Retirement is the “drawdown” phase of life: a sort of a marathon: Which will last longer – you or your money?
Just how successful your retirement is depends on how much you have at retirement and how much you spend IN retirement. Yes, achieving high returns would help; but, you can’t control interest rates, inflation, or the markets. While they can be managed to some degree, the only thing you can control is saving and spending.
How much can you withdraw? To a large degree, that depends on how long you live! While the average life expectancy has risen steadily in the United States, is now reaching 78.2 years,¹ it’s worth remembering those numbers are based on full lives, counting everyone beginning at birth! – so, those numbers may have little to do with you. Your lifestyle, health, and your parents’ history all have an impact. You might want to check-out this site to maybe get a better idea of your own life expectancy. Today, it’s not uncommon for retirement to last three decades! If you’re married, two lives for three decades is a tall order.
Inflation: The Invisible Danger
Whatever drawdown rate you choose, you’d better crunch some numbers: Can you sustain that rate – with annual inflation adjustments – during the entire length of retirement without running out of money?
What inflation assumption should you use? I wouldn’t use the U.S. consumer price inflation numbers. According to government, inflation has averaged under 3% over the past 30 years.2 Too bad the government numbers don’t include food or energy – people are often shocked when they find this out.
For long-term planning many top advisors assume that inflation will average in the range of 3% to 4% a year; but some of the most respected advisors are even using numbers north of 4%!
Be careful, though, of what one of America’s elite advisors, Harold Evensky, CFP®, calls “The Retirement Income Myth[*]” During my twenty-three years in the financial industry, I’ve noticed that many companies are very good at identifying fears and addressing them with by creating “too good to be true” products and marketing them through dinner seminars. Fear sells – and the biggest fear most people have today is longevity risk: fear of outliving their money; so, it’s no surprise the industry has responded by manufacturing products with guarantees to relieve those fears. The problem, of course, is there’s no free lunch – and those guarantees cost money that could otherwise be use to fund your retirement. There’s no substitute for quality planning, managing expectations, and sticking to a discipline when others are reacting from fear (a sign they DON’T have a plan).
Hidden Risk #2: Portfolio Volatility and Sequence of Returns
Average annual return figures may be useful during the accumulation stage of your life; but, during the drawdown phase, it may be the most worthless statistic you’ll ever be subjected to. Volatility and the sequence of returns will be far more important. For more on the ‘sequence’ risk, you may want to look at my ‘Hidden Risk” report.
A quick lesson on volatility: A $100,000 portfolio that suffers a 20% loss goes to $80,000. It would take a 25% gain from $80,000 to get back to $100,000. A 25% gain to make up for a 20% loss – that’s without withdrawals! If you’re in retirement and assuming you can withdraw 5% a year while this happens, the numbers look very different: At the end of the first year, you’d have $75,000 because of the withdrawal. Now you’d need close to a 27% return just to get to $95,000, where you thought you’d be if the market hadn’t suffered it’s decline.
As you can see, it’s about managing the downside
1Source: Center for Disease Control, March 2012 (based on 2009 data, latest available).
2Source: Bureau of Labor Statistics, January 2014.
[*] The New Wealth Management, Evensky, Horan, Robinson, John Wiley & Sons, Inc. 2011