Tag Archives: Financial Independence

Safe Withdrawal Rates in Canada (for any Retirement Age)

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So you have been reading Million Dollar Journey (MDJ) for years, have used your Canadian online broker account to DIY-invest your way to a solid nest egg.

You’ve got a TFSA, and RRSP, and maybe even a non-registered account – full of good revenue-generating assets.

Kudos!

Now comes the tough part: How do you turn that nest egg into a usable stream of money that you can spend as you enter retirement?

Surprisingly, when it comes to discussing Canadian safe retirement withdrawal rates, and talking to folks who have retired at all ages, spending their retirement savings represented a massive mental strain for them.  I guess (as someone who has never retired or sold investments to pay for retirement) that I always thought that saving for retirement would be the hard part.

Isn’t spending supposed to be more fun than squirreling away?

It turns out that once you get into that savings mindset, it can be hard to flip the switch back to enjoying spending the fruits of your labour.  This is especially true for folks who are looking at strategies for an early retirement because they are much more likely to have been super-aggressive savers during their time in the workforce.

I didn’t go into the topic of safe withdrawal rates for retirement expecting the topic to be so deep and full of variables! Afterall, the concept seems simple enough right?

How much can I take out of my investment portfolio each year, if I need that nest egg to last for 30, 35, 40, or even 50 years?

Ok, so let’s maybe start with the rule of thumb that advisors have used when looking at retirement drawdown plans for a while now.

Back in 1994 a financial advisor named William Bengen looked at the last 80 or so years of markets and retirement, did a bunch of math, and arrived at a concept we now call “The 4% rule.”

The basic idea of the 4% retirement withdrawal plan is that someone could safely withdraw 4% of their investment/savings portfolio each year and – assuming a 60/40 or 50/50 split of bonds/stocks in their portfolio – they would never run out of money.  This idea of withdrawing a certain percentage of your portfolio to fund your retirement is called the Safe Withdrawal Rate (SWR). The math behind this magic 4% figure means that if you have the nice round $1 Million investment portfolio that we all dream of, you could safely pull out $40,000 the first year, and then adjust for inflation and withdraw 4% plus inflation after that. (So if there was 2% inflation between year one and year two, you could now withdraw $40,800.)

Bengen, and another highly influential study took their rule and retroactively applied it to retirees from every single year from 1926 to 1994.  They found that nearly 100% of the time (depending on what was in the investment portfolio) people could retire, and withdraw 4% of their portfolio for 30 years of retirement – and not run out of money.  In fact, a large percentage of the time, if retirees followed the 4% rule, they not only didn’t run out of money, they finished life with more money than when they started retirement!

Keep in mind, these authors didn’t worry about OAS or CPP, or a workplace pension, or even the tax implications of different types of withdrawals.  They were simply trying to come up with a useful rule of thumb for how much a person could safely withdraw from their retirement portfolio.

What the 4% Rule means for your Magic Retirement Portfolio Number

If you can safely withdraw 4% of your portfolio to fund your retirement, then the simple math tells us that if you can accumulate 25x your annual retirement budget, you no longer have to work.

Here’s the breakdown:

  • Jane looks at her budget and realizes that once she retires she will have a lot less spending demands.  She carefully weighs the numbers and believes she’ll need $40,000 per year to quit her 9-to-5.
  • Consequently, Jane needs the magical “4% of her portfolio” to equal $40,000 per year.
  • For a 4% withdrawal to equal $40,000, Jane will need a $1,000,000 portfolio.
  • If Jane reassess and realizes she needs $60,000 per year in retirement, Jane would need 25 times $60,000 (because 4% goes into 100% twenty-five times) which is $1.5 Million.
  • Jane might not need anywhere close to $1.5M if she intends to do a little part-time work in retirement, and is willing to use some math + research strategies to help herself out a bit when it comes to managing her nest egg!  But more on that later…

4% Safe Withdrawal Rate: Potential Problems

Up until the 4% rule became a thing, when financial advisors were asked about safe withdrawal rates, the only thing they could really say is, “it depends.”

This was followed by a whole lot of graphs, math, and other boring stuff that no one really understood, but didn’t want to admit to not understanding.

The 4% rule of thumb was a BIG deal when it came to financial planning.  It provided the best answer yet to the millions of retirees who desperately wanted an answer to the question:

“How much money can I take out of this portfolio each year without going broke and eating cat food as an 80-year-old?!!!

Before we get into discussing the nitty gritty of safe withdrawal rates today, we must understand the limitations of the 4% rule.  Here are the major rules that I came across after reading for roughly a hundred hours. The research I read was mostly done by people who have dedicated a major part of their life’s work to studying retirement and spending patterns across the globe.  As far as I can tell, they are our best hope for trying to define just what the range of outcomes will be for various types of retirement spending + investing plans. The two major experts that I relied on most were Wade D. Pfau and Michael Kitces, with major assists to the writers behind Early Retirement Now, The Mad Fientist, and Millennial Revolution.

1) There is no way to know the future returns for any asset class.  We’ll get into this more later on in the show, but basically, the vast majority of the math that these folks are basing their withdrawal rates on is underpinned by a US stock market that has done incredibly well over the last 100+ years.  A few other stock markets of developed countries have done as well (Yay Canada!), but the majority of stock markets DO NOT return 10%+ over the long haul.

It turns out that when you don’t know how much money your nest egg will be generating, solving for how much money to take out becomes kind of hard to answer!

2) These withdrawal plans were mostly created with a 30-year retirement time horizon in mind.  When most people were retiring at 60 or 65, and living to 75-80, a 30-year window looked like a pretty safe horizon for most people.  If this still describes your plan, a 30-year horizon is probably still a pretty safe rule of thumb. If you’re looking at leaving your job at 40-50 years of age (or even earlier) and living well into your 90s, you could easily be looking at a retirement that lasts 50+ years!  (Which is pretty cool to think about, really!)

3) The 4% rule doesn’t reflect how many Canadians actually invest and pay for investment advice.  In a perfect world, we would all handle our own withdrawal plan and DIY our portfolio allocations and withdrawals.  But many of us aren’t interested in diving into the deep end of handling our own assets. Consequently, we have to take those pesky investment-related fees into account when looking at our safe withdrawal plans.  If you’re paying 2% of your returns to a mutual fund salesperson each year, you will need a lot more than $1 Million to safely withdraw 4% each year.

4) The 4% rule doesn’t take into account adjustment in behaviour.  For example, Jane might take on a little part-time work to make $10,000 per year if she sees her account balance going down too fast.  Or she may decide to move somewhere that has much lower living costs. A blanket rule that tries to predict 30 years into the future can’t possibly allow for all of these variables.

5) There is no OAS and/or CPP taken into consideration when looking at the 4% rule.  It’s also likely that Jane might not have considered how taxes might affect how much she needs to withdraw each year.

6) The 4% rule tries to address what us finance geeks call Sequence of Return Risk – but it gets really hard to do so after you go beyond the 30-year mark of retirement.  More on this below.

So, now that we know what the rules of thumb are for safe withdrawal rates that the professors of all things money have come up with, as well as some of the limitations of those rules of thumb, let’s take a look at what this might mean when applied to your retirement!

How has the 4% Rule Done in the Past

Given all of these variables that the 4% rule doesn’t account for, you might be wondering just why it is so widely used.

The truth is that I put all that naysayer stuff first because folks love to poke holes in financial theories. (For good reason, we’re talking about people’s life plans here.) Let’s look at just why the 4% rule has become the rule of thumb.

As always when discussing financial planning and financial projects, one must understand that while looking at past results in the stock and bond markets is one of the best tools we have, it does not guarantee future results!

Drawing on what I’ve read from Bengen, the Trinity Study, and recent authors such as Pfau and Kitces, here’s some summary notes on just how the 4% rule would have worked in the past in the USA market. (The Canadian market has actually done slightly better most of the time, so the conclusions would be quite similar when looking at past Canadian returns.)

1) When you apply the original 4% withdrawal philosophy, not only does your money never run out over any 30-year period over the last 100 years – But 95% of the time the retiree would have finished with MORE THAN THEY STARTED WITH!

I know this sounds crazy, but companies have made a lot of money the last 100 years.  If you owned a piece of them, you’ve done pretty well!

2) More than half of the time, the retiree who stuck to the 4% rule would have DOUBLED THEIR MONEY at the end of the 30-year time frame.

What this means, is that in the past, it is far more likely that retirees could have spent substantially more than that 4% withdrawal safety number, than it was that they would ever run out of money.

3) Rather than use Bengen’s 60/40 portfolio, you can actually increase your chances of favourable outcomes by skewing your portfolio to take on more stocks.  Of course, your portfolio will also be likely to cause a bit more heartburn as you watch stocks gyrate up and down over the years.

4) Even folks who retired during the rough decade of the 2000s are doing just fine.

If I Want to Retire Early or do this whole “FIRE” Thing – Does the 4% Work for Me?

The short answer is: Probably Not

When you start to take rules that were created for a 30-year safe withdrawal period, and stretch them out over 50+ years, it makes sense that the rules of thumb don’t really work anymore.

Taking money out of your nest egg for that long means that you’re more likely to encounter a long-term period of rough markets, and have your money run out.

The website Early Retirement Now (created by folks who are fluent in high-level economics math and Monte Carlo simulations) have created the following chart and conclusions when it comes to safe withdrawal rates and long retirement periods.

I’ve checked their assumptions with a ton of really smart people that I trust, as well as doing the math myself, and if you assume the same returns that we’ve had the past 100 years or so in North America, I can’t find anything to argue with!

The Ultimate Guide to Safe Withdrawal Rates in Canada

1) The 30-year 4% rule still works pretty well, and a 5% withdrawal rate is only fit for the very adventurous or flexible-minded out there!

2) Tilting your portfolio towards stocks over bonds increases your chances of the best outcomes – assuming that you don’t panic when markets go down and sell at the worst times.

3) At high stock allocations, the 4% rule still worked pretty darn well for a 50- or 60-year retirement! (With past returns that is.) Continue Reading…

Retired Money: Review of Die with Zero and 4,000 Weeks

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Chapters Indigo

My latest Retired Money column looks at two related books: Die with Zero and Four Thousand Weeks.

You can as always find the full version of the MoneySense column by clicking on the highlighted text: Why these authors want you to spend your money and die with $0 saved.

I start with Die with Zero because it most directly deals with the topic of money as we age. In fact, as most retirees know, one of the biggest fears behind the whole retirement saving concept is running out of money before you run out of life.

But it appears that many of us have become so fixated with saving for retirement, we may end up wasting much of our precious life energy, and being the proverbial richest inhabitant of the cemetery. For you super savers out there, this book may be an eye opener, as is the other book, 4,000 Weeks.

As I note in the column, this genre of personal finance started with Die Broke, by Stephen Pollan and Mark Levine, which I read shortly after it was first published in 1998. That’s where I encountered the amusing quip that “The last check you write should be to your undertaker … and it should bounce.”

The premise is similar in both books: there are trade-offs between time, money and health. Indeed,  as you can see from the cover shot above, its subtitle is Getting all you can from your money and your life. As with another influential book, Your Money or Your Life,  we exchange our time and life energy for money, which can therefore be viewed as a form of stored life energy. So if you die with lots of money, you’ve in effect “wasted” some of your precious life energy. Similarly, if you encounter mobility issues or other afflictions in your 70s or 80s, you may not be able to travel and engage in many activities that you may have thought you had been “saving up” for.

A treatise on Life’s Brevity and appreciating the moment

Amazon.com

The companion book is Four Thousand Weeks : Time Management for Mortals, by Oliver Burkeman. If you haven’t already guessed, 4,000 weeks is roughly the number of weeks someone will live if they reach age 77 [77 years multiplied by 52 equals 4,004.] Even the oldest person on record, Jeanne Calment, lived only 6,400 weeks, having died at age 122.

I actually enjoyed this book more than Die with Zero. It’s more philosophical and amusing in spots. Some of the more intriguing chapters are “Becoming a better procrastinator” and “Cosmic Insignificance Therapy.” I underlined way too many passages to flag here but here’s a sample from the former chapter: “The core challenge of managing our limited time isn’t about how to get everything done – that’s never going to happen – but how to decide most wisely what not to do … we need to learn to get better at procrastinating.”

 

 

Private Equity: A Portfolio Perspective

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So don’t ask me no questions
And I won’t tell you no lies
So don’t ask me about my business
And I won’t tell you goodbye

  • Lynyrd Skynyrd
Image courtesy Outcome/Shutterstock

By Noah Solomon

Special to Financial Independence Hub

I know virtually nothing about investing in private companies. However, I do know a thing or two about the theoretical and practical aspects of asset allocation and portfolio construction. In this vein, I will discuss the value of private equity (PE) investments within a portfolio context. Importantly, I will explain why PE investments may contribute less to one’s portfolio than is widely perceived.

Before I get into it, I am compelled to state one important caveat. Generalized statements about PE are less meaningful than is the case with public equities. The dispersion of returns across public equity funds is far lower than across PE managers. Whereas most long stock funds fall within +/- 5% of the average over a several year period, there is a far wider dispersion among underperformers and outperformers in the PE space. As such, it is important to note that the following analysis does not apply to any specific PE investment but rather to PE as an asset class in general.

The Perfect Asset Class?

PE allocations are broadly perceived as offering higher returns than their publicly traded counterparts. In addition, they are regarded as having lower volatility than and lower correlation to stocks. Given these perceived attributes, PE investments can be regarded as the “magic sauce” for increasing portfolio returns while lowering portfolio volatility. In combination, these attributes can significantly enhance portfolios’ risk-adjusted returns. However, the assumptions underlying these features are highly questionable.

Saturation, Lower Returns, & Echoes of Charlie Munger

It is reasonable to expect that average returns within the PE industry will be lower than in decades past. The number of active PE firms has increased more than fivefold, from just under two thousand in 2000 to over 9000 today. This impressive increase pales in comparison to growth in assets under management, which went from roughly $600 billion in 2000 to $7.6 trillion as of the end of 2022. It seems unlikely if not impossible that the number of attractive investment opportunities can keep pace with the dramatic increase in the amount of money chasing them.

Another reason to suspect that PE managers’ returns will be lower going forward is that their incentives and objectives have changed. The smaller PE industry of yesteryear was incentivized to deliver strong returns to maximize performance fees.  In contrast, today’s behemoth managers are motivated to maximize assets under management and management fees. The name of the game is to raise as much money as possible, invest it as quickly as possible, and begin raising money for the next fund. The objective is no longer to produce the best returns, but rather to deliver acceptable returns on the largest asset base possible. As the great Charlie Munger stated, “Show me the incentive and I’ll show you the outcome.”

There are no Bear Markets in Private Equity!

It is also likely that PE investments on average have both higher volatility and greater correlation to stocks than may appear. The values of public equities are determined by exchange-quoted prices every single day. In contrast, private assets are not marked to market daily. Not only do PE managers value their holdings infrequently, but they also must employ a significant degree of subjectivity in determining the value of their holdings. Importantly, there is an inherent bias for not adjusting private valuations when public equities suffer losses. Continue Reading…

Then and Now – Revisiting the need for bonds

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Image courtesy myownadvisor/Pexels

By Mark Seed, myownadvisor

Special to Financial Independence Hub

It has been said bonds make bad times better.

Is this the reason to own bonds?

Welcome to another Then and Now post, a continuation of my series where I revisit some older blogposts and either rip them to shreds (because my thinking has totally changed on such subjects) or I’ll confirm my position on various personal finance topics or specific stock and ETF investments.

Since my last Then and Now post (whereby I shared I sold out of all Johnson & Johnson (JNJ) stock to buy other equities in recent years), I figured it might be interesting to review this post and update my thinking from a few years ago before the pandemic hit – on bonds.

Then – on bonds

Back in 2015 when the original post was shared, I referenced this quote that frames my own portfolio management approach when it comes to my bias to owning stocks over bonds:

“If you want to make the most money, you should invest in stocks. But if you want to keep the money you made in stocks, you should invest in bonds.” – Paul Merriman.

Bonds are essentially parachutes when equity markets fall; bonds will cushion the portfolio landing. And equity markets can fail big at times!

While I understand there are different ways to measure the “equity risk premium,” the summary IMO is the same: the risk premium is the measure of the additional return that investors demand or expect for taking on a particular kind of risk, relative to some alternative.

Buy a bond and hold it until it matures and you know what you will get back.

Invest in equities and the range of outcomes is wide.

With equities, you could make a lot of money, but you could lose a lot.

Equities have to have a higher expected return to compensate investors for taking on this risk.

Otherwise, if the risk premium is not there – why bother with stocks at all?

Now – on bonds

That’s the rub these days, for many investors. Why invest in stocks when interest rates are higher and you can earn 4-5% essentially risk-free?

Of course, there is no way of knowing how equities or bonds will perform until returns for each happen. You can consider rebalancing your portfolio from time to time between stocks and bonds because you expect equities will do better longer-term but that doesn’t mean they will short-term.

Which brings me back to this: risk is the price of the entry ticket to buy and hold stocks. Continue Reading…

9 Business Leaders Share their most Impactful Financial Independence Milestones

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Photo by Karolina Kaboompics on Pexels

In the quest for Financial Independence, milestones vary from mastering debt to embracing minimalism.

We’ve gathered insights from nine professionals, including Finance Experts and Founders, to share their personal triumphs. Discover how these individuals have navigated their paths from mastering debt through frugality to paying off mortgages independently.

  • Mastering Debt through Frugality
  • Achieving Total Debt Freedom
  • Securing a Higher-Paying Job
  • Early Retirement through Real Estate
  • Eliminating Debt with Side Hustles
  • Embracing a Debt-Free Minimalist Life
  • Regulating Finances with Nervous System
  • Strategically Paying off Student Loans
  • Paying Off Mortgage Independently

Mastering Debt through Frugality

Each milestone marked an important stage towards a more confident future on this road to Financial Independence. One turning point occurred when I became a master of managing Debt and adopted frugality as my way of life.

Although, in my pursuit of financial freedom, it dawned on me that Debt was both a burden and a tool; this happened at the time when I decided to confront my debts openly. Eventually, I divided them by interest rates and then talked with lenders about much better repayment terms. With discipline and focus, little by little, I got rid of a mountain of debts while coming closer to financial liberty after each payment.

Another significant landmark was when I began practicing frugality. For instance, being mindful of small savings that accumulate over time into significant wealth-creation opportunities has been one key lesson that I learned from this approach. In other words, I dissected every expense into what need was involved for its necessity or want and became good at finding creative ways to save without losing sight of the quality of life. 

Whether it is meal planning or relying on loyalty programs or DIY solutions; being frugal does not mean living without but instead making conscious decisions towards personal financial objectives.

Whenever I look back on the path that led me toward my financial independence, I don’t see these checkpoints as just what they are; instead, I think of them as turning points in how I think and act. Learning how to manage debt properly and adopting a saving lifestyle have given me complete autonomy over my financial future, thus laying down a foundation for abundance and stability.  –– Arifful Islam, Finance Expert, Sterlinx Global LTD

Achieving Total Debt Freedom

One of the biggest milestones on my journey to Financial Independence was finally becoming 100% debt-free. This achievement felt especially meaningful because it required a serious commitment to smart money management and embracing a frugal lifestyle.

Early in my career, I was weighed down by a ton of student loans and racked up credit-card balances. I realized all that debt was just holding me back from reaching my bigger financial goals and living the life I really wanted. So, I made a decision to make paying it all off as fast as possible my top priority.

I started by creating a super-detailed budget that accounted for every dollar of income and expenses. Then I looked for any areas where I could cut back on non-essential splurging: like eating out, entertainment, shopping sprees, etc. Any money I could free up got funneled directly towards making bigger debt payments, focusing on the highest-interest accounts first.

At the same time, I fully embraced a more frugal, minimalist lifestyle overall. I learned to appreciate simple, free pleasures and find joy in experiences over buying a bunch of material stuff. I also hustled to increase my income through side gigs like freelancing or selling unwanted items.

Through diligent budgeting, living frugally, and a strategic debt repayment plan, I managed to become 100% debt-free within just a few years. Not only did it drastically improve my overall financial situation, but it gave me this incredible sense of freedom and control over my life. It laid the foundation for even bigger money wins down the road while teaching me the value of living below my means to prioritize long-term goals. –– Loretta Kilday, DebtCC Spokesperson, Debt Consolidation Care

Securing a Higher-Paying Job

The most critical milestone I reached was getting a job that paid more than just “enough.” I’ve tried freelancing, selling online, starting a website, doing social media, and I even tried digital marketing for a startup. But it wasn’t until I got a plain old job that just paid more than I needed that I found everything I needed: peace of mind, freedom from debt, the start of a retirement fund, and more.

For anyone who’s struggling even $50 makes the difference between starving or surviving: I suggest just building your skills and portfolio and moving up to better-paying jobs. Get the certainty and security that comes from a regular salary, one that allows you to pay all your bills and gives you breathing space.

Once that’s done, you have the room to plan for the future, to pay off debt, to organize your finances so that if you want to budget, it’s actually possible. — Debashri Dutta, Founder, Dmdutta.com

Early Retirement through Real Estate

Being able to retire in my early Thirties was a significant milestone toward Financial Independence. I started investing in real estate in my twenties, and I had to work two jobs and live frugally to afford a down payment. 

But today? I don’t have to worry about working a job I’m not particularly passionate about. Instead, I can spend my time doing what matters more to me, like coaching others who want to escape the rat race and build financial security for themselves. 

Bottom line: If you have a goal in mind, short-term sacrifices will be worth it in the long run. — Ryan Chaw, Founder and Real Estate Investor, Newbie Real Estate Investing

Eliminating Debt with Side Hustles

I gained Financial Independence through hard work and side hustles. The biggest milestone I achieved was paying off US$60,000 in student loans. That debt was debilitating, and I was able to pay it all off by devoting all the money I made from side hustles to debt reduction. After I paid off my student loans, I used the same methods to pay off the house.

The next milestone that was incredibly important to me was having US$250,000 in savings. That milestone was important because it felt like the investment income began to snowball. It also felt like my hard work was paying off, and it made it easier to make the effort to save money after that point because I felt it working. — Jonathan Geserick, Managing Attorney, Texas Probate Pros

Embracing a Debt-Free Minimalist Life

I had a business go very south about 10-15 years ago. I held on way too long because it was “my baby.” Because of this, I racked up a lot of debt that I really knew I shouldn’t have, trying to save the business.

I moved that debt into a very low-interest situation long ago, which allowed me to pay a very small amount towards the principal and interest every month. That was a great solution; however, I recently decided to just pay the whole thing off. Continue Reading…