Do you go to a doc­tor when you get sick?  Of course!  Do you take your car to the mechan­ic?  You bet!  This makes it inter­est­ing why so many peo­ple choose to act as their own finan­cial advi­sor.  Having 6 dif­fer­ent mutu­al funds might cause some­one to brag about how they are diver­si­fy­ing, or per­haps a recent retiree might say, “Well, I cal­cu­lat­ed how much I can take out of my port­fo­lio each year, you know there is a rule of thumb.”  Your retire­ment lifestyle will depend not only on your assets and invest­ment choic­es, but also on how quick­ly you draw down your retire­ment port­fo­lio.  Fig­ur­ing out an appro­pri­ate ini­tial with­draw­al rate is a key issue in retire­ment plan­ning and presents many chal­lenges that the do-it-your­selfer like­ly over­looks.

Why is your with­draw­al rate impor­tant?

Take out too much too soon, and you might run out of mon­ey in your lat­er years.  Take out too lit­tle, and you might not enjoy your retire­ment years as much as you could.  Your with­draw­al rate is espe­cial­ly impor­tant in the ear­ly years of your retire­ment; how your port­fo­lio is struc­tured then and how much you take out can have a sig­nif­i­cant impact on how long your sav­ings will last.  No longer do we work until 65 and live anoth­er 5 to 10 years.  Many peo­ple will spend near­ly ½ of their lives in retire­ment, and that is why the sim­ple math just doesn’t work.

Con­ven­tion­al wis­dom

So what with­draw­al rate should you expect from your retire­ment sav­ings? The answer: it all depends.   One study of annu­al per­for­mance of hypo­thet­i­cal port­fo­lios that are con­tin­u­al­ly rebal­anced to achieve a 50–50 mix of the S&P 500 Index and inter­me­di­ate-term Trea­sury notes found that a with­draw­al rate of slight­ly more than 4% would have pro­vid­ed infla­tion-adjust­ed income for at least 30 years.   More recent­ly, sim­i­lar assump­tions show that a high­er ini­tial with­draw­al rate–closer to 5%–might be pos­si­ble dur­ing the ear­ly, active years of retire­ment if with­drawals in lat­er years grow more slow­ly than infla­tion.  Of course, adding asset class­es such as inter­na­tion­al stocks, real estate, and com­modi­ties helped increase port­fo­lio longevi­ty, but you already know that, right?  A with­draw­al rate can be fine-tuned from year to year, but one has to start some­where to find a base to start with.  We think the best place to start is with some­thing we call Pros­per­i­ty Plan­ning®.  (Call me and we can talk more about this one.)  One retiree might be com­fort­able with a 75% chance that his or her strat­e­gy will per­mit the port­fo­lio to last through­out retire­ment; anoth­er might need assur­ance that the port­fo­lio has a 100% chance of life­time suc­cess.  Explor­ing your goals and com­fort needs should always begin before crunch­ing num­bers.

Infla­tion is a major con­sid­er­a­tion

For many peo­ple, even a 5% with­draw­al rate seems low.  To bet­ter under­stand why sug­gest­ed ini­tial with­draw­al rates aren’t high­er, it’s essen­tial to think about how infla­tion can affect your retire­ment income. Here’s a hypo­thet­i­cal illus­tra­tion; to keep it sim­ple, it does not account for the impact of any tax­es. If a $1 mil­lion port­fo­lio is invest­ed in a mon­ey mar­ket account yield­ing 5%, it pro­vides $50,000 of annu­al income.  But if annu­al infla­tion push­es prices up by 3%, more income–$51,500–would be need­ed next year to pre­serve pur­chas­ing pow­er.  I have heard the sto­ry too many times, when some­one has said “I need 5% of my mon­ey and CDs usu­al­ly get 5%.”  That’s great, but infla­tion means you need to get at least 8% if it’s going to last.  That large cash account should prob­a­bly be invest­ed in the mar­ket in at least some pro­por­tion.

Cal­cu­lat­ing an appro­pri­ate with­draw­al rate

Your with­draw­al rate needs to take into account many fac­tors:

1)     Asset Allo­ca­tion

2)     Pro­ject­ed Infla­tion rate

3)     Expect­ed rate of return

4)     Annu­al income tar­gets

5)     Time/Investment Hori­zon

6)     Com­fort with uncer­tain­ty

These are just a few, but I will let you go ahead and get start­ed with that.  All you need is a cal­cu­la­tor and a few spare days off work.  Myself, I tend not to like wan­der­ing around for a week feel­ing awful try­ing to cure an ill­ness with time and my own inge­nu­ity.  My car is prob­a­bly in much bet­ter shape since I only know how to pop the hood, check the oil, and put air in the tires.  Explor­ing our futures and retire­ment should be a fun and excit­ing process, and is far too impor­tant for guess­ing games and “rules of thumb”.  It is nev­er too ear­ly to begin prepar­ing for the future, how­ev­er; some­thing this impor­tant usu­al­ly requires a pro­fes­sion­al, so pick up the phone and call a friend, ask around town, or stop by and see us!