You will be able to choose a starting withdrawal rate and write a rule for adjusting spending in good and bad years.
Choosing a withdrawal rate is often done by borrowing one. Someone on a forum says 4% is safe, a podcast host prefers 3.5%, and a careful relative insists you should never go past 3% (all three are illustrative figures). Each of those numbers may suit the person who said it. None of them was worked out from your horizon, your costs or your spending, and a rate that works for one household can leave another short. The work below builds a starting rate from your own position, records why you chose it, turns it into a target number, and sets out in writing how your spending will move when markets go badly or well.
Set aside about twenty-five minutes. Before starting, get out three pieces of earlier work: the spending base you worked out in lesson 1.4, your notes from lesson 2.2, "Four reasons the rule may not fit you", and the draft spending rule from lesson 2.3.
On one sheet, note each of the four reasons from lesson 2.2 that fits your case, one line apiece. This becomes your downward list.
The length of time your money must last weighs more heavily than anything else on it. The research you met in lesson 2.1 tested a thirty-year period. If you plan to leave work in your forties or early fifties, your savings have to keep paying out for a good deal longer than that.
Costs belong on the list when they are high. Total your yearly fund fees and platform charges, and write down whether tax is taken off dividends from overseas holdings. A budget made up almost entirely of essentials also goes on this side, because when nearly every dollar has to be spent, a poor year gives you very little to trim.
Priya, from earlier lessons, spends S$44,000 a year (her figures throughout are invented). Three entries go on her downward list. She expects to stop working at about 50, which could mean drawing on her savings for forty years or longer. Her funds charge a little under 1% a year between them. Some of those funds own US shares, and tax is withheld on their dividends.
On a second sheet, write the upward list: the things that reduce your risk and give room for a somewhat higher rate. They are:
a sizeable portion of your spending that is flexible, backed by a written rule for trimming it CPF LIFE paying for much of your spending once you reach payout age, which means your investments bear the whole cost for only part of the plan (module 3 goes into CPF LIFE in detail) a cash buffer to draw on so you do not have to sell investments in the worst years (module 6 works out how large it should be) low costs income you expect to carry on receiving, such as rent or part-time work (module 5 covers this)
Priya's second sheet has four items. Roughly 35% of her spending, about S$15,500, is flexible, and her spending rule is already written. From her payout age, CPF LIFE should meet a large share of her costs. She also intends to keep a cash buffer.
Lay the sheets next to each other and judge which carries more weight. A downward list that is longer and heavier points to a starting rate between 3% and 3.5%. When the upward list is the stronger one, a rate near 4% is easier to justify. Going above about 4% is hard to support for almost any early retiree, since nearly all of them have the long-horizon factor on their downward list.
No study produced these ranges. They are a working device for converting your two lists into a first choice of rate.
Write your reasons for the rate underneath it. Priya settles on 3.5% and gives three: she expects to draw on her money for far longer than thirty years, her costs are near 1% and cannot be brought down quickly, and she has enough flexible spending to absorb a poor start.
To get your target number, divide your spending base by the rate expressed as a decimal. Priya's sum is S$44,000 divided by 0.035, which comes to about S$1,257,000. In lesson 2.1, "Where the 4% rule came from", she worked out a 25 times figure of S$1,100,000 and a 33 times figure of S$1,452,000, and her new target falls between the two.
The rate is a first version. Module 4 has you run it through your own model, and you check it again once you finish module 3 and again after module 7, which deals with healthcare.
An adjustment rule sets out in writing how your spending will change in good and bad years. It has three parts: what counts as a bad year, what you will cut and by how much, and what counts as a good year along with what that lets you do.
Define a bad year tightly enough that you could not talk yourself out of it when it happens. You can use either of two tests. One is a fall in the portfolio of a stated percentage over the past twelve months. The other is the portfolio being worth less, after adjusting for inflation, than it was when you started.
For the cut, the mildest choice is to forgo that year's inflation increase. A stronger choice is to reduce flexible spending by a fixed proportion.
A good year is defined by how much the portfolio has grown, together with what that growth permits. Many people let themselves have a single extra, such as a larger holiday, and leave their regular spending unchanged, since an ongoing increase is difficult to reverse.
Priya's bad year is a fall of 15% or more in her portfolio over twelve months. When that happens she forgoes the inflation increase and cuts her travel budget in half, and keeps it there until the portfolio returns to what it was worth at the start of that year. Her good year is a portfolio sitting 25% or more above its starting value after inflation, and in that case she may take one additional trip while leaving her regular spending where it was.
Both the 15% and the 25% are her own choices. Your thresholds can be your own as well, since no research is needed to set them. They need to be on paper, and you need to be able to stick to them.
Draft the rule at a time when markets are steady and so are you. Rules written in the middle of a crash tend to be responses to that crash.
Read your rule as if you were in the middle of a bad year. Is it clear what you would cut? Could you live with it for two years in a row? If not, change it now.
When you are happy with it, you have everything the activity needs: a rate, the reasons behind it, and a rule for both kinds of year.
Write down your withdrawal rate, three reasons for it, and your adjustment rule for good years and bad years.
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