Whether you’re ready for FIRE or approaching the golden years of your life, one of the most pressing questions that looms large is: “How much can I safely withdraw from my investment portfolio without running out of money?”
It’s a question that has perplexed many, but with the right tools and understanding, you can navigate this crucial phase with confidence.
In this post, we introduce our Safe Withdrawal Rate Calculator that employs two distinct methods to help you determine the optimal withdrawal rate from your investment portfolio during retirement. Let’s dive in.
Safe Withdrawal Rate Calculator
Please hit the Calculate button to proceed.
Usage Guide
Our calculator offers two methods to determine your safe withdrawal rate (SWR): using a target pre-tax income or using a withdrawal rate.
Inputs
There are two tabs with only very slight differnces in inputs.
Tab 1: Income-Based Method
This method focuses on your desired annual income during retirement.
Inputs:
- Portfolio Value: The total value of your investment portfolio.
- Pre-Tax Annual Income Needed: The annual income you aim to have during retirement before taxes.
- Inflation Rate: The expected average annual inflation rate. This adjusts your annual withdrawals over time to maintain your purchasing power.
- Portfolio Growth Rate: The expected average annual return on your investment portfolio.
Tab 2: Yield-Based Method
This method is based on a fixed percentage of your portfolio that you plan to withdraw annually.
Inputs:
- Portfolio Value: The total value of your investment portfolio.
- Portfolio Withdrawal Rate: The percentage of your portfolio you plan to withdraw each year.
- Inflation Rate: The expected average annual inflation rate.
- Portfolio Growth Rate: The expected average annual return on your investment portfolio.
Outputs
The calculator presents the results in 4 different ways:
- Descriptive: This section just provides a simple text based summary with the basic numbers for how much you can withdraw from your portfolioand how long you can expect it to last for.
- Chart 1 – Portfolio Value & Annual Investment Income: The black line shows how your portfolio value (left y-axis) will behave over time. The vertical bars show the annual investment income generated by your portfolio. Note that this income will be a combination of capital gains (share prices going up) and dividends.
- Chart 2 – Annual Cash Flows & Returns: This chart shows the cash withdrawn from your portfolio in the retirement years. These are in orange. The blue bars show the annual investment income from the portfolio. The black line shows the net cash flow in each year. If the line is above 0, it means that your portfolio is growing even after deductions.
- Table: If you select “Yes” in the dropdown box, the results will be shown in a tabular format for each year.
This calculator is applicable across the world, so whether you are in the US, UK, Canada, or Australia, this calculator will work for you. Just remember to set your currency format properly so your results are shown in the proper format.
The Safe Withdrawal Rate
The Safe Withdrawal Rate (SWR) is a pivotal concept in retirement planning. It represents the percentage of a retiree’s portfolio that can be withdrawn annually to sustain their lifestyle without depleting the principal prematurely.
The goal is to strike a balance: you want to enjoy your retirement years without the fear of outliving your savings. On the flip side, some people may not want their portfolio to last more than a certain number of years. They’d rather Die With Zero.
But to truly understand SWR, we must delve into its relationship with three critical factors: the portfolio growth rate, the inflation rate, and time.
Portfolio Growth Rate
The portfolio growth rate is the expected average annual return on your investment portfolio. It’s the rate at which your investments grow over time due to interest, dividends, and capital appreciation.
Naturally, a higher growth rate can support a higher SWR. As the portfolio’s value increases it allows for larger withdrawals without depleting the principal.
Inflation Rate
Inflation is the rate at which the general level of prices for goods and services rises, causing purchasing power to fall. For instance, what $50,000 can buy today might require $55,000 or more in a few years due to inflation.
Inflation becomes important as even small values can start eating in to your purchasing power over a number of years. Over time, it can erode the real value of your withdrawals. Inflation therefore necessitates a larger draw on your portfolio each passing year and unless your portfolio can grow to cover that increasing draw, your portfolio will start to decline in value.
Time
This is the overriding factor which will determine how much you can safely withdraw from your portfolio.
If you intend to only depend on your portfolio for a short period of time – say a few years for a sabbatical – then the other factors become irrelevant. You could easily draw heavily on your portfolio and work it down quickly.
However once you start looking at a longer period of time, your safe and sustainable withdrawal rate will start to drop rapidly. Again other factors like whether you intend to keep the portfolio going indefinitely – i.e. pass it on to your heirs – or whether you intend to use up all the money in your lifetime become important drivers.
Interplay between the factors
The SWR is a delicate equilibrium between portfolio growth, inflation, and time. Here’s why:
- Growth Exceeds Inflation: If your portfolio’s growth consistently outpaces inflation, you can maintain or even increase your SWR without depleting your savings.
- Inflation Exceeds Growth: If inflation consistently outstrips your portfolio’s growth, you would need to reduce your SWR to prevent running out of money.
- Portfolio Volatility: In the real world, it’s unlikely that your portfolio will consistently deliver a return in your target range. Each year will be different and so you have to be open to adjusting your withdrawals based on the returns – particularly in the down years.
- Sequence of Negative Returns Risk: The order in which you earn your investment returns can significantly impact the longevity of your portfolio. A few years of sequential negative returns in the market combined with a sustained draw on your portfolio for living expenses can really impair your portfolio and its longevity.
The SWR isn’t set in stone. Economic conditions, market performance, and personal financial needs will change each year. It’s essential to review and adjust your SWR periodically to reflect these changes.
Remember the average is just a guidance, so be prepared to adjust as necessary.
The 4% Rule
We’ve talked about the 4% rule in our articles often as being a safe withdrawal rate and it’s probably the most commonly cited number in the investment industry.
The rule suggests that if you withdraw 4% of your portfolio in the first year of retirement and adjust for inflation thereafter, your savings should last for a long period of time.
This rule is based on historical data and market returns, but it’s essential to note that changing market conditions and personal circumstances will dictate how much you should withdraw each year.
Historical returns for a balanced portfolio consisting of 60% equities and 40% in bonds has been between 6% to 8% in nominal terms. If we assume that inflation is 2% on average, that leaves you with an inflation-adjusted growth rate of 4% to 6%. This is called the “real growth rate”, as its the real increase in purchasing power or value that your portfolio achieves.
Hopefully you can see where this 4% rule now originates: it’s the average nominal return of a balanced portfolio (6 to 8%) – the average long-term inflation target (2%).
The 25x Rule
You may have heard about the 25x rule – multiply your expected annual requirements by 25. The good news is that the 25x rule and the 4% rule are exactly the same thing.
Please use whichever method you feel most comfortable with as the end result is exactly the same.
For the 4% rule, portfolio value = expected annual requirements ($) ÷ 0.04.
For the 25x rule, portfolio vaue = expected annual requirements ($) x 25.
In other words, 0.04 = 1 ÷ 25.
How do you calculate safe withdrawal rate?
Calculating the SWR is a blend of art and science – factoring in historical market data, individual financial needs, and future economic predictions. So, how exactly do you determine this crucial rate?
It’s difficult to do this mentally or on a piece of paper, so we’ve built this calculator for you! This calculator, as described earlier, offers two distinct methods to help retirees ascertain their optimal withdrawal rate, ensuring a balance between enjoying retirement and financial longevity.
1. Income-Based Method: This approach is tailored to those who have a clear picture of their desired annual income during retirement. By inputting the total portfolio value, the pre-tax annual income needed, the expected inflation rate, and the portfolio growth rate, the calculator will hlep you determine the sustainable withdrawal rate for your personal circumstances.
The beauty of this method lies in its direct alignment with a retiree’s lifestyle aspirations, adjusting for market performance and inflation.
2. Yield-Based Method: For those who prefer a more investment-centric approach, this method focuses on a fixed percentage of the portfolio for annual withdrawals. By entering the portfolio value, desired withdrawal rate, inflation rate, and portfolio growth rate, the calculator offers insights into the feasibility of the chosen rate.
This method provides flexibility, allowing retirees to adjust based on market conditions and personal financial shifts.
What is a realistic safe withdrawal rate?
A realistic safe withdrawal rate is different for each case. The industry standard figure for most people is the 4% rule.
We’ve outlined the factors above that go in to determine a safe withdrawal rate, so I think it’s best to really think about each input carefully in your specific situation and then enter it in to the calculator. Of course it’s a free calculator, so please use it as many times as you like with different input variations!
Let’s look at an example for someone who is 65 years old with a $750,000 portfolio. As would be natural, they would be wondering how long will the $750,000 portfolio last in retirement?
A 65-year old retiree would likely want to invest their cash conservatively in a balanced fund and earn around 6-8% on it. With a 2% inflation rate, the most they can realistically withdraw is $30,000 at withdrawal rate of 4% if they want the portfolio to last forever.
However if they’re okay with running down their portfolio to zero in the next 40 years (by which time they’ll be 105 years old!), then they can easily withdraw a slightly higher $37,500 annually. Their safe withdrawal rate in this case is 5%.
And if they want their portfolio to only last for the next 30 years, their realistic safe withdrawal rate increases to 6% which yields an annual income of $45,000. Of course in both of these cases their withdrawal rates start to exceed their portfolio growth rate very early on. This leaves them with little margin for error when markets go down or if they have a sudden need to withdraw more cash for an emergency.
When planning for the long-term, I’d urge you to err on the side of caution. If your portfolio is limited in size and you find that it will not generate sufficient income for your needs, you may want to examine generating some part-time income – as in the Barista FIRE lifestyle.
If that’s not an option, you may have to look at cutting costs aggressively to ensure that your portfolio does not run out in the oldest stages of your life.
Before You Go…
I hope you find this calculator useful. Our team works hard to get your the best and most accurate information. If you do spot any errors, please do not hesitate to leave a comment here or send us an email at hello@projectfinanciallyfree.com.
Our whole blog is dedicated to help you get on the path of financial freedom. Feel free to browse around and read through the articles.
Please also do check out the various other calculators that we’ve built.
by Andrew Garcia
Andrew, an alumnus of South Florida State College, loves finance, fintech, and coding. When he’s not crunching numbers at the bank, he’s passionately writing about personal finance and building calculators for PFF. See more.
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