EngFI2022

2 Mar, 2022

Posts

Managing Withdrawals In Retirement

I didn’t realize it but I had reached my minimum Financial Independence number in 2016. I was planning a 2020 retirement date and still had some financial house keeping to complete. We were making double payments on a 15-year mortgage. Our budget still needed refinement before I could confidently calculate my final FI number.

It was about this time I realized my investing focus had always been on accumulation and I had little knowledge of withdrawal strategies. It seems everyone writes about saving, investing and how to acquire wealth. But few write about what to do when you reach your goal. My guess is there are more people needing coaching in the accumulation phase😊

Top 5 Withdrawal Strategies

A quick internet search of retirement withdrawal strategies results in five common strategies. The 4% rule, Fixed dollar, Fixed percentage, Systematic and The 3-bucket strategy. As an engineer I sometimes like to get lost in the numbers and simulate untold options. In the end a much simpler approach seems to always win out.

If you want to dive into some advanced strategies, I suggest looking into Darrow Kirkpatrick’s January 4^th, 2016 post in Money.com. I’ll be discussing the top 5 simple strategies here.

The 4% Rule

The 4% rule has been discussed in my earlier blog and has been the gold standard of investment professionals for years. Trying not to oversimplify you start your first year of retirement by withdrawing 4% of your 50/50 stock/bond portfolio. You rebalance annually and in your second-year withdrawal no more than 1.02 x your last year’s withdrawal. The added 2% gives you a raise for inflation. The research indicates a high success rate of a 30-year retirement never depleting the portfolio.

Fixed Dollar

In a Fixed Dollar strategy, you simply withdrawal a fixed dollar amount like $40,000 annually for a set number of years. At some time during the set term, you reassess your plan and adjust accordingly. Very convenient for budgeting but doesn’t account for inflation or principal growth or erosion. You may run out of money or live below your portfolio’s potential.

Fixed Percentage

Using a Fixed Percentage strategy, you withdraw a fixed percent of your portfolio total. If you select 4% of a $1m portfolio you would receive $40,000 your first year. Without any growth your next year’s withdrawal would be $38,400 (($1m – $40,000) x 4%). If you received 7% growth after year one’s withdrawal you would have a second year withdraw of $41,088 ((($1m – $40,000) x 1.07) x 0.04). The advantage is an easy annual calculation (Total portfolio x 0.04 = Withdrawal). Disadvantages are irregular withdrawal rates and no long-term protection against running out of money.

Systematic Withdrawals

A Systematic withdrawal strategy is favored by some dividend investors. You plan to withdrawal only dividend and interest income from your portfolio. You never touch the principle and your portfolio is left to your heirs or the charity of your planning. Your income will vary by market performance. A very conservative approach that could be used with retirees who’s pension and social security cover most or all of their basic needs.

3-Bucket Approach

The 3-Bucket Approach gives a bit of security and still allows for the potential of growth. Bucket one, for near term needs, will hold typically 3-5 years of cash. Bucket two is invested in 5-8 years of fixed income securities and bucket 3 holds the remainder of your portfolio in equities. As you pull cash from bucket one you refill if from growth from buckets 2 and or 3. This takes a bit of management but gives you security from a downturn in the market. In a lean portfolio it may leave the equity allocation too low for adequate long term growth.

What’s Best For You

No one strategy is right for all. Taxes, market valuation, required minimum distributions and other considerations muddy the waters. You may find a mixture of strategies works best for you or a more complex method altogether. I find the simple solution if often the most elegant. That way I can spend more time spending time with the things we enjoy.

1 Engineer’s Strategy

Here is what I have done so far. Being somewhat conservative I left work with a portfolio value of 35 x my gross annual budget. I guess that’s Chubby FIRE in today’s FI world, only requiring a 2.8% withdrawal rate. At two years prior to retirement, I moved 5 years of income to bonds within my 401-k. The balance of my 401-k, my IRA’s and other investments remain invested in 100% stocks.

The year I turned 55, I “separated” from my company and then qualified to use the rule of 55. This allowed me to withdraw penalty free from my last employer’s 401-k. I rolled the remaining balance of my 401-k into a mix of low-cost index funds. I currently take a quarterly withdrawal from the 401-k bond fund.

During the second ½ of 2020 and all of 2021 it was like magic! I would take out my quarterly withdrawal and by the next quarter the account balance had grown back. My other investments continued to grow as well. The “Money Making Machine” was alive and well!

The 1 Engineer on FIRE withdrawal strategy is simply to continue to make quarterly income withdrawals from my bond fund. Maintain 5-7-year bond buffer in good markets (the average bear market lasts ~4.5 years). In bear markets I may tighten my budget belt (reduce or eliminate lifestyle budget items) and draw down my bond fund allowing my equities to recover.

Conclusion

So, I guess I have a Modified 2 bucket strategy!

What do you think? Do you have a withdrawal strategy?

1EngineerOnFIRE.com

EngFI2022

27 Feb, 2022

Posts

The 4% Rule

It only seems right for 1 Engineer On Fire to start with the 4% rule. Why you ask? Because an engineer developed the rule! In 1994 Bill Bengen, a former aeronautics engineer turned financial planner, published an article describing his 4% rule. He used historical stock market data to estimate a “worst case safe withdrawal rate”. Safe meaning a high probability of success of not exhausting a portfolio over 30 years.

The Trinity Study

If you really want to dive into the numbers, I suggest looking into the Trinity University study. In this study they used historical 30 year rolling stock market data, various rates of return and various asset allocations to calculate a percentage of success! If you are nearing your FI number and considering retirement, take a good look at the data found in the Trinity study.

In my reading I find many financial advisors and bloggers tend to oversimplify the 4% rule. Like so many numerical simulations the assumptions are critical. Variables like length of retirement, your asset allocation, rebalance frequency all play a huge role in the result. Data analysis is an awesome tool but must be understood completely to avoid misleading conclusions. Bengen used a 50/50 allocation rebalanced annually but again look at the Trinity study for wider variation on the subject.

The 4% Rule Modified

In 2006 Bengen raised the 4% rule to 4.5% and spoke of even higher average rates. In an Oct 2020 interview, he updated the rule to 5% but also considered an updated portfolio allocation (30% S&P 500, 20% US small cap and 50% intermediate treasury bonds). He warned the rule is not a law of nature it is empirical. Meaning it is only based on the data we have available.

What does all this mean?

I believe the work done to determine the safe withdrawal rate was some of the most important for modern day investors and people seeking FIRE! It’s really a rule of thumb giving people a data-based benchmark to start planning. So many variables to consider for every individual case. If you are new to your FI journey, just use 4% and keep investing. As you get closer (5 years) to your FI number, dig into the data and realign your goals to your comfort level.

What did I do?

In my twenties I just put away every penny I could spare (401-k and mutual funds) and didn’t worry about it. I tracked my progress monthly and targeted double-digit growth.

In my thirties I maximized my 401-k and bought more mutual funds in IRAs. As life turned more complicated with family and work my monthly tracking turned to quarterly.

In my forties I could see the light at the end of the tunnel and began making serious projections. I used 3% inflation, 4% withdrawal rate and no Social Security. I ran projections with growth percentages from 5-11%. I realized my personal and professional responsibilities took more and more of my time. I had amassed a pile of different mutual funds and began to lose focus in my portfolio. I decided to seek the help of a professional advisor. When I had little money and plenty of time, I managed everything myself (no load mutual funds were the index fund of the era). When I no longer had the time, I searched out the best help available. I selected Merrill Lynch and their analysis confirmed my plan was sound.

At age fifty I realized I liked my job and the people but the commute and politics were wearing on me. I decided to work until 55 and made a shift in my planning. I had reached a Lean FI number but wanted to target a lower withdrawal rate. My wife and I started expanding our leisure activities in preparation for retirement. I realized my focus was always on accumulation and I knew practically nothing about withdrawals!

My brother-in-law, also an engineer, introduced me to “Can I Retire Yet” by Kirkpatrick (another engineer!) and I found “You Can Retire Sooner Than You Think” by Moss. Both books confirmed I was in good shape financially. I decided I never wanted to go back to full time work so I added a buffer to my FI number. I calculated 25 times my annual budget (4% withdrawal) and added 40%. Why 40% you ask? Over my investing life my worst year was -32%. If I suffered a 40% drop in the market the day I retired, I would still have my full FI number. 😊

1 Engineer On Fire

What rule do you use for planning?

EngFI2022

25 Feb, 2022

Posts

Introduction To 1 Engineer On FIRE

Engineering is a science that teaches one to make decisions based on available data. My working career involved mechanical gizmos but the same methodology applies to everything including money. I used that methodology to build my financial portfolio and retire early. Today everyone calls that Financial Independence or FI. Whatever the name, it gives you the freedom to do more of the things you enjoy.

FIRE, Fast FIRE, Slow FIRE, Coast FIRE, Chubby FIRE… Money, time, happiness, goals or “sticking it to the man”. It’s really all about freedom. Freedom to work where you want, when you want, how much you want. Freedom to sleep in, travel, spend time with friends and family. It’s also about time and how you spend it. Early in our working years we trade our time for money.

Engineers work hard to improve efficiency in everything they do. If one efficiently converts time to money, he can create more money. The best way to do that is to invest in yourself making your time more valuable. Become an expert, get that degree, training or certification, be known as the best in your market.

In the U.S. we have a culture of more. If I just could get a nicer car, home, apartment, phone… I’ll be fine. I always said “Money is only a problem if you don’t have any.” I grew up in this materialism culture. Success was defined by how much stuff you have and the more the better! My wife and I followed this materialistic middle-class culture – Good grades, University, Job, Career growth, House, Cars and more Stuff. BUT we did it a bit differently. We never stopped investing.

At first, we were “all-in” on spending every penny to build our first house. I mean we built it with hammers and nails. We worked every day after work until dark for nine months. We didn’t know it at the time but that house would become our foundation for financial independence. Our mortgage was 1/3 of our contemporaries. Now we had money to invest. We continued to drive our used 100,000 mile+ cars and invested the savings. Our home culture shifted from building to education as we continued to invest in ourselves with degrees that brought us promotions and pay increases.

The old fashion pension plan was closed very early in my career and replaced by a 401-k. I maxed out my contribution, collected the company match and maxed out our IRA’s. We were lucky that both our parents were conservative savers, we grew up in that culture as well. My parents spoke openly about finance and investing and included me in most discussions. Back then there was no investing community to share and learn from, heck there was no internet! I found books on investing, taxes, insurance and read everything I could find.

Sure, we fell into the trap of spending on nicer things but we had plans, goals and a written roadmap for success. We kept on investing. We continued to live life on an increasingly better scale. I wanted the stuff and my wife wanted the experiences (She did manage to teach me to enjoy the journey). Our careers accelerated and the stress of management began to consume us. We refocused our roadmap to early retirement. We accelerated paying off the mortgage. We started exploring our favorite vacation leisure activities. Retirement became a 5 yr. goal and my wife retired from her primary career and only worked her “fun” job.

We kept investing. Our nest egg had grown to the point that contributions were nearly insignificant as the power of compounding had taken over. We had created the “money making machine” we needed and further investing would just be added insurance. I retired from corporate life in 2020 and my wife retired a second time early in 2021. We reached Financial Independence in our 50’s.

Looking back, we could have achieved FI faster. We have zero regrets. We feel our success is due to communication, having goals and a written plan. We lived, we learned, we were not afraid to change course along the way.

Welcome to 1 Engineer On FIRE