Retire with more money and less risk
Reprinted courtesy of MarketWatch.com
Published: April 30, 2014
To read the original article click here
Some people enter retirement with a great financial blessing: More than “just enough” resources to meet their needs.
Compared with those who retire with just enough, these people:
- have more ability to weather the storms of bear markets;
- can sleep better because they don’t need to take so much investment risk;
- can deal with financial emergencies and take advantage of opportunities;
- can plan to “live it up” a bit more in retirement; and
- be confident that they won’t run out of money and in fact will likely leave some resources to their heirs.
It’s a pretty picture, one I think is especially important for two groups of investors: retirees who have ample resources (to show how they can make the most of their situations), and pre-retirees (to show why this state of financial affairs is worth achieving before they retire).
The following discussion is centered around distributions, the regular portfolio withdrawals that often make up the bulk of the cash flow that retirees use to support their living standards.
Because the greatest financial risk most retirees face is running out of money, they need to be prudent about how much they spend. One time-honored formula for relatively prudent spending is to withdraw 4% or 5% of your portfolio each year.
The question is: What do you take out after your first year of retirement?
As I described in my article last week, retirees with just enough money to meet their needs can adjust each subsequent withdrawal upward to reflect inflation.
That will assure them a relatively constant inflation-adjusted income. But as I described in that article, they will pay for that “certainty” about future withdrawals by taking more risk than they might like.
On the other hand, retirees who have saved what I think of as “more than enough” may be able to take a different course, basing their future withdrawals not on inflation but on the growth of their portfolios.
That’s all sort of esoteric. Let’s get more concrete.
Imagine that you have saved enough money that you can more than meet your cost of living by taking out 5% a year. For the sake of easy numbers, let’s assume your portfolio is worth $1 million and you can get by with room to spare if you take $50,000 from it in the first year of retirement. That’s a withdrawal rate of 5%.
Because of that “room to spare” in your budget, you know you can get by with less if necessary. If this describes you, then you are a prime candidate for what I call flexible withdrawals.
The plan I’m about to show you is one that I have sometimes described as the ultimate retirement luxury. To see why, look at a table of numbers that contains five columns showing year-by-year portfolio values and distributions. (These are hypothetical numbers but based on real returns and real inflation.)
This table shows what would have happened to somebody who retired with $1 million at the start of 1970, took out $50,000 for the first year, then made a 5% distribution every subsequent year based on the fluctuating value of the portfolio.
This means that after a bad year, the retiree had to take out less. But it also means that after good years (which historically outnumber the bad ones), the retiree could take out more.
I believe that many if not most investors can live with the ups and downs of a properly diversified portfolio invested half in stock funds and half in bond funds. So let’s look at the column labeled “50% Global Stocks/50%Bonds.”
The stock market threw some serious curve balls at investors in the early 1970s, and the upper part of this column shows that our hypothetical retiree lost some money and had to take out less than the initial $50,000.
These declining withdrawals reached their low point in 1975 ($45,171). But starting in 1976, that withdrawal quickly rose to be more than the initial $50,000. By the 10th year of this hypothetical retirement (1979), he or she could safely take out $68,443.
Some years later there were a few year-to-year declines as the markets went up and down (1991, 1993, 1995, for instance). But in return for accepting uncertain withdrawals, our retiree lived very well in the later years. All the way through the major bear markets of the early 21st century, this portfolio kept its value without any apparent danger of running out of money.
At the start of this discussion I made some big claims about the benefits of retiring with more than enough. Let’s see if I can back them up.
Suppose this hypothetical retiree had worked a few more years and saved much more than just enough. Let’s assume this portfolio started out with $1 million but only $40,000 was needed to pay for the first year, again with “room to spare.”
If you look at another table, you’ll see what would have happened in that case. Again, these columns use hypothetical returns that reflect real investment opportunities that were available in those years.
Here, the 50% equity column shows the annual withdrawal declining; in 1975 it hit a low of $38,037. However, it never again fell below the initial $40,000.
In the 10th year of this retirement, 1979, the withdrawal had reached $60,166 – a full 50% above the initial target.
So, what’s different about this table’s results? This lower withdrawal rate resulted in significantly larger portfolio values and withdrawals in the middle and late years of retirement.
This is a case of “less” (lower initial withdrawals) becoming more.
Now that you know how to read the table, you can see that this retiree would have done quite well with an even-more-conservative 40% allocation to stock funds. That means less volatility and less risk, which translates into more peace of mind. When that comes in a package with ample withdrawals, it seems to me like a winning combination.
For more on this topic, I have recorded a podcast.
I think the lesson is simple: If you want to retire with less need to worry about financial things, you should do whatever you can to save more than you will need, then adopt a modest (or at least flexible) lifestyle and use a flexible distribution plan.
This has worked well for many retirees I know, and several years ago my wife and I retired with enough savings to comfortably withdraw 5% following the flexible plan I have described.
As far as we are concerned, having enough resources to do this certainly is a candidate for the ultimate financial retirement luxury.
Richard Buck contributed to this article.
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