Root Ready
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Root Ready
Keys to Nailing Withdrawal Rate Conversation with Clients
Today’s episode goes beyond the 4% rule to uncover the real concerns behind client questions like, “How much can I safely spend in retirement?” We explore the origins of sustainable withdrawal strategies, from Bengen’s 1994 research to Guyton’s Guardrails, and show how dynamic approaches can ease anxiety and build confidence. Most clients aren’t overspending—they’re underspending out of fear. Learn how to communicate the why behind the numbers and help clients make empowered, informed choices.
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The strategies discussed may not be appropriate for all viewers. Hypothetical examples based on historical research are for illustration only and do not guarantee future results. All investing involves risk, including the potential loss of principal.
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Welcome back to another episode of the Root Ready Podcast. I'm your host, james Canole. Today we're going to have another episode that's a bit more technical based. Last episode we talked about Roth conversions and how to properly and most effectively explain them to clients and why we would do it. Today we're going to do the same thing with withdrawal rates helping clients understand how much they can spend, and not just through the tired talking points that too many advisors use when they talk about what is a sustainable withdrawal rate, but actually getting to the fundamental core issue, the core principle of why do these rates exist, why do these spending rates exist and how can we instill confidence in our clients as we explain the rationale behind our recommendations for what that can look like.
Speaker 1:So let's jump into an example. A client comes to you and says how much can I spend for my portfolio? I'm feeling a little bit on edge about am I going to outspend my portfolio assets? Am I going to run out of money? How much can I spend? If you jump right into well, the software says you can spend this. It's the wrong answer. If you jump right into well, 4%, because you know we're going to assume that your portfolio grows by 7% per year. You take out 4% per year and reinvest the remaining 3%. Wrong answer. And again, technically these answers are not incorrect.
Speaker 1:But the reason I hope that you're listening to this podcast, the reason I'm doing this podcast, is to help growth-minded advisors become the best advisors they can be, and that means both possessing a mastery of technical planning concepts as well as mastering the ability to communicate that to a client in a way that instills confidence and, most importantly, communicates it to a client understanding the. That instills confidence and, most importantly, communicates it to a client understanding the question behind the question that the client is actually asking. So I'm going to get some nuances here, because sometimes this can be overkill if you answer in the way I'm going to walk through, and sometimes it's not overkill, but I'm going to start by walking through. How should you be approaching this? And, by the way, as you're listening, if you want to ask a question for me to answer in a future episode, go to therootreadypodcastcom, submit a question and you can submit something there to be answered on a future episode. So one of the things that I mentioned on episode number two of this podcast was we're going to go over the standards, the skill sets, the ways of working that we promote internally at Root Financial. To say this is what it means to be a root-ready advisor, to provide the best possible advice to clients, and one of the pillars of advisor excellence that we adhere to is that a root advisor does not rely upon software to make decisions, but knows how to use it as a tool when needed. This is a perfect example of this.
Speaker 1:So many advisors, too often, are relying on software to tell clients how much can you spend from your portfolio? The answer is well, let me see what the software says. Let me plug in the numbers. What does the software tell us? You are now making the software the advisor, and that is not why the client hired you. You, as the advisor, need to have the deep technical understanding of why these withdrawal rates work, specifically to what we're talking about today, and, again, the ability to communicate that in an effective way.
Speaker 1:Here's why, if we just take a look at a common answer that advisors give of, why can you spend 4% per year? And, by the way, with 4%, there's nothing magical about that and we'll walk through the way. I like to talk about this, but I use that 4% rule as a foundation for everything that I do talk to with clients and show them where it comes from. But if you're talking to a client and they're just curious, how much can I spend, and you say 4%, no big deal, that's very different than if a client's coming to you because the market's down 20%, 30%. If you say, well, you're just gonna grow by 7% on average, take out 4% and reinvest the three to keep up the inflation, they're gonna look at you and say, james, what do you mean? We're not growing by 7% on average. That's not actually happening. Sure, that makes sense when times are good, but that's not the case right now. That's not happening. So, as the client, they're not going to have a ton of confidence in that explanation if you're given that same answer when things are not going well. And, by the way, our value as an advisor is highest when things are not going well. So we need to be prepared to have a better answer in times like that. So I'm going to walk through a brief overview of what this 4% rule actually is and if you haven't done so already, if you're an advisor listening, you've not read the white paper that laid out the foundations of the 4% rule. Go read it.
Speaker 1:I don't think that this is the perfect way to approach things with clients. This white paper was written in 1994, so a lot has obviously changed in terms of how this has evolved. But it's the foundational research, in my opinion, that leads us as advisors to be able to, with confidence, tell clients that they can spend a certain amount of money in retirement. Because the reality is we have no idea what the future is gonna hold. We have no idea if our client's gonna retire and they're gonna have wonderful years for the first few years of retirement, or if they're gonna have horrible years for the first few years of retirement. So the reason this 4% rule white paper and, by the way, I'm gonna link to it in the show notes here if you want a quick access the reason this is so impactful is this doesn what if everything's fine and dandy? What if you average 7, 8, 9% per year in retirement? What can you spend? That's easy. If all the market did was go up, you wouldn't have much need for an in-depth understanding of how do withdrawal rates need to work, both in good times and in bad times. But what I love about this paper and the thing that you can take away for your clients is when clients come to you concerned about what does this mean, how much can I spend? You can answer them in a very confident way and say look, I'm not concerned about how much can you spend when times are good. Of course, you can spend 4%, 5%, 6%, even more if times always were good, but what I know as your advisor is we need to prepare for when times aren't good, because if you're looking at a 20, 25, 30 year retirement, there are going to be many, many years where times are not good, and my biggest concern for you is what do we do then? Now, here's why I feel so confident in this withdrawal rate that we're looking at here.
Speaker 1:There's research done by a guy named Bill Bangan. He wrote this white paper that essentially studied what would it look like for a 30-year retirement, what's the highest possible withdrawal rate that you could have, and he made some assumptions about how much would you have in stocks versus bonds. But based upon that, he was trying to solve for what's the highest amount you could spend from your portfolio without running a serious risk of running out of money over a 30-year retirement. Why is that so important? Well, that's important because, if you look back over the last hundred years, if you look back over the time period that he was actually looking at when doing this white paper, there were plenty of times where things were not good in the market, the most obvious of which was the Great Depression. Now, in Bill Bangan's research, he actually looked at three distinct time periods that we might categorize as worst case scenario for investors. One was 1929 to 1931, the initial years of the Great Depression. Now, believe it or not, he actually calls that the Little Dipper. Number two was the Big Dipper. These were the years from 1937 to 1941. And then, finally, the third time period that was most substantial or most important to work through in this time period was what he called the Big Bang, which was 1973 to 1974. Now, here's why those three time periods were so important, and this is how we talk to clients.
Speaker 1:Those were, as an investor, what we might consider a worst case scenario. Of course, things could always be worse. We have no idea what the future holds, but if we look back at these times 1929 and 1931, stock market was down over 60%. All the things that you plan for for your retirement are probably going out the window, you might think, if the stock market is down 60% during your first couple years of retirement? That was one time period that was included in this. In other words, we were looking at what's the most you could spend, such that you could still have your money last for 30 years into retirement, even if you were to go through a time period just like that Now, believe it or not. Even if you were to go through a time period just like that Now, believe it or not, that was not the worst case scenario.
Speaker 1:1973 to 1974 was actually worse in many cases. If you look at it. Stock returns during that time period were down about 37, 38%. But here's the kicker Inflation during that time was up over 22%. So not only was the cost of everything that you need to purchase as a retiree dramatically increasing year over year, but the portfolio, the means by which you pulled money to purchase those things, were increasing. That portfolio was declining. So worst case scenario here the cost of everything is increasing while your purchasing power is decreasing based upon the portfolio that you have.
Speaker 1:Here's the interesting thing about the Great Depression During that 1929 and 1931 time period horrible time period in the market there was actually deflation. During that stretch, inflation actually dropped by about 16%. So what we're looking at here isn't just what did the stock market do, it was the real return of your portfolio, and the real return during that time period was actually not quite as bad as the real return of 1973 to 1974 when you compare the delta or the difference between what inflation was doing and what your portfolio was doing. But if we look at these three separate time periods, what you can see is these were horrible times to be an investor the Great Depression, 1973 to 1974. And, by the way, if we go back to 1973 to 1974, paint the picture for your client. It wasn't just the stock market declining, it wasn't just inflation rising. We had an oil crisis. There was a Watergate scandal. We dropped the gold standard in 1971. The price of the dollar fell against many other major currencies. There was a whole lot of turmoil, and that's what clients fail to see.
Speaker 1:Sometimes we look at these IPS statements or we look at portfolio analytics software and say, hey, would you be okay with a portfolio that might decline 20% or 30% when everything seems to be going well? Of course clients say, yeah, of course I'd be okay with that. Of course I'd be okay with that if it means I get great long-term results. But then times come, then things actually happen. And when the stock market is down 20% or 30%, it's not happening in isolation. It's happening because of a tremendous amount of uncertainty externally. And that's what we fail to grasp, or that's what clients fail to grasp, and what we as advisors sometimes fail to paint the appropriate picture for is you're never just going to be down 20% or 30%. You're going to be down 20% or 30% and have terrifying headlines all around you. So when you can help to paint this picture of look what we've gone through before. Look at the 1973 to 1974 downturn in the stock market, combined with massive inflation, combined with global uncertainty, combined with all these crazy things going on, look at 1929 to 1931. Paint the picture of what was going on there. Those were really horrible times and despite that, this 4% rule.
Speaker 1:This white paper, this study, showed that if you started with your portfolio, even if you retired right in those years, and you took 4% per year and adjusted that for inflation, you would be okay. You would be okay for at least 30 years in those instances. And that's no guarantee that something even crazier won't happen, but at least helps to reassure clients that you know what. This isn't just an arbitrary number. This isn't just 4% if everything goes well. This is 4% per year that we're looking at, expecting that. Things are gonna go poorly in the market at some point and, by the way, this is why we also want to engineer your portfolio the right way to have the right types of assets to give you optionality and flexibility of where can you draw money from in retirement. So that's step number one.
Speaker 1:Ideally, what I like to do with clients is not just say, yeah, you can take 4% per year out and stop. What I like to do is start with that as the foundation and I'll get to. When do you use this? When do you go into all this detail? Versus when do you just give a very simple answer? But start with that as a foundation.
Speaker 1:This was foundational research that helps us to understand, as retirees, as advisors, what is a withdrawal rate, such that we don't need to be overly concerned about what's to come, because we know that this withdrawal rate is low enough to be able to weather some of the storm. Here's the downturn, here's the downside. If you were to retire in a year like 1975, and you only took 4% per year out of your portfolio, you would have left a lot of money on the table. This same research shows that in 1975, just to pick an arbitrary year your portfolio that same exact portfolio could have actually sustained a withdrawal rate of closer to 7.5%. 7.5% because not of a difference in the asset allocation, but because that just happened to be a better time in the market. From 1975, the next 30 years things did pretty well on average.
Speaker 1:So as your advisor, I don't want you just to take the lower withdrawal rate to start with, because that might mean you're giving up the upside If things don't go worst case scenario, if things actually are even somewhat of a normal circumstance or even a good circumstance. So as your advisor, I want to protect against you overspending. And that's where the 4% foundational floor comes into play. Understanding that. But since then there's been some further research. There's further studies that show how can we not just protect against calamity but also protect against what I like to think of as regret.
Speaker 1:If you retire in 1975 and you have a million bucks in your portfolio and you just spend $40,000 per year, I'm not considering that a success. I know that your portfolio could have generated closer to $75,000 per year, because in retrospect I know that a 7.5% withdrawal rate was actually achievable at that point. Now the problem, of course, with that statement is I'm looking backwards. I have the benefit of hindsight to know what the forward looking 30-year return at that point would have been. Now that we're past it Today going forward from 2025 to 2055, no idea what's going to happen. But here's what we do need to do Instead of just having a static approach. There was further research that came along and said look, the 4% rule and the research around it is great, but it assumes simply you take your portfolio, put half in the S&P 500, half in intermediate-term government bonds, take 4% out, adjust that for inflation over time. Now, as a side note, bill Bang in a sense updated his research. It's more like the 4.5% rule or even higher, but I'm going to table that for a different day.
Speaker 1:Where I go to next with clients is talk about the fact that look, what if we improve upon this a bit? What if, instead of just owning the S&P and intermediate term bonds, what if we diversify a bit further? What if we own small companies, international companies, real estate, emerging markets? What if, in other words, we're giving ourselves flexibility to not have only two asset classes that we can draw from. What if, in addition to that flexibility, we didn't just blindly take out 4% per year or a certain percentage per year, but we tried to only take out the thing that had increased in value the most or, at a minimum, had decreased the least?
Speaker 1:So what I'm saying is, instead of just having two arrows in your quiver, what if we have eight, nine, ten and what that means is we have optionality of what to choose between? And instead of just drawing evenly from all of them or proportionately from all of them, what if we just choose the one that's up the most or down the least? What that's doing is protecting you, and it's protecting your portfolio, of having to sell when a certain asset class or a certain one of your investments is down most, because I can guarantee you, each of these probably, at some point, will be the underperformer. That's why we diversify. But the benefit of this approach is we can be very mindful, we can be very selective of which specific asset are we going to draw from, to prevent, in most cases at least, from selling the thing that's down the most. And then, finally, what if, in addition to doing that, we take a bit more of a dynamic approach. We don't just blindly take 4% per year and increase that for inflation. What we want to do is we want to say can we actually start that number at a higher level? Let's say, somewhere in the 5% to 5.5% range.
Speaker 1:If we start at a higher level, but we take more of a dynamic approach, what we can do is, if things are really bad, we can simply freeze inflation adjustments for some time. Meaning what we can do is, if things are really bad, we can simply freeze inflation adjustments for some time. Meaning, if you're taking out $50,000 this year, next year instead of giving you an inflation adjustment, maybe we freeze that. Things get really, really bad. We might need to take a little bit of a haircut temporarily. So instead of spending $50,000 per year, do we drop that down to something in the mid to high $40,000s, for example?
Speaker 1:But on the flip side, if things are going really well, if you were that person that retired in 1975 and you started out at a 4% withdrawal rate, how do we know at what point you can increase that? So do we essentially put guardrails on your portfolio and your spending more specifically, so that if you cross on the lower thresholds. We know it's time to shore things up. We need to freeze inflation adjustments. We need to take temporary cuts. We need to save that vacation you want to take this year. Can you maybe push that out a year or two?
Speaker 1:But on the flip side, if your portfolio is growing and growing and growing and your spending is not going to keep up with that, I, as your advisor, I'm going to come along and recommend to you can we spend more? And so, just to back up a bit here, what you're doing with clients is you're helping to paint a picture that here's the foundations. Here's the foundations of how much we might be able to spend to protect against the risk of overspending and running out of money. That's where the 4% rule comes in. That's step one. Number two you're putting guardrails around this.
Speaker 1:This is research done by Jonathan Guyton and William Klinger, essentially saying how do we not just protect against worst case scenario, but I also want to protect against what if you're underspending? What if you're that person in 1975 that could have spent 7.5% per year but instead chose to spend 4% per year because you didn't know that you could spend any more? On a million dollar portfolio, that's an extra $35,000 per year. I'm talking to my client. I'm not just saying $35,000 per year. I'm asking them what else could you do if you knew that you could have another $35,000 per year, adjusted for inflation, every year in retirement? What does that mean for the extra trips that you could take? What does that mean with the extra family support you could give? What does that mean for the extra charitable giving you could now do? That is not immaterial. So I, as your advisor, want to make sure that we are protecting against the downside, but we are also making sure that you have full permission to spend an amount that's not going to jeopardize your long-term ability to stay retired but is also fully allowing you to utilize these assets you've worked so hard for.
Speaker 1:So I'm going to put a link to each of these in the show notes. If you're an advisor, in my opinion, this should be required reading. The 4% rule the white paper is not actually called the 4% rule. It's called determining withdrawal rates using historical data. I'll put a link to the PDF there. The Guyton's guardrails approach it's not just called Guyton's guardrails and it's Jonathan Guyton and William Klinger. The paper is actually called Decision Rules and Maximizing Initial Withdrawal Rates. That should be required reading. That is so much more effective if you can understand that, if you can internalize that and if you can communicate that effectively to clients than just saying, yeah, we expect your portfolio to grow by 7% per year, so you can probably spend four and just be fine. Now here's the final step.
Speaker 1:Sometimes the answer I just gave is absolutely completely overkill. The clients can be sitting there saying, james, chill out a bit. I just asked you a simple question how much can I spend for my portfolio? I did not need that 10 minute monologue. In other cases the clients can say, okay, now I do feel much more confident in my spending because I have a foundational understanding of where is your recommendation and your guidance coming from. Here's how to discern the difference. Number one you just got to get reps in as an advisor. You're going to start to be able to tell when is a simple answer appropriate and when is a more in-depth answer appropriate. But, generally speaking, when I would give a more in-depth answer is when I can tell the question is really not a question and it's more a concern that's coming to light. The clients may be questioning can I really keep spending this much, typically because the market's down or typically because they're spending more than they thought that they would. So try to gauge where your client's coming from and I'll give you a perfect example of how this played out.
Speaker 1:A couple of years ago, when I was speaking to the client, there was a client. He was retired. He had about a million dollars in his portfolio. He and his wife did. He and I were having a conversation. They had been retired for a couple of years. They're fully living on social security and rental income that they had coming in. They had not touched their portfolio in the first two, three years of retirement. Expenses started to go up. They had moved, they had some additional expenses and he called me fairly concerned because he had a shortfall about $500 to $1,000 per month and he did not know where it was going to come from. Now you and I can look at that and say someone with a million dollars in their portfolio with a $500, $1,000 monthly shortfall, that's no issue.
Speaker 1:But as a client, the reason they're hiring us sometimes is to make sense of all the complexity in their financial lives. And as obvious as this might sound to us, it's not always immediately obvious to a client, and so he's having some concerns of where do I pull this money from? I don't want to drain my portfolio. I don't want to spend that down. I need that to last for another 30 years. They had just recently retired.
Speaker 1:Now if I had just told my client you know what, let's get off the phone and hop on a Zoom call and let me show you your financial projections I would have shown him his financial projections and they were totally good. But that would not have hit upon his actual concern. Because when a client is looking at these projections, it's a whole bunch of variables all commingled into one output. So he didn't know are these projections assuming I get a certain rate of growth, a certain rate of return? Are these projections assuming I spend a certain amount? Are these projections assume there wasn't one single standout thing that showed him why these projections were working so well? So if you remember back to your algebra class, there's a principle called isolate the variable. When you have all these variables working in tandem, sometimes it's hard for people to understand which of these variables is most impactful to this outcome that we're looking at for a client.
Speaker 1:So in that moment, talking to this client, I, as his advisor, could isolate the variable that I knew gave me confidence that he could spend that extra $500 to $1,000 per month. That variable was his portfolio. Now, yes, this sounds obvious again to all of us. Probably we've done this, but to him this wasn't immediately obvious and if I just showed him a projection and a plan, he would have had no idea. That wouldn't have instilled confidence that he can spend more because of his portfolio. He would have just thought that's a collection of a whole bunch of different things. So when I walked him through this, in a very abbreviated version of what we did here of here's how confident I am in terms of the income that your portfolio could create, not just because of some rule of thumb, not just because of whatever the reason is, but because this is research that shows whatever comes, whatever has come. I should say, obviously we can't predict the future, and that's a big disclaimer. I tell the clients anything could happen and we'll adjust if it does, but based upon all that, your portfolio could actually sustainably support about $40,000 to $50,000 per year.
Speaker 1:The final step was then connecting this to his spending. I then told him if you're spending $1,000 per month, that's $12,000 per year On a portfolio of about $1 million, that's a 1.2% withdrawal rate each year. In other words, even if you start taking this, you could take double, triple, quadruple that amount before I would actually have any concerns about you being on a path to potentially run out of money. Now that might sound absurdly simple to a lot of you listening, but I could sense, even just over a phone call, a tremendous weight lifted off his shoulders Because here he was living on social security, living on rental income, having no idea really what could this portfolio do for him.
Speaker 1:He had been told before but he hadn't internalized it Like we as advisors internalize this stuff. Told before but he hadn't internalized it Like we as advisors internalize this stuff, so isolating the variable, I could tell what his core concern was. It was how much could his portfolio actually support, not just in good times but in bad times too? So by understanding that, by understanding the true concern and then walking him through this why behind? Why do I believe you can spend this amount gave him a ton of confidence and we walked away from that. Call him being totally content, totally happy, totally confident that they could take that out.
Speaker 1:And my actual recommendation was to take more. My actual recommendation was to say look, even by doing this, you are still spending far less than your portfolio could support. So that is our job as advisors If we want to be the best advisor we can be. It's understand what is the core concern behind your client's question. We, as advisors the need to have mastered these technical elements of being a good financial planner In this case is withdrawal rates, what research is based upon? The 4% rule, the guidance guardrails, these things that we hear about.
Speaker 1:Know it, internalize it and then know when to and how to communicate that as effectively as possible to your clients, and in doing so, you're going to build better relationships. You're going and in doing so you're going to build better relationships You're going to create, ideally, better outcomes and you're going to be a better advisor. So that's it for today's episode of the Root Ready Podcast. Like I said at the beginning, if you have a question you would like to have answered on a future podcast, go to the rootreadypodcastcom. Submit a question In the meantime. Thank you all for listening and I'll see you next time.