You probably think the way you're gonna pull money out of your retirement savings is a pretty normal, sensible plan. There's a good chance you're wrong. Most people default to one of a handful of different strategies without comparing them side by side first. But the thing is, the strategy you pick is what will determine the stress you carry with you every time the market drops and how much you can spend over the next 20 to 30 years of your retirement. In this video, I'm walking you through the five most common strategies I see, and I'm ranking them from my least favorite to my most favorite and showing you a framework for what might be best for you. Let's get started. First
of all, this is a personal ranking. Every single one of these strategies has a specific situation where it might be the best strategy for that situation. What I'm looking at is after working with hundreds of different people and seeing what works and what doesn't, and what's going to protect and also what's going to support the life you want to live. These are my personal favorites based upon patterns that I have seen. But the real value is not in the order, it's in understanding the benefit and the downside of each so you know which might be best for you. I've read all the white papers on all of these, so you don't have to. Let's jump in, starting with my personal least favorite
strategy. Number five is the constant percentage of portfolio balance. Now, Morningstar released a white paper where they went over this in detail. And here's what they showed. They showed that you could start by taking 5.7% of your portfolio balance as income in year one of retirement. Now that's significant. If you have a million dollars in your portfolio, you can take $57,000 from that portfolio. Now, most of us, especially when we're conditioned to thinking maybe like 4%, is more realistic as a starting point. That number sounds quite high. Here's the catch. Go back to the title of what this is called constant percentage portfolio balance. What does that mean? It means if your portfolio is up 20% the next year, your income climbs 20% the next year. If your portfolio is down 20% the next year, your income falls 20% the next year. You're taking that same percentage and applying it to whatever your portfolio balance happens to be. So here's why I really dislike this. Most people, when they're planning for retirement, they're trying to see how much do I need in my portfolio so that that portfolio hits that critical mass to where it can support the income I need from it. Usually you'll have Social Security, maybe a pension, maybe rental income, but there's some gap between what you're getting from Social Security and what you want to spend. The way you work backwards from that gap is you say, okay, how big of a portfolio do I need to be able to fill that gap consistently? So let's say that's you and you know that that gap is $57,000. Maybe you have $23,000 coming in from Social Security and you want to spend exactly $80,000 per year. Well, if you were taking this approach, once you finally hit a million dollars, you would say, I'm good. This million dollars, I can take $57,000 out per year. I can supplement that with the $23,000 per year from Social Security, and I get my $80. And here's the thing you are right until the market drops. Next year, the market drops 20% and your portfolio drops 20% with it. Well, in this scenario, your $57,000 of income will need to drop closer to $46,000 of income. Now, if you're approaching this from the standpoint of I needed that $57,000 to meet my living expenses, you can't afford an $11,000 per year decrease in your income. So this gets at the core of why I don't like this strategy. That percentage, it doesn't adjust to your life. It's not connected to your spending specifically, it's entirely focused on the portfolio.
Now, where can it work? Maybe you're that individual where all of your income needs, or at least most of your income needs, are already covered. Maybe you have a healthy pension, you have strong social security, you've got rental income. Whatever it is, your income that you already have coming in before even tapping into your portfolio, it's covering what you need to live on. So in your view, your portfolio is extra. It is excess. And you're thinking, what's the most I can spend? And if I have to cut that back every once in a while, no big deal. Well, in that case, this could be a strong option. It allows you to start by taking a higher amount than other strategies would allow for. And the cuts, they don't impact you like they would someone who needed that income to live on. That's not most people, and that's why this isn't my favorite
strategy. My fourth favorite is living off dividends alone. Now I get the appeal of this. This feels intuitive. None of us ever wants to have to sell an investment to live on it, especially knowing that at some point we're probably going to be forced to sell things that are going down in value. That is the appeal of dividend investing. You're not selling anything. Your portfolio is there, your portfolio is generating dividends, those dividends go to support your paycheck. Easy enough. But a
couple things I want to point out. First is the mechanics. Mechanically, this isn't much different than selling a share. If I own a stock and that stock is trading at $100 a share, and today that stock pays me a $3 dividend, the stock price doesn't stay at $100. It decreases to $97. Now you can make the argument that over time it tends to build back to where it was. Sure, but you're still losing that share price the day the dividend was paid. That's no different than say a pure growth stock that doesn't pay any dividends that's also trading at $100 a share. But instead, I sell $3 worth of it to create income. So functionally the same, but it feels different. Now I know there's some nuance to that. I know there's some other details, but just high level, that's the first thing to note. The
second, and more importantly, is this. If you want to diversify your portfolio, and for the sake of simplicity, let's just say owning the S P 500 is diversifying. Now it's not. You're only owning large US stocks, you're not owning small stocks, you're not owning international, you're not owning emerging markets. It's actually not diversified. But let's just use that as an example. Well, the SP 500, depending upon when you're looking at and what it's trading at, it might have a dividend yield of around 1.5% or so. So if you have a million dollars in your portfolio, you're living off $15,000 per year. It's a very low percentage of what you actually have. So what do people tend to do? They say, okay, well, I want to live on more than just one and a half percent of my portfolio. So I'm gonna own stocks that have a higher dividend yield. So what does that mean in practice? Nothing wrong with those high dividend paying stocks, but it means they start to shift their allocation from being more spread out and more diversified to say, I'm gonna own certain sectors more than others. I'm gonna start tilting to different asset classes more than others. Practically speaking, it means you're owning fewer growth stocks and you're owning things that have higher dividends. So you might own a handful of stocks, a few dozen stocks, maybe in a couple hundred stocks. But if you look high level, they're all in the same sector. They're all in the same industry, they're all in the same asset class. And all of a sudden, yes, you could look at your diversified portfolio and say it's yielding now three, four, five, six percent. But the higher that yield, the more likely it is you're concentrated in one specific sector or industry. That's not really diversified. Just having multiple positions isn't truly diversifying you. The Googles, the Apples, the Nvidia's, the Teslas, companies that aren't paying much of a dividend, or very little dividend, if at all, and they're concentrating more stocks that aren't. So you're sacrificing diversification for the sake of higher dividend yield. And that is a major recipe for disaster if you're not careful here. Now,
on the pro side, on the benefit side, one thing I will give to dividend investors is dividends typically remain very sticky, very resilient. Look at a time period in the US market, say 2000 to 2002, the US equity markets lost about half of their value in those times. Dividends on those same exact companies fell in the neighborhood of 1% to 2% on average. So if you're living on dividend yield, even if the company's stock price falls significantly, that dividend typically remains pretty resilient. Now it didn't hold up quite as well in the 2007 to 2008 market. But on average, even as stock prices are very volatile, dividends tend to remain pretty resilient and actually tend to outpace inflation in terms of how much they increase. So I do like that. But to me, dividends are one component of an income strategy. They should represent part of what you're doing. The risk to me is when that starts being all of what you're living on. You're either leaving a lot of money on the table, because to go back to my S P 500 example, you're taking a very small amount of what you otherwise could be taking from your portfolio, or you're sacrificing diversification to be overly concentrated in a handful of sectors or a handful of asset classes that give you a higher dividend yield, but don't give you the benefits of diversification. Now, one of the most important decisions you can make with your portfolio is how do you take money out of it? And by the way, this doesn't just impact how much income you can create. It will inform how you should invest, what the right tax strategy is, and other details like that. If you want to see how we tie all of this together at Root Financial to help our clients build a well-coordinated plan, check out the link in the top of the description here or check out the first pinned comment. You can watch our Sequoia system video to learn more about how we do just this
for people like you. Next is my third favorite, and this is annuities. Now, annuities get a very bad rap, and that's typically because a lot of the people selling annuities aren't really good at what they're doing, frankly. All they know is annuities, all they know is a sales pitch. And so whoever you are, an annuity is always a solution. Now, because of that, annuities get a very bad rap. And by the way, I don't sell annuities, so I'm not here to sell anything. But what I am here to say is there is a time and a place where annuities can be a very strong component of a financial plan. What you are doing is you're essentially trading some of the risk that you are naturally exposing yourself to because there is nothing that we do. There's no investment strategy, there's no withdrawal strategy that has zero risk. The only question is what risk are we more willing to accept? With annuities, we are transferring some of that risk to an insurance company in exchange for a guarantee. And yes, there are many different types of an annuity. So I don't want to generalize and say that they only do one thing, but there's plenty of research that shows annuities can have very significant financial benefits, especially for those of you that say I've got some minimum amount of income. To
me, here are the top benefits. Number one is for those of you that want to ensure some baseline level of income is guaranteed. Now, maybe you have your social security benefit, and that covers some of your core expenses that you could not get by without spending, but there's still a gap. So maybe an annuity is layered on top of that. Now, between the annuity and social security, you've got a strong floor. It covers your basics, it covers your essentials, so you're freed up to invest in a way for your discretionary expenses with the rest of your portfolio. That's a strong financial benefit. The second is psychological. There is something about just receiving that monthly paycheck that can feel really good regardless of what
the market's doing. Now, what don't I love about them? Well, I already mentioned the first thing, which is I've seen so many annuities that could have been a fine product for the right person, but they were just sold because the person selling them didn't know what to do besides pitch this thing to everyone they came into contact with. So maybe right tool, wrong situation, or wrong tool for that specific situation. And I see way too much of that. The other thing is you are trading upside. The annuity company has to make money somehow. So maybe there's no expense that you're paying for this annuity. It depends on which annuity that you have. Some have explicit expenses, some don't. Many of them, the expense is more what you're giving up on the upside. And that makes sense. The insurance company is guaranteeing this. They have a profit that they are seeking. For them to obtain that profit, they need to understand what they can do with your funds. They need to say, we'll peel off portion of that and guarantee it for you. And that excess is essentially how they are being compensated. Overly simplistic way of saying it, but that's the general point. And then the final downside, there's not much flexibility. Let's say you purchase a single premium immediate annuity. So you have $500,000, you put that in a single premium immediate annuity. And let's just say for round numbers, you get $30,000 per year. That's great. But in many cases, that's not increasing for inflation. So $30,000 per year is great this year. It's a little less great next year. It's certainly less great 10 years from now as inflation's grown. But the other thing is most of us don't have linear spending. For most of us, our spending, there's some that's consistent, but some of it's lumpy. We probably want to front load some of our spending in our early retirement years to fully enjoy them. Maybe there's bigger needs on the latter side of retirement, healthcare expenses, big one-time expenses. The annuity is great for guaranteed income, but it's not flexible income. So it can serve a purpose, but it's definitely not my favorite way to draw income in retirement. So those three are all pretty static: a fixed percentage, a fixed yield, a fixed payment. The last two are far more dynamic, and that's why I rank them
higher. My second favorite is the 4% rule. Now here's the thing. I interviewed Bill Bangin himself. Bill Bangin is the one who formulated the original white paper for the 4% rule well over 30 years ago. And he made one thing very clear when we spoke. The 4% rule is outdated. He went further in his updated research. He said, What if you spread your money out a little bit more? What if you follow a few additional rules with this? The takeaway was 4% no longer becomes a starting point. His updated findings find that that number is closer to 4.7% to low to even mid 5% range. Now think about the implications of that. If you have a million dollars in your portfolio and you're taking out 4%, that's $40,000 a year. In almost all cases, you end up with a lot of money left on the table. Keep in mind the foundation of the 4% rule was how do you make sure that even going into the worst case scenario that we've seen over the last several decades, you didn't run out of money. What does that mean? It means that for all situations that were not worst case scenario, you had maybe a good amount of money left over. So the updated findings were designed to address that at least to some degree. And what they found, if you can spend closer to 5%, that maybe seems like a small change, but that's an extra $10,000 per year adjusted for inflation that you can now spend.
So why do I like it? Well, I want to compare it to my least favorite of these strategies that we started with, which is the constant percentage portfolio balance. In that strategy, your income would vary potentially significantly year by year based upon the value of your portfolio. What's different about the 4% rule is once you have that starting draw, that starting withdrawal amount, it doesn't matter what your portfolio is doing, you can adjust that for inflation. This fits much better within the context of a financial plan. Because going back to what I said before, your financial plan, you need to have a reliable source of income. It says regardless of what the market's doing, how much can we plan to pull from this income source to supplement Social Security so we can live the life we want to live? If our income is as volatile as the market, that's not a recipe for success in retirement. The 4% rule solves for that. It says this is an amount that you can count on that can stay consistent and that can actually adjust for inflation over time. The downside is it's not fully dynamic. It doesn't build in cost of living adjustments when things are especially good. It doesn't have any downside protections to say when should you freeze adjustments? When should you even take pay cuts if things aren't as good? And it leaves a little bit on the table in terms of how much you could start your spending at.
That's why my favorite, and number one, is the guardrails approach. It takes the same concept that we just talked about with the 4% rule. But it says this if you retire in some years, you're gonna have incredible markets that you retire into. And if your spending is always kept at that same rate, but with simple inflation adjustments, there's a lot of instances where you could have spent a whole lot more. 1%, 2%, even 3% more if you're retiring into a good market. Translate that. So that there are things you want to do. Maybe they're not realistic, day one of retirement. But if we're fortunate and we have good years in front of us, can we make sure that you're the one that benefits there instead of your portfolio, just having way more balance at the end of the day when you're no longer here? So that's what a guardrails approach does. It says, let's take a more dynamic, rules-based approach that gives us rules ahead of time. For if here's our withdrawal rate today, if it ever exceeds this number on the high end or goes below this number on the low end, that triggers an adjustment. That allows you to start by spending more and it gives you a framework to make sure that you're protecting yourself when things are down and giving yourself a raise when things
are especially good. What's actually best for you depends on your full situation, and that's the exact point here. All these strategies have a place for the right person. But it depends upon your income sources, your needs, and your other goals to know which specific one is best for you. And if there's one thing you take away from all five of these, it's this a plan that can actually adjust to what happens beats a plan that just hopes for the best. And that's why I say your withdrawal strategy is just important as your portfolio balance, how much you have in your portfolio, because it's the thing that translates what you've built and what that can do for you. As I mentioned before, our Sequoia system was designed to show you just this. Of all the strategies that exist, what's right for you? It's gonna depend upon your goals, your other income sources, your tax situation, your legacy goals. All those go into determining how do you pull money out of your retirement. If you want to see more about how that works, click the first link in the description below about our Sequoia system video, or click the first pinned comment below to view our Sequoia system and how it works now. And if this was useful, the next video to watch is this called Don't Retire If This Is You.