Early Retirement

This is perhaps the most difficult and critical question to address when planning for early retirement. Retire too early and you run out of cash but working several years longer than you might need burns up years of your life in the office when you could be climbing El Capitan or surfing in Puerto Escondido.

The crux of this question comes down to the SWR or Safe Withdrawal Rate which is the percentage of your principle you can withdrawal every year, adjusted for inflation, without running out of money. Most FIRE evangelists reference the Trinity Study (Explanation & Actual Study) to support a 4% Initial Withdrawal Rate, Adjusted for Inflation (Cost of Living) each year. A couple points you will note if you read the actual study itself which I linked to above:

• The study assumed a maximum 30 year retirement period
• The Study showed that a 75% S&P 500 Index/ 25% Long Term High Grade Corporate Bond Portfolio with a 4% Initial Withdrawal Rate, Adjusted in Each Year of Retirement for Inflation, had a Success Rate of 98% for each 30 year retirement period between 1926-1995.
• This was the optimal Portfolio mix for a 30 year retirement assuming you want to adjust the initial withdrawal rate for inflation (cost of living) each year in retirement

Since I am retiring at 45 and my wife is 39 (she says 29), we need to plan for a much longer retirement of around 60 years.

Fortunately, Karsten Jeske aka Big ERN, has compiled an extensive analysis of Safe Withdrawal Rates over much longer periods of time and with numerous Stock/Bond Portfolio comparisons, glide paths, market valuation levels, capital preservation assumptions, etc. His analysis is posted here. I definitely recommend reading it in it’s entirety but let me try to summarize very briefly.

I created the above chart based on Big Ern’s analysis and, as you can see in the chart, a 4% withdrawal rate had a 95-97% success rate for a 30 year retirement with at least 50% Stocks. Not terrible.

However, a 4% withdrawal rate had only a 65-89% success rate for a 60 year retirement and at least 50% Stocks! That is not acceptable at all for me!

A 3.5% withdrawal rate had a 97-98% success rate for a 60 year retirement with at least 75% Stocks.

A 3.25% withdrawal rate had a 99-100% success rate for a 60 year retirement with at least 75% Stocks.

So, in a longer retirement of 60 years, it is much more advisable to use a 3.25%-3.5% withdrawal rate and a 75%-100% Stock Allocation.

As of this writing, in September 2021, the stock market is at particularly high valuation levels (S&P 500 CAPE Ratio or Schiller PE Ratio is currently 38.21 vs. the historical average of 16.85). I created the chart below based on the data published continually by multpl.com.

How does this affect the withdrawal rate we should use?

Big Ern has also run an analysis of safe withdrawal rates based on CAPE levels at the time of retirement. It is posted here. The chart below is based on data from Big ERN’s article.

This chart shows that if we retire when the S&P 500 is at high CAPE levels (Cyclically Adjusted Price to Earnings Ratio’s based on inflation adjusted earnings from the prior 10 years) we generally need to use lower withdrawal rates to achieve the same probability of success. The scenarios above assume a 75% Stock/ 25% Bond Portfolio and were run on historical data from 1871 to 2021 and assuming a 60 year retirement period.

A withdrawal rate of 4.01% had a 50% failure rate when the CAPE was greater than 20 and the S&P 500 was at all time highs! So, we definitely would not want to use that!

A withdrawal rate of 3.25% had a 0.00% failure rate even when the CAPE levels were greater than 20 and when the S&P 500 was at all time highs. For me, this is the level I would want to use as the SWR.

To summarize, the historical data from 1871 to 2021, supports the use of a 3.25%-3.5% withdrawal rate for a 60 year retirement and a portfolio allocation of at least 75% Stocks. When S&P 500 CAPE levels are >20 very small increases in the withdrawal rate drastically increase the probability of failure and it is advisable to use a withdrawal rate less than 3.5% and ideally 3.25%.

This means that:

If you need $50k/year in retirement, you would need a portfolio of $1.538M assuming a 3.25% withdrawal rate.

If you need $70k/year in retirement, you would need a portfolio of $2.154M assuming a 3.25% withdrawal rate.

If you need $100k/year in retirement, you would need a portfolio of $3.076M assuming a 3.25% withdrawal rate.

These figures are before fees/taxes so make sure you consider that when determining your budget. The figures also assume you invest your money in at least 75% Stocks (S&P 500) and the remainder in Bonds (10 Year Treasury Bonds). I actually use the Total US Stock Market Index Fund VTI with the remainder in BND which is a Total US Bond fund.

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