I was recently re-reading the original article that presented the concept of this simple withdrawal strategy and found the explanation to be overly complex which seems wrong for something that’s supposed to be simple. So I ask you, dear reader, for another chance to describe the strategy in a way that is more approachable (with less math) to the average reader. In fact, the most complex thing about the strategy is the name1.
The Simplest Version
In it’s simplest form, the strategy boils down to the following 2 equations:
initial_monthly_withdrawal = portfolio_value / 400 next_monthly_withdrawal = ⅔ * current_withdrawal + ⅓ * current_portfolio_value / 400
The first equation tells you how much you can withdrawal monthly from your portfolio in the first year that you start taking withdrawals. Dividing your portfolio value by 400 is equivalent to taking a 3% annual withdrawal and gets the process started. Conversely, if you multiply your monthly expenses by 400, that can give you an approximation of how big your portfolio needs to be in order to retire.
The second equation tells you how much you should adjust your withdrawal amount each year. This particular version of the equation assumes a buffer-size of 3 years and 3% withdrawal rate. In case you haven’t been reading other articles on this site, the buffer is what provides ballast to the withdrawal equation so that your withdrawal amounts aren’t whipped around too much by a volatile investment portfolio.
That’s it! If you’re comfortable with the assumed withdrawal rate of 3% and buffer of 3 years then you can stop reading and just follow the above equations (which I use for my own situation).
Example: $900,000 portfolio
Let’s take a simple example, start with a portfolio worth $900k. Dividing a this by 400 gives the initial monthly withdrawal of,
initial_monthly_withdrawal = $900000 / 400 = $2250/month
Piece of cake. It’s up to you if you actually save the full 3-years of that withdrawal amount into a safe place. I recommend you at least save 1 year’s worth, $27k in this example, in a safe account such as an interest-bearing savings. Or maybe you’d feel better putting the entire 3-year buffer, $81k, in savings, that’s fine too. It mostly depends on your risk tolerance.
Next, after one year, you re-evaluate the portfolio to decide whether to increase or decrease your withdrawal amount. Let’s say portfolio has had a good year, and is worth $990k at the end of the year. Your next year’s withdrawal rate is computed as,
next_monthly_withdrawal = ⅔ * 2250 + ⅓ * 990000 / 400 = 1500 + 825 = $2325/month
So even though the portfolio grew by 10%, you only increase the monthly withdrawal amount by 3.33% (because of the buffering). It works both way, if the market has a particularly bad year, it won’t kill your monthly withdrawal income.
In every year after the first year, you just use the 2nd equation to determine the withdrawal amount for the following year. Over the long haul, with these equations, your withdrawal amount will hover around 3% of your total portfolio value2.
The General Version
If you prefer a little more control over the withdrawal rate and buffer size, then here’s the more general equations for this strategy:
initial_monthly_withdrawal = portfolio_value * withdrawal_rate / 12 next_monthly_withdrawal = (1-1/buffer_size) * current_withdrawal + (1/buffer_size) * portfolio_value * withdrawal_rate / 12
For example, if you prefer a more aggressive 4% withdrawal that is stabilized by a larger 5-year buffer then the withdrawal equations would simplify to,
initial_monthly_withdrawal = portfolio_value / 300 next_monthly_withdrawal = ⅘ * current_withdrawal + ⅕ * current_portfolio_value / 300
That’s all there is to implementing the Super-Simple Virtual-Buffer Withdrawal Strategy. If you want to see the math behind the strategy, refer to the overly-complex original article. The main takeaway from this strategy is that you only need to know two data points each year, (1) the current withdrawal amount and (2) the current portfolio value. With those two numbers, you can calculate the next year’s withdrawal amount in a way that is simple to compute but still buffers your retirement income against wild fluctuations in the market.