Starting at 5%

I started with Taken at Face Value. Then, in Building On Success, I showed a straightforward way to reach a continuing withdrawal rate of 6.1% of the original balance (plus inflation). But as a matter of caution, I recommended starting at a 5% withdrawal rate in Today’s Alternatives.

Taken at Face Value
Taken at Face Value: Upside
Building On Success
Today’s Alternatives

This is how an early retiree might go about it.

The First Decade

For this study, I prepare for the possibility that intermediate term timing fails. That is, I assume that we really have reached a permanently higher plateau. Valuations continue to stay in record territory (P/E10=20).

After playing with the numbers, I settled on this allocation:

I allocated 80% of the portfolio to the Dividend Blend portfolio, which has a continuing withdrawal rate of 5.5% (plus inflation) at its minimum. The withdrawal rate increases to 6.0% in Year 25. It exceeds 7.7% in Year 40. [This original Dividend Blend has an allocation of 20% Investment A and 80% Investment B.]

I allocated 20% of the portfolio to a TIPS ladder at 2% (real) interest. For the first decade, I withdrew 3.0% of the original balance (plus inflation).

The combined withdrawal rate was 5.0% (=5.5%*0.8+3.0%*0.2) of the original balance (plus inflation).

If Successful

If prices have fallen, replace the TIPS ladder with a Dividend Blend. Referring to Building On Success, the Dividend Blend would have a continuing withdrawal rate of 11.18%. [This new Dividend Blend has an allocation of 15% Investment A and 85% Investment B. The change is because of improved yields after the price drop.] Referring to the TIPS Table (see the button on the left side of the page), the TIPS ladder will still have 89% of its original balance (plus inflation) at Year 10.

This portion of the portfolio has a withdrawal rate of 9.95% (=0.89*11.18%) of the original balance (plus inflation).

Since the special portion was 20% of the original allocation, the new continuing withdrawal rate is 6.4% (=5.5%*0.8+9.95%*0.2) of the original balance (plus inflation).

This is a nice boost from 6.1% (plus inflation). It is your reward for being patient.

If Not Successful

This time, I increased the withdrawal rate from TIPS to 5.0% (plus inflation) at Year 10. From the TIPS Table, I can do this for 26 years.

The new starting balance is 89% of the original balance (plus inflation). At 5%, this is 4.45% (=5.0%*0.89) of the original balance (plus inflation).

Since this was 20% of the original allocation, it contributes 0.9% (=4.45%*0.2) to the continuing withdrawal rate. Adding in the rest of the portfolio, the new continuing withdrawal rate is 5.3% (=5.5%*0.8+0.9%) of the original balance (plus inflation).

This is less than the 5.5% (plus inflation) that you could have withdrawn if you had not tried for the benefits of intermediate term timing.

Remember, I am assuming that this time it really is different. You don’t do as well as hoped for. But you still do OK.

Not stated earlier: the 5.5% from the basic Dividend Blend portfolio is a minimum income stream. It grows after Year 8. At Year 36, when the income stream from TIPS goes away, this portion of the portfolio is yielding 7.29% of its original balance, which is 7.29% of 80% of the total original balance.

At Year 36, the income stream is 5.8% of the total original balance (plus inflation).

Outcomes

If successful, reducing withdrawals to 5.0% of the original balance (plus inflation) results in a continuing withdrawal rate of 6.4% (plus inflation) and growing after year 10. This is a nice boost from 6.1% (plus inflation) that you would have received by assuming that intermediate timing would have worked all along. You get paid for withdrawing only 5.0% during the first decade.

If intermediate term timing were to fail, you would withdraw 5.0% during the first decade, a minimum of 5.3% for the next 26 years and 5.8% (plus growth) after that.

Have fun.

John Walter Russell
May 29, 2007
Update: December 31, 2007