Tag safe withdrawal rate

Growth or Yield for Retirement Income?

Paul - The Wry Eye Guy Leave a comment
Growth or Yield?

Since Jack Bogle came up with the idea, it’s been difficult to beat a market index portfolio for total return. This approach can work well over decades of saving & investing for retirement. But we can feel differently about things as we get older. After a lifetime of picking up a regular paycheque, we’d really like a regular paycheque in retirement too, eh? And if there isn’t a nice pension ready to deliver that paycheque, income investing might have appeal.

Interest rates & bond yields have declined over the past couple of decades, so not much income to be had there. Even old-fashioned dividends have declined, particularly in the US equity market, as valuations increased. Some years ago, fund companies realised the boomer retirement market was in search of bigger income streams. In response, they created covered call funds with higher distribution yields. More recently, fund creators are adding some leverage. This not only boosts the distribution yield, but it also boosts the potential to recover the some of the return that covered call writing tends to lop off. Here’s one example of how this might work …

This is a simple comparison between HYLD (Hamilton Enhanced U.S. Covered Call ETF) & VSP (Vanguard S&P 500 Index® ETF). Hamilton describes HYLD as having an “overall sector mix broadly similar to the S&P 500®”. Since it’s hedged back to the Canadian dollar, we are comparing it to VSP, from Vanguard Canada, which is also hedged. The equivalents from iShares (XSP) & BMO (ZUE) would also work for this. HYLD has only been around since February 2022, so it’s far too short a time to say how it will fare over the long-term. For this exercise, I trimmed off the first year’s performance for HYLD. Because it contained some third party funds that might have impacted performance. These were gradually replaced by Hamilton’s own funds & performance improved. Though it shortens the timeline, I think it is a fairer comparison for guesstimating what it could look like going forward.

With all dividends & distributions reinvested from March 2023 up to July 25th, 2025, the result sees VSP compounding at a shade over 21.6% annually & HYLD comes in at 20.9%. Over that time HYLD actually took the lead occasionally but, for the most part, they tracked very closely together. I think it’s fair to call it a tie. For a $100k investment, VSP would have grown to about $160.5k, while HYLD would have turned into about $158.2k. In contrast, the yield from VSP is only about 1%, while HYLD is currently throwing off almost 13%. Despite the huge difference in yield, the total return is virtually identical.

Each investing strategy brings its own unique challenges for a retiree. The “growth” investor has to decide how many shares to sell to augment the income. The “income” investor has to decide how much of the distribution should be reinvested to ensure the success of the portfolio into the future. That’s a bit of a challenge for either one, so we’ll start by paying out $1,000.00 a month. That’s a simple annual withdrawal rate of 12% based on the starting value. And, to keep pace with inflation, we’ll adjust the income stream over time. Since the annualised growth rates were over 20% for both funds, that sounds reasonably conservative, eh? With this arrangement, both funds deliver an identical income stream of just over $29k to the investors over the almost two & a half year period. After all withdrawals, HYLD has an end value of $122.2k, with $124.2k in VSP. Again, little to no difference. This is a great outcome for both investing strategies.

Along with a great monthly cheque, the other important thing here is that the remaining value of both portfolios, after all withdrawals, is well up from the original $100k invested. Using the Bank of Canada’s inflation calculator, a portfolio value of $100k at the start of 2023 would equate to a value of about $107.5k in 2025. Since both funds are well ahead of this number by the end of the comparison, that bodes well. In fact, we could have started with a $1,400.00 dollar monthly withdrawal & the end values of both funds would have been in line with the inflation adjusted portfolio value needed for the future. But my crystal ball was broken back in 2023, so I took a safer path! 😜
That larger withdrawal amount would have been a withdrawal rate closer to 17%. Wow!

Some huge words of caution about this example: 12% is not a typical withdrawal rate over the course of a 30 year retirement. High yield percentages can not automatically be used as a withdrawal rate either. It may be possible for a time, but we also need to keep an eye on the underlying share price. And on the trajectory of the income stream. Is it going up or down? Are we keeping up with inflation? Unfortunately, we have to plan for an uncertain future. We can’t depend on the markets delivering consistently incredible returns over a long retirement timeline. Indeed returns are very uncertain over any future timeline, long or short. Look at the total return profile of your portfolio, not just the yield. In this case, there are older S&P 500 Index® funds that can be back-tested to show how precarious retirement life can be. At times, withdrawal rates much closer to 4% were required. It will be interesting to see if some of the newer funds can do better.

There are some very good reasons that the 4% Rule (of Thumb!) was used as a baseline for evaluating retirement plans. These days, a financial planner will use some pretty sophisticated software to plot out what’s possible for a given set of circumstances & predictions. In addition, the plan may produce higher or lower income streams based on individual investor choices. Financial plans should be reviewed regularly. Each new year starts with the new return estimates. Along with age revisions (money needed for fewer years with each passing year!), revised needs & wants, etc. And, of course, the current portfolio value is now the new portfolio value for planning the rest of the retirement journey. An investor that is willing & able to tolerate large income swings from one year to another may be able to sail closer to the wind on higher withdrawals. As would a retiree with a large guaranteed income stream from pensions, for example. Without that safety net, it can be far more challenging. The superb performance of the US markets for the past decade or more might have us believing that there are unicorns & leprechauns underneath all the rainbows & sunbeams. Tread very carefully. For most of us, it’s likely worth shelling out for a professional financial planning review to see what’s possible. The good & the bad.

One last thing: regardless of which strategy you favour, it’s usually worth listening to the other point of view. I know both growth & income investors that are killing it with their chosen strategy. Then there are some that aren’t quite sure how well, or how poorly, they are doing. We can all learn something new, eh? There may even be circumstances, both data driven & psychological, that encourage using a combination of strategies to navigate retirement. It’s usually worth taking the time to see a different perspective. And it might help to Benchmark Your DIY Portfolio against one of those recommended by experts & professionals in the field. Knowing how your portfolio behaves may help with engagement during the financial planning conversion.

Happy retirement spending!

If you want to learn more about saving & investing, please check out Double Double Your Money, available at your local Amazon store.

Important – this is not investing, tax or legal advice, it is for entertainment & conversation-provoking purposes only. Data may not be accurate. Check the current & historical data carefully at any company’s or provider’s website, particularly where a specific product, stock or fund is mentioned. Opinions are my own & I regularly get things wrong, so do your own due diligence & seek professional advice before investing your money.

Safe Withdrawal Rate in Retirement

Paul - The Wry Eye Guy 2 Comments
Take Care of those Pennies!

After a lifetime of saving for retirement, spending what we’ve saved can get pretty messy. Even a flock of pros would all come up with a different, at least slightly, spending plan for each of us. We don’t want to go broke too early. But we don’t want to make our retirement miserable by not spending enough either!

While it’s not actually a rule, the so-called “4% Rule” is often used as a guideline for determining a safe withdrawal rate over a 30 year retirement timeline. The rule suggests we can take out 4% the first year of retirement & take out inflation adjusted amounts (i.e. 4% + inflation adjustment) every year thereafter. And we can do that for 30 years, with a high degree of probability that the portfolio will make it all the way to the end. Bill Bengen originally used a portfolio of US stocks & bonds to develop this strategy. In recent years, he created a more diversified portfolio that he calculates allows a higher withdrawal rate of around 5%. Other experts point to the greater capability of an all-equity portfolio to deliver improved lifelong results. And still other experts in the space present models that suggested we might have to drop down closer to a 3% withdrawal rate to ensure portfolio survival. What gives?

There are a few things to consider here. The markets, particularly the US market, have produced great returns over the past decade & a half. An investor, convinced of the strength of the US market, who retired in 2010, might be looking like an investing genius today! Since 2010, a million dollar portfolio, all invested in the SPDR S&P 500 ETF Trust (SPY), being drawn down at an inflation-adjusted rate of 4%, would have a portfolio value of over $5m today. Not a typo. Using the 4% withdrawal methodology for more than 15 years, the portfolio would still have grown to a value of over five million dollars today. This retiree could have withdrawn a whopping 12% for year one. And, even after increasing that far bigger income by inflation every year, the portfolio would still be worth almost a million bucks today. That is an amazing outcome, eh?

Yeah, it is. But we can’t always take big withdrawal rates to the bank!

Let’s jump back another 10 years & look at a retiree who quit working in 2000. Exactly the same scenario as above. This retiree also has a million dollar portfolio & starts out with a $40k withdrawal the first year, or 4%. By today, the portfolio is only worth just under $340k. Even less in inflation adjusted value. What happened to the five million bucks from the previous scenario? The lost decade, including the dot-com crash & the great financial crisis, is what happened! Early poor returns damaged the future value of the portfolio.

If this “Year 2000 retiree” had used the 12% withdrawal rate from the other example, the Year 2000 portfolio would have gone to zero by 2006. Yes … zero. Nothing left after only 6 years. This is not a good outcome. In fact, just blindly following the 4% guideline in this example would have been a cause for worry by today. And withdrawing much more than an inflation-indexed 4% would almost certainly have resulted in a portfolio that died before the investor did!

Those examples are from the past. But the big lesson is that there is no guarantee that the future will be all rainbows & sunshine. We need a plan that handles grey skies & storms too. As we progress through retirement, financial plans must be reviewed & revised on a regular basis. To account for changes in the markets & in our lives. There may be the potential to increase our income for greater enjoyment during some years. Or there may be a requirement to reduce spending, to ensure we have income to the end of our days. Flexibility may be required en route.

And that’s what makes retirement planning so challenging. Financial planning is not a set it & forget it deal. As we saw above, we can’t depend on a financial plan that was created in 2000 or 2010 delivering the same results all the way to today. Modifications along the way are warranted. Similarly, if we were to start retirement this year, it is very unlikely that a financial plan created in 2025 will see us, cleanly & smoothly, all the way to the end. Will our asset allocation selections & portfolio choices allow us to spend way more than 4% every year? Or will we get trapped in a scenario where even 4% might be too aggressive? If we don’t use the 4% Rule, how do we handle the added burden of inflation through the years? There are a few challenges there, eh!

Some investors put their trust in dividend growth portfolios to sustain a growing income stream for a lifetime. And a plethora of new high income funds are proving very popular with investors who see early retirement calling via funds with huge distributions. Can these alternatives work? Some of these new funds offer distributions of 10 or 15%, some even more than that. Imagine you need a million dollar portfolio to produce 4%, or $40k, of annual income to retire on. If you’ve only got $400k saved, how about building an ETF portfolio yielding 10% & calling it quits? This might work. Or it might not. We’ll have to look at how we might compare, & perhaps even combine, these different strategies. However, that’s a whole other bunch of numbers & I’m getting grumpy now, so we’ll leave those questions for another day.

Meantime, take care out there & make sure you have an up-to-date financial plan.

If you want to learn more about saving & investing from the ground up, I’d like to suggest that you check out Double Double Your Money, available at your local Amazon store.

Important – this is not investing, tax or legal advice, it is for entertainment & conversation-provoking purposes only. Data may not be accurate. Check the current & historical data carefully at any company’s or provider’s website, particularly where a specific product, stock or fund is mentioned. Opinions are my own & I regularly get things wrong, so do your own due diligence & seek professional advice before investing your money.