Retirement from Saving to Spending
When we look at retirement planning, the big questions are: How much can I spend in retirement? How much do I need to retire on? When and how much do I draw down or ‘disinvest’ to make it stretch?
“History never repeats itself, but it rhymes”. This Mark Twain quote is often rolled out by authors wanting to use a period in history to demonstrate a point of view they hold. However, it was perhaps better observed by humourist Max Beerbohm in 1896; “History, it has been said, does not repeat itself. The historians repeat one another.”
This is worth remembering when it comes to considering financial services advice; in particular, the area of practically applying the conclusions of academic research to personal financial affairs.
Is the “4% rule” the answer?
Most people who are googling retirement planning will come across something known as the ‘4% rule’. This is indeed a good starting point. It’s a basic guideline on how much to save for retirement: 25 times (or the inverse of 4%) of what you will need in the first year of a 30-year retirement from your portfolio. The 4% rule is a rule of thumb used to determine how much a retiree should withdraw each year from their portfolio without reducing the account value. It was developed by a financial planner William Bergen in 1994 and has been used to calculate how much a retirement fund should be.
Beyond that, adapting for your own personal spending rate, based on your situation, investments and risk tolerance, and then regularly updating it is sage advice.
How do you determine your personal spending rate?
Start by asking yourself these four questions:
#1 How long do you want to plan for?
Obviously, you don’t know exactly how long you’ll live, and it’s not a question that many people want to ponder too deeply. But to get a general idea, consider your health and life expectancy; your family history may be useful, as might the most recent government data from your country. Also, consider how you feel about the possibility of outliving your assets and/or your access to other resources; for example, government pensions, private pensions or annuities.
#2 How will you invest your portfolio?
Equity holdings in retirement portfolios provide the potential for future growth and help support spending needs later in retirement. Cash and bonds can add stability and can be used to fund spending needs early in retirement. Each investment serves its own role. Generally, asset allocation has a relatively small impact on your first-year sustainable withdrawal amount, unless the portfolio allocation is very conservative. However, it has a significant impact on the portfolio’s ending asset balance.
In other words, a more aggressive asset allocation has the potential to grow more over time, but the downside is that the “bad” years tend to be worse than with a more conservative allocation.
Asset allocation can have a big impact on a portfolio’s ending balance, but it’s not just a mathematical decision. The pain of losses is often observed to be more memorable than the pleasure in gains; this effect can be magnified in retirement. It’s important to choose an allocation you’re comfortable with (especially in the event of a bear market), not just the one with the greatest possibility to increase the potential ending asset balance.
#3 Can you live with confidence that your money will last?
Think of a confidence level as the percentage of times in which the hypothetical portfolio did not run out of money, based on a variety of assumptions and projections regarding potential future market performance. For example, a 90% confidence level means that, after projecting 1,000 scenarios using varying returns for stocks and bonds, 900 of the hypothetical portfolios were left with money at the end of the designated time — anywhere from one cent to an amount more than the portfolio started with.
Targeting, say, a 90% confidence level may mean spending less in retirement; the trade-off is that you are less likely to run out of money. If you regularly revisit your plan and are flexible if conditions change, then 80% might provide confidence that you can be successful even if you manage to overspend slightly.
#4 If conditions change, can you make changes?
Research around the 4% rule assumed a rigid guideline; that is, spending didn’t change, and investments didn’t adapt as conditions changed. Useful in theory, but it has its limits. Making simple changes to spending during down markets can increase the likelihood that your money will last – like adapting the way you take a vacation. Time flexibility in retirement can be a very useful attribute.
After applying the answers to those retirement-planning questions. Some basic thoughts to keep in mind:
The bottom line
The transition from saving to spending from your investment portfolio can be a challenge; this is especially true when there are so many opinions and propositions justified by anecdotal or statistical history out there. There will never be a single “right” answer to how much you can spend from your portfolio in retirement.
What is important is to have a plan and a general guideline for spending. Then adjust it as and when necessary.
No matter, we’re quite certain that your time shouldn’t be wasted on listening to historians repeating each other …
“If you obsess over whether you are making the right decision, you are basically assuming that the universe will reward you for one thing and punish you for another.” – Deepak Chopra