Withdrawal Rate Rule # 5: You Must Take Retirement Income Pay Cuts During Bear Markets
This capital preservation rule functions as a safety net to protect your future retirement income from erosion during bear markets. It is triggered when your current withdrawal rate is 20% greater than your initial withdrawal rate. Sounds confusing? The best way to explain this rule is to use an example.
Assume you have a $100,000 and you start withdrawing 7% or $7,000 each year. The market goes down for several years and your portfolio value is now at $82,000. The same $7,000 withdrawal is now 8.5% of your current portfolio value. Since your withdrawals now represent a bigger piece of your portfolio, the capital preservation rule kicks in, and says you must reduce your current year’s withdrawal by 10%. In this example, your withdrawal would go from $7,000 to $6,300 for the year.
Much like real life, where some years you receive a bonus and other years a pay cut is required, this rule adds the flexibility you need to endure changing economic conditions.
Withdrawal Rate Rule #6: When times are good, you’re eligible for a raise.
The final rule is most people’s favorite. The opposite of the capital preservation rule, it is called the prosperity rule. It says that as long as the portfolio had a positive return in the prior year, you may give yourself a raise.
Your raise is calculated by increasing your monthly withdrawal in proportion to the increase in the consumer price index (CPI). If you were withdrawing $7,000 per year, the market had a positive return, and the CPI went up by 3%, then the following year you would withdraw $7,210.
Following these rules takes discipline. The reward is a higher level of retirement income, and an increased ability to maintain purchasing power.
It is important to make informed decisions about your money. If all this investment “mumbo jumbo” gets overwhelming, then take a step back, and think of it like a new career. It takes time to learn new skills. Remember, the right decisions will help you generate retirement income that will last.
Prior to implementing a retirement income plan of your own, take the time to learn as much as you can. Try one of these online investment classes to learn more. If you seek professional advice from a qualified fee-only financial advisor make sure you find someone familiar with the latest research in this area.
