Using Our 7 Account Drawdown Strategy to Live Off Investments in Early Retirement
Getting to retirement is one thing. When we start our FIRE journey it’s likely the most important thing. But what about once we finally get there? People often don’t put enough thought into exactly how their retirement lives will play out in terms of specific financial strategies. But htis can’t be ignored because once we finally pass our financial finish line, the big question becomes how exactly are we going to translate our investments into a steady source of retirement income that can last us decades. Remember, with FIRE the goal is not just retiring early, but STAYING retired once you’ve left the workforce.
Like I said, one of the things that you have to do as an early retiree is figure out how you are going to live off of the assets that you’ve been accumulating throughout your FIRE journey. The drawdown strategy for FIRE may look much different than the typical retiree because your money is meant to last you for the next 30, 40 or 50+ years. At retirement typical 59+ year old retirees usually put their money into annuities, bonds, cash or CDs. Our approach as a FIRE couple, on the other hand, is much different. I mean it has to be because we need to make your investments last at least 20 years longer!
So with that in mind, let me describe, first, our investment strategy, followed up with the retirement drawdown strategy that we use and recommend!
Our 7 Account Investment Strategy
Our investment strategy is VERY simple. We basically just invest in low-cost index funds and certain sector ETFs. We also have a really small Robinhood portfolio where we invest in a few individual stocks. The majority of our investments, however, are in index funds that track the total stock market.
Personally Amon and I rely on 7 different accounts to reach our investment goals. This is what I like to refer to as our 7 Account Strategy. First is our Vanguard Pre-Retirement Brokerage Account. On top of that Amon and I each have our own Vanguard IRAs, our own 401K accounts, a joint HSA account, and 2 years worth of living expenses in CDs and cash.
I know 2 years sounds like a LOT but remember, when you’re retiring early you really have to be prepared for anything. Who knows what kinds of things might occur in the next 50 years that might require a large amount of readily accessible funds. For us specifically, we’re holding on to 2 years worth of living expenses in case of a stock market crash. Typically a stock market crash only lasts around 14 months, so we’re holding this money as a buffer in case we don’t want to withdraw from our funds during a crash when the value of those stocks will be significantly less than normal.
So we use the above 7 accounts to pay our annual expenses, which we’re able to calculate because we did the work of tracking our expenses well in advance. As I’ve already discussed in a previous post, one of the first steps in our financial journey was to establish our financial independence number, the number that we’d need to reach as a goal in order to retire early. Determining this financial independence number required us to track all our annual expenses, so if you’ve followed our steps to financial independence , you too should already be familiar with your financial independence number, and by extension, your annual expenses.
That said, your annual expenses might change once you’re actually in retirement, but the best you can do for now is estimate what your expenses will likely be and plan accordingly. Based on our estimated annual expenses, we determined that we would be able to successfully apply the 4% Rule, meaning we could withdraw 4% from our total investment portfolio and live off of that. Now i didn’t just pull this 4% rule out of thin air! It’s actually based on findings from the Trinity study, an academic study that looked at portfolios consisting of various allocations of stocks and bonds, historical market returns, and various different withdrawal rates in order to determine what the ideal drawdown rate would be.
The Trinity study shows that if you’re withdrawing 4% annually, after 30 years you will have a 100% success rate, meaning that you won’t run out of money. Interestingly, the study also allowed for a 100% success rate with a portfolio of 75% stocks and 25% bonds. So right there are two scenarios that you can pick from with confidence! That said, the study also found that the less you have in stocks and the more you have in bonds, the lower your success rate gets.
This may seem counterintuitive because stocks are inherently more risky, but what the study confirms is that you need growth from the stock market in order to sustain your portfolio because bonds and CDs have such a low growth rate that they simply can’t keep up with inflation. So, for example, if you have a portfolio of 50% stocks and 50% bonds, you would only have a 91% success rate. If you have a portfolio of 25% stocks and 75% bonds, that success rate decreases to 65% after 30 years, and with a portfolio with only bonds, that success rate drops all the way down to 0%!
The point is: you NEED GROWTH in order to sustain your portfolio and carry you through early retirement, and you can only really get that growth through the stock market. This is why Amon and I keep the majority of our investments in stocks. The stock market averages around an 8-9% return, and if your portfolio is big enough, this is likely more than enough to withdraw 4% a year and still last you decades.
Our 7 Account Retirement Drawdown Strategy
Ok, so now that I’ve covered how we invest, let me get into our 7 investment accounts and how we apply the 4% rule to them. Basically what you do is calculate 4% of the total sum of money from all 7 accounts and then draw that calculated amount out of just one, SINGLE account.
To simplify, Amon and I have broken our drawdown strategy into 2 separate phases: Phase 1- Pre-Retirement Age (before 59), and Phase 2- Retirement Age.
In Phase 1 we only withdraw money from our Vanguard Brokerage Account. Over the years we’ve invested enough into this account that we can continue to pull our 4% directly from it up until the age when we are able to access our retirement accounts penalty free. Because we’re leaving our 6 other accounts untouched while we pull from our Vanguard Brokerage account, we are able to let most of our money grow in the background and benefit from the glorious power of compound interest! Specifically, our two Roth IRAs, our two 401Ks and our HSA, all continue to grow at a significant rate through phase 1, without our needing to invest anymore money into them! In our case, we can even count on this money to double every 9 years, as per the Rule of 72 (which states that the number of years it takes for your investment to double is 72 divided by the annual rate of return).
Following this, once we’re in Phase 2, we’ll finally be able to access all that money that’s been growing in our retirement accounts. Now you guys may have to do a bit of your own research at this point because the order in which you withdraw from each account will depend on the specific tax benefits you’d get for each. In our case, we’ll likely draw from our Roth IRAs first, then our HSA, and then lastly our 401Ks. The beauty of having 7 different accounts, including both PRE-TAX and POST-TAX accounts, is that regardless of what laws change in the future you will always have multiple options available and can then make the best decisions given your future situation.
As you guys might have noticed by now, our calculations have omitted both pension and social security calculations. This is the gravy money people- a little something on top! We purposely excluded these income sources because honestly we have no idea whether these programs will even be around in 50 years!
So that’s our 7 Account Drawdown Strategy for you folks! Even if you don’t end up following it to a T, I hope I’ve given you guys some guidance on developing a drawdown strategy that works for you!
