Unquestionably, the best time to retire is after you have accumulated more money than you will ever need.
But that’s not possible for everyone, and today I’ll show you how to retire with savings that aren’t necessarily as ample as you’d like.
This is Part 5 in a series of articles I think of as Boot Camp for Investors 2023.
· The first installment was The best way to invest for retirement.
· The third was How to control your investment losses.
Our main focus today is how you will plan to withdraw money. This involves balancing how you invest, the lifestyle you adopt and how much you will take out every year. Every dollar counts. Every decision counts.
Your highest priority should be to avoid running out of money before you run out of life. Because you don’t know how long you’ll live, assume it will be to a ripe old age.
In short, you need a plan.
For this discussion, I’m going to assume that in your first year of retirement you will need to withdraw some fixed amount of money, then increase that amount every year to keep up with actual inflation.
Although I can’t know how much you need for a year of retirement, we can discuss this in terms of percentages.
Financial planners often recommend annual withdrawals of 3% to 5% of your portfolio’s value. If you can meet your needs taking out 3%, you’re unlikely to run out of money.
A withdrawal rate of 4% probably will be sustainable, based on history. However, if you need to take out 5% every year and adjust it for inflation, your portfolio may not last as long as you do.
For many years I’ve published and updated a set of tables showing hypothetical year-by-year results (starting in 1970) from various portfolios and rates of withdrawal.
You can use these tables to see how much of your portfolio you should plan to withdraw each year.
When you’re planning your retirement distributions, there are two main variables under your control:
· What percent you’ll take out each year;
· How your portfolio is invested.
To get started, open the link above and scroll down to the third page, Table D1.5. You’ll find 10 columns, showing year-by-year portfolio values for various combinations of bond funds and the S&P 500
In this table we assume you took out $50,000 (5% of your portfolio) in 1970 and then adjusted that amount each year to keep up with actual inflation.
Scroll down and you’ll quickly see that—starting in the early 1990s—these portfolios simply couldn’t keep up with the increasing demands for annual withdrawals.
Now look at Table D1.4, based on taking out $40,000 instead of $50,000 in your first year of retirement.
With that lower withdrawal rate, your money would have easily lasted many more years than most people spend in retirement.
Table D1.3 shows the effect of 3% withdrawals (never came close to running out of money), while Table D1.6 shows 6% withdrawals (which dried up in less than 20 years).
Fortunately, you’re not limited to those choices. As I mentioned, the investments you choose will make a big difference.
First, of course, there’s the delicate balance between equities, which in the long run should help your portfolio grow, and bond funds, which should contribute to your peace of mind.
Second, as you can see if you scroll down farther in the tables, your results can be quite different if you diversify your equities beyond the S&P 500. This, by the way, is something I strongly recommend.
Tables D9.3 through D9.6 show the results from using a popular U.S. four-fund strategy. This involves dividing your equities in equal parts: the S&P 500, large-cap value stocks, small-cap blend stocks, and small-value stocks.
Table D9.5, for example, shows that combination would have supported 5% withdrawals for 40 or more years of retirement, so long as you had at least 30% of your money in equities.
When your equities were limited to the S&P 500, there was no combination that came even close to doing that.
Other tables show results for equity combinations that in some cases held up considerably better than the S&P 500.
If a 40-year retirement is your standard, you could have achieved that—and taken considerably higher distributions—by substituting a U.S. small-cap value fund for the S&P 500 (scroll down to Tables D12.5 and D12.6).
Although future returns won’t be the same as those from 1970 through 2022, the relative strengths and weaknesses of these portfolios are likely to hold.
Here are two key points to remember:
· Whatever the size of your portfolio, consider diversifying your equities beyond the S&P 500.
· No matter how much or how little money you have available to spend, you will benefit if you can live a bit below your means. Your retirement will be less stressful if you build in a cushion to deal with unexpected needs and opportunities that are sure to arise.
In half a century of helping investors, I’ve concluded that the single best thing you can do is begin your retirement with as much money as possible. A few years ago, in this article, I argued that many people could effectively double their retirement income by postponing the start of retirement by five years.
Over the years, these tables have helped thousands of investors plan their finances in retirement. But if all these numbers seem daunting, you might find it worthwhile to discuss them with a fiduciary financial adviser, one who does not have products to sell. In an upcoming article, I’ll discuss finding such an adviser.
In the next installment in this series, I’ll show you how to spend even more in retirement without running out of money—providing of course that you have saved more than just the minimum to meet your needs.
Richard Buck contributed to this article.
Paul Merriman and Richard Buck are the authors of “We’re Talking Millions! 12 Simple Ways to Supercharge Your Retirement.” Get your free copy.