Hello everybody, it's Sam from Financial Samurai. And in this episode, I want to talk about the Financial Samurai safe withdrawal rate formula. And that formula is the 10-year bond yield times 80% equals the safe withdrawal rate in retirement. So if the 10-year bond yield is at 1%, you're going to withdraw 0.8%.

And when the 10-year bond yield is at 2%, you withdraw at a 1.6% rate. And the formula is very simple. And it's predicated on the fact that the 10-year bond yield tells us a lot of things. It tells us a lot of things about the future of inflation, for example.

So if inflationary pressure is building, if we expect inflation to explode, the 10-year bond yield should go up to help dampen inflation, and vice versa. The 10-year bond yield also tells us about equity risk premium, the risk-free rate of return, and what we can expect for stocks and bonds and other risk asset classes in the future.

Because everything is relative to a risk-free rate of return. You wouldn't invest any money in anything if it didn't provide you a risk premium. So what is that risk premium that you require to take risk? Now, if there's no risk premium, then you would just invest it in a risk-free asset.

And that risk-free asset is the 10-year bond yield. So for example, the 10-year bond yield today is about 1.3%. What kind of equity risk premium do you require to invest in stocks, which historically have gone up by about 10% a year, but tend to correct by 10% every couple of years, and 30% every three to five years.

So what is that equity risk premium ERP you require to take on that risk? It's kind of different for everyone. There are mathematical models that calculate it over time. But a simple calculation is, well, if stocks are expected to return 10%, and the risk-free rate is 1.3%, then the equity risk premium is 10% minus 1.3%, and that's 8.7%.

Very simplified, but that's how you should think about things. So the 10-year bond yield is the number one economic metric that I follow, that all of y'all should follow, that will tell us a huge story about so many things, if you understand basic economics and finance. So back in August 2020, remember that time period?

We're about four months into lockdowns. Things were looking up, but there was still a lot of uncertainty. I came out with a post called "The Proper Safe Withdrawal Rate," colon, "The 4% Rule is Outdated." And the reason why I think it's outdated is because the 4% rule came out in the 1990s when the 10-year bond yield was over 5%.

It was at 5% or 6%. So of course, a 4% safe withdrawal rate is safe. That's lower than the risk-free rate of return. Therefore, a logical conclusion to carry on this type of thinking is to say, "Well, 4% was 80% of where the 10-year bond yield was at the time, let's say at 5%.

So let's carry on that formula." So I came up with the Financial Samurai Safe Withdrawal Rate formula of the 10-year bond yield times 80% equals your safe withdrawal rate in retirement. Very logical. You don't need to have a PhD in economics or finance or be a pontificator researcher of retirement to come up with this formula.

But hey, nobody came up with this formula and nobody connected these dots, so I took it as my own. And what ensued was a lot of hysteria. Seriously, hysteria, folks. Take a look at my post, "The Proper Safe Withdrawal Rate," "4% Rule is Outdated." There are over 370 comments, and more than half of them are people saying, "That is a ridiculous rule.

That is way too conservative. What are you talking about, Sam? You should be banned from the internet." I don't know. It's pretty crazy. I haven't encountered so much vitriol for suggesting people be more conservative in retirement, at least for the initial one, two, three years. After a lifetime of saving and earning money, it is very, very weird, very difficult to start spending more money, to start spending down your capital.

I'm telling you, folks, because I'm living it right now. I could not spend down capital for the life of me for the first several years. And even today, it just feels so painful to spend down capital, which is why I'm trying to generate more passive income and just live off the income and not touch principle.

And it's also why I've spent time since the beginning of the pandemic trying to make some more money online, because it's very hard to lose capital, as we saw in March 2020. And it's even harder to spend down that capital for some people. And so look, I understand where part of the hysteria came from, because when the 10-year bond yield was at 0.7% in August 2020, my formula, the Financial Samurai Safe Withdrawal Rate formula, indicated that you should withdraw at a 0.5% rate.

Now, 0.5% is unheard of. It is so small that people were starting to freak out because they flipped the formula around and said, "Well, wait, does that mean I need to now accumulate 200 times my annual expenses before I can declare financial independence or retire?" Well, for that moment in time, that one-month moment in time, the answer is yes.

But as we know, the 10-year bond yield and the markets, they're dynamic. They change every single day. So in 2021, the 10-year bond yield started going up and it reached a high of about 1.75% as the economy roared back. Earnings in 2021 for the S&P 500 are estimated to rebound by over 45% from 2020.

So as you can see, there's hope now. There's inflation building up. The 10-year bond yield has gone up. Now, it's gone back down to 1.3%. My formula is dynamic because our lives are dynamic. They change every single day and week and month and year. You might be single, living in a van one day and then you might have three kids and you want to buy a bigger house.

You might be happily married another day and you might get divorced another week. Life is unpredictable. We think we're in control. We have our plan, but things generally don't always go according to plan. So a formula is just that. It's a guide. It helps you think logically about risk and returns and spending money and saving money.

And a guide is meant to guide you. It doesn't say, "Look, this is exactly what you have to do," but it's meant to guide you towards the right direction because if the direction is correct, sooner or later you're going to get there. If you're feeling down, just remember this Chinese proverb.

It's one of my favorites. So one of the things I discovered while writing the post on do-it-yourself investing, which I highly advocate, which I've been discussing since I started Financial Samurai in 2009, and the second post on reasons why you might want to hire a financial advisor or investment manager or robo-advisor is that future returns could be coming down.

And if future returns on risk assets like stocks and bonds are coming down, then paying a 1% financial advisory fee is going to feel even more egregious. And one of the reasons why I came up with the Financial Samurai safe withdrawal rate formula in retirement is because I believe that returns for risk assets will likely come down in the future.

Whether that's true or not, nobody really knows, but that's what I believe. And given that's what I believe, it is only logical to lower your safe withdrawal rate in retirement. Really logical, but a lot of people were very angry at this belief. Just read the comments. It's not me.

Just read the comments. I always try to be very level-headed and logical, but just read the comments and you'll see. So it was with great relief, maybe, maybe a little joy that Vanguard, one of the largest money managers in the world, came out with something in August 2021, a full year after I came up with my Financial Samurai safe withdrawal rate formula.

They came out with their 10-year median forecast for US stocks, US bonds, and inflation using their "Vanguard Capital Markets Model" registered trademark. It's their financial simulation engine to forecast future performance by analyzing historical data that drive asset returns. So if you don't want to believe me, who thinks about things way ahead, then let's think about, maybe believe in Vanguard.

So the historical returns for US stocks, according to them, is 10.37%. For US bonds, 5.3%. And inflation, 2.87%. That's historical average returns. Their model now predicts 4.02% future returns for US stocks, 1.31% future returns for US bonds, and 1.58% future return for inflation. So Vanguard is forecasting more than a 60% decline in returns for stocks, bonds, and inflation.

And I like that inflation number, 1.58%, because since I started Financial Samurai, I've been talking about a permanently lower inflationary environment. Why? Because we're getting smarter. Technology is connecting us more. We're learning from our mistakes. We have global central coordinated banks. All of these things help us combat global inflation, and we're becoming a smaller world.

We're exporting deflation. Well, China and India are exporting deflation. All that good stuff is allowing us to control inflation better. So any kind of rising inflationary expectations, I think they're just temporary. They're just temporary. We're structurally going down, folks. Just look at the 10-year bond yield again. Since the 1980s, the late 1980s, the 10-year bond yield has been going down, down, down, which is one of the reasons why I believe real estate is going to continue going up, up, up, because there's an implicit tailwind due to low mortgage rates.

When it comes to managing your money, it's always better to be a little bit conservative if you already have the money. If you are in retirement, or you've decided you have accumulated a large enough financial nut to be free, the last thing you want to do is take excess risk, lose lots of your money, and have to go back to work at a job you disliked.

At the same time, if you are a financial samurai, you need to be flexible in thought and understand that everything is yin-yang in finance. There are no absolutes. So if you start getting angry at things, my beliefs, someone else's beliefs, question your rigidity of thought, and maybe try to see the other person's point of view.

If you can be flexible in thought while having your beliefs, I think it's going to go a lot better for you in the long run. Not only will your finances probably be better, you're probably also going to be a less stressed and happier person as a result, right? Because at the end of the day, this is about using money to achieve happiness and do the things that you want to do.

And there's another thing I personally realized, and that is I continue to write and talk about things that are in the future. And so when things are in the future, I think most people just aren't able to think about the future or grasp these concepts in the present. And then there's a lot of discomfort, and there's a lot of anger.

And I'm not trying to make you folks angry, folks. I'm trying to help you guys think forward into the future, what things could be like. And that way, you can kind of get ahead of things. You can asset allocate your capital towards these long-term investment trends and benefit. There is no downside to thinking ahead and planning ahead.

Anybody who tells you otherwise is being lazy, because thinking ahead is free. It is so free, we should do it for a little bit of time every day. Why not create pre-mortem situations so you know what to do in case bad things happen or good things happen. Let me tell you a final story about a friend, my son, and tennis.

In 2017, I decided to coach high school tennis. I thought it would be fun because I enjoy teaching, I enjoy writing, I enjoy interacting with people. I had been out of the workforce since 2012. I thought it'd be good to get into some type of community again. And so my friend said, "Why the hell would you want to teach high school tennis to a bunch of boys?

The pay is $1,000 a month, you got to shuttle them around. Sounds like a pain in the ass." Well, I told him, "I like to coach. I love being part of a community." And I was expecting a son. And as a new father, you just don't know what to do.

But as a new father, I was always hearing stories about how it's very difficult to manage teenage boys. So I thought, what better way to understand teenage boys than to be the coach of 12 teenage boys on a high school tennis team. I wanted to learn how they would deal with authority, how I should speak to these boys, what are their interests, how do they interact with each other, and what type of conflicts happen.

And my friend was like, "Oh, okay, you're crazy." And I told him, "Well, I'd be crazy not to plan ahead, because I don't know what I'm doing. I'm a new father." So please, folks, plan ahead, use opportunities to think ahead. And if you see something that seems out of left field on Financial Samurai or on this podcast, don't get angry.

Just think, "Well, maybe Sam is thinking ahead." And maybe sometimes these things do come true. Thanks so much for listening to this latest episode. If you enjoyed this episode or this podcast overall, share it with your friends. Please leave a positive review. It keeps me motivated to keep on going, because I sure am a terrible monetizer of this podcast, because I haven't reached out to anybody to help sponsor it.

So thanks so much and keep thinking forward.