One service we provide that is very popular with our clients is our guardrail retirement withdrawal, or distribution, strategy for those in retirement or who soon will be. In this episode of Retire Your Way Radio, I describe how our dynamic distribution strategy with guardrails works for providing on-going retirement income and how we determine how much money you can safely withdraw from your investments in retirement.
For years I've studied different withdrawal strategies: the 3% rule, the 4% rule, the bucket strategy, and so on. There are a bunch of different methods and ideas from studies done looking at the past 100-120 years.
The one that makes the most sense to me is the dynamic distribution model, which is based on an initial study done by Jonathan Guyton and William Klinger.
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With a dynamic distribution model, technically you will never run out of money because when the market (or your investment balance) goes down, and if they go down enough to trip that lower guardrail, your monthly withdrawals will just keep getting ratcheted down as well. We tell our clients: running out of money in retirement is not an option, but stuffing your mattress full won’t move the needle either.
First, everyone has to realize we can't guarantee any method for sure. There are simply too many variables and too much going on. Although we base this strategy on these great studies, the future is still unknown.
We're going to take the dynamic distribution model and combine it with a guardrail process. This makes sense because there are two things we don't know:
- We don't know how long your retirement is going to last (hopefully quite a while), and
- We don't know what the stock market is going to do.
Just like when you're driving your car down the road, there are guardrails if there's a sharp curve or a cliff. Well, we're going to put guardrails around your portfolio. Hopefully it stays in the middle of the road, but if it swerves and hits a guardrail, your investments get dinged up a bit, but that is much better than going over the cliff!
If you're willing and able to follow a few rules, you can safely withdraw around 5% annually (the specific amount depends on your individual goals and your risk-tolerance, but it’s usually a bit over 5%). We know your investments are going to go up and down, but as long as they stay above the lower guardrail, you’re all good and we'll keep sending you your regular monthly distribution.
If your investment balance drops below the lower guardrail, then you have to be willing to tighten your belt a bit. We're going to have to temporarily reduce your monthly distributions or withdrawals, by around 10% typically, while we wait for the market to come back up. On the flip side, if you break through the upper guardrail, you get an increase in income. So, yes, everyone likes to go through the upper guardrail!
Also, I often tell clients how much we can safely send them from their nest egg and they say, “Oh, well Tim, that is great to know, but we don’t need that much. We only need x amount of money.” So we often don’t even send the max amount to them that we could. Therefore, this allows us to drop the lower guardrail considerably. But they all like to know what amount we could safely send them if they need it.
War Chest of Fixed Income and Cash
One of the rules with this process is we have to have a war chest of cash and fixed income to get us through the down times. Because we don't want to sell if the market goes down, we want to have a buffer of time for the market to come back. We're trying to avoid selling when everybody else is panic-selling. As most of my clients have heard me say, panic is not a strategy.
What's the Worst Time To Retire Since 1900?
If I were to ask you, "what year do you think was the worst year to retire since 1900," what would you say? Most people I've talked to say the Great Depression, and some say 2008 or 2009, and this makes sense. Things were pretty bad during both time frames, but the answer is actually 1973. 1973 was the worst year to retire since 1900 because the market was down and there was high inflation.
During the Great Depression, the market obviously went way down, but only about two or three percent of people actually owned stocks in the stock-market crash in 1929. It continued to get worse when all the banks started to fail and everybody lost their savings. But there was also deflation because no one had anything to spend. So, everything went down and there was deflation.
In 1973, there was inflation and investments were cut in half. This was technically the worst time to retire. If our guardrail method was used during the period of 1973 and after, you would have hit the lower guardrail two to three different times causing two to three pay cuts, depending on timing.
For this to work, you have to understand statistically and historically every one in three years, we're going to lose money. The market DOES go down.
The average down market lasts about 1.5 years. The longest since 1900 was just shy of 8 years. So in order to weather the storm, you need at least 1.5 years of spending in your war chest (consisting of fixed income and cash). But we typically recommend a larger war chest mainly because the future is still unknown and because of human behavior and simply getting peace of mind. Most of our clients are comfortable with a war chest that can last 5-6 years.
BUT if you go too conservative with too much of your money in fixed income and cash, you may not earn enough of a return and risk running out of money prematurely.
Also one last note, everyone’s investments vary depending on: age, risk tolerance, Social Security strategy, pensions, size of investment accounts, goals, and your household expenses when determining how much to put where.
Bottom line: As I mentioned, our guardrail withdrawal strategy is the best method I’ve found that makes the most sense for retirement withdrawals, and it is very popular with our clients because it is a predetermined method, and we aren’t simply shooting from the hip or taking lower distributions than we need to.
So, that is an inside look at how our popular guardrail withdrawal strategy works!
Resource: Decision Rules and Maximum Initial Withdrawal Rates by Jonathan T. Guyton, CFP® and William J. Klinger
Would you like to hear more about how this withdrawal method could apply to you?