Early retirees may be ‘cheating themselves’ by withdrawing less money, says the expert behind the 4% rule. Nailing the right rate

That’s above the historical average of 16 and close to levels only seen during the dot-com bubble of the late 1990s. Higher valuations generally predict lower future returns, suggesting caution for those retiring today. Conversely, retirees who begin withdrawals when ratings are moderate or low can historically use safely higher withdrawal rates.

Inflation trends are important. Rapidly rising costs erode purchasing power, potentially forcing retirees to withdraw more or cut spending. Current inflation, at 2.8%, remains above the Federal Reserve’s 2% target, according to the Federal Reserve Bank of St. Louis (3). Early retirees should monitor inflation closely, as persistently high inflation favors more conservative early withdrawals.

Interest rates and bond yields. Benzene’s updated research has the portfolio holding 45% bonds and 5% cash (1). When bond yields are high, that portion generates more income, supporting higher overall withdrawal rates. But when yields are depressed, retirees may need to draw more carefully.

Currently, yields have normalized from their pandemic-era lows but remain below historical averages, creating a moderately supportive environment for exports.

The order of return risk. The sequence of investment returns is very important. Strong returns early in retirement create a cushion, allowing higher withdrawals. Poor returns in the first few years can create a portfolio “hole” that can be difficult to recover from.

This uncertainty means retirees should reassess withdrawal rates regularly rather than set it once and forget it.

Flexibility works in favor of early retirees. Unlike traditional retirees who may have fixed expenses and limited ability to return to work, early retirees often have more options. For example:

• You can reduce discretionary spending during market downturns.

• You can earn income from consulting, part-time work or side projects if needed.

• You can reduce your living conditions if necessary.

The more flexible your spending is and the more options you maintain, the more aggressive you can be with initial withdrawal rates, because you have options if conditions deteriorate.

For early retirees questioning whether their withdrawals are too conservative, Benzene’s research suggests asking these key questions:

• 1. What was the market valuation when you retired? If withdrawals begin when stocks are overvalued or undervalued, you may have more room than you think.

• 2. How has your portfolio performed in early retirement? Strong early returns can build a cushion. If your first few years provide above-average benefits, you may be unnecessarily restricted in spending.

• 3. How flexible are your expenses? If you can cut 20 to 30% of expenses during downturns, you can afford higher basic withdrawals.

• 4. What is your earning potential? Early retirees with marketable skills and the occasional desire to earn income can withdraw more aggressively than those without a backup plan.

• 5. How is your health and family longevity? A 45-year-old retiree in excellent health with a family history of longevity should plan more conservatively than a 55-year-old retiree with significant health challenges.

Early retirement requires planning for a longer time horizon. Although not fun to consider, realistic longevity expectations are another important factor to consider for early retirees.

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CNBC (1); Master Focus (2); Federal Reserve Bank of St. Louis (3)

This article provides information only and should not be construed as advice. It is provided without warranty of any kind.