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Flexible Spending Rules For Early Retirees | Ep 176

Michael Kitces joins the show to share his research on flexible spending rules as they apply to Financial Independence. His call for flexibility could impact your path to FI by several years.

Michael Kitces

  • Michael has worked with countless retirees to build plans that allow them to spend their nest egg without running out of funding. In too many cases, he has seen retirees find themselves earning wages due to a successful passion or hobby. If they had recognized that they would likely continue to work in some capacity, then they could have shaved years off of their path to FI. Even a small amount of actively earned income in retirement could dramatically affect the amount you need to save in your nest egg.
  • The Trinity study was based on the 4% over a 30-year time horizon in which you would likely not run out of money. The goal was to determine which withdrawal percentage would allow you to safely fund 30 years of expenses. Essentially, the number was based around the worst possible scenario. However, it also showed that in many cases, the retirees would end up with portfolio values that had multiplied several times.
  • The withdrawal rate you choose will be based on your personal portfolio. Plus, the likelihood of whether or not you will continue to pursue paid work after reaching Financial Independence.
  • Instead of thinking about the probability of failure, consider the probability of adjustment. If things are not going your way, then you’ll have time to adapt your drawdown strategy to avoid a disaster. You’ll have the option to rachet your spending up and down based on your flexibility and the performance of the market.
  • Consider setting up guardrails for your drawdown strategy. Typically, Michael starts at a percentage point in either direction. If you hit a guardrail, then you will need to adjust your spending accordingly.
  • As you build a portfolio, realize that a more diversified portfolio is better able to handle the ups and downs of the market.
  • In Purple’s case study, Michael feels very confident that she will be able to successfully navigate the drawdown to pull out what she needs.


Table Of Contents

An Introduction Of Michael Kitces

Jonathan: All right everyone, super excited about this episode we’re getting the chance to talk with Michael Kitces from Nerd’s Eye View and and there’s a couple reasons that I think this episode is incredibly valuable.

First of all, let me just give you the title again Flexible Spending Rules for Early Retirees. If you remember several weeks ago, we spoke with a Purple Life, we’ll reference that episode shortly.

In that episode, Purple Life is approaching the age of 30 years old. I don’t even think she’s 30 yet. She’s just hit a $500,000 net worth and she’s going to be pulling the trigger and retiring. And you could say at face value, well, that’s dubious. I’m not sure how that’s going to work out for you.

But I think what it misses is some of the nuance and actually the advantages that the early retiree has over the traditional retiree. I’m not just talking about time horizon 30, 40 years, I’m talking about flexibility.

And I think flexibility can be a cliché word that you drop. But I think that if you actually say well, what is that flexibility and then you pair that with Flexible Spending Rules, it becomes a very powerful lever and the reason I’m excited to talk to Michael about this is one, an article that he wrote in July, actually addressing this exact thing. We’ll have it linked up in the show notes for this episode.

Two, Michael is someone that is deep in academia, like he wrote at Nerds Eye View. But more than that, talking about a talent stack, this is someone that is accessible and understandable. This is someone that is able to take data that, frankly, would make, is mind numbingly boring and tell a story with it.

So for multiple reasons, he’s the guy, he’s the guy to bridge the gap and help us take the data and actually apply that data to her situation and say, does this make sense? Is this viable? What should she be aware of?

To help me with this, I have my co-host, Brad with me here today. How you doing, buddy?

Brad: Hey, Jonathan, I’m doing quite, quite well.

This is a rare opportunity to really dive into the numbers with a true expert. And I think flexibility on the path to FI is something we have long talked about here. People who have the wherewithal to reach Financial Independence at any age, frankly, not less, maybe decades early, they, in all likelihood are not just going to sit on a beach somewhere and just kick their feet up and just call it a life.

I think flexibility on the path to FI is something we have long talked about here. People who have the wherewithal to reach Financial Independence at any age, frankly, not less, maybe decades early, they, in all likelihood are not just going to sit on a beach somewhere and just kick their feet up and just call it a life.

They’re going to, in all likelihood, earn some money, add some value somewhere, do something productive and I think that flexibility is often lost in the, oh is FIRE a terrible idea conversation that we see sometimes in the mass media.

They’re going to, in all likelihood, earn some money, add some value somewhere, do something productive and I think that flexibility is often lost in the, oh is FIRE a terrible idea conversation that we see sometimes in the mass media. And I think this conversation is going to provide some nuance to that. So I’m really personally very excited. So Michael, with that, welcome to the ChooseFI podcast.

Michael Kitces: Thank you guys. I excited to be here and talk about FIRE, talk about FI and flexibility.

I couldn’t agree more, Brad, with your comments are, not just importance of flexibility, but the dynamics of flexibility not only in spending, but just what you do with your time and the potential that you actually end out even putting some earnings and dollars back on the table. This was something that hit me pretty early in my career.

In addition to doing a lot of the nerdy retirement research stuff, I also just live in a world where my partner went back to an advisory firm, and we do wealth management for affluent retirees.

And having done that now for nearly 20 years, one of the things that hit me pretty hard early on with working with our clients is we would have these folks that would spend been years and years accumulating building and saving dollars, and trying to get to that point where they could retire in essence, they were Financially Independent, but they could retire at 65, or whatever it was that they had set is their goal.

Maybe things went really well in our lives and like I got out at 60 and they would get out at 60 and they would retire and they would hang out for six months. Then they would realize they were insanely bored and there was nothing to do and they were all excited about playing golf until they went to the same golf course and played the same thing four days a week with their same three buddies and they got really tired of the same foursome and said, oh my god, I have like 29 and a half years of this left. I’m not feeling so good about retirement anymore.

And they ended up going back to work and doing stuff. Like go back to an old industry and started consulting or started a new business. We had a client who just decided she was a retired engineer and she really wanted to start making window treatments. She was good at making window treatments. She made them in her house, her friends loved them, she made a window treatments business on the side as a retiree and money started coming in.

To me one of the first piece around flexibility that I think often doesn’t get well understood in this journey to retirement and this journey to FI is that, if she had realized up front, she was going to map a window treatments business and make a little money, she could have been out two years prior.

We had a client who was an executive who stayed in a very high stress lucrative but very high stress leadership position for five more years trying to get to a certain lifestyle, retired realize he was bored and miserable out of his mind six months in.

Ended up going back and consulting in his old industry making some pretty decent money at it, even working like a third of the time that he used to, and realize he could have been out probably five to seven years earlier, had he acknowledge up front that his time was not going to be completely idle, and some of it was probably going to end out in a productive manner that brings a little bit of dollars, in a minuscule fraction of what he used to earn, but enough that it dramatically changes the trajectory of sustainability of retirement or sustainability of FI.

And just recognizing that flexibility, the fact that people overlook that flexibility, to me is one of the first gaps that gets created and it means people work later than they needed to. They get more fearful about the financial risk of pulling the trigger, not realizing there’s this income valve that they could turn back on and may even find they like to turn back on once they have the true freedom to say, you don’t have to keep working the job you did. You don’t even keep working in the company did, you don’t even have to work in the same industry, if you don’t like that industry anymore. Just find anything for a fraction of your time that earns a fraction of the dollars that you used to and it actually is a really, really material impact.

Why Michael Pursued Financial Independence

Jonathan: Michael, I think in many cases, in many people, you might be one of the unsung heroes of the FIRE movement. I say that and that it’s your name is not a name that you encounter as soon as you hear about this idea right away. But if you realize all the stuff that we’re talking about is credit, we talk about the simple math, but the simple math is so powerful, because it works but the simple math is backed by data. That data is something that had to be researched and you did that research, along with many other people but you did that research.

You were one of the first people to really advocate for it and make it so understandable that people like Mad Fientist could then do their own iteration of it and talk about some of the tools and tactics that we’re using. And I say that to say that you are someone that clearly is an advocate for the FIRE movement believes in this and in many ways, has taken advantage of it.

I’m curious, what does FIRE, Financial Independence? What about that resonates with you and how has that been reflected in your own journey?

Michael Kitces: So frankly, for me, it’s much more of the FI side than the RE side.

RE is a choice of one of the things you might do if you get to the FI threshold. And part of this maybe just a little bit of a bias of who we’ve historically worked with as clients in the financial advisor world.

I’m based here in the Baltimore-Washington area and the county we’re in has the unique bragging rights of having the highest rate of graduate degrees per capita of anywhere in the US.
So we tend to have some pretty smart, well-educated folks, lots of doctors, lawyers, engineers, researchers. We’ve got NIH in the area, we’ve got jet propulsion labs in the area, so super smart folks whose super smart brains don’t turn off when they’re not in their old job anymore.

Just watching, basically one client after another retire and get bored, six months, 12 months, two years, five years into retirement. And then find that they want to do something to apply their knowledge and brains back into what they were doing previously or in a different direction or in some direction. And having a bunch of money show up because they start earning again, just for me really started to hit home that it’s less about the RE, that might be a choice.

We do have a couple of clients that just, they retire and they’re traveling around the world, they’re seeing the sights, they’re doing stuff, they’re totally super happy and more power to them. They are never going back to any kind of work ever. But that’s a choice.

And to me, well, I think one of the biggest frustrations that I just view is the frustration of retirement and started writing about this 15 years ago then the FIRE movement came along and I think gave some frankly better words to it, better labels to it, is that the real threshold you’re working towards is Financial Independence, is the FI. It’s the, I am at a point where what I do with my time no longer needs to be connected to the income that I make.

That doesn’t necessarily mean I’m at a point where I’m not going to go make any income. I’m just at a point where the way I spend my time doesn’t have to have any connection to the income that I make.

Now choose what you want to do with your open and flexible time and some people do that in a, call it an RE frame, like, I’m done, I’m out, I’m traveling the world, I’m doing my thing. And a lot of folks, it turns out, well, we actually want to stay engaged, we want to do something, we got brains we want to go put to use, we got a service mentality we want to put to use, we like helping others and we’ve got the flexibility to be able to do so.

Then we do a thing and lo and behold, it might even turn out to make some money and change the trajectory of the FI part in the first place. That to me is the most interesting aspect of how the loop closes, that it’s not just, hey, you can get to Financial Independence and then decide what you want to do. Maybe you’ll work, maybe you won’t.

It’s that if you recognize that in yourself, that there’s even a possibility you may end up doing something that turns out to bring a little bit of dollars in, you can suddenly pull your FI target forward by two years, five years, 10 years, sometimes more. Because we create these worlds and I see it in our retired clients when they’re doing their 50s and 60s, I see in the FIRE community when they’re trying to do in their 30s and 40s.

It’s that if you recognize that in yourself, that there’s even a possibility you may end up doing something that turns out to bring a little bit of dollars in, you can suddenly pull your FI target forward by two years, five years, 10 years, sometimes more. Because we create these worlds and I see it in our retired clients when they’re doing their 50s and 60s, I see in the FIRE community when they’re trying to do in their 30s and 40s.

We’re trying to get this one giant massive lump sum egg that will hold all of the spending for our rest of our lives, which could be decades and decades and decades and you don’t want that to run out and blow up. So we build these really big nest eggs and we make the really conservative spending patterns.

Then we end out just finishing with way more dollars and accumulating more than we’d expected and like not that oops, I have more money is an unfortunate surprise. The part where it hits home to me are the people that spend 2, 5, 10 years more than they needed to in work that they weren’t happy with because they didn’t recognize that they were close enough to say if I do some work I like and make some money, that actually is a flexibility choice that completely changes when I can pull the FI trigger in the first place.

Brad: Yeah, it’s interesting, because I think a lot of people look at almost like a worst case scenario. And let’s say somebody who has a $60,000 annual expense target. So, therefore, at 4%, they’re looking to save $1.5 million but you’re saying even if you make 20 grand, people don’t actually think about this very often, but that’s $500,000 less you need in that pot. That represents a full third of your yearly spending, but-

Michael Kitces: It’s this monster, monster reduction. It’s a fantastic example of seeing folks that are out there that are, maybe they’re in good jobs, they’re in good incomes. They’re making six figures. That’s how they’re living frugally and able to bank a whole bunch of money.

So they’re working towards this one or $2 million pot, 1.5 million in your example. And they’re so focused on living as frugally as I can to get to that $1.5 million pot that no one realizes, if you merely took a 80% salary cut, you only need two thirds of the nest egg you’re shooting for.

If your income just goes from 100 plus grands to 20, you only need 1,000,000, 7 million and a half. That gets you there a lot faster, and not only that, but it turns out, you might even actually be happier. Because you can do a thing that is gainful work that you actually like, just most of us as human beings, we’re not wired to just literally be idle and sit around and do nothing.

So we may do that by having they’re called an active retirement lifestyle. I like to travel, I like to volunteer, you might do a whole bunch of “work,” that’s completely unpaid and more power to you if you want to do that.

Just I see it happen over and over again people do a thing and particularly if you got say 50 years of your life left to do it, there’s a decent chance, you’re going to end up being pretty good at it and it might even be worth something in the economic marketplace someday. And just a little bit of dollar, just $20,000 a year is pulling half a million dollars off of what you need for the nest egg to pull the FI trigger in the first place and that’s a meaningful multi-year shift for most people.

The Data Behind Flexible Spending In Early Retirement

Jonathan: So that’s the macro level. Let’s get a little nerdy man. Let’s go on the home territory here and let’s just talk-

Michael Kitces: Sweet. We going data?

Jonathan: Yeah, let’s do it. Just a little bit, just a little bit. We’ll keep it simple.

So I want to talk about safe withdrawal rates, which is what a lot of this is predicated on. It’s what a lot of your work was focused on, and I would just for our audience, I think it’s important. I want to give you some scope here.

I know you talk about things in terms of human capital, financial capital, and then how you allocate those. And with safe withdrawal rates, the data that you pulled out was largely extracted from the Trinity study and with that, and I’ll let you go deeper on this, but I just want to set this up real quick.

The 4% rule, as it was known, was applied to mostly traditional retirees. And it was a number that you could safely withdraw over, I guess, a 30 year time horizon and not run out of money with a 90% plus confidence level, maybe it was 100%.

Anyways, the larger point being it was a number that was in place to resolve the worst possible case scenario. And what they were resolving was, you would either run completely out of money, right? How do we make sure you don’t run completely out of money, but there’s also what is likely to happen.

Then there was the fact that for the vast majority of people, they ended up with multiples of what they started with. So where if we’re talking about a $1 million portfolio based on this article that I was reading of yours, the problem was, we want to make sure they don’t run out of money, they’re probably going to have what they started, they might have as much as $150 million, depending on what cohort they find themselves in. That’s crazy.

And what do we take away from that knowing that we’re not traditional retirees, like we’re not doing this at the age of 65? How does that change with regards to these withdrawal rates, with regards to flexibility, with regards to human capital versus financial capital?

Michael Kitces: So let me give maybe a little bit more context or how I look at this. I think about it a little bit iteratively. So the starting point as you said is the original 30 year retirement horizon studies, the Trinity Study and a lot of us in the financial planner world actually look back to the original Bill Bengen study that came a few years prior.

Trinity Study did on a Monte Carlo basis with randomized simulations. Bill Bengen’s work did it with just looking at actual rolling historical periods from all the historical data that we had at the time.
You have to set it in the context of what was going on, the 1990s. So we were in a raging bull market. Prevailing wisdom was that you could spend 7 or 8% of your initial retirement account balance, adjusting each year for inflation and you would be fine. That was the discussion at the time.

If you were conservative, you might have picked only 7%. Because again, markets have been doing double digits for almost 15 years since the early 1980s.

So in this realm where everyone was talking about 7 and 8%, withdrawal rates, Bill Bengen comes forward and says, well, funny thing I get that works with the recent returns we’ve had, and if you just sort of look at long term average returns, you got about six and a half percent as a sustainable withdrawal rate.

But when I look at all the different time periods in history, it turns out that if you take that six and a half, seven to 8% number, it actually crashes and burns a lot. Not all environments are as good as the 1980s, 1990s have been.

So Bill’s big breakthrough at the time was, well, what if we just look at all the different time periods and see what withdrawal rates would have worked. And all the different time periods and a bunch of them 6, 7, 8% work, sometimes you get up at nine, every now and then it’s worse, and you might get down to five or even four something.

So Bengen’s original sort of formulation around a safe withdrawal rate was, well, if you want to figure out what would work, what would, “be safe”, well, a safe withdrawal rate would be just take all the ones that have ever worked in history, find literally the one worst one that we’ve ever had in history and pick that one.

So if we get a future that’s as bad as anything we’ve ever seen in history, by definition, you’ll make it. And if we get anything better, you’ll be okay and you’ll just have extra money. That was the original framing. And it was heresy at the time, because he’s publishing this idea that a withdrawal rate might be around 4% when everybody else was talking about 7 and portfolios were earning 10 to 14.

So you have to keep it in that original context that it was about, ratcheting around literally was the worst thing that we’ve ever seen happen. Let’s start there. And I think part of the challenge that shifted at some point in the general lexicon from this is a conservative assumption because it’s literally the worst thing we’ve ever seen in history into this is a mid level, this is a reasonable thing, this is a moderate thing. Oh, and you might go a little higher, you might go a little lower if you’re conservative, and sort of missing how conservative it is.

That’s part of what we’ve tried to put some data out there just to recognize that, if you actually start at this 4% rule, yes, there is one or two scenarios in history where you only barely made it for 30 years, like that’s why it was the 4% rule, because that was the number that would make it all 30 years, even if just barely. But the median result, so 50% of the time, your million dollar nest egg turns into 3 million on top of all your spending.

In the best case scenario, it turns into 9 million. Which means if we kind of look at the book ends, like the odds of taking the 4% rule and having no money left at the end is the same as taking a 4% rule and having nine times your nest egg untouched left at the end.

That’s a really wide variance. Like a really, really, really life changingly wide variance. We spend so much time focusing on the well, what if my million dollars ends out in the path going down to zero, that we seem to spend very little time recognizing, but actually half the time you triple your nest egg, and you’re equally likely to run out of money as you are to finish with nine times your nest egg leftover and that’s just a 30 year time period.

Jonathan: All right. So you have set this up perfectly.

So there’s less variables when you’re talking about the traditional retiree. They may go back to work, in fact that there’s some data in this article, which I’m referencing many, many times, and we will obviously have linked up in the show notes. But in this article, you actually mentioned that entrepreneurship peaks in its 40s.

In fact, you see incredible levels of entrepreneurship the start in their 60s.So we can’t completely write off the fact that even traditional retirees are bringing in additional sources of income. But let’s just assume their traditional retiree with a 30 year window is not going to earn another dollar, at least you have less variables.

Now when you’re talking about this early retiree, so we’re not confining ourselves to 30 years, we’re saying we could have 30 plus 40, 50, 60 years and beyond in some extreme examples. That’s a massive window.

What does that look like? What’s the variance there? The best case scenario for someone with a 60 year window? What does that do?

Michael Kitces: So yeah, so when you start stretching it out. So first of all, when you start stretching now, bad scenarios get worse. If you get behind, you start compounding even further behind, you drag a little bit further down. So when we look at the safe withdrawal rate research, if it’s 4% for 30 years, it’s only 3.5% for 50 years.

We got to rein it in a little because you are tacking on some more years. So kind of by definition, if there was a 4% rule scenario where you were just spending your last dollar in your 30th year, you can’t do 4% for 50 years, because if you went down that path, you would have been broke 30 years in your 50 year retirement.

So the starting rule comes down a little, we go from a 4% to about a 3.5%. It’s actually not a dramatic change, because the reality of how market sequences play out is if you survive some horrible thing in the first decade of your retirement and you get to the good returns that eventually follow, you usually get so far ahead off of the first big bull market cycle that the second bear market that hits you well into your retirement usually isn’t very problematic. Like it hurts at the time, but you’re so far ahead from the intervening bull market, that it’s usually not enough of a pullback to be a threat.

It’s mostly about, I got to survive that first 5 or 10 years, however long it takes to get to the next long bull market that comes in the economic cycle. If I get to that one, I usually kind of hit escape velocity and we’re safe from that point forward. But I got to rein back a little, because I got to have a little bit more left to fire, no pun intended, if I’m going to go for 50 years, not 30.

It’s mostly about, I got to survive that first 5 or 10 years, however long it takes to get to the next long bull market that comes in the economic cycle. If I get to that one, I usually kind of hit escape velocity and we’re safe from that point forward. But I got to rein back a little, because I got to have a little bit more left to fire, no pun intended, if I’m going to go for 50 years, not 30.

So the 4% rule comes back to 3.5. Now the problem is, if a 4% rule on average gives me almost 3 million after 30 years, and I pull my spending rate back to three and a half, and I allow another 20 years of compounding, a three and a half percent rule for 50 years.

Yes, in the one worst case scenario, it’s just barely running out of money by your 50. That’s why a three and a half percent rule becomes the number, 50% of the time you multiply your nest egg by eight.

So you go from 1 million to over 8 million 50% of the time, which is like, we’re not only not conservative, like-

Jonathan: Wow. That’s 50% of the time, that’s not even the best case scenario.

Michael Kitces: That’s 50% of time. So we go up to the best case scenario. The best case scenario is your million dollar portfolio on top of your lifetime of three and a half percent rule spending goes from a million to 71 million dollars.

Jonathan: Brad, your daughter’s plan to be a trillionaire-

Brad: Yeah, she’s well in her way.

Michael Kitces: I can’t emphasize enough, if you start with a million dollars at three and a half percent, $71 million, which sounds like this like stupidly fantastical, absurd number for most people, the 71 is literally equally likely to the I’m running out of money at the end of 50 years.

Jonathan: Wow.

Brad: Yeah, and Michael, I’m looking at your chart here and what’s illustrated to me is actually the more extreme stuff, so the fifth percentile. So 95% of people would do better than this. But the fifth percentile is essentially $2.3 million. So, we’re talking about-

Michael Kitces: 95% of the time you accidentally double your nest egg on top of a lifetime of spending.

Brad: Right, on top of taking out that 3.5% and this really gets back to risk tolerance. And begs the question like, if you gave me, so it sounds like and I’d love to hear the exact number but 99% plus, that you’re not going to deplete your money. And I’m not sure what the exact 99 point X percent is. If you gave me a bet, and said it’s a 99.6% chance, I would take that every single time.

The Probability Of Success Or Adjustments

Michael Kitces: I think the challenge that comes with, that whole probability of failure framing like we do in the Monte Carlo’s, we do it in the safe withdrawal rate studies, I actually think indirectly this has become part of the problem. Because the minute you put failure on the table, our heads all kind of go the same place, like homeless under a bridge, I’ve lost all my social circles, I can’t connect to anything anymore. I can’t do any things I like, I don’t even have a roof over my head, for most people that failure scenario is pretty painful for them.

Nobody wants to get to that kind of failure scenario, even remote chances for most people, you literally have to get to 1 or 2% failure rates and most people start getting really concerned of like, yeah, I get it’s remote, but that is so horrible. I do not want to take any chance of being there.

The problem kind of getting back to the conversation, what we were talking about earlier, is these numbers that we’re talking about, including the, you got to take three and a half percent because it might just barely be failing in the 50th year.

That’s where the 3%, three and a half percent rule comes from. That literally assumes that for the next 50 years or 49.9 years after you pull your FI trigger, you are marching like a blind lemming he will go straight off the cliff without ever making any kind of change or adjustment along the way. Even though this is going to be telegraphed like 20 years in advance, your nest egg is probably starting to spend out in a dangerous manner, it assumes that you are going to lemming yourself off a cliff. And the only possible solution is, if you don’t want to run out of money in the 50th year, 49 years earlier, you have to ratchet your spending down by a little bit more so that you don’t lemming yourself off the cliff at the end.

I just don’t find the conceptual framework valid from that perspective. I sit across from retirees, like that’s what we do in our business. This is not how real human beings behave. Well, to be fair, every now and then I have clients who really will just deny reality and probably go straight off a cliff. But almost everybody else, at some point reality sets in and we start making some adjustments.

And it’s become such an impact to me that when I have retirement conversations with clients now, I don’t talk about probability of failure. I’ve actually kind of banned the word from our lexicon. I talk about probabilities of adjustment because that’s what happens in the real world. If things aren’t going well, oh crap, you pulled the FI trigger and 10 years in, it turns out there’s another complete economic meltdown and things are horrible and the whole world might be melting down, like you got some stuff left but clearly this is going to have to change our lives.

We don’t just keep marching straight forward anyways, and go, well, damn, it turns out another 10 years, all my checks are bouncing because apparently I ran out of money at some point along the way. Horrible stuff happens and we say, well, crap, sucks but I guess I’m going to have to make an adjustment.

Once you introduce the possibility of an adjustment, the whole discussion starts to change, because if I told you, look, any retiree can have 100% probability of success. It’s really easy. Just promise that if something horrible happens, you’ll drastically cut your spending. Won’t feel good, but I can always stop you from running out of money, just drastically cut your spending.

Now, not everybody wants to drastically cut their spending. So if I save a little bit more in my nest egg I might not have to adjust as much to pull back and it might be a little bit less likely that I need to adjust at all.

When you start thinking those frames, it’s not about a probability of failure, it’s about what’s the probability you will have to make an adjustment and how significant would the adjustment be. The whole framework starts to change.

And we had a client where we were going through this and they were one of those really conservative folks and we showed them a plan with a 98% probability of success, and they were just fixated on the 2% chance of failure.

Jonathan: Stop saying failure, Michael. We use the word adjustment around here.

Michael Kitces: So I’m talking about the 2% probability of failure with them. And I sort of had this crystallization moment with the client, like I’m looking at their situation, their life was like they go back and forth between a home here and a condo up in Rehoboth, where in the Maryland area lots of people like to grow up to Rehoboth Beach.

I point out something, you realize if the 2% scenario happens, all it means is you’re going to have to downsize your Rehoboth condo, like you’re going to have to get rid of the mortgage there because you’re going to have to relieve that cash flow. So you’re going to have to downsize to whatever you can buy with the equity in your existing condo, which was actually a decent amount.

They could buy something, wasn’t going to be the fancy condo they had, they’re going to have something. Was like so you realize the only 2% failure here is actually just, you might have to downsize your condo, you even still get to have a condo in Rehoboth, you just might have to downsize the condo and then it goes to 100%.

They were like, oh, well, that’s not so bad. It would be a bummer. We really like the place but, you’re telling me I won’t even have to materially change my lifestyle and that we’re fine. It’s like yeah, and that was basically the last time I ever talked about probabilities of failure.

We started talking about probabilities of adjustment and the next natural extension, which is what kind of adjustments are we talking about? Because that’s the part we really don’t spend much time talking about. How would you make adjustments to stay back on track.

Withdrawal Rates

Brad: Michael with maybe that client in mind or similar client, what withdrawal rate are you looking at? Is it 3.5%? Is it 4%? Does it vary based on their age or other factors? Talk us through that.

Michael Kitces: So, first of all, it varies quite a bit based on age and other factors.
We’d actually published a piece a number of years ago, that was sort of our retrospective on 20 years worth of safe withdrawal rate research up through the mid 2018. Since we put it out a few years ago, that build essentially a chart of about a dozen different factors that actually moved that number up and down, because there’s a lot that wasn’t in the original research and I don’t mean that as a knock to them, like, I published some of this research as well, like you got to start somewhere.

So you start with simplified models, then you complexify them over time. It didn’t have fees in there, it didn’t have taxes in there, which pulls everything down, but it didn’t have much diversification the original studies. Most of them were like large cap US stocks and intermediate government bonds.

And most people have at least a little bit more diversification in today’s environment, like maybe we have small stocks, additional large ones, maybe we have a few international ones, there’s more types of bonds than just government bonds.

Once you start mixing in diversification, you start getting much higher, safe withdrawal rates, maybe a little bit higher, maybe a lot higher, depending on quite what you believe around diversification because we don’t have great data for 100 years on some of this stuff but we know there’s some positive diversification effect. The only debate is how much.

Some people have more tolerance around risk. Not everybody starts in the same market environment, they actually retire when stocks are cheap, the withdrawal rates are more like five and six, if you retire when they’re expensive, the withdrawal rates are four.

So there’s all these different levers that move the safe withdrawal rate just on that basis alone, as well as time horizon. We work with people who come in in their 70s, they’re not even planning for 30 years, they’d be thrilled to get 20 and then we have folks that are in the FI community and we’re planning 50 years.

So that number moves all over the place on that basis alone. In practice, I find a lot of people start out with numbers anywhere in between around three and a half up to about six, depending on how we move all of those different levers for their individual circumstances.

The second effect that comes from it, just a little bit more real world is overgeneralizing a little. I find retirees or FIers tend to fall in one of two buckets.

The first are folks that say, I’ve got this lifestyle, and it’s extremely important to me to sustain this lifestyle. I do not want cuts, I do not like cuts, I’m not going to tolerate cuts very well. So we generally dial them to the lower end of the scale. If we’re looking at anything with a range, they’re at the lower end of the range because just to me, fundamental to that drive force for them, they’re certainly willing to move their lifestyle up if times are good. Everybody’s comfortable with that for the most part. But they do not want to risk of having things go backwards.

So these would classically be folks where if you’re coming down for a 50 year FI, yeah, we’re talking about numbers like three and a half, granted, it’s equally likely that you have $71 million is running out. But running out is a total catastrophe to them. $71 million is a woo-hoo, I’ll find a way to spend it. So they’re okay with that trade off. They just say, look, if times get better, we’ll ratchet our spending higher.

I call these ratcheting clients or ratcheting rules, like, we’re going to start with a number that’s low enough that even if times are bad, we shouldn’t have to cut. And if in the overwhelming likelihood things go better than horrible, we’ll figure out how to spend more money later. Most people don’t complain about that.

The second group we have are the folks that I would call the more flexible spenders, where they say look, here’s the lifestyle I want to have but I’ve had some ups and downs in life already.So here’s what I want to do, and if times are bad, here’s what I’m going to give up. Here’s what I’m going to rein back.

Like, hey, if I can have a fat FIRE retirement and I can do lots of cool things, that’s great but if horrible stuff happens, and I have to dial my lifestyle back a little, I’ll dial my lifestyle back a little. I still want to pull the trigger, but I want to order the fancy bottles of wine and stay in the high end places. But if bad stuff happens, I will order less expensive wine and I will fly coach instead of first class and life will be okay. I can still live most of my lifestyle, but I’m going to give up some of my luxury expenses, I’m going to adapt my spending down.

So if they’ve got some flexibility to me almost by definition, now we can start at a higher number. I can’t guarantee you if you start at five, it’s going to stay at five because we’ve got some probability of adjustment, but-

Jonathan: I love probability of adjustment. That’s my only lingo going forward.

Michael Kitces: Fantastic. If you’re comfortable with that probablity of adjustment and the magnitude of adjustment that would come thereafter, like how much of a cut are we talking about to get back on track. If you’re comfortable with that, then almost by definition, you can start higher. You might have to adjust but you can start higher, and there’s a decent chance you won’t have to adjust.

So I find most people kind of fall into one of those two camps, like I need an anchor lifestyle, I’m not willing to go backwards, and I’m happy to ratchet forwards, if it goes well. Or I’ve got a more flexible lifestyle, there’s things I want to spend on but if I have to adapt the numbers down, I can adapt the numbers down.

I tend to think of it in terms of, so I call them adaptive expenses. I still don’t love the label, I’m trying to find the right label, like essential versus discretionary, which is how a lot of the industry, I think historically has talked about this because again, just sitting across from retirees, if I went to someone and said, hey, well the good news is you’re not broke. You still got food, clothing and shelter. Unfortunately, you’re never going to afford to travel again, you can eat at any of the restaurants you like and you won’t even have the budget to see your grandchildren.

For most people, that is still a retirement catastrophe. You’re not homeless, but I have obliterated the lifestyle to which you are accustomed. I can’t take all of your discretionary expenses away and say, hey, at least you’re not homeless, retirement worked out. Because for most people if that’s what they’re staring down, they’re like hell, I’m just going to work a little longer and save a little more money. I don’t even want that on the table.

Often we have adaptivity to our expenses. So it’s our clients where the adjustment was, well, you might have to downsize the condo and it’s your second home the first place, we’ll be okay. That was an easy adaptation for them. For some clients, we like eating out at nice places, we’ll eat out slightly less nice places.

Jonathan: You’re back to Chipotle.

Michael Kitces: Yeah, I like traveling fancy, we’ll dial it back a little. I’m going to stop ordering the sweets, I’m just going to dial back. We had one very affluent client, like the breakthrough for them in the financial crisis when they lost a significant amount of wealth was like, here’s an idea to rein in your spending. Just fly first class, stop renting jets. That was their version of adaptive expenses.

We didn’t want to get rid of all the discretionary stuff and be homeless, which was sort of the vision that was in their head, like we need to adapt expenses a little, but they were still traveling, they were still doing a lot of stuff they like to do, it was like, we just have to adapt it down a little. Let’s stop renting private jets and just fly first class.

So there’s an adaptivity level that a lot of us have in our expenses. The more we spend, usually the more room there is to rein that in. If we’re a little more frugal, there’s a little bit less give in the first place, but for the people who have some adaptive flexibility to their budget, I can take these line items like housing and food and transportation, entertainment and travel and the rest and I could rein them into a thing where I still do stuff I like to do but in a less expensive manner, are the folks that I would generally say fine, then we can start out at a higher number.

We don’t have to sit down at three and a half. We can go to four, we can go to five, even for 50 year plus FI scenarios, but you have to agree to the adaptivity. You have to agree that if stuff starts moving the other way, you got to be ready to actually rein that stuff in and if that’s not going to sit well with you, we aren’t starting at the higher number, we’re starting at the lower number.

Then to each their own about how comfortable they are in being adaptive. Just, I’ve seen a lot of human beings go through this path, and some really are and some really are not and to each their own. Just know yourself, so you don’t set yourself up for a tough scenario.

Ratcheting Up

Brad: So Michael, you talked about the adaptive flexibility. They’re kind of on the potentially downside cutting, but a handful of minutes ago, you talked about ratcheting up. So you’re talking about that five person who has a 50 year time span, maybe they start at 3.5% but you said if things are going well, maybe they can ratchet it up.

I’d love to hear you talk through like that scenario, what people would be looking for, what milestones, what percentage, numbers et cetera. Talk us through that.

Michael Kitces: Sure. So, I think there are a couple of different ways you can go about this. The original ratcheting rule that we made in some of the work that we published was just super simple. If your portfolio gets up 50% from where you started, give yourself a 10% raise, check back every three years.

It’s pretty simple, I can keep track of this, basically need two or three numbers and a little bit of math. If you get that far ahead, so you built a cushion, which means even if there’s a market pullback, it’s only pulling back on the cushion, you can give yourself a raise.

Now if you ratchet up every single year in a bull market, then the bear market may hurt you a little bit more. So we said, don’t ratchet up every year, check every three and you’re off on a good path.

So that’s one version, that’s kind of a pure ratcheting strategy. When you got a cushion, give yourself a raise, as long as you got the cushion, keep giving yourself raises.

The second way to go about this are what I like to call guard rail rules. So I sort of think of this like, so I’ve got three little ones. We take them bowling every now and then. When I was growing up, when little kids went bowling you had bumper links where they would actually have these like, giant inflatables that you would blow up and put in the gutters of the bowling alley, so you wouldn’t get a gutter ball. Now it’s all modern with technology. So these little rails just pop up, block the gutters when the kids are up, and then the rails pop back down when the adults come in bowl.

So when my kids go to the bowling alley, and they get on the bumper lanes, one of two things happens. So either my daughter grabs the ball, rolls the ball down the alley, gets a fairly straight roll, it goes to the end, it hits the pin, she’s all excited, she does a little dance.

Or she rolls the ball, it drifts slightly askew, hits a bumper, bounce off the bumper, goes back the middle lane, hits the pins, she’s equally happy, has no context as to even the significance of having hit the bumpers or not because there are no gutter balls in her world in the first place because we have bumpers in place. All she knows is every time she hits the pins, and she just wants to see how many pins fall down. Every roll’s a win.

And you can do the same conceptual framework with your retirement spending. Our roll of the ball is whatever our current withdrawal rate is and our bumpers are just extremes on our withdrawal rates about how much you’re willing to let it vary.

So I might start the role. With a lot of our retiring clients and we’re talking like 30 year time horizons, we might start the ball rolling at 5% but we put bumpers in at four and six. We say at any time during the first 15 years because that’s sort of the danger zone. If at any time in the first 15 years you veer so far off track that your withdrawal rate either goes above six, which means your spending is outpacing your portfolio, which is bad. We don’t want our spending outpace our growth. If your withdrawal rate goes above six, you got to take a 10% spending cut. I find for most people 10% hurts, it’s not pleasant, but it’s manageable. I got some flexibility in my budget, I can handle this.

If my portfolio outpaces my spending, so my portfolio is growing, my spending relative my portfolio is dropping, my withdrawal rate is five and four and a half to four and then it drops down to three something. If I get under four, I’ve hit the guardrail on the other end, this guardrail bounces me back into the lane by giving me a 10% raise.

So now, I’ve got an adjustment system in place. We’re going to start your roll at five, we’re going to keep you between four and six and we’ll see what happens. I don’t know what particular market path you’re going to get on, I don’t know what market returns are going to be, but I know by definition, you’re never going to be outside of four and six.

I know by definition you actually could never run out of money in this scenario because at worst you’ll just keep hitting the bad guardrail and reining you’re spending it until you get down to a cruising path that’s comfortable for you.

Now the one caveat to this unlike traditional bumpers, so when my little boy goes up there like, he’ll take the ball and like wing it at the left bumper as hard as he can because he actually wants see if he can wing it off the left, bank it off the right and then go down and get the pins, you don’t always get the zigzag pattern.

You can kind of roll a curveball where it hits the bad bumper then spins off, hits the bad bumper again, spins off hits the bad bumper again. That’s what happens if you get like a really horrific protracted bear market that lasts for several years. Your withdrawal rate may rise up to six then you cut your spending, but then the portfolio falls again and you’re five and a half withdraw returns into a six something again, so you got to cut again. Then the market falls further and you might have to cut a third time.

So recognize you can hit the bad bump or more than once. But if we’ve got some flexibility, if we’ve got some adaptive expenses that we’re able to rein in, then I can start putting some guardrails in place. And I know I’m not going to run on money, I just have to be prepared for the probability that we hit guardrails and have to start making some adjustments.

Where you set the guardrails then, frankly, we need some modeling tools to do this. We certainly don’t have good tools in the financial planning software world, perhaps someone who’s listening to this who’s an engineer and a software person, will build it in the FIRE calc or into one of the others.

I think what we end out with is you get some parameters around this. How and why do you want to set the guardrails or sort of narrow in, the narrower they are, the more likely you hit them, but the narrower they are, the less dramatic the changes have to be.

If I make really wide guardrails, you’ll hardly ever hit them but if you veer that far off track, it’s got to be a really dramatic spending adjustment when you get there. So again, to each their own about how wide or narrow they want to set the guardrails and how much of a change they’re willing to make when they get there.

But conceptually, that’s about where we start. I find this framing of plus or minus 1% of a withdrawal rate seems to be a pretty good number. Just in practice, it takes a pretty dramatic market events to move you that far but it can happen. So be prepared for adjustments to happen.

Again, it gives us a rules framework to know how we’re going to adjust and handle the spending going forward. Now, we just have to see how it unfolds but the key part is, if that’s your strategy in the first place, you don’t have to sit down at three and a half percent.

Now, if you start higher and bad things happen, you may get knocked back down to what would have been three and a half percent originally, but bad stuff doesn’t always happen. If bad stuff doesn’t happen, you just start spending more and keep doing it for the rest of your life.

Purple’s Case Study

Jonathan: So Michael that really sets us up. I’d love to take this framework and actually apply it to a case study.

And I have, as an opportunity, I have a case study this little bit more extreme as an example. It’s really perfect to apply this to several weeks ago, it was Episode 169 for our audience, we interviewed a Purple Life. She blogs anonymously at because of that she’s radically transparent with her numbers and with her retirement plans, which are to leave the workforce next year with the nest egg of about $500,000, two years in cash. She has plans for health care.

This for her, if she goes back to work at some point, she’s open to that she’s built a skill set as a blogger, she could probably monetize that, she works in marketing, she could get another job in the industry if she ever had to go back. She feels confident about her healthcare plan. She also feels confident with geoarbitrage. She’s 28 years old, she’s hit the minimum. She would qualify technically for Social Security. She’s not building it into her plans as a 28 year old.

Michael Kitces: She’s barely got her 10 years of credit.

Jonathan: Just barely. Yeah, just barely.

So now she’s leaving and she’s walking away with this two years of cash, this $500,000 in her investments and kind of applying these Flexible Spending Rules, how it might apply. Like the worst case scenario, we want to make sure we don’t run out of money. We’re okay going back. You talked about adaptive expenses really in the context of adjustments and flexible and being flexible.

The other part could be adaptive income. The willingness to go back to earn additional income if you need it. What, as you kind of apply this framework to that case study and admittedly, one of the more extreme case studies that I’ve heard, I think there’s incredible value here for our audience to hear that just because she’s starting with 500,000 does not mean, because she’s so young does not mean that that is going to be her final number. How would you process this?

Michael Kitces: So there’s a few things that I would sort of process for this off hand.

First, just $500,000 nest egg, if we’re going to go down to the lowest-

Jonathan: Three and a half, I missed one detail. For her that’s a three and a half percent withdrawal rate, based on current expenses.

Michael Kitces: So there’s a few things that jump out at me in a scenario like this.
First just, I’m sure everyone’s starting to like do the math or pull out their yellow pad. $500,000 for three and a half percent is about $18,000 a year or 1500 dollars a month.

So I guess plus health care that she’s got sorted out separately. So just, does that math work for her? That’s a pretty frugal lifestyle for most people almost anywhere. So, does that work for her? I guess if it works for her, it works for her.

So that’s her call but I think that’s the first question that some people are asking. Now, I would be looking at this again and saying, holy cow, you’re 28. How do you really feel about never doing work again, for the next 60 or 70 years? Work 10, take 70 off, it’s just not quite how our brains are wired. So I would be wondering, asking questions like, is there really some likelihood that you’re going to end up working again at some point? Heck, you’re doing this blog thing. Do you-

Jonathan: Highly likely. Highly likely.

Michael Kitces: Do you want to keep doing the blog thing and you can dial it back a little if you feel like it’s been too intensive, but you got a cool story. There’s going to be some people that want to follow it. You can have some advertising or affiliates or some other things on there.

Is there other money coming in that either we can consider or just that we can spend. One of the ways that I see a lot of people do this even in the, I’ll call it the traditional retirement realm, as well as the FI realm is kind of segment they’re spending a little to say, look, I’ve got this nest egg. I’m going to do my withdrawal rate off of it, that kind of covers baseline expenses and I’m comfortable with that.

And if I decide to go work a little bit more and do a thing, any of that money I get, that’s gravy money, that’s spending money. So you want to take an extra vacation, get a gig, get a marketing gig, get a consulting gig, whatever she’s doing in her space. Like get a gig, get some money, take the money, spend the money.

So to me her lifestyle certainly is upside potential just on that basis alone. And really for someone that’s looking at FIRE this young, I have to admit, just like hearing the scenario, I come much more to what she’s going to do with her time for the next 70 years than what she’s going to do with her portfolio for the next 70 years.

As we’ve sort of discussed here, if she’s got any flexibility in her spending, maybe she could start at a little bit of a higher number. Now, when I hear someone that’s spending at these levels in the first place, unless she does some pretty extreme geoarbitrage to really bring expenses down, I would be worried she doesn’t have a lot of adaptive spending flexibility when we’re already starting here.

So I really would probably have her down at the lower end of the withdrawal rate scale. Because I would be nervous that if she starts higher, it may be difficult or uncomfortable to trim. But she’s got a skill set as a marketer and a blogger. She’s good enough at it. She’s been able to put a really great nest egg away before she’s 30.

What on earth is she going to do with the rest of her time on earth? And can we make some realistic assumptions or at least have some conversations of what are you going to do if some earnings show up at some point, both because it’s additional money and just from the nerdy technical perspective, additional work for her at this point actually has a monstrously positive return for social security purposes.

Social security calculates its benefits based on your highest 35 year average of earnings. Personal security formula will basically be 10 years of earnings and 25 zeros, because that’s her high 35 if she’s out of the workforce for the rest of her life.

So each year she works with any level of money is averaging into that formula, replacing zeros with working years. When your income is that low, you are still on the first replacement tier of Social Security, which gives you a 90% replacement rate on your income. That’s how the Social Security benefit is calculated until your lifetime earnings are more than $10,000 a year and she may not be much above that if she’s going average in 25 zeros. Even the second tier is a 32% replacement rate, which isn’t bad for your dollars going in.

So she’s got, to me, a double return on any level of work that she does that not only is it additional money that she can earn and generate, but there’s actually a really favorable ROI on Social Security benefits when you have worked this few years and you have this many zeros in your Social Security formula.

Jonathan: Now from a guardrail and adaptation perspective, let’s just play this out a little bit. So you’re at a 3.5% withdrawal rate on a $500,000 nest eggs. You have two years in cash, and without judgment on whether or not your life will scale up or down or be more expensive or less expensive, for the sake of this scenario. I want to talk about that in the context of ratcheting now that we actually have some numbers in place.

So let’s say we are at all time highs, and I say that the market is usually at or near the all time top until it’s not. Let’s just she retires and then within the next year just drops, let’s bank on 30% drops, she’s got one year covered. She’s got two years covered in cash. But now she’s comes to that end of the year and she’s refilling, I guess her buckets, if we’re doing it that way. She’s doing it while the market is still at this 30% drop.

How do we implement these guardrails and these Flexible Spending Rules to account for one, that possibility but then two, the other side of that where the market goes up 30%. Just keeps going up and up and up and you’re just looking down at where you started.

Michael Kitces: So if we’re going to do this on a ratcheting methodology which I think is reasonable is kind of the way that I would lean here just hearing this scenario. And again, just wondering how much room there is to cut from here in pullbacks.

So on a ratcheting strategy, for nest egg is $500,000, 50% ahead on that would be $750,000. So if her portfolio gets ahead enough to be at 750, she gets a 10% raise every three years we keep looking.

So if the market starts off well, she’s starting out around $18,000 with the spending here. If the market starts off well, and her portfolio gets out of the gates well initially, and she gets up to $750,000, she gets a 10% raise over and above inflation.

So, her 18 jumps up to almost 20. If it’s still had three more years after that, she gets another 10% raise to 22. If it’s still ahead three years after that, she gets another raise up to 24 plus.

So you can just start ratcheting it up, which, again, recognizing for most people in these scenarios is overwhelmingly likely.

And I’ll admit, even in our ratcheting research, we were largely running it over 30 year time periods, not 50 year time periods. I suspect actually on a 50 year time horizon, we would probably have to create a second ratcheting tier that says like if she’s more than doubled her nest egg, she’s up to a million dollars.

They’re not 10% increases their 20% increases because over 50 years, there is such compounding likelihood that at some point, we’ll hit the next bull market and her portfolio will hit like escape velocity to the upside. And our withdrawal rate falls to three in two and a half and two, if the markets really start compounding upwards. You just have to survive that kind of risk of pullback in the early years.

Now in terms of risk and pullback in the early years, as the question you asked, what happens if it goes the other way? So the whole point of these baselines around withdrawal rates, 4% rule, three and a half percent rule for longer time periods is that the whole point is, that’s the number you use and stick your spending at, even if the market falls off the cliff in the first few years. Because, a, at some point, eventually, what goes down comes up again and if the whole economic system is broken, the markets going to go down forever. We’ve got a whole other set of third world problems coming up.

Assuming that at some point the economy gets growing again eventually the rising tide lifts all boats, three and a half is low enough that, heck, if the market basically gives me nothing for 10 years, I mean, let’s get really long. If the market doesn’t give me anything for 10 years, and I’m only withdrawing three and a half percent, I’m still going to have 60% out of my portfolio left 10 years from now, for what by then is probably going to be a pretty tightly coiled spring for a potential bull market. Because if I’ve been getting no returns for 10 years, stocks are getting pretty cheap. Becasuse that’s what happens when they don’t give any returns for a while.

Jonathan: So to clarify, I just want to point out for our audience, what you just said there, make sure they slow down on that. So for her and again, we are not assuming we’re not placing any judgment of whether or not that spending is going to be maintained.

We’re just saying, all right, that’s what she says she needs. She’s living on 18,500, maybe let’s just say it’s somewhere in the 18,000 to $20,000 range, that’s what she needs. She has two years of spending and if, in cash, forget whatever the market does. She has two years covered there.

Then from there, she’s drawing out what she’s chosen, 3.5%, which for her, and this is the important part, it’s not 3.5% of the portfolio. It is in that first year, but then that basically says, if the market drops 25%, 30%, whatever, she can continue to take out that 18,500. It’s not 3% of the current portfolio value, it’s still that 18,500. Now, combined, she has 12 years.

So the question is, what is the likelihood that the market comes back in a roughly 12 year period of time? If the answer that is it likely will, she’s good to go and that assumes no adaptation on the income side, that assumes she’s not going to go back to work, she’s not going to earn another dollar. She’s not going to use the skills that we’ve just laid out. Like, if you understand the rules, Michael, I feel very confident for her in the context of what we’re describing here.

Michael Kitces: Yes, and frankly, I would point out like, I would feel confident for her without the two years in cash. Aside from the fact that just two years in cash means for nest egg actually isn’t 500, it’s a little bit more than 500.

I think there actually is a little bit of a misconception out there around even what sequence risk is and what the threat actually is. The threat of sequence risk is not a crash in the first two years. It’s actually not because, again, we’re withdrawing three and a half or 4% a year.

So she’ll have spent 7% in the first two years, she’ll have spent 10 and a half percent in the third year. So whether she has the cash bucket out there or not, the question of well, what if she only has 89% of her principal working for her instead of 93% of her principal working for her, is not actually that material over the next 50 years when on average, she’s going to eight X her wealth.

The first few years, it’s not just about a bear market that happens to hit because the reality of these low withdrawal rates and why the withdrawal rate ends out at four and three and a half percent in these scenarios, is because it’s so doggone low that almost, air quotes, almost all your money is still invested, and still there to participate in the growth and still there to participate in the recovery, again, that’s the point of where these numbers come from.

Just to put it in context, on a 4% rule for 30 year time periods, 4% rule if you retired in 1929. The first three years of retirement for a 1929 retiree was an 89% market decline from top to bottom.

So with an 89% market crash 4% rule worked for a 30 year time horizon. Now to be fair, we weren’t 100% in stocks, we had a balanced portfolio with bonds and bonds do well when markets well down. That’s part of the point of diversification, but an 89% market crash with some diversification to bonds didn’t break a 4% rule and that portfolio took over 15 years, over 15 years to make new highs.

If you started at 1929, you had to get past World War Two, before the recovery came and the first 15 years of your retirement was a decade of a recession, plus a global war, and 4% rule still worked.

So yes, in that intervening time period, your initial withdrawal rate that was 4% ended up creeping much higher than 4% relatively quickly when the market went down, but that’s fine. The point of 4% rule is not 4% every year.

The point of 4% rule is this spending number is low enough, that when you unleash a economic catastrophe on your retirement, not for the first two years, but for the first 10 to 15, there’s still enough money there when the good returns finally show up 15 odd years later, because eventually things get really cheap, that you’re able to then carry the subsequent years, carry the next bull market cycle because the late 40s and 1950s was a huge bull market cycle. You had enough left to them carry through, because the big bull markets are what you get for 10 to 15 years of misery.

The important thing to understand is, it’s really not about one in two year market crashes. If you retired in the summer of 1987, right before the crash of ’87, you took your first withdrawal in the September of ’87, you took your second withdrawal in the September of ’88. Your second withdrawal was at a higher portfolio value in the first withdraw, you literally wouldn’t have even seen the 24% market crash in the worst market decline in a single day ever, because we’re only pulling these checks once a year and by the time you got to the second year of the market had fully recovered because it was a sharp V.

So it’s not necessarily about a market crashing in the first year or the first year or two. Technically, it’s about the speed of recovery, much more so than the crash. So if I V down in one or two years, and then V back up in the next one or two years, the long term impact of my retirement spending is pretty negligible. If I decline the first few years and it takes me 10 to get back, because that’s what happened if I retired in the late 1920s, the late 1960s. Those are actually the danger scenarios and it’s actually less about how sharp the decline is, and just how mediocre the returns are overall.

I can give you growth every year for the first 10 years. If you only get 1% a year, for the first 10 years, you’re actually still in a scenario where you’re going to be really thankful you were only doing a three and a half or 4% rule, and you never lost any money but 10 years of mediocre returns is the real problem scenario and I point that out for two reasons.

One, strictly speaking, you don’t have to freak out even if there’s a market crash out of the gates because it’s really more a matter of how quickly it recovers than whether it went down in the first place.

The second reason I point that out is if what you’re really trying to protect against is a mediocre decade, two years of cash actually doesn’t do much for you. In fact, just like good old fashioned balanced portfolio, if her nest eggs part in stocks and part in bonds and we have a horrible market crash in the first two years, she doesn’t need a cash bucket. She’s got bonds. They’re going to be up. It’s what government bonds do when market crashes and there’s a recession and things go down, there’s a flight to safety and bond prices rally.

So you don’t even necessarily need the cash when you’re worrying about that decade because two years of cash isn’t going to solve a 10 year problem. And you don’t really need the cash if you’ve got a diversified portfolio because that’s what the bond part is supposed to do. It’s not there to be a return engine, particularly in today’s low yield environment. It’s there to be the thing that does well when everything else goes down.

Even as we look at this and talk about this with a lot of retirees who really hate owning anything in bonds because the yields are so low. As we usually frame them like we’re going to have an allocation for bonds and you know what, I hope they make you no money for the next 20 years. Because if they do, your stocks are tanking and that’s actually probably not good.

I hope they don’t make any money for you because you know what happens if they don’t make any money for you? Market’s probably doing great and you’re already on the path to two x, five x, eight x your money because that’s what happens when stocks compound for multiple decades.
So the bonds are there to actually be that balanced. It’s much more about 10 year mediocre returns than two year market crashes. And the whole point of the approach is you’re spending is low enough that even if you get the bad sequence and temporarily your withdrawal rate rises. It’s okay because it weathers 10 to 15 year storms. That’s where these 4% three and a half percent of rules came from.


Brad: Michael, you’ve been talking a lot about diversification. And looking at a lot of the research, it’s generally 60-40. So 60% equities 40% bonds but you did some analysis based on 80% equity, and percent likelihood of success.

We talked before about the fifth percentile at 50 years, three and a half percent withdrawal at 60-40 and it was 2.3 million. But that fifth percentile goes up to three and a half million at 80% equities, which I found fascinating. I’d love to hear you talk through that.

Michael Kitces: Yeah. So optimal portfolios overall. I’m going to talk about this in terms of stocks and bonds, because it’s a little easier just talking about two asset classes, not trying to mix a zillion of them together. Suffice it to say, more diversification, it all works better, at least a little bit.

When you look at different asset allocations for safe withdrawal rates, I’ll start with the 30 year time period and then sort of jump to the 50 year.

With the 30 year time period, what we see with asset allocation is if I were to draw a graph of your asset allocation from zero percent in stocks to 100% in stocks and then look at what is the withdrawal rate that works, what you get is a shape that looks like an upside down U.

So if you have very, very little in stocks, your withdrawal rates aren’t very good. The reason is high inflation like the 1970s is devastating bond markets. If you go really, really heavy in equities, your withdrawal rates are worse because now you got scenarios like crash in 1929 if you were all stocks, and you rode that all the way down 89% this is not going well for you.

So what you find is the peak is in the middle. And it’s depends a little bit on what data sets and assumptions you use, but you basically find the optimal exposure somewhere between about 40% and 70% in equities. Much lower than 40 and inflation becomes too much of a risk, much higher than 70 and severe bear markets actually become too much of a risk.

The balance point the middle really is better than either tail. Now, when you stretch the time period further, you go from 30 years to 50 years. That whole chart kind of shifts to the right a little bit and your optimal equity exposure shifts from a roughly 40 to 70% level, up to about a 50 to 80% level. Sometimes even as much as 90%, depending on whose data you use.

But things like crash of ’29 are, if your data goes back that far, that was a pretty pretty horrific scenario. So it usually limits how much you want to go up in equities. Again, the more conservative your spending is, if we stretch our 30 year time period out to 50 years and we take our withdrawal rate from four down to three and a half, we get even a little bit more room to have a little bit more equity growth in the long run, because we’re pressuring our portfolio a little bit less in the first 10 years if we get one of those bad 10 year cycles.

So when we look at 50 years scenarios, we do start finding optimal equity exposures for supporting withdrawal rates stretch out more to something like 80% in equities than just 60% in equities. And as we showed in that chart, like your worst depletion year is still very similar. You’re like, at three and a half percent rules for 50 years, you’re falling short like two or three years of the 50 year time horizon at 60 or 80% equities because the safe number is technically 3.45 or something, we round to 3.5. So you run out a year or two short.

But the upside becomes drastically higher for what’s basically still the same downside. You’re making it almost 50 years plus or minus a year or two but as you noted, your fifth percentile, the 5% worst cases, the really, really bad ones, you still go from my nest egg actually went doubled to instead my nest egg more than tripled.

So 50 years at 60%, my fifth percentile is 2.3 million, 50 years at 80% equities, my fifth percentile is three and a half million. My 95th percentile, so matching same on the other end is, I’m equally likely to have three and a half million, or 89 million. I’m equally likely to run out in 50 years, as I am to have $133.9 million. Just compounding over long term periods, especially when you get even more equities there. Just, frankly kind of become stupidly high and it really becomes more of a function of, I got to have a withdrawal rate that’s low enough to survive a horrible first decade first decade turns out to be horrible.

Then once the bull market eventually comes, other after the first bad decade or out of the gate, I quickly gets so far ahead that the only question is, where are you ratcheting, how quickly are you ratcheting and how are you moving up? That’s really what it boils down to in practice.

If you get the horrible decade and you’re pushing a portfolio enough, yes, there is that one scenario where you barely eke it out for 50 years, but as we’ve said throughout, that’s before you move any of the other flexibility levers that you may have along the way that even can take that one scenario where you might be cruising towards a decline and ratchet yourself higher or just adjust yourself so you’re on a better trajectory.

The Hot Seat

Jonathan: Michael, this has been amazing. I love how you were willing to take the time to break this down and then apply it to maybe what some people would consider an extreme case study but very, very important as a way of really highlighting the value of this type of conversation, really useful for me personally and I believe our audience will find value as well and will be able to extrapolate to their own situation.

Now in most shows, that would be the end of the episode but on this show, Michael, we would love to give you the chance to tackle the hot seat. Are you ready for this?

Michael Kitces: I think I’m ready. Let’s go for it.

Brad: All right, Michael, question number one. What is your favorite blog, podcast or book of all time?

Michael Kitces: Favorite blog, podcast or book of all time.

On the podcasting end, I kind of nerd out on all of our industry stuff and podcasts in our industry. I sort of have a two way tie, Barry Ritholtz’s Masters in Business and Patrick O’Shaughnessy’s Invest Like the Best. Big fan of their podcasts and what they’re doing on both sides.

On the, I hate to cop out on these but on the blog end, I really can’t say I have a favorite one because I’m one of those people that loves consuming a ton of information from a ton of different sources and it’s actually like, it’s the breadth of information and the range of it that actually really does it for me and gets me really excited.

When I think about best books and things that probably had the most impact on me, I have to go with Michael Gerber’s EMyth. As someone that’s have built business and build career myself and have lived the, as Gerber talks about, the challenging transition from technician to business owner, it’s a really, really powerful book about thinking about yourself differently and changing your mindset in what you’re building in your own career.

Jonathan: Man, I’m adding that back to my reading list for 2020. I think I own it, and I need to read it.

Michael Kitces: You definitely need to read it.

Jonathan: All right, question number two, an inflection point in your life that was especially memorable or meaningful.

Michael Kitces: So that’s an easy one for me. Taking the leap away from the firm that I worked at and out on my own. I spent my career internal for an advisory firm for about the first 10 years, made a decision in early 2008, surely coincidental to all the stuff that happened later that year, that just I had this passion for doing writing, speaking, research, analysis and I wanted to make my own thing to do it and get it out there to the industry.

So I launched a newsletter service and the website that we still write on today, and started speaking out to the industry and publishing actually a bunch of this retirement research in early 2008.

To me, it’s sort of an interesting kind of quasi FI transition in and of itself. I was able to make that leap because I spent the decade of my 20s living incredibly frugally. I had a crappy, like 12 year old used car that I paid for in cash off of eBay back in 2002. I split an apartment with two buddies. My rent even here in the DC area was like 350 or 400 dollars a month and I had a pretty good start to my career.

So by my late 20s, I was making six figures, and the total of my car payments and my rent payments together was about 7% of my income or less and had been that for the entire decade of my 20s.

And that’s what gave me enough of a nest egg, not necessarily for retirement and full FI, and I wouldn’t know what to do with myself in retirement anyways, but enough a nest egg that I went into the founders of our firm and said, here’s the deal. I would like to go do this writing, speaking, nerd thing in our advisor world. I actually don’t want to leave the firm completely, I think there’s some things I do around here that are still valuable. I would like to stay attached to the firm. I would like a little bit of a salary and health insurance benefits because I needed solve a health insurance problem at the time. If this doesn’t work out, I’ve got enough saved because I’ve been living really frugally that I’m not actually in danger if they say no, but it would be really nice if they said yes.

The confidence that I had because of the financial strength that I built for myself, I think is the only reason I was able to go in and have that conversation in the first place. And the fact I could go in and have that conversation confidently made it happen and was just an entire change for the trajectory of my career, of my life overall.

It stems from, not a total Financial Independence, I did need to work. I was not at the point where I didn’t need to work but I was at the point that if this didn’t work out, I was financially safe and that’s what made it financially possible to take the leap. That actually turned out to be the best financial thing that ever could have happened to me because that business has grown tremendously.

Brad: All right, Michael, question number three, your favorite life hack?

Michael Kitces: My favorite life hack?

Brad: Yeah. Anything that’s made your life easier. Anything you’ve done in particular.

Michael Kitces: Yeah, my favorite life hack at the end of the day is just letting the routine simple things be routine and simple. I’m a big fan of doing anything I can to just, if not automate, just reduce the amount that I have to remember stuff.

I’m someone who travels a lot. Anybody who’s, well pretty much ever been on trip, has had the experience of like, oh crap, I forgot to pack, like the power cord for my laptop or the charger for my phone. So then we make all these lists and do all this work to make sure we always pack all the things that we need to pack before we go.

So you know what, I just bought a second charger and a second power cord and they sit my travel bag and I never have to remember to put it back and forth. I don’t have to make whole bunch of lists of the things I need to remember because I just eliminated the need to remember it.

For me and granted this is a little bit for me, I’ve even ended up with a little bit of a brand of this blue shirt.

Jonathan: I was going to say, you’ve got the Steve Jobs blue shirt.

Michael Kitces: Yeah, it was a subconscious thing. I would travel for conferences every now and then. I guess just it was probably my favorite shirt. I’ve been thinking about it. If I was traveling for a day, I always grab this blue shirt and pulled it off the hanger.

So as I was going to some conferences and starting my speaking career in 2008, 2009, a bunch of my friends in the conference world started kind of kindly teasing me, like we only see about three or four times a year and every time you’re wearing that shirt-

Jonathan: It’s a great shirt.

Michael Kitces: So I just decided to make it a thing. So I bought 12 of them. I have matching a dozen blue socks. I have three versions of the identical black suits that I always wear and it’s turned into a brand. Our logo was literally a nerd with glasses, a goatee and a blue shirt.

Jonathan: Right. It shows up in his bitmap avatar.

Michael Kitces: You know I’d be like, it’s sort of joking and it was a fun branding thing, but there’s a little bit of a life hack thing to it, like you wouldn’t believe how much simpler your life gets. Never have to think about what you’re going to wear because you basically created a uniform for yourself.

Jonathan: And it’s the uniform you feel comfortable in.

Michael Kitces: Yes, it’s the uniform I feel comfortable in. It’s important.

Jonathan: All right. Now, this is actually one of my favorite questions for you specifically. Question number four, the biggest financial mistake that you’ve made.

Michael Kitces: So biggest financial mistake that I’ve made, so I kind of give this a two way tie.

One, like so many people in the investment world I had to get started by day trading my way to failure. So I have done that cycle like almost everybody has. I was coming into the industry in the late 1990s. So I had a day tech account. So in the mid 1990s I was still in high school and college.

I was a hardcore Magic: The Gathering player and back then this was when all the original Magic: The Gathering stuff was happening. So I had a multi thousand dollar Magic: The Gathering card collection, which frankly I wish I had kept today because it would literally be worth tens and tens of thousands of dollars. I sold it on eBay for $2,000. I took my $2,000 to a day tech online trading account and I day traded it down to zero in about six months.

So because I had to get a little bit of margin and this was the 1990s, the tech stocks like that’ll really wipe you out fast. So that was certainly early financial mistake, learned my lesson about not trying to actively day trade on an ongoing basis, when you’re doing that between classes or now between jobs and work. When there are people who do this for a full time career and live it all day, you are not going to win on your lunch break.

The second piece I would kind of tie to it is, I don’t really view it as a financial mistake, but it is technically my largest financial loss. When I launched my own business in 2008, I actually was very nervous about markets and the economy at the time.

We’re an investment management firm, it’s part of what we do for retirees, our own investment research was very, very negative on markets in the economy heading into 2008 already.

So I was really, really worried of what what was going to happen if I went and launched my own business, only to have markets meltdown and blow up on me. So I actually bought some options to hedge my career risk, which turned out great in 2008.

So well, that I was like, if you remember what it was like back in 2009, we didn’t know if the feds intervention was going to work or kick off hyperinflation, do a whole bunch of other crazy stuff. So there was still a bunch of fear of economic meltdown. So I re-upped a bunch of the options in 2009 and then lost 100% because markets went up and didn’t keep going down.

So it actually served its hedging purpose. It made me much more comfortable when I went out for the launch. I didn’t put a ton of dollars there but enough that if my business had not gone well in 2009, I had enough money that I’d made on the options to make up what I was going to lose an income but hedging two years in a row did not work so well because the market bounced back by the second year.

Fortunately, by then, the business was doing well and growing very well. So I didn’t need the hedge dollars anymore, but by just sheer financial dollars, hedging again in 2009 and having the market go up was by far the worst economic loss I’ve ever had in sheer dollar terms.

Brad: All right, Michael, question number five the advice you would give your younger self.

Michael Kitces: The advice I would give my younger self.

Frankly, not a lot different from what I actually did. Part of it may just be my attitude for life. Everything’s a lesson, everything’s something you learn. There are certainly things I have done that I do not want to do again. A good friend of mine calls them afgoes, another fricking growth opportunity, that come along and hit us from time to time.

So I’ve had my share of afgoes but I don’t really know if I would tell my younger self to change or doing anything different. I think the thing I would probably reinforce for my younger self and fortunately I did this anyway, so it worked out well, but might have been a little bit of dumb luck, is the just the sheer ludicrous value of investing in yourself. Even possibly to the extent of not saving in retirement accounts.

One of the things I figured out by about six or seven years into my career is that I stopped saving in my retirement accounts and I started buying education for myself, which is why I have two master’s degrees and a long list of designations and industry certifications.

I can do the math as well as anyone of what happens when you get 50 years of compounding and you’re off IRA tax free when you do it in your 20s as I could have at the time. But frankly, I’ve more than 10 X my income since then, driven very heavily off of the knowledge that I gained and all the re-investments I made into myself, and that 10 X income I’m going to earn for several decades more because I actually really like the work that I do now that I’ve gotten to a place where I can do the work that I like, and I can get paid well for it.

So I created far more wealth, economic value, and what ultimately can drive towards Financial Independence for me now by not plowing dollars away to save for retirement and FI in my 20s but plowing the dollars into myself, so that I could have a whole lot of career growth in my 30s.
And I’m now in a completely different place economically in my 40s than I would have been had I merely been diligently saving all along and I think sometimes we really underestimate the economic value of investing in ourselves when we’ve got multi decade, time horizons to work.

Even if you want to get to the point where it’s FI and you’re only doing the optional work that you want to do, if you invest in yourself, you’re probably going to have some value to create in the economy, you’re probably going to find a way to get paid for it.

As we said earlier, $20,000 side hustles is like a half million dollars on your FI egg and if you have a deep expertise, and you consult for larger numbers than that, you radically, quickly move yourself forward on the FI path by lifting the value of your human capital first and reinvesting that into your financial capital second.

Jonathan: I love it and it’s something I’ve heard echoed by Scott Trench when we interviewed him as well, invest in yourself. Great advice.

Now, we do have a bonus question for you. What purchase Have you made over the past 12 months that has added the most value to your life?

Michael Kitces: Oh man, what purchase have I made over the past 12 months that added the most value to my life.

Jonathan: Could be a book, could be some self education, self improvement. What do you got?

Michael Kitces: I feel bad, this is like just the nerdiness in me coming out.

Buying a high end laptop, bought a really nice high end Dell XPS 15 laptop. I’m a person that, in part to keep some semblance of my own work-life balance and someone who travels a lot, I have to be productive from the road, I have to stay productive from the road, I have to stay productive wherever I am. Because otherwise it spills over when I get home and then I got to work on the evenings and weekends and I don’t get as much time with my kids.

So buying just a very nice high quality laptop so that I am instantly productive wherever I am including buying a mobile hotspot to go with it so I don’t have to rely on hotel WiFi, isn’t tethering to my smartphone, that may or may not have enough battery itself.

Just giving myself the opportunity to be maximally productive when I want to be productive, gives me more opportunity to both do good work in my career, and eventually have better work-life balance because it keeps work from spilling over.

I’m constantly amazed at how often people in their working world or their business world, don’t spend on things that can improve their own productivity and basically handicap themselves and then wonder why they’re running out of time and all the work is spilling over and all the rest of the challenges they have.

So just that was really powerful for making sure that I can stay maximally productive when it’s time for me to do work, to get work done and not putting up with excuses like, oh, my laptop is being really slow today, and oh, the hotel WiFi isn’t working.

How To Connect

Jonathan: I can tell you Brad and I were both smiling as you’re sharing your story. Effectively, you said you hadn’t reached Financial Independence yet. But in our opinions, you had reached a fully funded lifestyle change and you were able to go into your employer and make a, “unreasonable” request and you got it because the benefits of Financial Independence are not binary, one and zero but you accrue power all along this journey.

I appreciate you sharing not only your personal story but also really the tactics, the data and applying that to specific case studies. I know our audience got value as well, people listening to this. I mean, you mentioned your productivity, you’re one of the most productive people that we have ever met.

I believe, on top of all the writing that you do, and the work that you do and the businesses that you’ve started, you do, I believe somewhere between 50 to 70 speaking events a year, which probably contributes a little bit to the travel that you mentioned.

If someone’s listening to this, they want to find out more about you, they want to connect with you, connect with your content, what is the best way for someone to do that?

Michael Kitces: So I was not so lucky on the immigration translation boat but at least if you see the name, it is me or my immediate family. has all of our content and all the related business and companies that we started in the advisor world. We do a lot stuff for advisors. We do a lot of stuff for retirees, we do some work for folks that are in the FI world as well. So you can find all that at

Jonathan: Michael, thank you so much for joining us on the show today.

Michael Kitces: My pleasure. Thank you so much for having me.

Jonathan: All right, my friends, I hope you got value from today’s episode and if you’ve been getting value from the episodes up to this point, go ahead and press the subscribe button on the platform you’re listening to this on, whether it be your podcast via Apple, Stitcher, Spotify, or YouTube.

If you have not yet checked out our YouTube channel, you can watch video of this at We’re bringing it to you in an extra dimension.

If you are hearing about this idea of Financial Independence and maybe some of the terms that we talked about, the data that we talked about was just a little bit next level, you’re not quite there yet and you’re trying to get some context for the conversation that we had today, by far the easiest way to start is just to aptly actually go to

There we’ve created An Illustrated Guide to FI which kind of walks you through some of the tenets of Financial Independence and a very easy to comprehend manual. And it also will reference you to some those essential listening guides, essential listening episodes that talk about really the backbone of what we were discussing today, making it very easy to get into and get started on your own path to Financial Independence.

All right my friends, the fire is spreading. We’ll see you next time as we continue to go down the road less traveled.

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