How to Implement the 4% Withdrawal Rule as a Potential Retiree in Singapore

The 4% Withdrawal Rule originated from the US, in a paper written and published by William Bengen in 1994.  He studied the returns on US portfolios (consisting of different compositions of stocks and bonds) beginning from 1928, to analyse if there was any withdrawal rule that would have ensured sufficient funds for retirees from their portfolios lasting beyond 25 years.  From his study, it concluded that the 4% withdrawal rule met the above criteria, provided 50% to 75% of the portfolio was invested in stocks, remainder being in bonds.

In today's context, the 4% withdrawal rule involves accumulating an asset portfolio that is the size of 25 times the annual expenses during active years, and withdrawing 4% of the value of the accumulated assets yearly upon onset of retirement (adjusting for inflation yearly thereafter).  Even without other sources of income, the retirement funds will not be outlived.

While the 4% rule is a reasonable place to start, it may not suit every individual's situation.  Personally, I hope to semi-retire by 45, and fully retire by 55.  Based on my personal scenario, I will discuss a few limitations of the 4% rule, and what I can do about them.

1)    It is a rigid rule 

The 4% rule allows individuals to withdraw 4% of the initial portfolio value, regardless of the market performance.  Therefore, in times of market corrections where portfolio value falls, the absolute amount that can be withdrawn will be above 4%.  This is worrying if the slump in portfolio value happens during the first couple of years of retirement (like what is happening currently), because it removes a significant amount from the portfolio and that affects future compounding effects.  Quoting from an article from CNBC:

"Here’s how a sequence of returns risk can impact your savings: Say a person had retired at year 2000 with $1 million invested in the S&P and withdrew $40,000 each year, with withdrawals after the first year adjusted 2% for inflation.  In 2020, the remaining balance would have been about $470,000, according to Ben Carlson, director of institutional asset management for Ritholtz Wealth Management, who crunched the numbers for a blog post.

In the above scenario, the portfolio would have been subject to a bear market at the outset of the person’s retirement, when the S&P lost 37% over three years during 2000-2002, but enjoyed a long-running bull market that began in 2009.

However, if the order of yearly returns were flipped — the gains posted by the S&P at the end of the 20 years happened first and that early bear market happened last — that same person would have more than $2.3 million after withdrawing the $40,000 or inflation-adjusted amount each year.

'It’s not the specific returns over time but the order of those returns that matter.' " 

2)     It applies to specific portfolio composition

A study made by MoneyOwl for the 4% rule advises that for the portfolio to last for 30 years, the composition of the portfolio should be 60% equities and 40% bonds.  However, as individual's portfolio composition varies, the duration that the portfolio can last, and its success rate may also vary.

3)    It assumes a 30-year time horizon

Now that the various FIRE concepts are gaining popularity, the retirement portfolio may need to last longer than the 30-year horizon used in the studies.  As such, the risk of portfolio depleting earlier than expected cannot be ignored.

4)    The study uses historical market returns

As the saying goes, past performance do not guarantee future results.  Based on the analysis by Charles Schwab Investment Advisory on March 2022, they projected that market returns for stocks and bonds are likely to be below historical averages over the next decade.  This may cause the 4% withdrawal rate to be too high, and portfolio will deplete sooner than expected.

5)    4% Rate may be Obsolete in Current High Inflation Environment

With super high inflation recently, and declining market returns, experts have claimed that the 4% safe withdrawal rate may be outdated, and perhaps 3.3% Withdrawal Rate may be more appropriate.  Its aim is to withdraw a smaller percentage from the portfolio in the initial few years, so that the portfolio can last for longer duration, hence increasing the probability of success.

So what do I plan to do to work around the limitations above?

As I am striving for Barista FIRE, therefore, I can continue to work part time from 45 to 54 to supplement my annual income.  Therefore for the first 10 years, I should able to lower my withdrawal rate to below 2% for the first 5 years, and below 3% for the next 5 years.  This allows me to reinvest more dividends back into the portfolio, further compounding my portfolio in the first 10 years.  Hence from age 55 onwards, the amount available for withdrawal will be slightly higher.  All I need to be wary about is the sequence of risk that may occur, that is, NEVER fully retire at the year of market downturn.  I believe Barista FIRE will provide me with some flexibility.

For my portfolio, the bond allocation is zero.  This is because I treat my monies in Central Provident Fund (CPF) as the bond fund compounding at 4% annually (in special account) almost risk free!

As I am aiming for FIRE, one major thing I need to always caution myself is the possibility of me outliving my portfolio.  Thus whenever possible, I should delay withdrawing the capital of my portfolio for as long as possible, and just depend on the dividends alone.  Complementing this, I am thankful for the provision from CPF Life after I reach 65.  The steady stream of income from CPF Life (aka my bond portfolio) will definitely supplement my income during retirement years, helping to prolong the period my portfolio can last.

Moreover, a large part of my portfolio now is concentrated in dividends shares in SGX.  As long as the companies I invest in remains rock solid, the recurring or even improving dividends I can collect in my retirement years should be enough to let me ignore the price volatility in the share price during my retirement years.  Yes, I fully understand that as market rotation and technological advancement occurs, there are no forever rock solid companies (think Hyflux, Sembcorp, Noble, Creative in SGX, and more recently, Meta Platforms, Netflix in NASDAQ).  I suppose I need to constantly be aware of market news and remain nimble, and look out for changes in fundamentals.

Due to the volatility and unpredictability of the market performance, it does not make much sense to do much projections as the only constant, is change.  As such, I may perform the 4% withdrawal of my portfolio based on the floor and ceiling approach. 

Floor and Ceiling Approach

The floor and ceiling approach, popularized by investment manager Vanguard Investments, involves adjusting withdrawals from investment portfolio to take into account how your portfolio performs.  Common floor and ceiling percentage used by Vanguard are -2.5% and +5% respectively.  The plus point of this approach is that it allows me to withdraw a ceiling amount during good years, and the excess can be reinvested to compound.  In bad years, the floor amount will enable me to meet the basic expenses for the year.  The floor and ceiling amount will cushion the portfolio's withdrawal, to allow a comfortable retirement.  Below is an illustration of how the approach works, taken from DBS website.

For more details of this approach, do read up in DBS website.

Most importantly for myself, due to my Nationality, I have the safety net option to retire back in Malaysia, so I can live with a lower amount in Singapore dollars, due to the SGD 1.00: MYR 3.16 exchange rate. All in all, I hope I can achieve a secure retirement life. Barista FIRE, here I come...!