Monday, May 08, 2023

The Joy of Unsafe Rates of Withdrawals


There is a lot of talk about safe rates of withdrawal. I would venture to opine that discussions on the safe rates of withdrawal in this blogosphere are enough for more than a lifetime!

I think the problem with this train of discussion is that we don't spend enough time discussing the opposite of a safe rate of withdrawal and taking a leaf off Charlie Munger's page, I wish to invert this topic so that we can glean some insights on retirement planning.

Today I want to talk about why I prefer unsafe withdrawal rates and why most readers should agree with me more than anyone asserting a safe option.

Specifically, an unsafe withdrawal rate applies to an intermediate investor who builds a decent dividends portfolio and spends about the current yield annually. In today's market, if you successfully replace your expenses with dividends, you may withdraw about 6-6.5% of your portfolio, which would be mathematically unsustainable based on long-drawn studies by academics and my Monte Carlo simulations.

Here are the reasons why I prefer rates of withdrawal to be unsafe:

a) You need to be unsafe first before you can be safe.

One way of looking at the problem of creating a sustainable retirement is that, unless you are an inheritor like me, you won't leap from being a new entrant into the working world to having a sustainable pension. If you need $2,000 a month, with a safe rate of 3%, you need $800,000. If you live on 6.5%, you only need about $370,000. 

So regardless of what happens, you will reach the unsafe stage before you can even be safe. Consequently, you are more likely to reach the unsafe range than the safe range.   

b) Easier to convince someone to be financially independent than to be retired safely

If I propose a target of $370,000 instead of $800,000, I would have a lot of traction because it's not just about freedom from an earned income. It's actually solving a bigger problem in the Singaporean workplace. If you attend my preview, I'm not just selling dividends higher than personal expenses. 

I'm selling freedom away from a toxic work environment. 

This can get many millennials and Gen Z to sit up and listen.

I've gotten feedback from my students and readers of the blog that $300,000 is a lovely spot for them.

c) People need to anchor themselves to success

During sports day, my 7-year-old son won a medal even though his team was last in a running competition. Even though his team came last, my son bragged about his award, would wear it all day, and even wore it to his piano lessons. 

In my earlier article on my existential crisis, it's essential to have significant achievements to fall back on when you hit a mid-life crisis - medals in life matter. Generating enough investment income to cover monthly expenses is one possible anchor to your personality. It is a formidable achievement and is consequential to your life.

Most investors should not be bothered to double their portfolio targets mentally to hit a safe withdrawal rate. You work on getting there unsafely first, and $370,000 is definitely achievable for local PMETs.

So you live on your dividends first, then you find a way to secure your retirement plan.

d) So what if you are really unsafe

The weakness of promoting a dividends approach is that not everyone will continue to build up their wealth after reaching 6.5%. 

Having observed some people, I don't think it's anything that should be pinned on their "dividends mindset". They just hate working for other people. Another weakness is that addiction to current yields can lead to concentrated portfolios, which means diversification across different dividend sources do matter.

By this time, my Monte Carlo simulator can pull ETF data from Yahoo Finance and simulate what happens if you run down a SPY/AGG portfolio using high rates of withdrawals. This table lists how long the portfolio will last for the worst 5% simulations. 

This means we can sort of estimate how long your money will last if you decide to throw caution to the wind.

So for a 60/40 portfolio with a withdrawal rate of 6.5% and average inflation at 3%, we are looking at 14-15 years of fun living. 

But humanity is resilient.

People don't lie on the bed and draw down their portfolios to 0. 

People can cut back on expenses, draw from CPF Life, or join the gig economy. They can downgrade their homes.

Finally, does it mean we avoid attaining a safe withdrawal rate once dividends are high enough? 

It depends on your personality. 

As an ENTJ, my withdrawal rate is around 3%, but I still want a day job to supplement my trainer fees and hit ERS CPF-Life. Because I can't sit still and want to contribute to society. I've got training revenues and Graves Disease, and I'm still interviewing!

Most other personality types will run the risk of quitting if they hit 6.5%. Singapore's corporate culture is toxic. If someone wants to live on their dividends and see their portfolios go to hell in 15 years, maybe we should examine the kinds of workplaces they function in.

IMHO, only the INTJ strategists who dominate the finance telegram group ( and every ERM intake ), will precisely quit when they reach the target rate. This is about 2% of the male population and 1.5% of the female population.

Finally, if I had not done some unsafe acts in the past,  I would not be a proud dad of two kids today. 

One just won a medal.

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