The Vanguard Dynamic Spending Rule: A Closer Look at Its Pros and Cons
Retiring comfortably is a dream shared by many. A key component of achieving this dream is understanding how to sustainably withdraw funds from your retirement nest egg. One popular approach is the "Spending Rule," and Vanguard’s Dynamic Spending Rule is gaining traction as a sophisticated alternative to more traditional methods. Let’s dive into its pros and cons.
What is the Vanguard Dynamic Spending Rule?
The Vanguard Dynamic Spending Rule is a withdrawal strategy designed to provide a sustainable income stream during retirement, while also adapting to market fluctuations. Unlike the "4% rule," which suggests withdrawing 4% of your portfolio annually, adjusted for inflation, the Dynamic Spending Rule dynamically adjusts withdrawals based on the portfolio’s current value.
Here’s a simplified breakdown:
- Initial Withdrawal Rate: You start with a reasonable initial withdrawal rate, often based on your specific financial situation and risk tolerance.
- Annual Adjustment: Each year, the withdrawal amount is adjusted based on two factors:
- Inflation: Similar to the 4% rule, your withdrawal is adjusted to maintain your purchasing power.
- Portfolio Performance: This is the key difference. If your portfolio performs well, your withdrawal increases slightly. Conversely, if your portfolio performs poorly, your withdrawal decreases, helping to preserve capital.
- Guardrails: To prevent drastic fluctuations in withdrawal amounts, the rule incorporates guardrails, placing upper and lower limits on how much withdrawals can change from year to year.
Pros of the Vanguard Dynamic Spending Rule:
- Increased Sustainability: By adjusting withdrawals based on market performance, the Dynamic Spending Rule aims to increase the longevity of your retirement savings. It’s designed to be more adaptive than fixed-percentage withdrawal strategies, reducing the risk of running out of money during long bear markets.
- Potential for Higher Withdrawals in Good Times: When the market performs well, retirees can potentially enjoy larger withdrawals, allowing them to enhance their lifestyle during favorable economic conditions.
- Flexibility: The rule allows for some level of customization. The initial withdrawal rate, the guardrail percentages, and even the portfolio asset allocation can be adjusted to match individual circumstances and risk tolerance.
- Mitigation of Sequence of Returns Risk: The Dynamic Spending Rule can help mitigate the "sequence of returns risk," which refers to the impact of negative returns early in retirement. By reducing withdrawals after poor market performance, the rule helps to preserve the portfolio and improve its long-term prospects.
- Psychological Benefit: Knowing that your withdrawals are adjusted based on market realities can provide peace of mind and reduce anxiety about outliving your savings.
Cons of the Vanguard Dynamic Spending Rule:
- Potential for Reduced Withdrawals in Down Markets: The downside of adaptability is that withdrawals can decrease during periods of market decline. This can be challenging for retirees who rely heavily on their retirement income and may need to adjust their spending habits.
- Complexity: The Dynamic Spending Rule is more complex than simpler withdrawal strategies like the 4% rule. Understanding how the adjustments are calculated and how the guardrails work can be daunting for some retirees.
- Requires Ongoing Monitoring: The Dynamic Spending Rule requires regular monitoring of your portfolio’s performance and annual adjustments to your withdrawal amount. This can be time-consuming and may require the assistance of a financial advisor.
- Still Not Guaranteeing Success: While the Dynamic Spending Rule is designed to be more sustainable than fixed-percentage rules, it’s still not a guaranteed solution. Unforeseen expenses, significant healthcare costs, or prolonged market downturns can still impact the longevity of your retirement savings.
- Potential for Overspending in Bull Markets: While the guardrails are meant to prevent excessive spending, strong market performance could still lead to increased withdrawals that may not be sustainable in the long run.
Is the Vanguard Dynamic Spending Rule Right for You?
The Vanguard Dynamic Spending Rule is a sophisticated withdrawal strategy that can be beneficial for retirees who:
- Are comfortable with some level of complexity.
- Are willing to adjust their spending habits based on market performance.
- Seek a more sustainable withdrawal strategy than fixed-percentage rules.
- Prefer a strategy that allows for potentially higher withdrawals during good market periods.
However, it might not be suitable for retirees who:
- Prefer a simpler, more predictable withdrawal strategy.
- Are heavily reliant on a fixed income stream and cannot tolerate reductions in withdrawals.
- Are uncomfortable with managing their finances and prefer a hands-off approach.
Conclusion:
The Vanguard Dynamic Spending Rule offers a more dynamic and potentially sustainable approach to retirement withdrawals compared to traditional fixed-percentage rules. However, it’s crucial to understand its complexities, potential drawbacks, and whether it aligns with your individual financial situation, risk tolerance, and spending needs. Before implementing this strategy, consulting with a qualified financial advisor is highly recommended. They can help you assess its suitability and tailor the parameters to your specific circumstances, ensuring a comfortable and financially secure retirement.
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Why does a 5% withdrawal rate take a 1M portfolio down to 950K? What if the portfolio was generating income? If the portfolio earned 5% wouldn't the principal still be 1M?
Has anyone just tried to strategy of "just wing it"? It would be impossible to copy, but would be an interesting thing to try.
To be fair, I would think most people, if they see a huge market crash that returns -10% a year, they might forget about the floor number and just withdraw way below that just in case. Remember, these people are cheapskates, that's why they're in this situation to begin with!
Wouldn't it be easier to just have a spreadsheet telling you at what market return withdraw what percentage? For example if market does over 14%, withdraw 6%, If it's between 5 and 14, withdraw 5% and if it's anything below 5% withdraw 3% for example? So you just check which of the three levels the market has returned and you see if you withdraw 6, 5 or 3. Easy. You can just add levels as well, I prefer four levels. And the best part is, you can change the numbers around.
FI Calc is top! Thanks for showing this tool, it's a game changer!!!
The 60’s were not that bad, more people had a pension and relied less on savings
4 years into retirement. Age 70. Videos very helpful. Thanks.
13:30 “All of these calculations” took, what, three minutes? Once a year? It is really that onerous?
Having trouble accessing this on the Vanguard site. They advise that this is not a free service and only available through a paid advisor! Not what I was looking for
It sounds like it would only take 5-10 minutes a year to utilize this system. Not too bad if it gives you a potentially higher spend rate.
The thing I can’t seem to wrap my mind around is how ANY of these spending rules mesh with the “retirement smile” and the fact BlackRock’s recent survey shows most retirees have 80% of their nest egg remaining after 20 years of spending. Choosing a set in-stone withdrawal strategy seems to point to a failed retirement enjoyment result.
Don't see the value in Fi Calc since it doesn't calculate against expenses.
Does this FICalc program actually output a scheduled yearly withdrawal amount based on the inputs provided? I see that it measures the chances of success against a number of historical periods, but is there a schedule of "recommended" annual withdrawals based on all the input parameters? I'm struggling with understanding the output results.
BTW, if you made a video ob this aspect of the calculator, I'd be forever grateful, as I've tried to find answers to this question. I'm assuming the calculator does not expect the user to manually calculate the annual withdrawals themselves OUTSIDE of the calculator???
Many Thanks….your videos are INCREDIBLY useful for an investment noob like me!
Barry.
I think the Vanguard Dynamic Spending rule is the best you going to get especially if you value making the most of all your money (not leaving it behind when you leave the planet). I think the analysis at the end is a little deceptive. Look at the difference between the median spend of the VDS and the percent of portfolio median. Or look at the average spend between '75 and '85. The VDS recognises that the percentage of portfolio rule is the way to go, but you don't have to panic if the market drops, you can work you way down.
Interesting video, the result of which is that I compared in my retirement spreadsheet the Guyton Klinger annual withdrawal method that I have been using with the Vanguard method you mention in this video.
I was quite surprised with the difference in annual withdrawal amount calculated by each method, this starting in calendar year 2021 which is the start of a high inflation and limited market growth or even decline period.
The Vanguard method appears to enable much higher annual withdrawals in recent years compared to G-K because it automatically applies inflation to the previous year withdrawal amount and thereafter calculates the 5% ceiling/ 2.5% floor values and even with a portfolio loss the next annual withdrawal amount becomes the calculated "high inflation floor".
The G-K withdrawal method which also has upper and lower guardrails seems to me to be more pragmatic because it only allows an annual withdrawal inflation increase if there has been an increase in portfolio value since the previous annual withdrawal. There are different G-K examples online as to whether the increase in portfolio value is nominal or real the latter being a higher than inflation increase, so to be on the safe side I use a real increase.
I am much more confident in the G-K methodology as it uses historical data as well as monte carlo simulation, and so will stick with the G-K withdrawal method.
Thanks again for your video and the factual demonstration of data within.
@Rob Berger nice job.
Fantastic video. Thanks for the information. I am a Vanguard customer and was wondering how this really worked. You mentioned it’s not a strategy you would use. What strategy would you use?
Greetings from Malaysia. Thank you Rob, love your video and analysis So insightful and inspiring and beneficial. 🙂
Thank you for explaining this. Your examples were very helpful.
This is a great analysis, I've watched a number of other videos on this subject and this is the clearest by far. It's really important to see how much spending can actually drop by. As in many cases that are "successful" in not running out of money they're not really successful as a retirement plan as the spending is cut by so much. Thanks for the thorough explanation
I think the Guyton/Klinger withdrawal rate rules deserve a look. I see mention of it in the comments. Jonathan Guyton did an interview in July 2020 on Morningstar's The Long view and explained his process and the application of it to retirement portfolios. Well worth the time.
Hey Rob, question about 401k contributions here. I want to get my contribution into a total market or S&P 500 fund, but all of my options look like they require minimums to invest (i.e. $3,000 minimum for the vangaurd funds). The only ones that don't are the fidelity target date funds for 2060, but I don't care for them (especially seeing their performance the last 8 years). Can I contribute to the S&P 500 with my monthly contribution of much less than $3000?
Very helpful video. Thank you for posting.
Rob: Today I came across the FINRA Fund Analyzer. It looks like an interesting tool – I've only spent a few minutes using it so far. Perhaps it is worth is worth a review in a future video.
What about taking social security into account? If my spend if $50k per year and my SS is 36k a year…
Interesting review. We’re Vanguard account holders. In 2019-21 we were careful to stay disciplined not to over spend when the market was exploding. Then 2022 took us all the way back to Jan 2019. The system generally worked but we were blindsided by the steep decline n bonds. It’s been unsettling.
Would I spend my dividends and then also do this calculation, or do I have to reinvest my dividends and then do the calculation?
It seems to me that we have lots of methods and “rules”. In essence all of the methods described use a dynamic approach of some type. Rebalancing your portfolio, is a dynamic strategy, to lower risk. So is the bucket strategy or the guardrail strategy.
I think the ABW (Amortization Based Withdrawal) that I found on the Boglehead's forum is the best for me and really easy to comprehend too.
Hi Rob, great video and really useful. Are you planning to do a video on Michael McClung retirement strategy? It looks good to me but would value seeing you break it down. Thanks Spencer
Rob, would you talk about Equal Weight indexes such as RSP in a future video? I can see that it outperforms the market cap weighted index and seems to be less volatile.
Interesting
We have been trying to understand the Vanguard Dynamic Spending rule since I began using them as a Personal Advisor a few year now. None of their advisor's has been able to explain it clear enough to me. Thank you for your examples on the this and your teaching it in a clear manner.
Rob, I prefer to adjust monthly to the balance of my portfolio. I hate making an assumption of a fixed monthly withdrawal based on what you ended the year with.
Great video, Rob. Appreciate the demo of FICalc and your analysis.
When is that tax software video coming out? I can't wait.
Nice job today Rob.
Rob: This was so incredibly helpful. I hope you’ll keep doing more videos like this where you show the math and also the charts and how to use the retirement calculators. In this case, having you discuss and compare the different retirement draw down strategies while doing that was immensely helpful. Cheers!!
I like the V D S it's easy and simple to implement but, the 4% rule is better and easier & might beat out the VDS ?
Great job explaining this concept. The $1M portfolio examples always go a long way in clearing up concepts.
Very interesting, thanks Rob!
I think as a modeling strategy this is good. In general if the stock market is down you are probably going to be looking at your budget to cut corners, and when the market is high you are going to be more carefree in your spending. One aspect that bothers me about all of these analysis is that it assumes that inflation is increasing at a continuous rate when in fact it should be treated statistically just like the other parameters. Over time your property taxes might be tracking inflation, but most years it may not change much. Same for other factors, costs can go up and down while they are statistically likely to increase. This can be important because if we have a few years of high inflation that are correlated with bad market performance then that is where we really need to tighten our belts, but if inflation and the markets are increasing together, then the risks are obviously reduced. In the end we need to stress test our plan, but as we execute our plan we need to continuously reevaluate our situation. What was my inflation this year. If it wasn't so much, no need to withdraw more just because it was part of the model we used to estimate our risks.
Good video! What would say are the advantages & disadvantages of the Vanguard approach versus Guyton's Guardrails?
So helpful as always, Professor Berger. After looking at all these different strategies, it seems like the best one is (1) starting with a conservative withdrawal rate (like 3%) if you can afford to and (2) using some common sense, informed by a good retirement planner like New Retirement, to see if you need to pare back spending. These strategies also need to account for the gap years between retirement and Social Security (62 to 70). Mike Piper has an interesting plan for that, involving setting aside money from the rest of your portfolio. And then there is the idea of setting aside some money from your portfolio to anticipate long-term care needs. Good luck, average retiree!
Excellent session! None of these formulas are hard core rules, but this suits a LOT of things I have been noodling over (in my head) and starts applying benchmarks
I think mixing this up with Retirment Manifesto’s idea of adjusting the ceiling and floor, based on just how big the market fluctuates each year, would get even closer… I guess I’m making it even more convoluted.
I’m all in on doing the homework each year .. I speak excel. Once you reach RMD age, you have tokeep track of these things, anyway.
Speaking of floors, your 2.5% might not meet the RMD requirements … I would make the floor the RMD minimum requirement. If you are not yet RMD age, make sure your floor is less than the RMD requirement.
Great analysis Rob. One question I have about FiCalc is that spending seems off if you have an inflation adjusted pension. Let's say you currently have a 30K pension, wouldn't that mean spending would never be below 30K. I'm getting minimum spending below that figure. How does this work?
interesting, I can see how people that like to do math would follow this! I expect to retire this year, wife already retired. I think we'll do something simple like take 4%, if market was good increase $10k, market bad subtract $10k. soc sec will provide $50k base anyway.
When do adjust for inflation?
80k subscribers, congratulations Rob!