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Revisiting my favorite topic: What withdrawal rate can you make from a portfolio without significant risk of going broke before you die? This isn't a new topic, nor are my ideas original. Rather, they are a blend of the results of the Trinity Study, David Braze's (TMFPixy) article "How Much Are You Gonna Take?" and an article by Frank Armstrong. Links to the other articles can be found in Pixy's article:

My plan relies on the following two assumptions:

1. I am not the least bit worried about how much I can leave my kids. They will very likely be very well set on their own.

2. I'll retire at 63 or 64. If the market sours early on (probably the biggest danger to my plan), I could go back to work for a year or two.

3. My Social Security benefits will provide fully 35% of my "minimum wage", which tends to soften the effects of market downturns somewhat.

The literature referred to above is extremely valuable, especially in suggesting a general direction. But I believe it would be a mistake to rely on withdrawal rates and probabilities of success too heavily. First, there is really not enough data available to warrant quoting probabilities of 100%. "The worst storm ever recorded for the city of ..." is a phrase you hear every so often. This could apply to economics as well as meteorology, couldn't it? Second, The behavior of the market and of the economy isn't governed by the same rules that applied in the past. The rules have changed, and we might expect the behavior of the market to change.

At some point in all our lives, we were naive enough to believe that we could accumulate a reasonable sized nest egg, and then "live off the interest". Now we know that it's a bit more complex than that. The fixed strategy of the Trinity study leads to unacceptably low (IMHO) withdrawal rates, while at the same time resulting in unacceptably high terminal values. I think a more flexible strategy is called for.

The first thing my plan calls for is a nest egg about 25% greater than what is required to maintain my standard of living. This will delay my retirement for a year or two, depending on the market. Better to pay a small price up front. After all, it's not as though I'm digging coal for a living. (I might well have a different outlook if I hated my job.)

The second thing my plan calls for is the managed growth of my nest egg, after adjusting each year for inflation, of course. This growth of about 2% per year is continued until age 75-80 (maybe depending on my health and that of my wife). In the later stages, a moderate reduction of principal (about 3%) will be programmed each year. I could be in trouble if I live to be 110, but I could also be in trouble when the comet hits. C'est la vie.

Asset allocation is an interesting feature of the plan. Instead of allocating on the basis of some arbitrary rule or general principle, my asset allocation is based on the premise that I will have to draw my income solely from cash and other fixed income securities if and when the market goes into the tank. I will cut back living expenses to a predetermined minimum level (which happens to be about 4.5% of my projected assets) and 20% of my nest egg will last me about five years, given that there will be some interest and dividend income.

It is no coincidence that the assets devoted to fixed income stuff is the same size as the "buffer" alluded to above. This allows me to invest the remainder aggressively, within reason. (I'm not going to the riverboat to bet it all on red!) The point is that the allocation is based on a definite strategy. This frees me from worrying whether I'm being conservative enough or aggressive enough. All I'm doing is to make it unnecessary to sell any stock for at least five years. Five years is my personal figure (and one found frequently here at The Motley Fool), but others might like a different number -- YMMV.

Here's how it works: Each year I plan to set aside my "minimum wage" in a cash account that holds two years worth of minimum living expenses at the start of each year. I then adjust my nest egg target for inflation, and if the remainder is less than my target, I go into austerity mode. If I have an excess, it will be split more or less evenly between more spending (think mai tais) and increased capital. First, I take care of minimum living expenses, then inflation, then programmed growth, then high living. The final step is to rebalance the portfolio. My personal taste in asset allocation:

8% Cash
12% Bonds
40% SPY and/or Rule Makers
25% DIA and/or Foolish 4
15% QQQ and/or Rule Breakers

The plan is not difficult to formulate, and if assets stray very far in either direction from the target, it can (and should) be reformulated.

If this has any merit, it lies in the conviction that one should plan for a nest egg 25% larger than what is needed to generate the desired income.



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