Do you have enough money to retire?
Reprinted courtesy of MarketWatch.com
Published: April 23, 2014
To read the original article click here
This is one of the most-often-asked questions posed by people in their 50s and 60s. There are simplistic answers (formulas, actually) that can tell you either “no way” or “maybe” or “for sure.“
But you can’t get much more precise than that without doing a bit of work and asking yourself some important questions.
One simple formula could be posed like this: Is your investment portfolio worth at least 20 times your current annual income? If the answer is yes, you’re probably at least in the “maybe” category. If the answer is no, you might not be there yet.
The problem with such a simplistic formula is that it doesn’t take into account all the things that make each of us unique. To get a really good answer, you should think about questions like these:
- Is my current income enough to meet all my anticipated needs in retirement?
- If I retire now, how many years do I need my investments to support me?
- Am I comfortable planning to use up all my investments by the time of my death, or do I want to provide for others in my will?
- Knowing that future investment returns are uncertain and could fall short of my expectations, am I willing to scale back my retirement lifestyle if necessary?
- Alternatively, can I reasonably count on being able to work part-time if necessary to make ends meet?
- How anxious will I be if I plan to have my retirement income vary from year to year depending on my investment returns?
That’s a lot to think about, and we can’t address it all at once. But we can start. I trust concepts more when I have numbers to back them up. And I have some useful tables of numbers that show hypothetical investment returns and withdrawal rates.
I suggest you use these tables, along with the accompanying discussion, to start figuring out for yourself whether or not you have enough money to retire.
Let’s start with one of the tables to see what we can learn from them. Table 2 is based on several important assumptions: It’s 1970 and you have just retired with $1 million in your portfolio. You have properly diversified your portfolio to include much more than just the most popular asset classes. You will withdraw $50,000 in your first year of retirement (a 5% withdrawal rate, in other words) and you will increase that amount every year based on actual inflation.
The table has 12 columns of annual portfolio values. Since each year’s distribution is “fixed” by the $50,000-plus-inflation assumption, the only reason the columns have different numbers is that the portfolios are invested differently. On the left is a portfolio entirely in bond funds. On the right is one that’s entirely in the S&P 500 index. The portfolios in between are widely diversified in equity funds, with varying percentages of stock funds and bond funds.
When you look at the table, you can instantly see that the yearly portfolio values dwindle and disappear in seven of the 12 columns—a majority. The blank white spaces indicate years in which our hypothetical investor ran out of money because the portfolio returns were insufficient to keep up with constantly rising withdrawals.
So here’s one obvious conclusion: A retirement portfolio based on these assumptions needed at least 60% in equities to keep supporting the retiree through 2013. In 2013, the “fixed” distribution was $305,680, about one-sixth of the value of the 60%-equity portfolio at the end of that year. This withdrawal rate could not last very many more years, which means that particular portfolio was approaching extinction.
To support a reasonable expectation of continuing much longer, the portfolio would need to be invested at least 70% in equity funds. And yet, the level of risk in such a portfolio is greater than most retirees can or should take.
I realize that 44 years is more than the postretirement life expectancy of most people. But if you expect a portfolio to continue to support a surviving spouse or to end up with enough to make significant gifts, some extra margin is necessary.
So it’s reasonable to conclude that this plan—5% withdrawals increased every year for inflation—is less than ideal for most retirees.
Fortunately, there’s a better alternative. You’ll find the evidence for it in Table 1. The numbers here are based on the same assumptions as the previous table with one crucial exception: This time we assume the 1970 retiree could get by with an initial withdrawal of $40,000 instead of $50,000. In other words, this investor had saved enough to get along with an initial withdrawal rate of 4%.
As you look at this table you can see that only three of the 12 portfolios ran out of money. Those, as you would expect, were the ones most conservatively invested.
By the end of 2013, the 30% equity column is withering and cannot be expected to last many more years. But all the columns with 40% or more in equities were in solid shape to keep going with this withdrawal plan.
These two tables contain a clear lesson: If you save enough money before retirement so you can meet your needs with withdrawals of 4% instead of 5%, you can invest more conservatively, and without much risk of running out of money. (Obviously the next 44 years won’t be the same as these, but I don’t have any reason to think that their general patterns will be radically different.)
So the original question remains: Do you have enough to retire? Obviously that depends on whether you want to retire with just “enough” or with an extra measure of assets so you can retire with less risk and less stress.
If you retire with only enough, you face several major risks. One is that, like many retirees, you will want or need to withdraw more than is prudent. Another is that you will invest your money so conservatively that your returns will struggle to keep up with inflation.
On the other hand, you run the risk of investing too aggressively, trying to make up for inadequate savings; if you do that, you may have an awful time getting through normal market declines.
This is a trade-off, and the choice is entirely up to you. My recommendation won’t surprise you: If you can, save more than “just enough” before you retire. For more on this topic I have recorded a podcast.
We are not quite finished looking at withdrawal strategies. There’s another way you can cut this cake, especially if you have saved more than “just enough.” We’ll take that up next week.
Richard Buck contributed to this article.
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