A withdrawal strategy that attaches your withdrawals to the balance of your portfolio by always taking a percentage of your current portfolio balance. There is more volatility, but it also allows you to reap the rewards of a growing portfolio.
The magnet strategy always basis your yearly withdrawals by a percentage of your current portfolio balance.
Other strategies only attach your withdrawals to your balance in the first years, but the Magnet Strategy, attaches the withdrawals to your balance in each year.
In other words, your withdrawals are always magnetized to your current balance at the time of withdrawal each year.
So, if your initial balance is $1,000,000 then you would withdraw 4% of that balance in year 1 for a $40,000 withdrawal. Then in year 2, if your portfolio balanced increased to $1,200,000 you would then withdraw 4% of the updated balance for a $48,000 withdrawal. But if your portfolio decreased in year 3 to $900,000 then you would withdraw 4% of the updated balance for a $36,000 withdrawal.
As you can see, there is more up and down volatility in your withdrawals, but you would also get to reap the rewards if your portfolio has a large increase.
Other strategies might not allow you to realize the rewards of an ever increasing portfolio. The Magnet Strategy prevents you from spending larger chunks of your portfolio if your portfolio is going down, but then allows you to take bigger withdrawals if your portfolio goes up.
Mathematically, you will never actually run out of money, because you can only spend, at most, 4% of your portfolio, but your withdrawal amounts could decrease if there is a long period of market downturns.
This is the strategy that most people confuse with the Four Percent Rule. To be more precise, many people actually think that the Four Percent Rule is this strategy, when in reality, the Four Percent Rule is different.
Here is the rub: The Four Percent Rule has you spend 4% of your original balance at the start of your retirement. However, come year two, you do not spend 4% of your new balance. Instead, you spend the withdrawal amount of your first year, plus inflation. In the Four Percent Rule, you only increase your withdrawals by the amount of inflation. In other words, after the first year of the Four Percent Rule, the balance amount has no bearing on the withdrawal amount.
The Magnet Strategy, on the other hand, always attaches the withdrawal amount to the portfolio balance, by always taking a set percentage of the portfolio balance each year. In year 1, you would withdraw a set percentage from your balance. In year two, you would take the same set percentage of your new balance and continue to do this every year.
In summary, the Four Percent Rule takes a percent of your balance in year 1 and only changes that withdrawal amount according to inflation, regardless of your how your balance changes. The Magnet takes a percent of your balance in year 1 and changes the withdrawal amount only according to the new portfolio balance and not according to inflation.
Lets say you start with a portfolio balance of $2,500,000 and you select a 4% withdrawal rate.
Your first year would allow you to take 4% of the balance for a $100,000 withdrawal.
In your second year, instead of only adding the inflation rate to your withdrawal, you would look at your new balance to determine your new withdrawal.
If your balance increased 20% to $3,000,000 than your withdrawal amount would increase to $1,200,000.
If, in your third year, the market tanked and your balance tumbled 20% to $2,400,000 then your new withdrawal would only be $96,000.
This up and down pattern would continue. By attaching your withdrawals to your ever change balance, however, you could possibly see bigger withdrawal down the road if the market is increasing, especially if you select a lower withdrawal rate such as 3.5%, 3%, or 2.5%.
While we don't recommend this strategy for most people, it would only be worth entertaining for someone who wants to have a very tangible gauge on what their withdrawals would be in relation to their ever changing investment portfolio balance.
In order to select this strategy, you would need to be comfortable with volatile withdrawal amounts, as they have the propensity to jump up and down with market changes.
Additionally, you would need to be comfortable with the fact that it doesn't inherently track inflation, although your portfolio could end up growing at a rate higher than inflation, therefore, allowing you to actually realize withdrawal increases at a rate higher than inflation.