Simulations run by academic and financial institutions, using historical investment returns and inflation rates indicate a balanced portfolio has a good chance of lasting 30 years using an initial withdrawal rate of between 3 percent and 4 percent. Like most generalizations, however, they do not apply to everyone. Each retiree needs to evaluate his or her own personal circumstances and then adjust those percentages and dollar amounts accordingly.
The second method involves withdrawing a predetermined percentage of the portfolio’s beginning balance each year. In other words, the amount taken out is directly tied to the performance of the investments during the prior year. Spending is reduced during and after poor performance and increased when the investments recover.
As an example, let’s say a retiree with $500,000 in retirement savings decides to withdraw $20,000 or 4 percent of the portfolio in the first year of retirement. If the markets do well and by year-end the portfolio swells to $600,000, the drawdown amount for the following year would be 4 percent of $600,000 or $24,000. If during the next year, the portfolio experiences a steep decline and the year-end value is $450,000, the withdrawal would be reduced to 4 percent of $450,000 or $18,000.
Since poor investment returns are partially offset by a reduction in withdrawals, this strategy minimizes the chance the retiree will consume the portfolio too quickly. On the other hand, since the dollar amount of the drawdown fluctuates with the portfolio’s balance, retirees should be prepared to reduce spending when warranted. The reality however, is that many may be unable to tolerate these spending adjustments.
Deciding how much to spend and how to spend from your savings is an important issue that most retirees will confront. The best solution may be a “hybrid” of the two approaches we examined. Regardless of the withdrawal strategy employed, being flexible, and making sensible adjustments to spending when conditions dictate will increase the chances of realizing a secure retirement.
John Spoto is the founder of Sentry Financial Planning in Andover and Danvers. For more information, call 978-475-2533 or visit www.sentryfinancialplanning.com.
This article is for general information purposes only and is not intended to provide specific advice on individual financial, tax, or legal matters. Please consult the appropriate professional concerning your specific situation before making any decisions.