Transcription
Running out of money during retirement is probably one of the worst fears investors have. Today, I'm going to show you the perfect strategy that guarantees you won't run out of money during retirement. And I'll show you how retiring on $1 billion is not only possible, but you can also grow your money while doing so at any age.
But Joe, that's impossible. I agree. Seems impossible. But hear me out here. You need to watch this presentation very closely all the way through. It's that important.
So, let's start with some basic math. Let's say I have a million dollars stuffed under my mattress. I need to make that last until I die. And let's say I'm 65 years old, which is the typical retirement age for most people. Traditionally, we've been told to use the 4% rule. So, that means take 4% of a million, so $40,000. You take that out of your portfolio every year and you increase it every year for inflation.
This great piece by Schwab titled the 4% rule. how much can you spend in retirement looks at how you might play with that number and do better than just 4% of that portfolio every year. Now, what's very interesting about this chart is that there's not much room for error. So, what they've done here is they've taken two tables. The first is a 90% confidence interval. That means there's a 90% chance you're not going to run out of money. The second table is a 75% confidence interval. Same thing, 75% chance you're not going to run out of money. And look at how for only 30 basis points increase in withdrawal rate, you're dropping from 90% to 75% probability. In other words, this stuff is very sensitive when you start going over 4% withdrawal rate.
And you're probably wondering what these different strategies are listed here. Conservative, moderately, conservative, moderate. I've listed them out here because I think most investors like to think in terms of stons only when in fact you ought to think across more than just one asset class. And what you'll notice here is that asset allocation can have a big impact on a portfolio's ending balance. This is very interesting. So they've run what seems to be a Monte Carlo analysis looking at various withdrawal rates and outcomes. And you see there are outcomes in the negative that means you ran out of money. So unless you can run a Monte Carlo where there's no negative outcome, essentially there's always a chance that you're going to run out of money. So we see that withdrawing above 4% is not feasible because there's a probability that you can run out even at 4%.
And I promised you that you'll never run out. So here's what we'll do, a thought exercise. Let's take 50% of the portfolio value and spend it every year. And here's what that looks like. So the first year you're going to let that million dollars run in the market, it's going to gain 12.43%. So he's simply chosen a arbitrary 10-year time frame here. And you can see that after that money has grown 12%, well you spend half of it and the next year the remainder grows by well gee it looks like not very much 0.29% and you spend half by year five you're already down to 45k. So your money's never going to run out. And I know you're saying, "But Joe, you tricked me." We're getting there. Just bear with me, please.
So, we know if we take out a percentage of the portfolio value every year, there will always, by definition, be money left over. You'll never run out. Therefore, if we minimize the percentage that we take out every year, we can maximize what's left over at any given point of time in the future. So, let's go ahead and take 4% every year of the balance of your portfolio. Now, this is not a fixed amount. It's 4% of whatever your portfolio happens to be at the end of the year. Look at this. Rather interesting, right? Same time frame. You see how that first year you're taking 4% of the portfolio value, so about $45,000. And you see it goes down a little the next year and it goes up. But look, after 10 years, it's more than doubled. And not only that, but your principle is growing as well. How is this possible? Well, the stock market historically has returned about 9% a year. So if we take out 4% every year, there's a fair amount of gains left to accumulate.
Now of course over the past 10 years, the period of time we used for this back test, things have been quite good. What we need to consider here is the variability of income. So this is looking at those past 10 years. You see there's a year when your income dipped 10%. Then there's a year where your income dipped 30%. Now we don't like that volatility, right? That unpredictability. So you know how we can minimize it? Well, investing across asset classes. So here we've taken a portfolio that's 40% stocks, 40% bonds, and 20% gold. And now look at how the variability in income has decreased. So you have a down year of 7% and a down year of 18%. Now it's not as smooth as it could be because of this interesting chart here from Vanguard, which shows that in 2022, stocks and bonds actually were correlated. They usually aren't. So that was an exception.
Now, what we can then do is back test this new 4% rule strategy for the past 50 years using real US stock market data. And back testing is what we've been doing so far, looking at how a portfolio might behave using real market data. So, if we had $1 million invested in the US stock market in 1974, we withdrew 4% of the portfolio value every year for 50 years, what would our brokerage account look like and what would our income be on year 50? It's rather surprising. Now, you'd be generating $1.2 million in annual income on a $29 million portfolio. Now, what's very important to note here, you need to consider inflation. So, let's ask this question. What should that income be if it only grew by inflation, which is what your four traditional 4% rule says? Well, you would have about $254,000 a year. So, you're what? Running more than four times that with this different strategy, $1.2 $.2 million in income versus $254K. What about the principal? Well, if the principal simply grew at inflation, you'd have a $6 million portfolio in 50 years. Instead, you have a $29 million portfolio.
So, what we can then do is look at the traditional 4% rule over that same time frame. And what's interesting here is that first of all, our income matches inflation increases as we expected, right? So, it's roughly in line 273K versus 254K. But look at the balance of the principal. So that's 10 times inflationadjusted expectations. So under this particular scenario, we could probably safely withdraw 5.5%. Of course, your income won't be increasing and that's a problem. Now just remember that this outcome can differ dramatically because of something called sequence of returns. And we're going to talk about that.
So $63 million is a lot of money. You might say, "Well, Joe, I don't want to leave my worthless children $63 million. I want to spend more. Fair enough. Let them grow up to be PhDs. It stands for poor, hungry, and determined. They'll be better for it. Trust me. So, you're saying you want to spend more upfront. So, just bump that withdrawal rate up and run the number. So, what if we withdrew 10% of the portfolio value every year? That's a lot, right? It's slightly exceeding what the stock market typically returns. This is very interesting. So, our income is $119,000. That's less than half of the inflationadjusted income. And so we've actually lost half our purchasing power. And look at we only have a million dollars left. So that should be six million if it's simply adjusted for inflation. So we've lost dramatically across the board. Here's what that income looks like when you chart it. So this is 50 years back test withdrawing 10% every year. We can't have income that stops growing. That means we've increased that rate too much. We need to find a sweet spot.
So what about 6.5%. Well, this is actually rather interesting. So our initial investment is retained. So that's been adjusted for inflation. We're getting twice the amount of income we should be getting. So this seems a lot more interesting in terms of the amount of money that we're able to save and the amount of income that we're able to generate. We don't want to leave too much cash on the table.
So let's talk about sequence of returns risk. So let's say you put that million dollars in the market and after the first year you have half of it left. That would have happened in 2008. That's when I started working on Wall Street. It was some tough times watching the CEO of our company, John Mack of Morgan Stanley, curse on live television. So yes, that could happen. For some people, it did happen. So let's take a look at what one of the worst draw downs over the past 50 years would have done. So here you can see what taking 4% of that balance that would have been left over after the 2008 massacre, you would only be withdrawing about 25K. So that's a lot tighter than that 40K. What you can then do here is adjust for that and withdraw 6.5% instead. So, this was the worst year in the past 50 years. Here's how you could have handled that. You could start withdrawing 6.5% of your portfolio value. Remember, as long as you're doing a percent of the portfolio value, you're not going to run out of money. That would have brought you to 40K. And then you see here how that slowly starts increasing over time along with your portfolio balance.
So the takeaway here, the traditional 4% rule focuses on matching inflation and your income reflects that over time. So you're not enjoying any better quality of life. In our back test, we left way too much money on the table. So in other scenarios such as what Schwab looked like looked at and what other firms looked at a marginal increase over 4%, there's a likelihood you might go broke. You might run out of money. You don't want that happening in old age. Taking a variable approach is rather genius because guess what? You're selling more at market highs and less at market lows. That's what you want to be doing. Now, you need to accommodate for the volatility that I showed you, and you can do that by diversifying across asset classes, but your income's going to grow a lot faster, and you still have growing principles.
So, I wanted to touch on just living on 40k. So, some people might say, well, even if I use the traditional 4% rule, 40k isn't enough. So, I'm telling you that $3,333 a month is sufficient to live a comfortable life. People in America usually have a paidoff home when they retire. They have social security that can help them afford rent if they don't. But let's assume that you have neither. You only have that $3,333. I'm telling you, you can easily live very, very well in many countries across this planet. What we refer to as geographic arbitrage. I've been to 80 countries in the past decade, nearly 150 in total. And I think most the time I spend traveling, I'm spending less than I would if I lived in the United States.
So just remember that 4% rule only gives you income that grows at inflation. Your quality of life doesn't improve. You can use this new 4% rule to increase your income above inflation. And you can accelerate that when faced with a sequence of return scenario. You're never going to run out of money this way. It's a rulesbased method which also helps keep emotion out of it. You're going to sleep a whole lot better at night when you have a rule that ensures you don't run out of money during retirement.
So, another thing that people might look at is how to maximize the income that they receive off a million dollars. We did a piece on that. It's excellent. Give that a watch next. Thanks so much for taking the time to watch this today.