Offering a new take on the 4% Safe Withdrawal Rate.
music selection: “Conga” — Miami Sound Machine (sooner or later, the rhythm really is gonna get’cha!)
weigh-in: 195.4 (2.4)
I want to show some spreadsheet work I was doing over the weekend. Basically, I wanted to see what kind of super early retirement was available by leaning on closed end funds (CEF) as an initial anchor and transitioning to a rising equity glidepath. The maximum recommended allocation for fixed income is 72%. Turns out, by having all your assets correlated, your risk starts to increase after that by adding more fixed income.
So, I built a model that assumed starting with a maximum 72% allocation to fixed income CEFs. I set the initial yield on same at 10%, similar to what I have been demonstrating in my Friday Fixed Income posts. For equity, I chose a maximally conservative indexing approach by selecting Vanguard Dividend Appreciation ETF (VIG). This fund currently yields 1.86% and I built the model assuming that yield will be static.
I further made the model conservative by assuming 4% annual growth rate of the equity portion (no growth for fixed income portion) for the first 10 years as predicted by Jack Bogle for the next decade. I think increased the growth rate to a pedestrian 6%. I personally think the Dividend Achievers will do better than 4-6 percent over the next 4 decades but I’m trying to prove a point here.
I set inflation to 2% per annum. After working with the other variables, I played around with starting withdrawal rates. I settled on 6.5% as being aggressive but still safe. The Bogleheads insist on saving 25 times your budget (or more!). With the approach I’m illustarting, a little over 15 times saved is enormously safe.
One more assumption. The subject would retire at 30 with a projected Social Security benefit of 750 a month. With 2% annual growth for inflation, this grows to a little over 18,000 a year by the earliest available collection date. I included these payments in the model.
Sorry that the image is a little blurry. I made the MS Excel file available on Google Drive if anyone wants to play with it. The first column is the Social Security estimate. Red years are ineligibility and green years are eligible to collect. The other colored column contains the year end value of VIG after accumulating either 4 or 6 percent growth plus any budget surplus.
In years 1 through 13, you will live solely off passive income (distributions) with surplus going into VIG. Thereafter, you will be selling a small portion of VIG each year to cover the shortfall in passive income. The chart below shows what the withdrawal rate looks like over time using this approach.
Note the trend goes from about 6.5% (our initial condition) to under the traditional 4% by year 47. Starting with 1 million dollars and withdrawing an inflation adjust 65,000 (dangerous by the Boglehead standard), the early retiree has a very smooth retirement glidepath.
I didn’t model in any market downturns. This is by design. The 72,000 initial fixed income distribution, ensures you are not selling during a down market in the first 8 years but rather buying additional equity. You actually want your downturn to come early with this model. If the downturn comes after year 8, you are already building a snowball.
Of course, I think an investor can easily do better than VIG by including some REIT, MLP, and BDCs to their equity portion of their portfolio. The high yields will add enough additional passive income to ensure more equity is purchased in the early years. And of course, you can juice your portfolio by selling options. But neither is truly necessary.
Devour your prey raptors!