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Sensible Withdrawals

Sensible Withdrawals is a variation of the Constant Dollar withdrawal strategy. It works like this: you choose a "base" withdrawal rate that is enough to cover the minimum amount of spending that you must do each year, which includes paying your food, housing, bills, and so on. This base amount is calculated from your portfolio value at the start of retirement, not its value in the current year. It is adjusted for inflation each year and does not change with the market.

Typically, your base rate should be lower than typical Constant Dollar withdrawal rates. For instance, if you would normally withdraw 4% when using Constant Dollar, then you might consider a base withdrawal rate of 3% with Sensible Withdrawals.

On top of this amount, you specify a second rate, the Extras Withdrawal Rate. Each year, you look at the gains of the previous year's portfolio. Whenever those gains (accounting for inflation) are positive, you withdraw an amount equal to the Extras Withdrawal Rate times the value of the gains.

This extra money can be used for frivolous spending: vacations, a new car, hobbies...whatever it is that you want. Because the base withdrawal rate covers all of your essential spending, the extra income can be considered completely disposable.

Let's look at an example: suppose your portfolio was worth $1,000,000 at the start of retirement, and its return in the previous year was $25,000 after accounting for inflation. Assume no inflation for simplicity.

A 3% base withdrawal rate gives you $30,000 from your initial portfolio value, regardless of its current value. A 10% extras withdrawal rate adds $2,500 from the previous year's return, for a total planned withdrawal of $32,500. A separate minimum withdrawal limit only raises this amount if you set it above $32,500.

The Sensible Withdrawals strategy is not only less likely to run out of money than the Constant Dollar strategy, but on average it also allows you to withdraw more money over the course of your retirement. However, it suffers from high withdrawal fluctuations from year to year in volatile markets. If a steady withdrawal amount is important to you, then you may wish to consider other strategies.

Strengths

Weaknesses

  • Withdrawal amounts can vary considerably from year to year