Many economic minds have weighed in on what might be the proper percentage rate of annual withdrawal from a retirement portfolio. In my experience, a withdrawal rate of between 3 and 4 percent tends to be optimal for a couple entering retirement (dependent upon age). If a couple in their mid to late seventies is withdrawing a bit more, I am less concerned. Younger retirees, however, should stay in the 3 percent range. Of course, individual circumstances weigh heavily into all scenarios.
If your financial planning indicates that you could do well with only a 3 percent withdrawal rate from your portfolio every year, you might be inclined to think that you should be taking on more risk and growing your portfolio to greater heights so that you can leave your heirs a larger bequest. You might tell yourself that you are doing well now, leading you to question if there is room for more risk.
Answering that question requires projection of expenses far beyond the immediate. How will you be doing in your more vulnerable years, when you are in your seventies and older? If you run out of money, will you be able to seek employment? Even if you are physically and mentally capable, will anyone hire you? If you need help around the house or someone to provide basic care, can you afford it? The vulnerable years are when issues and expenses can rise rapidly. In helping you with your financial planning, I want to ensure that you will be well positioned when you get to that point in life.
To analyze cash-flow requirements, we must determine how much your portfolio needs to generate for you annually. In some years, the market will do well, and in others it will undoubtedly perform poorly. This much is certain: there is no crystal ball that will predict when those years will come.
If you retired in 2007, for example, and all your money was in the S & P 500 index, you would have lost a little over 38% of your portfolio value by December 31, 2008. Let us say that you also took out 3 percent for living expenses prior to that year’s economic crisis. The following year, your losses would have required you to take out 4.8 percent from what remained of your portfolio to maintain your existing income level. That is simple math. On the other hand, if you were able to maintain investments that generated 4.5 percent annual return throughout the decade from 2000-2010, you would have outperformed the S&P 500 on an average basis during that period.
The key is to mitigate risk so that you do not absorb all the market downturns and are able to maintain reliable income during your retirement. To suffer a financial punch early in retirement does not necessarily mean that you will be destitute in the immediate future. But fast-forward ten or fifteen years and your situation could be tenuous. You could eventually run out of money, and your problem would have it’s roots firmly implanted to when you first retired. To avoid running out of money, it is important to position your assets so that you participate in the up markets and try to mute the impact of the downturns.
This is what I mean when I say, “winning by not losing.” Though you cannot guarantee against a loss, properly diversified portfolios are designed so that your livelihood and lifestyle are not at the mercy of the markets. As we work with clients to develop income plans, we look to generate the lowest rate of return that will bring in enough money to meet their standard of living and their hopes for the future.
*Excerpt From “Financial Stability For Life”, by Daniel E. Butler, CFP®
**Raymond James and its advisors do not offer tax or legal advice. You should discuss any tax or legal matters with the appropriate professional.
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