Building a nest egg for your retirement is only one aspect of retirement planning; this may well be the easy part. For many people, what is more difficult is ensuring that those savings you have accumulated over the years, actually last as long as you live. Indeed, perhaps one of the greatest challenges to financial security is the transition from earning money and accumulating assets to spending down those hard-earned assets over what could end up being almost a third of your lifetime.
Whilst we all hope and pray for long life, the “risk” of longevity has huge implications for retirement planning. The generation approaching retirement age, have to a large extent redefined the traditional view of retirement; they are radically reshaping societies views of how “older” people are supposed to act. From the traditional view of relaxation, leisure, and comfort, it is a time for renewal, growth, new opportunities, self-fulfillment and brand new challenges. With medical advances, it is increasingly possible that today’s healthy 60-year-olds may live well into their 80s or 90s. In some countries there have been calls to increase the retirement age to 65 or even 70.
Withdrawal risk keeps many retirees awake at night, as they must determine how much they can realistically afford to draw down from personal savings and investments without seriously depleting their capital. The rate at which you withdraw money from your assets is one of the most important factors affecting how long they will last.
Several studies have been carried out using various portfolio compositions to see what withdrawal rates would leave portfolios with positive values after say 20 years. Some of these scenarios assume 100% cash, 100% bonds, 100% stocks along with 25/75, 50/50 and 75/25 mixes. For years, financial advisers have presented the 4% rule for retirement, which is a rough guide for portfolio withdrawals in retirement. The basic premise is that you withdraw a conservative 4% to 5% of your portfolio in the first year of retirement and then every year afterwards you withdraw the amount you took out the previous year with an inflation adjustment.
With the help of simulations of thousands of possible investment and inflation scenarios, observing decades of stock market returns, William Bengen, a financial advisor and one of its leading proponents, concluded that a retiree with a relatively balanced portfolio should draw down a portfolio by 4% or less per year. He felt that retirees who did this had a better chance of making their retirement money last a lifetime whilst those taking more than 5%, increased the chances of depleting their portfolios during their lifetime.
So what is a safe withdrawal amount? It is virtually impossible to give precise guidance as to how much you can afford to spend from your savings in any given year; no simple solution exists and investors’ withdrawal rates will vary from person to person and according to the vagaries of the markets and their particular needs.
Many investors end up withdrawing well over 10% of their portfolio each year to support the lifestyle they have become accustomed to. Indeed many people spend more in their early years of retirement when they travel and “enjoy the fruits of their labour.” This can rapidly deplete that portfolio. However, even though this initial outlay can seem a little worrisome initially, it does tend to even out in later years.
Others are very pessimistic and scared of the prospect of being dependent on family in their later years and after building a portfolio of Certificates of Deposit, Bonds and dividend yielding stocks only withdraw interest and dividends and are too scared ever to touch principal or liquidate stocks; this also has implications for their living standards.
Clearly there are many considerations to be taken into account including, your age and health, the overall size and composition of your retirement portfolio, your objectives, your spending pattern and lifestyle, and the fluctuation of your investment returns, the impact of inflation and the exchange rate on your assets and cost of living. Retirees must naturally be cautious particularly where portfolios are not well diversified and investments underperform for long periods and interest rates remain relatively low.
Developing a plan for this spending phase can be difficult, as obviously no one knows how long he or she might live. It is important to seek professional advice to plan with the appropriate timing that makes sense given your overall goals and your own unique situation.
In the past the conventional wisdom was to have begun to divest from stocks as one approached retirement, and then migrate to bonds and cash as safer guaranteed investments, stocks being volatile in the short term. One traditional rule of thumb suggests that a 65-year-old should retain only 35% of his or her money in stocks, Nowadays one is encouraged to continue to retain stocks and stock mutual funds in a portfolio to have any prospects of long-term growth.
An investment strategy that is too conservative can be just as dangerous as one that is too aggressive, as it not only exposes your portfolio to the effects of inflation but also limits the long-term upside potential that stock market investments offer. On the other hand, being too aggressive can mean assuming too much risk in volatile markets.
The “artificial” deadline that retirement appears to present is becoming less practical and should not be what rigidly drives planning decisions. What is thus required, is a strategy that seeks to keep the growth potential for your investments without assuming too much risk. After an “official” retirement age of 60, there is a real possibility that you may need 30 more years of retirement income and the ideal should be to find a balance between growth and capital preservation.