This strategy can be very simple or very complicated, depending on the unique needs of the investor. A simple hypothetical example would be a person who has $200,000 and wants to spend $5,000 a year for 10 years and after those 10 years, be back to having $200,000. So they might set $50,000 in a bank savings account and take $5,000 a year from that account. But what should they do with the other $150,000?
With the other $150,000 they would need to find something with a a goal of generating 2.88% a year for 10 years. If they found an investment that could potentially do that they would be back to $200,000 after the 10 years has passed. As the name implied, they spent some money and completely replaced it.
The strategy can get more complex if need be to accommodate various income needs at different points in time. For example, you may need $5,000 for 3 years then $10,000 for the next 3 years then need $0 for 2 years. Using various Time Value of Money calculators you could craft a strategy to help meet those spending needs and replace that money by a later point in time.
Some people may prefer to use lower investment risk vehicles like CDs, Government Bonds or Fixed Annuities. While others may use investments that carry additional market risk knowing they might not replace what they have spent but they are taking that risk in hopes of maybe having more. There are many types of hypothetical scenarios I could come up with but hopefully you have general sense of the ‘spend and replace’ strategy.