Follow_A_Dynamic_Safe_Withdrawal_Rate
00:00:00.000 | Hello everybody, it's Sam from Financial Samurai and in this episode I want to talk about your dynamic safe withdrawal rate in the retirement
00:00:07.280 | Because interest rates have gone up
00:00:09.520 | Your safe withdrawal rate has gone up and the reason why is because the formula that I have offered to the world
00:00:15.620 | the financial samurai safe withdrawal rate formula equals the 10-year bond yield times 80%
00:00:21.980 | So as the 10-year bond yield goes up
00:00:24.600 | So does your safe withdrawal rate and vice versa?
00:00:27.960 | And if you think about it, it makes a lot of sense
00:00:31.560 | the 10-year bond yield is the risk-free rate of return and it encapsulates the state of the economy you can write
00:00:39.080 | Thousands and thousands of words on the 10-year bond yield, but it is the single most
00:00:44.120 | Important economic indicator you should follow because it's the risk-free rate. It is a reflection of where
00:00:50.360 | Inflation is heading or where inflation is right now
00:00:54.700 | it reflects the state of the employment market and it also discusses where the bond market thinks the economy is heading as
00:01:02.920 | A investor who is willing to risk his or her assets to make money and probably lose money on occasion
00:01:10.320 | The 10-year bond yield is so important because you would not invest in any other asset if there wasn't an equity risk
00:01:17.560 | premium and that equity risk premium is the difference between your
00:01:22.400 | Expected market returns and the risk-free rate of return the 10-year bond yield
00:01:26.380 | So if you expect an investment to generate a 10% return and the risk-free rate of return right now is 3%
00:01:33.760 | Your equity risk premium is 7%
00:01:37.160 | So you might be wondering where did I come up with my formula the 10-year bond yield times 80%
00:01:43.480 | Well, it comes from history
00:01:46.080 | back in the
00:01:48.020 | 1990s the 4% rule became very popular and the 4% rule states that if you withdraw at a 4% rate
00:01:55.900 | You will unlikely run out of money over a 30-year time frame and back then
00:02:01.700 | You know people were retiring at around 60 and the median life expectancy was under 80
00:02:06.940 | So in other words if you follow the 4% rule you would unlikely run out of money by the time you
00:02:14.100 | Passed away what I found very fascinating when I was studying the 1990s and when the 4% rule became more popular
00:02:21.140 | Was that the risk-free rate of return the 10-year bond yield was at 5% to 6%
00:02:27.980 | Therefore, of course, you would never run out of money if you're withdrawing at 4% because you could earn
00:02:35.020 | risk-free money at 5% plus
00:02:38.620 | I'm honestly not sure why nobody in this world is talking about this reality
00:02:44.700 | But since someone has to talk about this reality
00:02:47.640 | It might as well be me and you don't need a PhD
00:02:51.300 | To understand that you're not gonna run out of money if you can earn a higher risk-free rate or return
00:02:56.220 | So 4% is 80% of 5%
00:03:00.420 | That is how I came up with my safe withdrawal rate formula of the 10-year bond yield times 80%
00:03:07.020 | so if you believed in the 4% rule back in the 90s and
00:03:11.660 | 2000s and 2010s then you should believe in the logic of the financial samurai safe withdrawal rate formula and
00:03:18.820 | to be frank I
00:03:21.300 | Created this formula to be simple to be very logical
00:03:24.800 | But also to poke fun at the 4% rule and why everybody just thinks that's the gospel rule
00:03:31.300 | Things are forever changing folks since the 1990s inflation and interest rates have come down
00:03:37.100 | We invented the internet. We're texting instead of writing letters to loved ones friends and family
00:03:43.820 | So it's important to adapt with the times and I promise you that you will be happier and wealthier
00:03:49.980 | if you are more dynamic in your thoughts and in your actions if you don't believe me identify the
00:03:57.140 | unhappiest person, you know
00:03:59.700 | Chances are high. They are very set in their ways
00:04:02.700 | They're rigid and thought and in action and that means a lot of opportunity
00:04:08.100 | Has and will pass them by part of my responsibility as a financial educator is to ensure that as many people
00:04:16.540 | Understand what I'm saying what I'm writing. Otherwise, I'm failing, you know
00:04:22.180 | I was a high school tennis coach for three years and
00:04:25.180 | If my students didn't understand my instruction or I couldn't get through to them or motivate them or make them feel confident
00:04:31.700 | I was failing as a teacher. So I do believe no
00:04:35.980 | Buddy should be left behind and I'm trying my best to explain this concept to you
00:04:41.220 | So, please take some time to understand the formula and also to listen to a couple of examples
00:04:47.460 | I want to give to you right now. Here are two formulas just to listen to you
00:04:51.580 | Don't have to understand it yet. But here they are one the expected market return equals the risk-free rate
00:04:57.780 | plus beta times the equity risk premium and the equity risk premium equals
00:05:04.420 | expected market return minus
00:05:07.500 | risk-free rate
00:05:09.300 | Now logic dictates you would not invest in a risk asset if it didn't provide a greater potential return
00:05:16.260 | Than the risk-free rate therefore as the risk-free rate rises and falls
00:05:21.140 | So does the expected market return and expected risk premium and these variables are always changing
00:05:28.280 | It's not set in stone
00:05:30.260 | Which is why when you hear about the 4% rule and you must follow it for the next 30 years
00:05:35.340 | It doesn't make sense
00:05:37.140 | If you have studied finance or if you're just a normal person who realizes that things are changing all the time
00:05:44.180 | Let me explain using two examples why the risk-free rate is important when investing. So the first example is real estate investing
00:05:52.000 | With the risk-free rate currently at about 2.8%
00:05:55.020 | You would not buy property when an expected market return of 2.8% or less
00:06:00.140 | Why? Because you could lose money in your property further it takes time to manage a physical rental property, right?
00:06:07.020 | You've got to find tenants. You've got to deal with the maintenance issues. It can be a hassle if you're unlucky
00:06:13.100 | Therefore you look for the highest expected market return above the risk-free rate of return
00:06:18.060 | Which equals the equity risk premium from the formula as the risk-free rate goes higher
00:06:23.480 | Real estate investors will refuse lower cap rate properties
00:06:28.100 | So cap rate think about it as a net rental yield if you have no mortgage
00:06:32.600 | This will in turn lead to market softness in those markets with lower lower cap rates
00:06:40.020 | Those cap rates are going to increase because investors who are like well
00:06:43.340 | Why bother investing in such a low cap rate property now people do that?
00:06:47.740 | They've been doing that for decades in big coastal cities where cap rates are lower because of the assumption that
00:06:53.500 | principal returns that
00:06:56.540 | Depreciation of these properties will more than make up for negative cash flow
00:07:01.300 | this investing strategy works well in a bull market because
00:07:05.580 | Rising tide lifts all boats things are doing well your cash flow and no big deal if you're making
00:07:10.340 | 10% 15% on your principal but in a bear market it puts
00:07:15.080 | These type of investors more at risk because their cash flow gets crunched and they're not making
00:07:20.220 | Positive returns on their principal. So when you think about this logic, you'll better understand my real estate investing rule
00:07:27.900 | Which is burl
00:07:30.740 | Burl by utility rent luxury so the idea is to buy utility those properties with higher cap rates
00:07:37.500 | With higher net rental yields and then rent property
00:07:41.320 | Those properties in usually bigger cities with lower cap rates, you know
00:07:46.540 | It might sound very expensive to spend a hundred thousand dollars on rent in New York City
00:07:51.220 | But if the if it costs let's say a 2.5 percent cap rate to buy that property
00:07:57.700 | Then it's actually a relatively good deal. So in terms of finance money investing you've always got to think about
00:08:04.100 | Yin-yang yin-yang a positive is often
00:08:07.820 | Counterbalanced by a negative. So for example
00:08:11.160 | Rates are going up. So this is causing growth tech high beta stocks to go down because there's a higher discount rate which
00:08:19.940 | Reduces the present value of its future cash flows
00:08:24.100 | however, if you are a retiree who is relying on
00:08:27.540 | Investment income higher rates is a good thing because you earn higher risk-free investment income and you earn
00:08:35.700 | higher dividends and higher bond income and
00:08:39.500 | Many other sources of income which will help you live a better life
00:08:42.940 | The second example I want to use is investing in corporate bonds and the risk-free rate
00:08:47.780 | corporations issue bonds to raise capital for
00:08:51.500 | corporations and acquisitions when interest rates are low
00:08:54.780 | You'll see more corporate bond issuances because the cost of capital is lower and vice versa
00:09:00.660 | When equity valuations are high some companies might issue more primary shares
00:09:05.400 | Because they can raise capital a lot more capital when their share price is high again
00:09:10.860 | Yin-yang finance
00:09:12.780 | so with the risk-free rate at about 2.8 percent a
00:09:15.500 | Corporation would need to issue bonds with a coupon rate higher than 2.8 percent
00:09:21.060 | Otherwise, it may have a hard time attracting capital that they want since investing in corporate bonds has risk
00:09:27.980 | corporations could default on their bond payments or go
00:09:31.880 | Bankrupt if you believe inflation and interest rates will decline and the market hasn't yet priced in this likelihood
00:09:38.780 | Then you are even more excited to buy some bonds today
00:09:42.560 | For example, the corporate bond you purchased yielding 5% today will look more attractive if the risk-free rate
00:09:49.380 | Drops to 1.5 percent in one year versus 2.8 percent today. So again, everything is relative
00:09:56.780 | there is something interesting for everyone to think about and that is when
00:10:00.700 | Bond prices go up Treasury bond prices go up or when the government issues Treasury bonds with a higher interest rate
00:10:07.700 | It effectively starts crowding out sources of capital that private companies could get
00:10:13.740 | So if you put on your economist hat and investor hat
00:10:18.020 | Raising rates too quickly or seeing the bond market sell off too quickly to see higher Treasury bond yields
00:10:24.580 | For example can be detrimental to the economy because if you crowd out so much of the limited capital
00:10:31.700 | You could say capital is unlimited because we print unlimited amounts of money
00:10:35.540 | But let's just say that capital is limited for most institutions and people
00:10:41.740 | The government starts attracting all this capital and then companies can't get that capital to pay salaries to hire to acquire
00:10:49.180 | To grow to innovate and that is how you see the economy slowing down. So I hope that kind of makes sense
00:10:55.740 | It's just a battle for capital battle for talent, you know companies go through battle for resources in this finite world
00:11:02.980 | Everything is competitive and everything moves up and down with a variable price now
00:11:09.460 | Let's move on to a situation where my dynamic safe withdrawal rate
00:11:13.900 | suggest
00:11:16.020 | Increasing your withdrawal rate in a high inflation and negative return environment
00:11:20.500 | That's kind of like what we're experiencing right now and conventional wisdom is saying well, you should lower your safe withdrawal rate
00:11:27.500 | Because it'll reduce your wealth quicker now that it makes sense
00:11:32.700 | If you've started with a high withdrawal rate in the first place
00:11:36.860 | So if you're stuck if you've been stuck on a 4% 5% withdrawal rate, yes lowering it makes sense
00:11:42.260 | But you're not stuck if you follow my recommendation because it's dynamic
00:11:47.460 | When you know the market was collapsing in March and April of 2020
00:11:52.100 | The dynamic safe withdrawal rate said well lower that withdrawal rate to 0.5%
00:11:58.500 | and by so doing you can invest more of your money in the market to take advantage of the sell-off or
00:12:06.740 | You can just raise more cash
00:12:08.740 | It makes sense during times of uncertainty and it depends on you
00:12:12.860 | But unfortunately, I was bonked over the head by this type of thinking so in this current environment of high inflation
00:12:18.900 | Negative returns at least in the stock market
00:12:21.940 | I say you continue to follow the safe withdrawal rate formula that I've proposed and
00:12:27.220 | Really the answer does depend on your timing risk tolerance your ability to generate supplemental retirement income
00:12:33.860 | What is more important to you? Do you have a working spouse that I know a lot of
00:12:37.900 | Male readers do have who say they're retired. They they say yeah, you know
00:12:42.420 | I can raise my safe withdrawal rate because my wife continues to work and pay for health insurance
00:12:48.300 | Everybody's situation is different
00:12:50.740 | But let's go through this logic if you are willing to invest more when you know times are bad
00:12:56.140 | In other words, you have a lower safe withdrawal rate and you're buying stocks and real estate in 2020
00:13:03.420 | Then logically you should be willing to spend more when times are good or not yet that bad
00:13:10.700 | So right now we're still up over 60% from stock market bottom in 2020 and we've only seen a 10
00:13:18.700 | Plus percent correction in the S&P 500 so things are not going up, but they're not that bad to me
00:13:25.980 | It is way better to enjoy your money rather than see it disappear in a bear market
00:13:31.740 | And here's a very important point if you don't spend your money when things are good
00:13:36.500 | then you most likely won't spend your money when things are bad and
00:13:40.980 | If this is the case you will more than likely die with too much money
00:13:45.540 | And that would be a darn shame and a big big waste of time
00:13:49.940 | Unfortunately, I see this happen all the time
00:13:54.020 | Retirees who've spent 40 years saving and investing they can't change their ways
00:13:59.140 | So they continue to save and invest for a future that is quickly going to come to an end
00:14:05.100 | It's kind of sad, but we need to recognize our mortality. I have this frugality disease problem myself
00:14:10.980 | I have t-shirts that have holes in them pants that have holes in them
00:14:15.220 | I wear shoes for many many years also with holes in them because I'm kind of lazy
00:14:19.980 | But I also yeah, I don't I don't like spending money that much but I'm trying I'm trying because I'm entering the decumulation phase
00:14:27.860 | At the end of this year because I'll be 45 years old and I don't think I'm gonna live
00:14:32.460 | Far past 80 85 years old if you are a retiree right now
00:14:37.300 | What's more important is your income and not your net worth even if your net worth temporarily declines by 25% in a bear market
00:14:45.020 | It's gonna suck. It won't feel good to be frank
00:14:48.620 | So long as your net worth is generating a similar amount of income, you're gonna be fine
00:14:53.380 | but if your income declines by 25%
00:14:56.020 | You may have to reduce your lifestyle and living your best lifestyle in retirement is the end goal. Never forget the end goal
00:15:03.420 | So there is one risk to your investment income and that is during a protracted bear market
00:15:09.840 | If a bear market lasts for far longer than a year
00:15:13.260 | Chances increase dividend payout ratios may get cut property rental yields may decline as you
00:15:20.500 | Can't rent out your rental properties for as much or as long there might be more vacancies bond yields may also decline
00:15:28.220 | So this double whammy of declining principal values and declining investment income hurts retirees the most so you might be wondering
00:15:35.780 | What are you gonna do? Well, I think most people would lower their safe withdrawal rate
00:15:39.940 | That makes sense because you're trying to prepare yourself or just stop the hemorrhaging as much
00:15:46.700 | however, the beauty of the financial samurai safe withdrawal rate formula is that it will
00:15:51.300 | Automatically generate a lower recommended safe withdrawal rate in such a scenario because this is a bad scenario, right?
00:15:58.820 | We're going back to let's say March April 2020 a lot of uncertainty
00:16:02.020 | Recession all that stuff. So it'll naturally get you to withdraw less and spend less
00:16:09.460 | So the bottom line here is don't overthink things
00:16:13.260 | You don't have to overthink things because the 10-year bond yield and
00:16:16.820 | Encapsulates so much of what our economy is going through and so much about future expectations
00:16:24.040 | That's why being dynamic
00:16:26.180 | Is so important having a dynamic safe withdrawal rate formula is so beneficial
00:16:32.020 | And even if you follow the logic and the formula, you don't have to stick to it 100%
00:16:37.860 | It's a guide to help you through the ups and downs of life because there will always be ups and downs
00:16:43.060 | Now in addition to following a dynamic safe withdrawal rate formula
00:16:47.100 | I recommend trying to be more dynamic in other areas of your life
00:16:51.260 | Some examples include getting good at a sport a musical instrument or type of art meet new friends outside of your socio-economic
00:16:59.300 | Level meet new friends who are different in sex race culture beliefs learn another language
00:17:05.700 | Nima ha read all types of history take up a new hobby
00:17:09.620 | Interview people outside your circle. I promise you with a more dynamic thought process with more dynamic
00:17:18.140 | Actions you will have a more rewarding and happier life
00:17:22.380 | You will be able to bend when bending is required and not break
00:17:26.940 | You will be able to see different perspectives that were on once unfathomable because you were so set in your ways
00:17:34.660 | I hope this episode has better helped explain why I believe
00:17:38.580 | My safe withdrawal rate formula is superior to sticking to a fixed withdrawal rate in retirement over time
00:17:44.900 | If you haven't let go of a steady paycheck then do a test drive by living off various withdrawal rates
00:17:50.820 | You might discover you're fine with a much higher withdrawal rate or you might feel that drawing down principle feels
00:17:58.100 | Too terrible as a result, you'll find fun ways to generate supplemental retirement income to keep your withdrawal rate low
00:18:05.140 | The truth is folks you won't know how you will really feel about drawing down capital until you no longer have a job
00:18:13.420 | therefore
00:18:15.300 | Expect the unexpected. Thanks everyone for listening. If you enjoyed this podcast, please subscribe share
00:18:22.660 | Provide a positive review and I really appreciate it keeps me going
00:18:25.660 | My whole goal is to try to educate folks about my thoughts of spending 30 plus years writing about finance
00:18:32.580 | Working in finance and studying finance. There's always something to learn and I hope everyone keeps a proper open mind. Take care