P/E10=25), your probability of success when withdrawing 5% (plus inflation) is less than 50%-50%. Even with corporate bonds, the outlook is bleak unless you lower the withdrawal rate to 4.5% (plus inflation). A skillful fund manager has his work cut out if burdened with a fixed allocation.

Summary

Corporate bonds alone can lift the 30-year Safe Withdrawal Rate above 5% of your original balance (plus inflation). Using bonds instead of TIPS can lift the 30-year Safe Withdrawal Rate well above 5% (plus inflation) if you vary allocations. If you rebalance (i.e., maintain a fixed allocation), limit your withdrawals to 4.5% (plus inflation) or less.

Have fun.

John Walter Russell
May 8, 2008