One definition of wealthy is: ‘Not being able to spend the income from your income.’ Most retirees do not have this luxury. In fact, most retirees should expect to consume a portion of their portfolio principal in order to fund the costs of living in retirement. Which leads us to the first topic in The Retirement Income Planning Series.

What withdrawal rate is best for me and my portfolio?

Rates of withdrawal are a very important part of your retirement portfolio plan; Too low and you may compromise your lifestyle, too high and you may outlive your money. Just like choosing an investment strategy, your rate of withdrawal will be dependent on multiple factors: Your portfolio make-up, whether or not you have heirs, your lifestyle (including your health), your age and the estimated pay out period, cost of living, and of course, the value of your portfolio. Miscalculating could result in an involuntary return to work or, at the opposite end of the spectrum, the loss of enjoying your life savings due to fear of running out of money.

The safe range for distribution for many individuals falls somewhere between 3.5% and 6%. Adopting a withdrawal rate smaller than the rate of return on your portfolio allows the portfolio to weather the downturns that are an inevitable occurrence for long term investors. The average annual rate of return over the past 80 years for the S&P 500 is about 10%. A significant allocation to stocks in your portfolio, and maintaining a withdrawal rate between 3.5% and 6%, should allow a cushion for the years when your portfolio actually shrinks in value. If your portfolio is mostly bonds, you may have to adopt an even lower withdrawal rate. Remember, a portfolio over-weighted in bonds may be more stable in value, but inflation can insidiously destroy your ability to live the way you want to live.

This safe range of withdrawal rates has been developed from extensive testing of the last 80 years of market history. In 1994, Bill Bengen gave us the 4% Solution. He found that retirees could have weathered the three big storms from 1926 through 1994 with a 50% stock and 50% bond portfolio and a 4% withdrawal rate. Even through the stock market crash of 1929, the series of recessions and stock market malaise from 1968-74 and the Big Bang in 1987, the portfolio lasted for thirty years. If you need your money to last longer than thirty years or you want to leave a legacy, you may need to lower your withdrawal rate below 4%.

Another measure of a successful retirement portfolio is to have as much money four years into retirement as you did when you first retired. If this figure is larger than the beginning value, the portfolio is doing very well. If the portfolio has dropped below the beginning value, drastic changes may be needed to make the money last.

I hope to guide your portfolio allocation to avoid the big downturns in the market. I feel it is prudent, however, to take heed of the research and plan for a 4-6% withdrawal rate especially since we may live longer, healthier and more active (read expensive) lives.

Regards,