Make the Most of Your Savings With the 1/N Withdrawal Strategy

one of the toughest nuts to crack when it comes to retirement planning is determining just how long we're going to need our money to last because at the end of the day few among us really know how long our lives will ultimately be therefore we often very understandably tend to add a little extra dash of conservatism into our retirement withdrawal calculations we can see this in the gap of minimum median and maximum safe withdrawal rates when it comes to retirement planning we generally set up our retirement withdrawal calculations using the minimum safe withdrawal rate if not a little bit lower than that just to give ourselves a little extra cushion should something historically unprecedented happen to our investments during retirement however as you can see from the difference between the minimum median and maximum historical 30-year safe withdrawal rates in this chart that approach is usually quite a bit more conservative than we realistically need to be in most retirement scenarios this tends to lead to us leaving a lot of money on the table as you can see from this chart displaying the net worth of someone who retired with a one million dollar nest egg and followed the four percent rule for 30 years still it's what most of us are going to do because while leaving a little bit of extra money on the table is unfortunate for some running into a situation where you're still alive but have no money to put food on the table or keep a roof over your head is far worse for everybody today's approach basically says yeah forget about all that risk and uncertainty and yolos its way right into one of the highest retirement income performances of any strategy that i've ever come across but how does it do this and is there a way to balance out the elevated risks that it almost certainly presents relative to other approaches due to its desire to attain that reward of higher income levels in a way that makes it a more viable strategy for most retirees that's what we're going to be finding out today let's talk about the pros and cons of the one over n withdrawal strategy but before we get going be sure to like this video if you haven't already as it really does help out the channel a lot and subscribe with notifications on for more money related videos like this one every single week and if you want to further support this channel you can check out some of the links i've left in the description below which includes a link to the investing platform m1 finance get started investing for free today as usual before getting into the analysis for this approach i want to quickly discuss how i grade the strategies we look at in this series basically i look at four different criteria for each approach the first is how much income they generate more income is obviously better but we also give a little bit of extra credit for strategies that generate additional income in the early years of retirement since we're more likely to be healthy and energetic enough to take advantage of that income in our younger years than we are when we're 90 somethings the second is risk and sustainability this criteria basically measures how likely we are to outlive our money using a strategy as well as how easy or difficult it might be to follow the rules laid out by the strategy over the years based on the unique strengths and weaknesses that the strategy brings to the table the third is the predictability or stability of the income stream that the strategy generates basically this criteria looks at how often your income rises or falls on an inflation-adjusted basis from year to year while using a strategy and how big those changes are and fourth is how well the approach manages to maintain or raise your buying power over time which criteria will ultimately be the most important to you will depend on your goals financial situation and just general preferences and because the performance of withdrawal strategies are often heavily influenced by the mix of investments you happen to have i also look at each approach under a conservative moderate and aggressive asset allocation as shown by this chart with that being said let's get into the analysis for today's strategy so real quick for those who don't know here's how the strategy works the one over n method is simply an equation to determine what portion of your current nest egg you withdraw as income in retirement this year the n basically just represents the remaining years or months if you wanted to measure it on that time scale that you want your money to last you for the purposes of this video i'll be using 30 years as the number of years i want the money to last in order to keep things consistent between the other videos in this series but there are other ways that you could determine this figure which i'll cover in the alterations section at the end of this video since we're saying that we want the money to last us 30 years in retirement that would be the value of n when we go to make our first withdrawal so we'd withdraw an amount equal to one-thirtieth of the value of the nest egg in year two there would be 29 years left that we'd want our money to last so n would be 29 when we go to make that second withdrawal this pattern continues until the 30th and final year where n would be equal to one and therefore we'd withdraw whatever money is left in the nest egg so it's a pretty simple approach that has the added benefit of leaving no money on the table when all is said and done and in some cases can even lead to an increasing income over time since the portion of your nest egg that you're withdrawing each year steadily increases here's a chart showing how this approach works with some actual numbers put to it i've assumed that the money had to last five years which is obviously very short for a retirement period but again it's just for the sake of illustration and i've rounded down the market value before withdrawal and income figures down to the nearest 100 so that's how the strategy calculates its withdrawals but when we put it to the test under different scenarios how well does it stack up in regards to our four criteria as usual we'll start by examining its historical income generation capabilities the first factor i look at when analyzing withdrawal strategies is income as you can see from the chart on your screen now in terms of income generated on a one million dollar nest egg the one over n approach generally outperforms the forty thousand dollars a year in income that the standard inflation adjusted approach would generate but it definitely has a lower income floor with minimum incomes of roughly thirty thousand dollars a year give or take a few thousand dollars depending on the allocation used the story changes when looking at the performance during the early years of a drawdown period with the one over n approach never generating 40 000 a year in the first five years using the conservative allocation and averaging under that 40 000 a year mark under all three allocations so even though the income generating capabilities are relatively high for the one over n method overall it is a bit of a slow starter at least when you want the money to last you for a longer time period like the 30 years that we're using for today's video the second factor i look at when analyzing withdrawal strategies is risk and sustainability risk or the likelihood that you'll outlive your savings examines a couple of metrics the first is what i call the approaches survival rating or the percentage of possible retirement starting dates that would have avoided running out of money over a specific length of time in this series of course we're using 30 years as the time frame to determine if an approach survived retirement the second is what i call the approaches depletion time or how long the approach survives in its worst case scenario this is important to consider because while two approaches can have the same likelihood of making it at least 30 years they can have wildly different worst-case scenarios sustainability considers how easy or difficult an approach is to maintain given the experiences that its strengths and weaknesses are likely to produce for the retiree starting with the survival rating we see that the one over n approach is absolutely horrible by design it never manages to last a full 30 years with at least some money to spare which makes sense because at the start of the 30th and final year we withdraw whatever's left in our nest egg in terms of sustainability the one over n method seems to be a bit of a mixed bag at least as far as i can see on the one hand it is very easy to calculate withdrawals you don't need to be adjusting for anything relating to inflation or investment returns and you don't need to do anything complicated with math you simply need to decide how long you want the money to last look at the current value of your nest egg press a few buttons on a calculator and voila you have your withdrawal the fact that in general your income tends to rise over time due to the fact that you're withdrawing an ever larger portion of your nest egg assuming of course that your investments don't completely tank on you also tends to help with sticking to the strategy on the other hand it can be quite difficult to stick with the approach as the years go by because as you start drawing down such a large portion of your remaining nest egg each year your margin for error or recovery starts to get pretty slim what do you do if you end up living longer than you anticipated sure you can correct for this in a couple of ways such as artificially using a higher end value than you really think you're going to need or treating the calculated withdrawal amount as the maximum amount that you can withdraw in a year as opposed to the amount that you absolutely have to withdraw each year but those alterations come with trade-offs of their own namely in that it takes away from the largest strength of this approach its overall income generation capabilities there's also something to be said about the possibility of it being harder to reach financial independence using the one over n method of course this will largely depend on your situation and what you're comparing the approach to but coming at it from the perspective of a fairly regular retiree who's comparing the approach to the 4 rule if they want their money to last them more than 25 years in retirement then just because of how the math works they'll need to save more money to reach financial independence using the one over n method than they would of using the four percent rule it's also worth noting that especially for those with longer time horizons for their savings the one over n method often generates a lower income in the early years of retirement relative to many other approaches which may not seem like such a big deal and for some it isn't but it's worth taking into consideration due to the fact that most retirees tend to slow down when it comes to activities and adventures as they age and medical costs start to take up a larger portion of the budget so if the bulk of your income arrives in the back end of your golden years you may not actually be able to enjoy it in the way that you envisioned when you were working again not a deal breaker necessarily but something to think about and as with many other strategies the variability of income from year to year can make it a more difficult plan to stick to it's obviously great when the income rises from the prior year but it really sucks when it falls which as we'll see in a minute happens fairly frequently and occasionally by significantly large amounts so yeah bit of a mixed bag for those who have a decent amount of wiggle room in their retirement budget already and are willing to take advantage of that they may do just fine with the slower start in terms of income as well as the occasional income cuts and the ever narrowing margin for error since they could utilize some of those adjustments that we just went over while still coming out ahead the majority of the time however those that aren't in that boat may find the approach more difficult to stick to over the long term due to these limitations the third factor that i look at when analyzing withdrawal strategies is the predictability or stability of the income stream it produces historically speaking the one over n method manages to rise at a rate that's faster than inflation somewhere between two thirds and three quarters of the time depending on the allocation that's used which is really pretty good however its movements are rarely small in most of the approaches that we've covered so far the median change in inflation-adjusted income levels year-to-year was maybe a few hundred to a couple thousand dollars and as you can see from this chart that isn't the case for the one over n method unless you're using a conservative asset allocation the fourth and final factor i look at when analyzing withdrawal strategies is buying power and it's a metric where the one over n method absolutely shines regardless of which allocation you're using over time the average income figure grew from their initial inflation-adjusted amount of roughly 33 000. in fact the average income generated using an aggressive allocation nearly quadrupled that starting figure by the end of it so while it may get off to a slow start it's certainly capable of finishing very strong in terms of modifying the one over n method you could as i said before treat the withdrawal calculation as a spending ceiling rather than a required withdrawal amount or you could adjust the end value either from the outset or at some point during retirement in order to give yourself more of a cushion though obviously the later you do it the less impactful it'll be when it comes to giving yourself more breathing room you could even add in a safety margin or legacy adjustment to the formula if you wanted to so instead of simply deciding how many years you wanted the money to last you and then taking the commensurate amount of money from your nest egg the formula would look something like this this would ensure that you still have some money left over at the end of the anticipated drawdown period in case you live longer than you anticipated or so that you could leave something as an inheritance for someone or something else however all three of these modifications do chip away at some of the income generating advantage that the one over n method is best known for as you can see from this chart depicting the annual income for a hypothetical 10 year retirement scenario for the spending ceiling scenario i assume that the retiree would spend up to 200 000 in any given year for the longer life span i assumed an end value of 15 instead of 10. and in the safety margin scenario i assumed that the retiree wanted to have at least a hundred thousand dollars of their original 1 million nest egg left over after the 10 years were up the combined scenario combines all three of these adjustments all income figures have been rounded down to the nearest 100 obviously the amount that the income gets reduced by is going to vary depending on things like your returns and the sequence that they come in the specifics you set for your income ceiling expected lifespan and safety margin but this should give you a rough idea of how it could play out so in the end what we've got is one of the best long-term income generating withdrawal strategies out there that comes with all the risks you'd associate with such an approach from survivability and sustainability to wild income swings both positively and negatively year to year and everything else in between there are definitely things you can do to minimize these risks to a certain degree and even leave a little something to future generations if that's something you want to do but doing so will almost certainly chip away at some of that income related advantage and is unlikely to make the approach as safe as some other strategies that focus primarily on risk minimization but with that being said for the right person such as those with a good amount of flexibility in their retirement budget and lifestyle and or those with the ability and willingness to earn money from other sources in retirement should the need arise down the road it can be a highly rewarding approach but what do you think is the one over n method a viable retirement withdrawal strategy or does the fact that it seeks to drain the entirety of your savings by design assuming you don't alter it in some fashion kick it out of the list of contenders for your own retirement withdrawal plans let me know in the comments section below but that'll do it for me today once again if you enjoyed this video be sure to smash that like button if you haven't already subscribe and hit that bell next to my name so you'll be notified of all my future uploads i generally upload every single monday and if you have a friend that would be interested in this kind of content be sure to share it with them let's really get this information out there and start our own financial revolution

Channel: Next Level Life

Views: 9,289

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Id: ChOu_LucNfM

Length: 13min 57sec (837 seconds)

Published: Mon Jul 04 2022