In fact, this is the basis for the well-known “4% Rule”, which advocates this approach using 4% of your initial portfolio as your initial withdrawal – in our case, this would be $40,000, adjusted for inflation each year after.īut one significant gap with this method is that it takes no account of the remaining portfolio value when deciding each year’s withdrawal – it looks just at the previous year’s withdrawal and the inflation rate. This scheme is very simple to implement, and has the very nice feature that your spending level and thus lifestyle will be the same from year to year – after all, you have the same amount each year after adjusting for inflation, so have the same buying power. You then repeat this process each year to get that year’s withdrawal from the withdrawal of the year before. For example, if the inflation rate was 2.3%, you’d add on $805 (2.3% of $35,000), and take out $35,805 for the second year’s spending. You’d take out $35,000 the first year then for the second year, you’d see what the inflation rate was over the first year (from government statistics or the like), and add this on for the second year’s withdrawal. Thus if you have a $1000,000 portfolio, you might decide to take out the equivalent of $35,000 each year. In this scheme you take out the same amount every year, with an adjustment for inflation. The first and most basic scheme is inflation-adjusted constant withdrawal. They have different properties which affect our lifestyle (how much we have to spend) and our success probability (whether we’ll outlive our assets). There are a number of popular approaches, several of which will be discussed here. The withdrawal scheme is the formula/algorithm/system we use to determine how much to take out of our portfolio each year for spending. The withdrawal scheme is a key tool to help adjust for market-related changes in our portfolio and the uncertainty of the retirement timespan. Thus we need some strategy to adapt for this uncertainty. And the market conditions throughout the course of our retirement are similarly unknown, and this can make a huge difference between success (having all the funds we need throughout retirement) and failure (running out of money). Though there are some reasonable ways to estimate what period we should plan for ( as discussed in another article on this website), we can never be completely sure that we won’t live longer than we’ve planned, which should be a good thing, but isn’t if we run out of money. One natural issue is that we don’t know how long we’ll live, so don’t know what the duration of our retirement will be. This determines both our quality of life (how much we have to spend each year) and how likely our funds will last over the course of our retirement. One of the most important decisions in retirement is the withdrawal strategy from a portfolio.
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