So you want to retire. Perhaps even earlier than most people.
Sounds like a great idea. But… How much (or how little) money do you need? $500k? $1 million? $10 million? What is your retirement number?
Pick a number that is too low, and you might end up begging for change, working at Wal-Mart, or worse. Pick a number that is too high, and perhaps trade years of life working for money that will benefit only your heirs
Determining the right amount starts with some basic questions
- How much does your target retirement lifestyle cost?
- How long do you expect to be retired? 15 years? 30 years? 60 years? More?
- How many dollars do you want to leave to your children or to charity?
Each person will answer these questions in their own way, with no answer necessarily better than another
“I plan to retire at the age of 57 with a cost of living of $10,000/month, mostly for golf club membership and my wine collection. Society never gave me nothing, and I’ll return the favor.”
“We will retire in our 30s to travel the globe, which we estimate will average around $3,000 per month. Ideally we will leave behind a large endowment to fund charitable hospitals”
There are other important questions that are more subtle and nuanced
- Do I have to change my shorts every time the stock market drops?
- Am I so set in my ways that I will refuse to make life changes regardless of the cost?
“Wow, 2008 was a wild ride! Stocks dropped 50%, but businesses took advantage of opportunities and made changes to enable future growth. Next time that happens, if our cash flow isn’t what we would like we can spend next year in South America instead of Europe”
“I don’t care what it costs, I’m driving the stretch RV to Florida every winter and dining on steak and lobster every night! And those Wall Street guys are crooks! No way am I putting my money in the stock market”
Somebody with low risk tolerance and great resistance to change will need a larger bank account than somebody that goes with the flow and enjoys a bit of excitement.
For better or worse, the older we get the less any of these things matter. But for somebody that plans to retire extremely early, all of these factors are of utmost importance
With all of this complexity, no wonder every bit of retirement advice in the press seems contradictory or not actionable.
Fortunately, some really smart people found a way to cut to the core of the question, “What is your retirement number?”
The Trinity Study
In the 1990’s, a key retirement planning study was published by three Professors from Trinity University, often referred to as The Trinity Study.
The Trinity Trio essentially asked the question, “Had we retired at any time in recent history, how much could we spend annually for 30 years without running out of funds?”
The original Trinity Study looked at rolling 30-year periods between 1926 and the end of 1995, and was later expanded to include data through 2009, a span of 84 years that covers a wide range of economic environments including 2 World Wars, the Great Depression, the oil embargo and high inflation period of the 1970’s, and the Boom period of the 1980’s
With a portfolio of at least 50% stock and a little flexibility, plan to spend 4% of the initial portfolio value, adjusted for inflation each year, and have a high degree of confidence the portfolio will survive at least 30 years, and often much longer
This is commonly referred to as the 4% Rule or the Safe Withdrawal Rate (SWR)
In other words, build a portfolio of 25x your target annual spend and you’ll be able to keep a constant standard of living throughout your retirement
If your target annual spend is $40,000, then your retirement number is $1 million. Want to spend $80,000 per year? Your number is $2 million
If you are extremely conservative, at most save up 33x your target annual spend (a 3% withdrawal rate.) The likelihood of joining the Forbes 400 late in life will increase substantially, but starting retirement with this level of wealth is about as close to a guarantee as one can get
For most people, that is really all of the planning necessary. Simple, effective
We aren’t most people though, so let’s dig deeper
Trinity Study Data
The core results of the Trinity Study are in the Table below, which reports how many of the possible retirement periods in the 84 year study period still had assets remaining after a period of up to 30 years
One example that may help with reading the table: A retiree with a portfolio of 50% stocks/50% bonds, withdrawing 4% a year and adjusting for inflation, would have assets remaining after 30 years in 96% of the cases studied
The mainstream media took this report and reduced it to a simple sound bite. “A retiree can blindly withdraw 4% of assets every year, adjusted for inflation, and be 100% confident that they will run out of life before they run out of money”
The Trinity Trio was never as confident as the press, however:
What, then, can be done to help an investor in planning for a withdrawal rate? The word planning is emphasized because of the great uncertainties in the stock and bond markets. Mid-course corrections likely will be required, with the actual dollar amounts withdrawn adjusted down-ward or upward relative to the plan. The investor needs to keep in mind that selection of a withdrawal rate is not a matter of contract but rather a matter of planning
Sometimes people on the Internet like to argue about the conclusions, but it’s just math. This method worked in the past is just as true as I had eggs and bacon for breakfast today. Those are the facts.
But to be reasonable, remember the 4% Rule is a Rule of Thumb based on experience, not a Law of Nature. It is the base of a plan
What is Success?
But wait! A 96% success rate isn’t guaranteed, how can they call that safe?!
This is a pretty common reaction, and many people make an immediate commitment to build an extra large portfolio so they can spend much less than 4%
But how long would it take to grow your portfolio to support a 3% or 2% withdrawal rate, years of life that themselves are not zero risk? And after working an extra 10, 20, or 30, years, wouldn’t it be a bummer if it didn’t really make a difference?
If we required 100% safety in all things, we would never board a plane, never eat a medium rare steak, and would wear a helmet and life jacket 24 hours a day.
For someone that has built wealth through living below their means, investing the difference, and patiently watching their wealth grow, the odds of a portfolio failing catastrophically is about equivalent to the odds of death by a cow falling on you while asleep in your own bed.
Sure it happens, but it is nearly pointless to plan for it (but if there is interest, I will do some posts analyzing the failure cases… #financialporn)
And worth mentioning, pretending that we are signing up for something with a 96% historical success rate is full of false confidence. Any number of unknowns could occur, ranging from an asteroid smashing into the Earth to the Simian Flu wiping out 80% of the world’s population to a terrorist setting off a nuclear bomb in downtown Manhattan. More money doesn’t save anybody from the real dangers
Even a 4% withdrawal rate will be too conservative in most cases.
Look at this other Table from the Trinity Study, which shows the median terminal value for the 55 retirement periods studied.
How would you like to spend 30 years living the good life, enjoying a constant standard of living throughout your retirement, and then look at your portfolio to find not only had it not disappeared, but it MORE THAN TRIPLED! Your children will love it even more than you do
For the 50% stock / 50% bond portfolio with 4% inflation adjusted withdrawals, which had only a 96% success rate, this was the case half the time
Even at a 5% withdrawal rate, the median value of a 50/50 portfolio after 30 years was nearly 1.4x the beginning value. For a 5% withdrawal on a 100% stock portfolio, the median terminal value was over $7.2 million
Don’t get too caught up in striving for 100% safety (an impossible feat.) The only thing 100% guaranteed in life, is death (not even taxes)
Success is not a number in a Table from an academic study
Trinity Study Methodology
If you are like me (and you probably aren’t because I love data and Excel spreadsheets a little too much) then the Tables from the Trinity Study probably aren’t exciting enough. You want to see the data behind the data
Viewing things graphically makes it easier to get an intuitive feel for the data, so let’s look at the source of the results shown in the Tables above
Starting with the case of a 4% initial withdrawal rate on a portfolio of 75% stock / 25% bonds, we model a 30 year retirement that begins in 1926. We withdraw the initial 4% for spending, adjust the stock and bond values based on market returns for the year, add dividend and interest income, and rebalance to the original asset allocation. Then we repeat for Year 2, but this time with a higher withdrawal amount to account for inflation. This is then repeated for each year up to Year 30
The portfolio value for the 30 year period starting in 1926 looks like this
Repeating this for 30 year retirements starting in 1927, 1928, and 1929 provides the following chart
We can see that the economic conditions of each 30 year period are very different. Retiring in 1926 had several years of stock market growth before the Great Depression, whereas a retirement starting in 1929 was hit immediately with the major stock market plunge on Black Tuesday. In all 4 cases however, drawing 4% of a 75% stock / 25% bond portfolio would provide a comfortable retirement for the full 30 years. In the grand scheme of things, for a retiree living off a portfolio the Great Depression was anything but depressing
Looking at all possible 30-year periods we can get a sense of which economic periods were most challenging with an initial 4% withdrawal rate, and also which ones resulted in a ridiculous amount of wealth
Now that we can see what actually happened in the past, we can start to do some interesting analysis and figure out how to boost our success rate without sacrificing many more years to working
Hacking the Data
There are some simplifying assumptions built into the Trinity Study that result in a reduced success rate and/or reduced safe withdrawal rate. No Social Security. No future income. No reduction in spending. No flexibility
To account for the differences in individual behavior, the Trinity Trio set some rigid rules, namely that each year’s spending would be exactly the same when adjusted for inflation, no matter what. When was the last time you spent the exact same amount 2 years in a row? The concept of homo economicus was simplified to a robotic existence.
And how many people would retire in 1929, watch the stock market suffer one of the largest declines of all time, and then think to themselves, “The Trinity Study says 4% is safe, so I’ll just pretend everything is fine”
Not me, not most people. We would do what people do in life, adapt
These same adaptations apply even in good times. What young person with unlimited free time isn’t going to earn a little extra income? Even $100 a month increases the Median terminal value for a 75/25 portfolio by $150k.
Despite the scare mongering in the press, even Americans who work only 10 years will still receive some Social Security income in return for their years of paying into the system. The likelihood of some additional income is quite high
Flexible spending also has a major influence. If 2008 happened all over again, instead of vacationing in Paris that year, perhaps go to Lake Atitlan, Guatemala, one of the most beautiful places we’ve ever been (Yes, it’s safe.)
Life is full of flexible spending opportunities. Perhaps you still use a car from time to time, and can extend the replacement cycle from 10 years to 11 if the economy is suffering. Or maybe only upgrade to the iPhone 19 when the iPhone 20 is announced
And then there is Ty Bernicke’s research, which shows people naturally spend less as they age. Apparently nobody cares what brand of jeans they wear at Age 75, and even Jerry Seinfeld’s parents would dine early to get the early-bird special.
Jerry: (bewildered) Four-thirty? Who eats dinner at four-thirty?
Morty: By the time we sit down, it’ll be quarter to five.
Jerry: I don’t understand why we have to eat now.
Helen: We gotta catch the early-bird. It’s only between four-thirty and six.
Morty: Yeah. They give you a tenderloin, a salad and a baked potato, for four-ninety-five. You know what that cost you after six?
Jerry: Can’t we eat at a decent hour? I’ll treat, okay?
Helen: You’re not buying us dinner.
Jerry: (emphatic) I’m not force-feeding myself a steak at four-thirty to save a couple of bucks, I’ll tell you that!
Helen: All right (sitting on the couch), we’ll wait. (pointedly) But it’s unheard of
But all of this is secondary to one very powerful hack. Wade Pfau has perhaps done more than anyone to embrace and extend the Trinity Study, and has concluded:
…the wealth remaining 10 years after retirement, combined with the cumulative inflation during those 10 years, can explain 80 percent of the variation in a retiree’s maximum sustainable withdrawal rate after 30 years
In other words, if you can make it through the first 10 years without severely depleting your portfolio or inflation going out of control, your portfolio is likely to enter Too Big to Fail territory. I’ve never heard better news, because I’ve always wanted to be a Bank
But let’s be crystal clear. Even if we do none of these things, with a 4% initial withdrawal rate, in nearly all cases we die ridiculously wealthy
Foundation for Long Term Success
Because the early years are critical, it would be worthwhile to at least consider using that time to lay a foundation for long term success. We can’t do anything about inflation (directly), but we have great control over most everything else
If world travel is of interest, why not start traveling in Latin America or Southeast Asia instead of Japan, Western Europe, or Australia? With a possible 60 year retirement, there is plenty of time to go everywhere and see everything, but front-loading the low cost of living countries will minimize portfolio withdrawals, the lower the better. This isn’t a sacrifice or even being frugal, it is just living large where it costs less to do so. Perhaps it would even be possible to live solely from dividend and interest income
To further reduce costs, while still working we can hack Credit Card rewards to load up on Frequent Flyer miles and Hotel Rewards points, in the same way that we build up our stock and bond portfolio. Consider it another asset class. This will allow us to fly and stay for free in the early years
Because all taxes and Mutual Fund fees are part of our overall withdrawal rate, minimizing these is critical. Aggressively managing taxes and investing in a low cost way mean less of a load on the portfolio. Consider that a typical 1% fee that might be paid to a financial adviser is 25% of the total budget for somebody living on 4% of a portfolio. By contrast, our total load is less than 0.08% (based on Personal Capital Retirement Fee Analyzer)
Having grand adventures means great stories and great photos. Perhaps you might type some of these stories into a computer or allow an online travel site to use your photos. Besides being great fun, it might even generate some accidental income. There are 7 billion different ways to make a little income, unique for each individual on the planet
If a nightmarish economy and stock market collapse lays waste to your stock portfolio, be ready to sell all of your bonds and buy stocks while on sale. The bonds did their job of reducing volatility in the early years when it mattered most, and having a 100% stock portfolio has historically provided the best long term growth and largest terminal value
If things are really bad, it would even be reasonable to go back to work for a short time. Some random people on the Internet will say ignorant and hateful things if you do, but nobody will ever make a movie about them. You on the other hand are pursuing your dreams. I’ve already reached out to Brad Pitt and Angelina Jolie to co-star in the Go Curry Cracker film
Winnie: “Where should we start our world travels?”
Jeremy: “How about Latin America? We can live like royalty for pennies and let our portfolio continue to grow”
Winnie: “But isn’t it dangerous?”
Jeremy: “Don’t worry baby, we have guns”
Summary and Conclusions
Based on the excellent research done by the Trinity Trio, we have great data to use for planning an early and extended retirement. By digging deeper into the data, we know we can safely plan on a 4% initial withdrawal rate to determine our retirement number, as well as make plans to boost the already nearly guaranteed success rate and/or increased spending over time
- Plan on a 4% withdrawal rate
- Spend less in the early years, the lower the better
- Minimize taxes
- Travel hack for free flights and hotel stays
- Minimize investment costs through Vanguard index funds
- Earn a little accidental income
- Be prepared to move bond position into stock in a severe downturn
- Be OK with going back to work for awhile
If you’ve read a little Go Curry Cracker in the past, this probably seems very familiar (yes, I’m one of those conservative people I made fun of earlier)
You have to have a lot of respect for the Trinity Trio, especially considering that the iPhone 6 processing power is at least 10,000x greater than a PC from the 90’s, and that most data was probably entered by hand from books.
What probably took them years, we can do now in seconds, and for a substantially wider data set. For this, check out cFIREsim and do your own Trinity Study.