Balancing Risk and Reward Through Retirement Withdrawal Strategies

att Blocki
00:00
Welcome to Ewa’s finlit podcast. Ewa is a fee only RAA based out of Pittsburgh, Pennsylvania. We hope all listeners of this podcast will benefit as we deep dive into complex financial topics that we will make simplified for you. And we hope that this really serves as a catalyst so that you can make the best financial planning decisions for your family and also save time. Welcome, everybody. Today I’m joined by Nick Stonecipher, and we’re talking about what is the best way to withdraw money when you’re retired. There’s a lot of information that we find is available online with this subject and a lot of different studies that have been put out there by highly regarded people. So the first study is a 4% safe withdrawal rate.

Matt Blocki
00:50
So, Nick, can you just give us a quick, I think this is the most common methodology that people use. Could you just give us a quick overview of what is a 4% safe withdrawal rate? Let’s just use, like a $2 million portfolio as an example.

Nick Stonesifer
01:02
Yeah, absolutely. So 4% safe withdrawal, you’d be looking at on annual basis, ensuring that you’re not over withdrawing past the 4% mark. So really just maintaining that buffer and not over withdrawing.

Matt Blocki
01:21
Yeah. And so they recently, there were some studies in the last ten years that came out that said this study, no longer 4% is no longer safe. Because what had happened was we had seen a downturn of the.com bust. We had seen 2008, the financial crisis happened. Then we had seen interest rates. And these studies really typically assume, like a 40% equity or 40% equity, 60% fixed income allocation. And so being that 60% of fixed income, it used to be bonds, were getting maybe four or five, six back in the decades ago, 1012 percent that you could get in a CD. And up until recently, a safe bond, you’re maybe getting two or 3% in.

Matt Blocki
02:05
And so when they started to stress test that withdrawal rate, when over half your portfolio is not even earning 4%, they started to see this is failing because they would go over these 30 year simulations and say, what’s the probability of success? And we want to keep that probability of success, like a Monte Carlo simulation, above a 90% probability. And so up until recently, a lot of that 4% rule was not a safe role anymore. So a lot of people were adjusting that down to the mid to low threes now recently, because interest rates have gone back up. So now you can, for example, purchase a Treasury bond, a one year treasury bond above 5%, maybe a ten year, 20 year, like four and a half to 5% term. Based upon today’s recording, we’re recording early May of 2024.

Matt Blocki
02:53
So now the 4%, if we look at a 90% probability, is safe and median. Morningstar just came out with the study. The median finding is that you still had your, not only your portfolio, but sometimes you had more in your portfolio at the end because of the returns that have been generated. But 90% of the simulations passed. Then there’s other simulations. So there’s the actual spending or the guardrail approach. Or you could do like a flat dollar amount. You forgo inflation, and you go through these different transitions of go years. Slow go years, no go years. But the guardrail approach we’re a big fan of. And this is simply stress tested. Now, under current assumptions, this would work up to 5.2%. You can take out of your portfolio safely and still maintain that 90% success ratio, that 90% probability.

Matt Blocki
03:41
So, Nick, give us just a high level on how the guardrail. So, obviously, you know, a client comes to you and says, I’ve got $2 million, I can take out 4% or five, 5.2%. That’s an extra 24 grand a year. That’s an extra 2000 a month they can spend. So tell us the parameters and some of the. How does that work?

Nick Stonesifer
03:59
Yeah, absolutely. Let’s just continue to use the 4% example. So if you were using 4% withdrawal rate as your safe withdrawal rate, guardrails would be. Let’s take a look at are you potentially under withdrawing in retirement and you have more Runway there to take money out of your portfolio, or are you potentially over withdrawing and you need to then temper back expectations. So, to keep it between the lines with the guardrails approach, if you’re taking too little out, we’re going to advise that in the next years, you actually take more out of your portfolio because you’re not optimally distributing from your portfolio. On the flip side, if you’re taking too much, we’re going to come back with recommendations to take less in the upcoming years because you’re actually. You’re at a dangerous withdrawal rate. You’re significantly over.

Nick Stonesifer
04:51
So for us, withdrawal rate or with the guardrail scenario, we like to keep it within, like, I’d say, like two standard deviations. So if we’re at, like, 4%, like, let’s keep that inside of or 20%, not two standard deviations. So let’s keep that inside of, like, roughly a percent, a little under a percent, up and down. So if you’re within that three to five range. Let’s just say you’re safely within your guardrails. But if you get up to six, we’re going to recommend that you take less out in the upcoming years.

Matt Blocki
05:25
So you could go up because market conditions are really good. You’d have to go down because market conditions are very poor. Right. So this is if someone has a, you know, a lot of fixed expenses and they just have Social Security dependent guardrails may not be the approach where someone that has a lot more income, they don’t necessarily have the goal to leave a bunch of money to their kids, but they want to make sure they stay financially secure for the rest of their life. That can be a very flexible approach where they can even save that money if it’s a 5% or even higher than 5% year. And put that on the sidelines for, you know, big vacation the following years, etcetera.

Nick Stonesifer
05:58
Absolutely. So, yeah, you’re looking at, on annual basis, kind of recalibrating this using the guardrails approach, because, like you said, upmarket. We’re not taking a flat dollar amount out on annual basis. We’re taking a look at a percentage and trying to keep it within that percentage range for a safe withdrawal rate. So that will fluctuate on annual basis based on household portfolio.

Matt Blocki
06:19
Absolutely. Thanks for sharing that context, Nick. Recently, Nick and I really went, we did a deep dive into, you know, what is the best way and the reason we did this. There’s all these studies that have a lot of historical assumptions, but they’re static assumptions. So just an example. If you’re a client of a, if you’ve had your money in a 401k, in a lifecycle fund, where maybe internally it has ten different asset classes, you have a large cap, a mid cap, a small cap, international fixed income, and it’s starting to get less and less aggressive when you. So maybe you started out when you were in your twenties as 100% equities. And that fund naturally gears more towards fixed income when you’re closer to retirement. But the issue here is that when you retire, and if you start withdrawing money, most companies will.

Matt Blocki
07:06
Well, especially in a lifecycle fund, when you sell out of, let’s say you have $2 million in there, you take your 80,000, you’re selling out of every asset class when you do that. And some of those asset classes are going to be up, some of those classes are going to be down. The whole purpose of having multiple asset classes, having the choice of what to sell out of. Well, in a lifecycle fund. You don’t have the choice to do that. And a lot of times we hear people say, well, why would I roll money to an IRA and pay an advisory fee? Well, I could just keep my fees lower. Again, you call your institution, we see this all the time with Tia cref. Look at the statements. And they processed RMD. It was 100 grand. Where did the money came from?

Matt Blocki
07:39
Well, they sold it pro rata out of all the holdings. And some of those were up and some of those were absolute baths. So they just basically sent you money at a loss and they locked in that loss for the rest of your life, because once you take the money out, it’s actually a loss. If you let it recover, it’s never lost. So the reason why this is so important, to really have your money at the professional manager, to avoid these risks of sequence of return risk, avoiding any kind of probability where you’re not financially secure, you’re even touching principle is you have to have a strategy. Next, let’s go to the data. We have the data here, which you give us the assumptions. I think we used a million. We’re pulling out.

Matt Blocki
08:19
So what’s the timeframe we looked at, and then I’ll go step by step into all the ones we did. We analyzed.

Nick Stonesifer
08:26
Yeah, absolutely. So we took a look at, we ran a few different analyses, taking a look at 2000 to 20, $20 million starting portfolio. We were looking to withdraw $50,000 annually.

Matt Blocki
08:40
Every year, no matter what.

Nick Stonesifer
08:41
Every year, no matter what. And we really wanted to optimize which asset class, which bucket were taking the distributions out of. So we ran a bunch of different scenarios. We based this off of an 80 20 portfolio, 45% s and p 510% s and p 405% s and p 600 small cap 15 into MSCI, all country world Index ex USA, which is primarily developed markets. It does have some emerging exposure there as well. And then 5% into MSCI emerging markets. So we have five right off the top. Three domestic asset classes, two international asset classes, and then we threw the remaining 20% in the Bloomberg global aggregate for our fixed income slave.

Matt Blocki
09:29
Okay, perfect. And so the reason we chose 2000 to 2020 is we really wanted some nasty years in there to illustrate the importance that, you know, the market can really be nasty. So. 20 00 20 01, 20 02 we had the.com bust. We had the financial crisis. Then there was, you know, Brexit, then there was COVID. So this is really some data that there’s some blood and sweat and tears that happened during this 20 year period, which I think is important, because you can cherry pick years and say, oh, this works great. We want to see the worst of it. I’m not saying this is the worst 20 years. There’s the Great Depression, but this wasn’t exactly smooth riding during the 20 years, but it also included some great years. After 2008 crash, there’s obviously that boom.

Matt Blocki
10:13
Okay, so the first thing we did is we just did a straight up s and p 500. Cause that’s the most common question we get, is, why don’t I just invest the s and P 500? So, the results of, again, you have a million dollars. You retire, all your money’s invested in the S and P 500. You’re taking 50 a year out flat. So no inflation adjustments, just really simple. So, you’re starting with a million. You’re withdrawing a million over 20 years. You are left with 454,483. So, less than half of your money is left at the end of the 20 years. So, one of the importance of following the principles of asset allocation. Now, the SB 500 is diversified. You have 500 companies, but it’s not asset allocated. You have one asset class, you have large cap. That’s it.

Matt Blocki
10:51
You don’t have these other asset classes that you described, is you’re pulling on great years, but you’re also pulling in some of the years that were bad, which there were several years that were bad over that 20 years in SB 500. So, the next thing we did is we did an 80 20 portfolio that you just described. So, you have a million dollars. You split it in those asset classes. Large, mid, small, international, emerging and fixed income. Six different asset classes. And we do the same thing. We start with a million. We pull 50 out every year over 20 years, we’re taking out a million. And at this point, now, this is assuming your pro rata selling from proportionately, from every asset class, huge improvement at the end of the 20 years, 890,308. So, almost double the result of the s and P 500.

Matt Blocki
11:41
But again, going back to the point of the whole purpose of asset allocation is to have the optionality of picking where you can choose. If we simply have the same portfolio. So, again, starting with a million, taking out 50 a year, but now you have a nick behind the scenes. It’s analyzing if you’re in distribution stage. If stocks are up, awesome. We’re pulling pro rat out of just the equities. If stocks are down, we’re pulling out a fixed income and pulling out the. Starting with a million, pulling out the same million over 20 years, this result, end of 20 years, you have 1.36 million, exactly 1,362,867. So over three times what you had if you had just indexed the S and P 500. And so that takes work. That takes data. That takes refilling your cash bucket. We’re looking at historical data.

Matt Blocki
12:31
We’re not guessing at which one to do. We’re literally saying, okay, we’re keeping this cash for the next year, spending. This is what happened. We’re refilling it appropriately. It does take a lot of work. And then the last analysis we did is, if you pull from the highest asset class of the previous year. So we’re not, it’s not stocks or bonds. It’s even a step. It’s out of which asset class of stocks and then bonds. The same analysis generated the highest value, 1,378,690. So that just proves the point that having a methodology in place, you know, 4% safe withdrawal or guardrails, that’s just step number one. Step number two is what’s the decision process and methodology and the discipline behind the scenes to stay within those barriers?

Matt Blocki
13:14
Because the discipline approach and the philosophy there can be the difference of keeping your principal, keeping your principle even adjusted for inflation, or eating your principal, and possibly losing out of money if you live for 30 years, as this data illustrates. Nick, any closing remarks on that? First, then I want to go through where we’re skipping down yours altogether from different asset class. Any closing remarks on the findings that you put together there?

Nick Stonesifer
13:42
Yeah, I think using 2000 to 2020 as the 20 year range was really great to analyze, mainly because we get a lot of questions on a daily basis, why invest internationally? Why am I investing in emerging markets? And in recent times, certainly agree the returns haven’t been there compared to domestically. But when you start to break down the early two thousands and you look at a proper asset allocated portfolio, and if you were taking distributions from the asset classes accordingly, looking to maximize by withdrawing from the asset classes that are up the most, you had emerging markets that was up 30, 40, near 50% in some of those early years.

Nick Stonesifer
14:28
And if you were completely avoiding that asset class and just investing in the S and P 500 domestically, you would lose out on a great opportunity on the distribution side, not just on asset accumulation. So I think 2000 to 2020 made a lot of sense, and it really isn’t that far in the too distant future, in the past, not future. So it’s fairly relevant still. But it’s just, I think it’s hard to remember 20 plus years ago what the market scenarios looked like. And that was a very real example of why you would want to be invested internationally.

Matt Blocki
15:05
No question. No question. And just to tie some further bows on this data, there was five years out of 2020, if you look at the SB, 502,000 was negative. 2001, 2002 were also negative, 2008 was negative, 2018 was negative. Every other year on here was positive. So it’s literally 75% of the time, 15 out of 20 years, the market was great. It was phenomenal. The other five years, it was. It was horrible. Just at 25%, if you just are in one asset class with no philosophy behind, when you’re pulling why, you’re pulling how to rebalance, et cetera, it can be catastrophic, as we saw with that data. And this isn’t guesswork, this is actual historical data that we pulled based upon the methodology. So, you know, one other thing we did is we, if you have.

Matt Blocki
15:55
If you want to just keep your equities as equities and then have safe money, which could be a mix of cash, bonds, cash value and life insurance, what we analyze is like an S and P 500 portfolio. You start with a million taking out 70,000 a year, but skipping the five years that were bad. So you start with a million, you take out, in this example, 1.12 million, you end with 71,000. Now, if you have that asset allocated portfolio, but we’re pulling the bond bucket away, we start with a million, we’re taking 70,000 out per year. We’re skipping those five years again. We’re taking out 70,000 a year for 15 years, taking out the 1.12 million. You actually end with over a million at the end.

Matt Blocki
16:38
So that brings us to our philosophy, where if we keep this time weighted bucket approach, where we have at least seven years of safe money. So, for example, if you have $2 million between IRA or Roth, a taxable account, you’ve got Social Security, that’s between you and your spouse is paying you 4000 a month net. Maybe you have an old pension that’s paying you 2000 a month net. Now, you’ve just eaten up your ten and 12% tax brackets and married filing jointly. So everything you’re taking out of an IRA is coming out at 22%, everything you’re taking out of taxable accounts, coming out of the capital gain rate of 15%, everything you’re taking out of our roth is coming out zero. But it’s really careful. We don’t jump up into different Medicare brackets, we don’t jump up into different tax brackets.

Matt Blocki
17:24
But assuming we have the right tax distribution strategy. That leaves us with a gap of someone that needs ten a month net, six a month come in between Social Security and pension, that leaves 4000 a month. And so where that 4000 a month comes from is so important either way, for that person, that would be 50,000 a year net. We want seven years. So 350,000, 50,000 times 7350,000 of their 2 million. It’s got to be safe. That’s got to be somewhere safe. It can’t go backwards. It’s got to be time weighted. So we have to have a year of cash, we have to have some short term bonds that there’s no risk of 2022 happening, where interest rates suddenly skyrocket and your bond funds down ten or 15%. And then we have to have some longer term bonds to fulfill. Okay.

Matt Blocki
18:06
If the market were to go down and not recover in seven years, here’s where we’re getting the next seven years of money without any risk of principal loss. And so then the rest of the money, we recommend to stay asset allocated, stay diversified. But that’s really how we come up with the methodology of how to invest, and then how we execute on the back end is we have that process behind the scenes of which asset class we’re pulling from. Based upon last year’s data, if the market’s been great, we’re pulling from equities. If the market hasn’t been great, we’re pulling from a short term bond that doesn’t have any loss to it, and then we’re refilling our cash buckets accordingly.

Matt Blocki
18:44
But having this process in place as you can, it can be a three x difference in how much principle you have on the back end of retirement.

Nick Stonesifer
18:53
Absolutely.

Matt Blocki
18:54
Which could lead to more spending by you where you’re living. It could mean a bigger legacy to your kids. But don’t leave this up for chance. The studies of 4%, 5%, that’s just the first step. The execution of that in the back end and the discipline on the back end is the most important steps here.

Nick Stonesifer
19:10
Absolutely.

Matt Blocki
19:11
Thanks for tuning into our podcast. Hopefully you found this helpful. Really hope this is as beneficial and impactful to as many people across the nation as possible. So hit the follow button, make sure to rate the podcast, and please share with any friends or family members that would also find this beneficial. Thank you very.