Running out of steam while on FIRE? How to know if you have enough in retirement

Much has been written about the need to invest when we are young, and how having a longer investment horizon lets us invest in riskier stocks in order to achieve returns higher than inflation over a 30 to 40 year period when we are working. But with longer lifespans, we will spend almost as long in retirement as we will working. And because we no longer have a steady income from work when retired, how do we know if we still have enough to last for the rest of retirement? This is even more critical for the early retirees: How do we know if we are running out of steam while on FIRE?

So far, we have posted quite a bit on how to drawdown on the investment portfolio during retirement, i.e. the Safe Withdrawal Rate:

• The 4 percent rule for Financial Independence
• Does the 4 percent rule work in Singapore?
• 4 ways the 4 percent rule can work in Singapore
• The Yield Shield, 4 Percent Rule and CPF Life – A Perfect Retirement Combo?
• How much can I spend from my investments?
• Combining CPF Life with Investments
• The Millennial’s Guide to How Much Does It Cost to Retire Early in Singapore

All this tells us how to start off our retirement, how much to draw from our investments, how much to put into annuities, etc. But what matters more is, how do we know when to do something different during retirement? This is because Sequence of Returns Risk, or Sequence Risk, which is a sharp market downturn happening in the initial few years of retirement, can reduce the amount we have in our investments, and throw the best laid retirement plans awry.

• How Sequence of Returns Risk Messes Up Retirement and the 4 percent rule
• Does the Yield Shield protect retirement finances?
• A Yield Shield Portfolio for 2020
• Does the 4 percent rule for FIRE work with the S&P500?
• Retiring and Surviving in a Pandemic – The Yield Shield 6 Months On

So how do we know if we can still continue on our retirement journey in the aftermath of a market downturn? Or if we should decrease (or even increase) our spending rate depending on how the markets have performed?

Will your retirement continue running under its own steam … or will it run out of steam?

What can we learn from Safe Withdrawal Rates?

For a start, let’s go back to the safe withdrawal rates for retirement investment portfolios. In Does the 4 percent rule work in Singapore? we saw how the high volatility of the Straits Time Index (26% a year) made the safe withdrawal rate for a Singapore-based retiree much lower than the ones being suggested for retirees elsewhere. And this is even if the returns are pretty good (5.1% in capital gains and 2.8% in dividends a year, and 2.80% interest on bonds). Assuming a portfolio with abut half allocated to equities and half to bonds, for a 95% chance of success over retirement, the safe withdrawal rates by length of retirement (based on a 10,000 run simulation) are:

Safe withdrawal rates for a 50:50 and a 40:60 portfolio of Singapore stocks and bonds

Length of retirement	50:50 portfolio	40:60 portfolio
40 years	1.65%	1.90%
35 years	1.90%	2.15%
30 years	2.20%	2.50%
25 years	2.65%	3.00%
20 years	3.35%	3.70%
15 years	4.45%	4.90%

So suppose a couple aged 55 today decides to retire early with a 40-year retirement in mind. Given that average spending for a couple is $4,000 a month (see the estimates in The Millennial’s Guide to How Much Does It Cost to Retire Early in Singapore, which are based on the Department of Statistics’ Household Expenditure Survey 2017/18), how much is needed now, and how much is needed to ensure they don’t run out of steam while on FIRE?

Suppose the $4,000 a month spending grows by an inflation rate of 2%. $4,000 today will be $4,416 in 5 years time, and $4,876 in 10 years time, and $5,383 in 15 years time. And so on. So the withdrawal amount will go up every year, and the total investment value, at the safe withdrawal rate for the 40:60 portfolio above, will be:

Investment amount needed to sustain a 40-year retirement at each age

Length of retirement left	Yearly Spending	Safe Withdrawal Rate	Portfolio Value Required
40 years	$48,000	1.90%	$2.53 Million
35 years	$52,996	2.15%	$2.46 Million
30 years	$58,512	2.50%	$2.34 Million
25 years	$64,602	3.00%	$2.15 Million
20 years	$71,325	3.70%	$1.93 Million
15 years	$78,749	4.90%	$1.61 Million

Now, one thing to note is that if you have set the end date for retirement at a relatively high age (say 95 years of age, where the chances of survival are quite low at less than 10% for a man, and less than 20% for a woman), the safe withdrawal rate problem gets a little less critical once there is less than 20 years to go. You could simply put the remainder of the assets into a high yield savings deposit account paying around 2% a year in interest, and withdraw 4% – 5% of the investment amount a year and be assured that the money can last until the age of 95. With increasing longevity, we may now need to budget for at last 35 years of retirement in normal circumstances e.g. retirement at age 65.

But in general, that is not the approach taken by most Safe Withdrawal Rate analysis, primarily because there is still quite a bit of uncertainty about the end date of retirement. Especially for the women, who may go on living till a much older age. Most Safe Withdrawal Rates will end up with a good amount remaining in the investment portfolio, which can serve as a liquidity fund (perhaps for those oh-so-expensive medical treatments needed towards the end) or as a bequest for the children and grandchildren.

What the table above tells us, is that to ensure that you will still have enough money for the rest of retirement, even after accounting for inflation of 2% a year, the investment portfolio needs to stay at roughly the same level as the amount with which you started retirement with. Until there are about 25 years or less to go to the end of the retirement horizon. After that point, it is acceptable to start running down the investment portfolio, i.e. spending the capital, gradually over time, as opposed to living off the dividends and capital gains prior to that point.

A good signal of whether you have enough in investments to last for retirement is whether the assets are worth roughly the same as you started retirement with

What affects the Safe Withdrawal Rates over time?

The discussion on Safe Withdrawal Rates for a Singapore retiree may look pretty daunting, especially for those who have the idea that they can retire early on the 4% per cent rule! But what is it that affects the level of the Safe Withdrawal Rates?

1. Portfolio with higher returns and lower volatility

Let’s look at the corresponding figures for a US-based investor in the SPY ETF which tracks the S&P500 index (7.65% capital gain over 1993 – 2019, with a volatility of 14.7% and a dividend yield of 1.9%).

Safe withdrawal rates for a portfolio of only the SPY ETF

Length of retirement left	Safe Withdrawal Rate	Yearly Spending	Portfolio value required
40 years	3.50%	$48,000	$1.37 Million
35 years	3.70%	$52,996	$1.43 Million
30 years	4.00%	$58,512	$1.46 Million
25 years	4.35%	$64,602	$1.49 Million
20 years	5.00%	$71,325	$1.43 Million
15 years	6.05%	$78,749	$1.30 Million

Interestingly, for a retiree who has the fortune to be invested in a equity portfolio which behaves like the S&P500 for the past 3 decades but without the currency risk, they can sustain a higher Safe Withdrawal Rate over time, and hence start off retirement with a portfolio which is smaller ($1.37 Million compared to the $2.53 Million required by the Singapore stock and bond investor). However, to ensure that this S&P500-like portfolio does not run of money in retirement, the retiree actually needs to ensure that the portfolio grows over time, at least until the 20-years-of-retirement-remaining mark is reached.

2. Portfolio with lower returns and lower volatility

Let’s now suppose that our retiree is still invested in a S&P500-like portfolio, only that the return going forward will be lower than what it was in the past (i.e. 6.5% capital gains a year only, instead of 7.65% historically). What happens is that the Safe Withdrawal Rates are reduced sharply (as expected):

Safe withdrawal rates for a portfolio of only the SPY ETF with lower returns (6.5% a year)

Length of retirement left	Safe Withdrawal Rate	Yearly Spending	Portfolio value required
40 years	2.90%	$48,000	$1.66 Million
35 years	3.15%	$52,996	$1.68 Million
30 years	3.40%	$58,512	$1.72 Million
25 years	3.85%	$64,602	$1.68 Million
20 years	4.45%	$71,325	$1.60 Million
15 years	5.55%	$78,749	$1.42 Million

In this case, as the Safe Withdrawal Rates are lower than before, the investment portfolio at the start of retirement needs to be bigger, but at the same time, all the retiree needs to do to avoid running out of steam is to ensure the portfolio does not lose value over time.

3. Portfolio with higher returns and higher volatility

Let’s now suppose that our retiree is still invested in a S&P500-like portfolio, with the return going forward just as high as what it was in the past (i.e. 7.65% historically) but with higher volatility (20% instead of 14.7% historically). What happens is that the Safe Withdrawal Rates are reduced even more sharply than the previous case with lower returns:

Safe withdrawal rates for a portfolio of only the SPY ETF with higher volatility (20% a year)

Length of retirement left	Safe Withdrawal Rate	Yearly Spending	Portfolio value required
40 years	2.15%	$48,000	$2.23 Million
35 years	2.35%	$52,996	$2.26 Million
30 years	2.60%	$58,512	$2.25 Million
25 years	3.00%	$64,602	$2.15 Million
20 years	3.55%	$71,325	$2.01 Million
15 years	4.55%	$78,749	$1.73 Million

In this case, the Safe Withdrawal Rates are almost as low as those for the STI-invested retiree, which means the starting retirement portfolio size is almost the same as well. Which goes to show that for retirement, volatility really matters! However, there is no escaping from it, because low volatility assets like bonds simply would not give enough return to overcome inflation for the long haul. But once again, all the retiree needs to do to avoid running out of steam is to keep the portfolio at a constant value over time.

If your Safe Withdrawal Rate is closer to 4%, you actually need the portfolio value to grow over time to avoid running out of steam while on FIRE!

What do we do about the short term fluctuations?

So far, we have only shown the trajectories with portfolio value must take in retirement at 5 year intervals to ensure we are still on track for retirement. That is simply because there are going to be a lot of short term fluctuations in the markets and in the portfolio value, but it is hard to distinguish the signal from the noise at short intervals.

But that is cold comfort to a retiree who may be living through a sharp drop in portfolio value due to the current Covid-19 crisis. And it is a very unpleasant situation to be in. The fall in portfolio value may necessitate returning to the workforce, but at a time when there are unlikely to be any jobs to be found. Which leaves the only other option of cutting back on spending to make the portfolio last, at least for these couple of years. What can we say to help on this question?

Let’s look at a couple of case studies. Firstly, a retiree drawing 4% from the STI ETF and a portfolio of blue chip REITs and dividend stocks which we discussed in Does the Yield Shield protect retirement finances?

Portfolio value of the STI ETF and a blue chip Yield Shield during retirement 2008 – 2019

The experience of the STI investor over the past 10 years is instructive. In general, a retirement portfolio with a prescribed Safe Withdrawal Rate cannot survive a sharp downturn where 50% of the portfolio value is lost. The only chance it has of not running out of steam is if the dividends paid on the portfolio are enough to cover the withdrawals made i.e. using a Yield Shield.

This is something we see even for the S&P500 investor during the 2000s, where the S&P500 suffered from the bursting of the NASDAQ bubble, the 9/11 attack on New York, and the 2008 Global Financial Crisis. We discussed this case in Does the 4 percent rule for FIRE work with the S&P500?

Portfolio value and withdrawals of the SPY ETF for a USD investor in the S&P500 2001-2020

Again, it is evident that after hitting a low at around 50% of the initial portfolio value, the SPY ETF portfolio sinks further and further, and never really recovers. There is a chance, however, that this retiree might last another ten years to 2030, but that is a relatively small chance.

Concluding Thoughts

The FIRE movement have generally adopted some variant of the 4% rule as the Safe Withdrawal Rate from their investments. However, less has been written abut how to monitor the value of the portfolio over time to ensure that they do not run out of money before the end of the retirement period, almost as if the 4% rule is a failsafe rule.

The truth is that the 4% rule is not foolproof. Investments still need to be monitored in retirement to make sure that the retiree is not running out of steam while on FIRE! A very simple rule for this is to ensure that the value of the portfolio does not fall significantly below the initial portfolio value at intervals of 5 years. Also, a sharp fall in the portfolio to around 50% of the initial value early in retirement will almost certainly spell the end of the Safe Withdrawal Rate adopted, and action will need to be taken to safeguard retirement finances.

Finally, the safest way is to pair the investment portfolio with an annuity! Even if the Safe Withdrawal Rate on the invest portfolio fails, there’ll still be the income coming in from the annuity. That way, you’ll never worry about running out of steam while on FIRE!

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