The big question everyone wants the answer to is, “When can I retire in Thailand?”
The simple answer is, “When you have accumulated 25 times your annual spending.”
Of course, in real life, the answer is a lot more complicated.
First, what does the 4% rule mean and where does it come from?
The 4% rule refers to how much someone can safely withdraw from their portfolio every year and not outlive their money. Withdrawing 4% per year is the same as having 25 times your annual spending in your portfolio.
A few studies have looked back at historical US market returns and concluded if you retired at the absolute worst possible time, withdrawing 4% of your portfolio per year adjusted for inflation would not completely deplete your portfolio for at least 30 years. Anything higher than 4%, even 1% more as in 5%, and you have a high risk of depleting your portfolio while you’re still alive or having to cut your spending by as much as 60%.
By withdrawing 3.25-3.75% per year, your portfolio can survive the worst case historical market returns and sequence of return events for even a 60-year retirement.
Fractions of a percent may not seem like very much, but with the way the math works, a fraction of a percent compounded annually for decades has an enormous impact on the final value of your portfolio.
The 4% rule can be thought of as a rule-of-thumb that needs to be tailored to your individual situation.
Let’s take a closer look at the factors you need to consider when determining your safe withdrawal rate:
- Market returns
- Sequence of returns
- Length of retirement
- Asset allocation
- Capital depletion or capital preservation
It should be no surprise those studies are based on historical returns that may or may not happen in the future. There’s no guarantee a future worst-case scenario won’t be worse than previous market crashes or economic depressions. Bond yields are currently much lower than their historical average. Some experts say equities are currently at ridiculously high evaluations, which typically leads to lower future returns.
The first decade of returns after you retire is a good predictor of your long-term retirement success. If you still have 50-60% of your original portfolio after the first 10 years, you will most likely be alright for the rest of your retirement. While there are things you can do to mitigate against unexpected low market returns (see below), you may want to be a bit more conservative with your safe withdrawal rate, especially if you experience low returns during the first 10 years.
Sequence of Returns
Sequence of returns refers to the order in which high and low returns occur. If you buy and then hold for a long time, the order of returns doesn’t matter because you will end up with the same amount. But, if you are adding to or withdrawing from your portfolio while you are working or retired like everyone does in real life, the sequence of returns has a significant effect on your final amount.
Let’s say you start with $100 and have a +30% return the first year and then a -20% return the second year. You would end up with $104.5. Now let’s reverse the order of those returns, so if you start with $100 and have -20% then +30% returns, you still end up with $104.5. The cumulative return is the same and the order of those returns doesn’t matter.
$100 + 30% = $130 – 20% = $104.0 (cumulative return of 4%)
$100 – 20% = $80 + 30% = $104.0 (cumulative return of 4%)
Now, let’s use the same example, but this time withdraw 4% of our original portfolio after the first year, which is $4.
$100 + 30% = $130 – $4 withdrawal = $126 – 20% = $100.8 (change in portfolio value of +0.8%)
$100 – 20% = $80 – $4 withdrawal = $76 + 30% = $98.8 (change in portfolio value of -1.2%)
A 2% difference may not seem like a lot, but like we said before, a few percent compounded over decades will have a significant impact on your final portfolio value.
The bottom line is when you are withdrawing from your portfolio, negative returns at the beginning of retirement affect your future portfolio value more than negative returns that occur later.
As an aside, the sequence of returns also affects your long-term portfolio value when you are in the accumulation phase. It’s much better to have low market returns at the beginning when you are young and your portfolio is small, and high returns later in life when your portfolio is larger, rather than have high returns at the beginning and low returns near retirement.
In fact, now we can conclude the best case scenario over your lifespan is to have low returns when you are young and accumulating, then high returns before you retire that continue for the first 10 years of your retirement, followed by low returns before you kick the bucket.
The worst-case scenario would be high returns when you are young, followed by low returns before you retire as well as during the beginning of your retirement.
Length of Retirement
As you already know, the 4% rule is based on a 30-year retirement. If you plan on retiring early and living well into your 90’s, a 30-year portfolio isn’t going to cut it. If you need your portfolio to last more than 30 years, or if you want something left at the end as a bequest, you may want to adjust your asset allocation and/or your safe withdrawal rate. It’s been shown that a withdrawal rate of 3.5% can protect against low returns the first two decades of retirement for time frames greater than 45 years. In other words, reducing your withdrawal rate by 0.5% gives you the same chance of success for a 60-year retirement vs. 30 years.
Also, the longer your retirement is, the more likely you will have unexpected large expenses. Planning for unexpected health costs, for example, is a good idea because you would not want to return to work if you are having a health crisis.
The 4% rule is based on a 60/40 portfolio, which means a 60% allocation to equities and a 40% allocation to bonds. For longer retirements of 40 or 60 years, you may want closer to 75- 100% equities. Bonds are less risky than equities, but they have lower returns. This means the longer your retirement, fewer bonds and more equities you want
One option to protect against a market crash during the first 10 years of retirement is to change to mostly bonds right after you retire. You would change back to a more balanced allocation between bonds and equities later on. While this option may protect against market crashes soon after you retire, it also has the opportunity cost of missing out on possible market gains as well. Having said that, it’s not uncommon to reduce the risk of your portfolio by adding more income-producing investments once you retire.
Dividends need to be included in your safe withdrawal rate. So, if you receive 2% dividends per year, then you would sell 2% of your portfolio to get a total withdrawal of 4%. Dividends have never been used to determine market returns, because in theory, receiving a 2% dividend is the same as selling 2% of a stock. In real life though, it’s often easier to receive dividends automatically in your account rather than deciding which investments to sell, especially if the market is down.
In addition to adjusting the ratio of equities to bonds, another way you can diversify your portfolio to decrease overall risk is by including international markets, such as Europe, Asia, along with emerging and frontier markets. While the S&P 500 was flat during the first decade of the 21st century (which is often referred to as the ‘lost decade’), international markets performed well. Regular rebalancing between international and US markets would have given decent returns.
You can also diversify by tilting your portfolio towards factors such as value, size, momentum, quality, and volatility. Factor investing is a whole other article, so I recommend having a look at Andrew Berkin and Larry Swedroe’s book here.
As a follower of FIRE, I like to avoid individual stocks as well as commodities. Investing in individual companies is just too risky. At least 30 stocks are needed for diversification, and the transaction costs and effort required to rebalance isn’t worth it when you can buy low-cost exchange-traded funds that have hundreds, if not thousands of stocks. While commodities, such as gold and oil, sometimes have price spikes, they don’t produce income and production over time gets more efficient, which leads to lower prices. Also, equities are a far better hedge against inflation than commodities.
Capital depletion or capital preservation
Many people will want to leave something for their children, other important people in their lives, or charity. An often overlooked consequence of the 4% rule is it’s possible to have nothing left of your portfolio after 30 years. Success is defined as total capital depletion during worst case scenarios. It should be no surprise by now if you want your portfolio to last longer than 30 years, which is the same as saying you don’t want it to be zero, you may need to lower your withdrawal rate.
Counter-intuitively, it is actually more difficult to achieve capital preservation with a 30-year time frame compared to 60 years. High equity allocations and the high returns they give make it easier to maintain capital for time periods exceeding 30 years. It’s been shown for equity allocations 75% or greater, to maintain 75-100% of your original capital at the end of 60 years with success rates greater than about 90%, you need a withdrawal rate between 3.50-3.75%.
It’s important to remember the 4% rule and all the above scenarios (except for sequence of market returns) are based on only US historical returns. No one has done a similar analysis using international returns because of the lack of data available, but it’s likely diversifying internationally with regular rebalancing will decrease your overall portfolio risk, allowing you to slightly increase your safe withdrawal rate.
In summary, while the 4% rule guarantees success for a 30 year retirement based on historical US returns for a 60/40 portfolio, if you want your money to last longer, you will need at least 75% equities and a withdrawal rate between 3.25-3.75%, depending on actual market returns and how much capital you want to leave as a bequest.
What if the Unthinkable Happens?
What if an unprecedented market crash happens and all your financial planning is thrown out the window?
Before we look at what you can do to salvage your retirement, it’s important to understand how hard it is for your portfolio to recover from a market crash, especially if you are withdrawing at the same time.
Let’s start with $100 again and look at the math behind a recovery. If the market crashes by 30%, it takes a gain of 42.8% to get back to your original $100.
$100 – 30% = $70 + 42.8% = $100
But you still need money to live, so let’s withdraw $4 after the market crashes. Then you need a 51.5% return to get back to your original $100!
$100 – 30% = $70 – $4 = $66 + 51.5% = $100
As you can see, withdrawing from your portfolio during market crashes makes it much more difficult to return to your original value. In above example, a market crash of 30% required a 51.5% gain if we withdraw 4% at the bottom. Combine this with the risk associated with the sequence of returns, and you can see why it is prudent to plan for the unexpected.
Here are a few things you can do to increase the success of your retirement if the unexpected happens:
- Reduce spending/adjust your withdrawal rate
- Go back to work
- Use an emergency fund
Just like during the accumulation phase, it’s easier to cut your spending than to bring in more money when you’re retired. Nightlife and traveling are probably the easiest to start with. If you have been following FIRE, should be debt free already, but make sure you’re not paying unnecessary interest on anything. It may be more difficult to cut spending if you have fixed costs such as tuition for your kids. If you have important expenses like tuition you don’t want to cut back, it’s probably better to work for a few more years and have a lower withdrawal rate in the first place.
Options to reduce your withdrawal rate include not giving yourself a cost of living increase if the market is down, or to withdraw 4% of the current value of your portfolio instead of the original value. Nonetheless, both options require you to lower your standard of living.
Going back to work is often given as advice, but it’s easier said than done. First off, it’s unlikely you will be able to go back into to your previous job at the same salary before you left, especially after being away for a long time or during an economic downturn. It may take a long time just to find a low paying job since many people will be competing for the same scraps if the economy crashes. If you retired early, your friends who are still working may not be sympathetic to your situation, but also think of the added emotional cost of going back to work after you have already given it up. Having a side hustle after you retire and putting more time into it if the market crashes could a be a good way of protecting your retirement.
Given the state of corporate and state pensions along with social security, while some people will surely disagree, I would think twice before including those in your FIRE plans, especially if you are retiring early.
It’s always a good idea to have an emergency fund in cash of at least a few months living expenses. Over a long retirement, the unexpected can and will happen, and you may need immediate access to money. It could also provide a cushion if it takes time to re-enter the workforce or to ramp up your side hustle. The retirement visa requirements for Thailand of having either 400,000B if you’re married or 800,000B if you’re single in the bank could be an emergency fund, as long as you could replenish it if needed. If you are planning on keeping a large emergency fund of more than 1 year’s living expenses, you need to understand the opportunity cost of not having that money invested over the long-term. For that reason, some people argue against emergency funds, but I like to stay on the safe side with at least a few months of cash.
A popular online retirement simulator called FIREsim is available here. Another popular simulator that uses a Monte Carlo analysis can be downloaded here. You can experiment with the different variables we talked about in order to find an acceptable success rate you are comfortable with.
We have shown the 4% rule is not as simple as it first appears if you want to FIRE. It needs to be tailored to your life situation by taking into account market returns, the sequence of returns, the length of your retirement, capital preservation, asset allocation, and how easily you could decrease your spending and/or increase your income after you retire.
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