The Safe Withdrawal Rate Solution

Peter Lynch guessed that retirees could withdraw an amount equal to the long term return of the market. Scott Burns corrected him, pointing out that prices fluctuate and selling when prices were low reduced the Safe Withdrawal Rate. It was a wonderful advance. Unfortunately, history froze at that answer. Retirees were denied a better solution. Peter Lynch, it turns out, was right. He just did not know how to accomplish his goal.

We now know that the single 4% (plus inflation) withdrawal rate number was a bad answer. At times, it has been 2%. At other times, it has been above 8%. We now know that a 30-year limitation on guaranteed income is unnecessary. We now know that earlier generations had had the right answer all along: Live on dividends and interest. Never touch principal. A few more sophisticated retirees knew to make inflation adjustments as well.

The Safe Withdrawal Rate Answer equals the real earnings power that you can buy in the form of income streams and dividends. At any instance, it should equal the long term return of stocks as indicated by valuations such as P/E10.

The key is buying income streams, including growing dividend streams and high, steady income streams. Reinvest and manage cash flows to keep up with inflation and to provide a stable, real income. I have identified two approaches along these lines. I call them the traditional income approach (as advocated by ElLobo) and the dividend blend. Readers would do well to supplement them with judicious use of long term timing (the delayed purchase approach).

Have fun.

John Walter Russell
May 11, 2009