# If I break the 4% rule, will I go to H-E-double hockey sticks?



## Davis (Nov 11, 2014)

Here is something I’d like to ask readers to mull over on while they are digesting their holiday dinners. 

The “4% Safe Withdrawal Rate” is something that I see a great deal in financial planning discussion – the idea that you should not draw down more than 4% of your capital each year of retirement. It is based in research by three American professors who studied actual historical stock and bond returns from 1926 through 1995 to determine sustainable withdrawal rates. They concluded that “clients who plan to make annual inflation adjustments to withdrawals should also plan lower initial withdrawal rates in the 4 percent to 5 percent range, again, from portfolios of 50 percent or more large-company common stocks, in order to accommodate future increases in withdrawals.” 

Many people seem to view this as a hard-and-fast rule. Others see it as being overly conservative.

I plan to finish working in 2016 when I will be 50, and husband is 51. We will draw from our portfolio of dividend-paying stocks (70%) and real estate income trusts (30%) for all of our income until we turn 65 when my inflation-indexed defined benefit pension kicks in and CPP begins. A year or two later, we will also get OAS. 

I have forecast out our investment income based on current returns (we’re invested mostly in dividend payers that have not cut their dividends in the past) and taxes based on current rules. To achieve our target income, we would draw down at a rate starting at 6.3%, rising to 12% when I’m 64, then dropping back to 6% when pension/CPP/OAS start, then rising again after that. 

I see our money lasting until we’re 92.

We will also have a GIC ladder to carry us for a couple of years if markets tank and we don’t want to sell any shares. Our home provides the final backstop for end-of-life care.

Your thoughts?


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## My Own Advisor (Sep 24, 2012)

I'm not a huge fan of the SWR.

Potentially it's because a) I'm not close to retirement age yet and b) I do not plan on withdrawing much capital in my senior years. I plan to live off the income derived from our investments. The capital will remain intact until our old age, should we need it for healthcare expenses or assisted-living.

Back to you, I like your plan since we are invested dividend stocks, REITs and ETFs that all pay dividends and/or distributions; so I have a bias here I guess  The annual yield from our current portfolio runs about 4.3% and has fluctuated between 3.9% and 4.8% for the last 5-years.

A draw-down rate of 6.3%, rising to 12%, seems high to me but I guess it really depends on the total income streams expected from pension/CPP/OAS. If those three are sufficient for all retirement expenses, and some 'buffer" (since you have no idea what the future holds) then drawing down your capital earlier may work for you. 

Have you thought about a cash-wedge approach in retirement?
http://www.myownadvisor.ca/cash-wedge-opening-investment-taps/

The wedge is largely constructed like this:

Year 1 – a small portion of your retirement portfolio is used for income withdrawals; money is allocated to a conservative, highly accessible investment such as a money market fund or savings account. This is the bucket where you draw your retirement income from.

Years 2-3 – a portion of your retirement portfolio is allocated into a guaranteed short-term investment, such as a 1-2 year Guaranteed Investment Certificate (GIC), some bonds or some fixed-income funds. On maturity, these investments are used to replenish the retirement income bucket you’ll withdraw from (Year 1).

Years 4+ – the rest of your portfolio is left to grow, as a diversified equity portfolio, providing growth for future years and to fund the early-year buckets.

Overall, seems like you have a plan which is a great thing.


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## Davis (Nov 11, 2014)

I think that's what I am doing with my GIC ladder -- I am including a portion in a high-interest savings account in that. I haven't gone out to three years as this strategy proposes. Also, the GIC/HISA portion is only to cover the part of target income that isn't made up by dividends and REIT distributions, i.e., the part that I have to fund through selling shares.

My portfolio is returning 5.73% on a current value basis and is composed of three Dream REITS (Office, Industrial and Global), Calloway REIT, BCE, Innergex, Liquor Stores, Brookfield Renewable Energy, AT&T, Boston Pizza, Bank of China, Construction Bank of China, Scottish and Southern Electricity -- all of these have dividend yields over 5%. My spreadsheet does not assume dividend increases (a good assumption for the Dream REITs, but a conservative assumption for Brookfield and AT&T, which have corporate plans to increase yields every year). I also assume no capital gains, which is a conservative assumption over a 35-40 year horizon. 

We have no kids, and the nephews and nieces will be approaching retirement by the time we expect to be done with this world, so we don't feel the need to plan to leave bequests.

Thanks for your comments, MOA.


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## OnlyMyOpinion (Sep 1, 2013)

^+ to MOA's comments on a cash-wedge approach. It will give you certainlty of income for the near term while letting your equities benefit from longer term growth. Daryl Diamond's website also has some material on this approach.
Make sure you have your future CPP income figured out correctly. The gov't website will not give you the correct value. Consider a one-off with Dogger1953 on this forum if you aren't sure.
To me, a 6.3% drawdown starting at age 50 also seems aggressive, with risk of outliving your investment capital, but it's impossilbe to say without knowing assumptions of total capital, income needs, investment returns, inflation, taxes, etc.
As MOA points out, just the exercise of thinking about 'decumulation' and planning for it puts you way out front.


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## RBull (Jan 20, 2013)

IMHO, 4% rule is only a very general guideline for the benefit of those without a large financial acumen, or a very simple plan. It is also normally used for about 30 years of retirement so may be aggressive for younger retirees. When you have a pension kicking in later, as well as CPP, OAS however its too simple a rule to pay any attention to. 

+1 for the cash wedge, which is part of our strategy. We also planned to age 95, exceeding family longevity most recent history. I actually pay no attention to %'s of withdrawal and prefer to work with actual future dollar calculations (inflation/growth adjusted). Ours would fluctuate a lot (%) because of pension factors, and a transition to a lower income at a later stage in life. 

If your numbers are trustworthy your plan sounds golden especially since you've assumed no capital gains.


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## Davis (Nov 11, 2014)

Thanks MOA, MYO and RB. I agree with using actual future dollar calculations rather than a % safe withdrawal rate, but I was looking for opinions of others since the 4% is just so darn prevalent in the discussion. This has been a useful discussion for me. 

Our plan includes inflation at 2%, CPP calculated based on actual years of contribution, rather than on a calculator. I seem to be exceeding my investment income target, so I am using this flexibilty to reduce risk in the portfolio. 

I think the remaining risks to the plan are inflation above 2% and policy changes (i.e., tax changes, and changes to OAS), but the tax changes can go either way -- I have not assumed any change to TFSA contribution limits, for example. I also am keeping in mind the research that shows that spending is higher in the earlty years of retirement, then falls by 20-30% as people's energy level drops, health care costs notwithstanding. I haven't factored this in, so inflation somewhat higher than 2% may not be a concern. 

Just 18 months to go. Thanks again for your input.


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## steve41 (Apr 18, 2009)

Time for Steve's annual rant....

Each of you are sitting at a computer which has more horsepower than NASA took to put a man on the moon. The rules of compound interest, inflation, taxation, pensions, loans... etc are known to all. Why not actually compute a plan?


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## Davis (Nov 11, 2014)

Because I'm waiting for tech support to call me back to tell me where the "on" button is for my computer. All that horsepower is no good if you can't get the gosh-darned gizmo to turn on. 

If you read the string of messages, you will see that I have a spreadsheet with assumptions and calculations of income, expenses, inflation, taxes, CPP and OAS, and withdrawals going out the next 41 years. I have computed a plan, but I was asking others for their opinions on breaking the rule of thumb that many commentators cite because CMF seemed like the right place to ask that sort of question. The above contributors kindly read my post, and offered me their opinions, for which I am grateful.


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## RBull (Jan 20, 2013)

^ditto above but only for 40 more years to age 95. We use 2.5% for inflation, but only 2% indexed on govt pension income. CPP has been calculated quite close with the assistance of dogger1953.


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## steve41 (Apr 18, 2009)

Sorry. My rant was to the effect that there is technically no such thing as a fixed withdrawal rate. As various entities come in and out of play over time (entitlements, loans, various forms of capital, lump sum cash calls, and especially taxes, your withdrawal rate is up and down like a yo-yo. It turns out that the calculation is quite tricky.


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## livewell (Dec 1, 2013)

No matter how powerful your computer this is not something that can be accurately calculated. With inflation, investment return, return volatility, mortality variance there are just too many variables to use any type of precision calculation. Thats why the "4% rule" is a useful starting place. Your choices are average returns calculations (That are normally too optimistic by not accounting for volatility) or use some Monte Carlo simulation (Firecalc being the most common) that will give you (only) a probability of success but again with a number of fixed variables chosen at the outset.


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## OnlyMyOpinion (Sep 1, 2013)

Like Davis, we have a spreadsheet built to estimate the various income streams we will have (2xcpp, 2xoas, 2xrrif, 2xtfsa, 1xlif, 1xinvestment); when they kick in; and whether they add up to an annual amount sufficient to meet our estimated annual expenses.
I agree that it is only an estimate but it seems better than just using "4% wdr of total assets". You can change assumptions to get some idea of sensitivity to returns, inflation, etc.
We have a good sized early cash wedge for a buffer, conservative assumptions, and we are only a few years away from deccumulation - so we don't have the uncertainty of accumulation phase assumptions at the front end. 
There are financial advisors who will provide analysis for you as well - but I probably wouldn't be able to understand the nuts & bolts that put it together.


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## Davis (Nov 11, 2014)

I don't use "average return calculations". I use the actual income stream coming from dividends, interest and REIT distributions. These returns are not guaranteed -- dividends and distributions could be cut, but they can also be increased. By buying companies that have not cut their dividends in the past, I think the actual current return is a good, possibly conservative, estimate of future returns. Like OMO, we are close to the decumulation phase, so don't have a lot of return uncertainty.

Capital gains and losses are another matter - no good way of predicting those, so I don't. I am mitigating the risk of capital losses by keeping a pool of cash in GICs and HISA so that I do not have to sell shares when the market is down -- I will use up the cash resources during a downturn, and replenish when markets have recovered.

Inflation is not predictable, but the Bank of Canada seems to be pretty good at keeping in its 1-3% band with an average of 2%. In fact, from 1994 to 2013, the average was 1.82%.


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## peterk (May 16, 2010)

My main gripe with the 4% rule is that people seem to think that the "low risk" implied by following the rule scales with the size of portfolio. That is hogwash, and doesn't consider the actual real world and what life may throw at you, nor the flexibility in your spending. Tons of those ERE and MMM guys who dream of retiring in their 30s or 40s are saying things like "I spend 20k/year so with the 4% rule all I need is a 500k portfolio".

Spending 20k/year with a 500k portfolio is far and away much riskier than spending 80k/year with a 2m portfolio. Just as the latter is much riskier than spending 4m/year with a 100m portfolio! But the 4% rule proponents seem to often suggest that each of these financial situations are roughly equal in terms of risk and portfolio longevity.


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## Davis (Nov 11, 2014)

Good point. Scaling back by 10% from an $80,000 spending rate because them arkets are bad is not nearly as difficult as scaling back 10% from a $20,000 a year spending rate. $20,000/year doesn't leave you much room for tightening the belt. 

Notice how many of the ERE people load their websites up with ads and links to how you can buy their books? (Take a look at =http://www.retireearlylifestyle.com/ this one.) It's fair for them to say they no longer work for someone else, but a fair number of them seem to spend a fair bit of time working on thier wesites or blogs.


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