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 Because interest rates have gone up Your safe withdrawal rate has gone up and the reason why is because the formula that I have offered to the world the financial samurai safe withdrawal rate formula equals the 10-year bond yield times 80% So as the 10-year bond yield goes up So does your safe withdrawal rate and vice versa?

And if you think about it, it makes a lot of sense the 10-year bond yield is the risk-free rate of return and it encapsulates the state of the economy you can write Thousands and thousands of words on the 10-year bond yield, but it is the single most Important economic indicator you should follow because it's the risk-free rate.

It is a reflection of where Inflation is heading or where inflation is right now it reflects the state of the employment market and it also discusses where the bond market thinks the economy is heading as A investor who is willing to risk his or her assets to make money and probably lose money on occasion The 10-year bond yield is so important because you would not invest in any other asset if there wasn't an equity risk premium and that equity risk premium is the difference between your Expected market returns and the risk-free rate of return the 10-year bond yield So if you expect an investment to generate a 10% return and the risk-free rate of return right now is 3% Your equity risk premium is 7% So you might be wondering where did I come up with my formula the 10-year bond yield times 80% Well, it comes from history back in the 1990s the 4% rule became very popular and the 4% rule states that if you withdraw at a 4% rate You will unlikely run out of money over a 30-year time frame and back then You know people were retiring at around 60 and the median life expectancy was under 80 So in other words if you follow the 4% rule you would unlikely run out of money by the time you Passed away what I found very fascinating when I was studying the 1990s and when the 4% rule became more popular Was that the risk-free rate of return the 10-year bond yield was at 5% to 6% Therefore, of course, you would never run out of money if you're withdrawing at 4% because you could earn risk-free money at 5% plus I'm honestly not sure why nobody in this world is talking about this reality But since someone has to talk about this reality It might as well be me and you don't need a PhD To understand that you're not gonna run out of money if you can earn a higher risk-free rate or return So 4% is 80% of 5% That is how I came up with my safe withdrawal rate formula of the 10-year bond yield times 80% so if you believed in the 4% rule back in the 90s and 2000s and 2010s then you should believe in the logic of the financial samurai safe withdrawal rate formula and to be frank I Created this formula to be simple to be very logical But also to poke fun at the 4% rule and why everybody just thinks that's the gospel rule Things are forever changing folks since the 1990s inflation and interest rates have come down We invented the internet.

We're texting instead of writing letters to loved ones friends and family So it's important to adapt with the times and I promise you that you will be happier and wealthier if you are more dynamic in your thoughts and in your actions if you don't believe me identify the unhappiest person, you know Chances are high.

They are very set in their ways They're rigid and thought and in action and that means a lot of opportunity Has and will pass them by part of my responsibility as a financial educator is to ensure that as many people Understand what I'm saying what I'm writing. Otherwise, I'm failing, you know I was a high school tennis coach for three years and If my students didn't understand my instruction or I couldn't get through to them or motivate them or make them feel confident I was failing as a teacher.

So I do believe no Buddy should be left behind and I'm trying my best to explain this concept to you So, please take some time to understand the formula and also to listen to a couple of examples I want to give to you right now. Here are two formulas just to listen to you Don't have to understand it yet.

But here they are one the expected market return equals the risk-free rate plus beta times the equity risk premium and the equity risk premium equals expected market return minus risk-free rate Now logic dictates you would not invest in a risk asset if it didn't provide a greater potential return Than the risk-free rate therefore as the risk-free rate rises and falls So does the expected market return and expected risk premium and these variables are always changing It's not set in stone Which is why when you hear about the 4% rule and you must follow it for the next 30 years It doesn't make sense If you have studied finance or if you're just a normal person who realizes that things are changing all the time Let me explain using two examples why the risk-free rate is important when investing.

So the first example is real estate investing With the risk-free rate currently at about 2.8% You would not buy property when an expected market return of 2.8% or less Why? Because you could lose money in your property further it takes time to manage a physical rental property, right? You've got to find tenants.

You've got to deal with the maintenance issues. It can be a hassle if you're unlucky Therefore you look for the highest expected market return above the risk-free rate of return Which equals the equity risk premium from the formula as the risk-free rate goes higher Real estate investors will refuse lower cap rate properties So cap rate think about it as a net rental yield if you have no mortgage This will in turn lead to market softness in those markets with lower lower cap rates Those cap rates are going to increase because investors who are like well Why bother investing in such a low cap rate property now people do that?

They've been doing that for decades in big coastal cities where cap rates are lower because of the assumption that principal returns that Depreciation of these properties will more than make up for negative cash flow this investing strategy works well in a bull market because Rising tide lifts all boats things are doing well your cash flow and no big deal if you're making 10% 15% on your principal but in a bear market it puts These type of investors more at risk because their cash flow gets crunched and they're not making Positive returns on their principal.

So when you think about this logic, you'll better understand my real estate investing rule Which is burl Burl by utility rent luxury so the idea is to buy utility those properties with higher cap rates With higher net rental yields and then rent property Those properties in usually bigger cities with lower cap rates, you know It might sound very expensive to spend a hundred thousand dollars on rent in New York City But if the if it costs let's say a 2.5 percent cap rate to buy that property Then it's actually a relatively good deal.

So in terms of finance money investing you've always got to think about Yin-yang yin-yang a positive is often Counterbalanced by a negative. So for example Rates are going up. So this is causing growth tech high beta stocks to go down because there's a higher discount rate which Reduces the present value of its future cash flows however, if you are a retiree who is relying on Investment income higher rates is a good thing because you earn higher risk-free investment income and you earn higher dividends and higher bond income and Many other sources of income which will help you live a better life The second example I want to use is investing in corporate bonds and the risk-free rate corporations issue bonds to raise capital for corporations and acquisitions when interest rates are low You'll see more corporate bond issuances because the cost of capital is lower and vice versa When equity valuations are high some companies might issue more primary shares Because they can raise capital a lot more capital when their share price is high again Yin-yang finance so with the risk-free rate at about 2.8 percent a Corporation would need to issue bonds with a coupon rate higher than 2.8 percent Otherwise, it may have a hard time attracting capital that they want since investing in corporate bonds has risk corporations could default on their bond payments or go Bankrupt if you believe inflation and interest rates will decline and the market hasn't yet priced in this likelihood Then you are even more excited to buy some bonds today For example, the corporate bond you purchased yielding 5% today will look more attractive if the risk-free rate Drops to 1.5 percent in one year versus 2.8 percent today.

So again, everything is relative there is something interesting for everyone to think about and that is when Bond prices go up Treasury bond prices go up or when the government issues Treasury bonds with a higher interest rate It effectively starts crowding out sources of capital that private companies could get So if you put on your economist hat and investor hat Raising rates too quickly or seeing the bond market sell off too quickly to see higher Treasury bond yields For example can be detrimental to the economy because if you crowd out so much of the limited capital You could say capital is unlimited because we print unlimited amounts of money But let's just say that capital is limited for most institutions and people The government starts attracting all this capital and then companies can't get that capital to pay salaries to hire to acquire To grow to innovate and that is how you see the economy slowing down.

So I hope that kind of makes sense It's just a battle for capital battle for talent, you know companies go through battle for resources in this finite world Everything is competitive and everything moves up and down with a variable price now Let's move on to a situation where my dynamic safe withdrawal rate suggest Increasing your withdrawal rate in a high inflation and negative return environment That's kind of like what we're experiencing right now and conventional wisdom is saying well, you should lower your safe withdrawal rate Because it'll reduce your wealth quicker now that it makes sense If you've started with a high withdrawal rate in the first place So if you're stuck if you've been stuck on a 4% 5% withdrawal rate, yes lowering it makes sense But you're not stuck if you follow my recommendation because it's dynamic When you know the market was collapsing in March and April of 2020 The dynamic safe withdrawal rate said well lower that withdrawal rate to 0.5% and by so doing you can invest more of your money in the market to take advantage of the sell-off or You can just raise more cash It makes sense during times of uncertainty and it depends on you But unfortunately, I was bonked over the head by this type of thinking so in this current environment of high inflation Negative returns at least in the stock market I say you continue to follow the safe withdrawal rate formula that I've proposed and Really the answer does depend on your timing risk tolerance your ability to generate supplemental retirement income What is more important to you?

Do you have a working spouse that I know a lot of Male readers do have who say they're retired. They they say yeah, you know I can raise my safe withdrawal rate because my wife continues to work and pay for health insurance Everybody's situation is different But let's go through this logic if you are willing to invest more when you know times are bad In other words, you have a lower safe withdrawal rate and you're buying stocks and real estate in 2020 Then logically you should be willing to spend more when times are good or not yet that bad So right now we're still up over 60% from stock market bottom in 2020 and we've only seen a 10 Plus percent correction in the S&P 500 so things are not going up, but they're not that bad to me It is way better to enjoy your money rather than see it disappear in a bear market And here's a very important point if you don't spend your money when things are good then you most likely won't spend your money when things are bad and If this is the case you will more than likely die with too much money And that would be a darn shame and a big big waste of time Unfortunately, I see this happen all the time Retirees who've spent 40 years saving and investing they can't change their ways So they continue to save and invest for a future that is quickly going to come to an end It's kind of sad, but we need to recognize our mortality.

I have this frugality disease problem myself I have t-shirts that have holes in them pants that have holes in them I wear shoes for many many years also with holes in them because I'm kind of lazy 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 At the end of this year because I'll be 45 years old and I don't think I'm gonna live Far past 80 85 years old if you are a retiree right now 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 It's gonna suck.

It won't feel good to be frank So long as your net worth is generating a similar amount of income, you're gonna be fine but if your income declines by 25% You may have to reduce your lifestyle and living your best lifestyle in retirement is the end goal. Never forget the end goal So there is one risk to your investment income and that is during a protracted bear market If a bear market lasts for far longer than a year Chances increase dividend payout ratios may get cut property rental yields may decline as you Can't rent out your rental properties for as much or as long there might be more vacancies bond yields may also decline So this double whammy of declining principal values and declining investment income hurts retirees the most so you might be wondering What are you gonna do?

Well, I think most people would lower their safe withdrawal rate That makes sense because you're trying to prepare yourself or just stop the hemorrhaging as much however, the beauty of the financial samurai safe withdrawal rate formula is that it will Automatically generate a lower recommended safe withdrawal rate in such a scenario because this is a bad scenario, right?

We're going back to let's say March April 2020 a lot of uncertainty Recession all that stuff. So it'll naturally get you to withdraw less and spend less So the bottom line here is don't overthink things You don't have to overthink things because the 10-year bond yield and Encapsulates so much of what our economy is going through and so much about future expectations That's why being dynamic Is so important having a dynamic safe withdrawal rate formula is so beneficial And even if you follow the logic and the formula, you don't have to stick to it 100% It's a guide to help you through the ups and downs of life because there will always be ups and downs Now in addition to following a dynamic safe withdrawal rate formula I recommend trying to be more dynamic in other areas of your life Some examples include getting good at a sport a musical instrument or type of art meet new friends outside of your socio-economic Level meet new friends who are different in sex race culture beliefs learn another language Nima ha read all types of history take up a new hobby Interview people outside your circle.

I promise you with a more dynamic thought process with more dynamic Actions you will have a more rewarding and happier life You will be able to bend when bending is required and not break You will be able to see different perspectives that were on once unfathomable because you were so set in your ways I hope this episode has better helped explain why I believe My safe withdrawal rate formula is superior to sticking to a fixed withdrawal rate in retirement over time If you haven't let go of a steady paycheck then do a test drive by living off various withdrawal rates You might discover you're fine with a much higher withdrawal rate or you might feel that drawing down principle feels Too terrible as a result, you'll find fun ways to generate supplemental retirement income to keep your withdrawal rate low The truth is folks you won't know how you will really feel about drawing down capital until you no longer have a job therefore Expect the unexpected.

Thanks everyone for listening. If you enjoyed this podcast, please subscribe share Provide a positive review and I really appreciate it keeps me going My whole goal is to try to educate folks about my thoughts of spending 30 plus years writing about finance Working in finance and studying finance. There's always something to learn and I hope everyone keeps a proper open mind.

Take care