Ep #32: Do I Need $1 Million to Retire? Pt. 2
New research published on safe withdrawal rates from Morningstar indicate a 3.8% safe withdrawal rate. Building on our earlier podcast: Do I Need $1 Million to Retire? We thought it was worthwhile taking a close look at this research and asking the more relevant question: Does my $1 million retirement portfolio really only support $38,000 of annual income per that Morningstar article and the 3.8% safe withdrawal rate?
How did Morningstar arrive at the 3.8% safe withdrawal rate? They used a case study to test out their hypothesis using a 50% stock and 50% bond portfolio with a 30-year time horizon with someone who wants a 90% probability of not outliving his or her money. They argue their research based on this case, which also factored in higher inflation adjustments, demonstrated that retirees embarking on retirement today could use a higher starting withdrawal rate than last year. The question we want to ask is: Is this research relevant?
What You’ll Learn in Today’s Episode:
What is “sequence of returns risk” – and why you should know what it is.
Adjustable portfolio strategies that consider the safe withdrawal rate but leave you with more portfolio flexibility in retirement.
Why Morningstar’s 3.8% safe withdrawal rate findings may not be relevant to your retirement planning.
What are guardrails and how they are used to manage your retirement spending.
The retirement spending smile – the phases of spending in retirement.
Ideas Worth Sharing:
“Will my $1 million dollar portfolio only support $38,000 of annual income? Is this question relevant? For most people, it’s probably not. There are a lot of different factors that go into spending in retirement, but a lot of people spend more earlier in retirement and that might affect what you’re starting withdrawal rate might be. It might make more sense to take out more early on knowing that you can reduce that later.”
“There’s a reason there’s a safe withdrawal number. And that is, people want to make sure they don’t run out of money within the next 30 years, which is about what the timeline is. They shouldn’t be taking 6-7% of the portfolio. This is where dynamic strategies come in. What’s the plan to adjust so that we don’t run out of money before we run out of life? The safe withdrawal rate is a good starting point, but not necessarily relevant for most people once you get into the planning.”
“Let’s think of the word “dynamic”. It means we can move and adjust based on circumstances. The guardrails, essentially what they’re doing is when things are going better than expected we can withdraw more from our portfolio. When things are going the way we expect, we continue to take the same amount. When things are worsening, we have a plan for reducing the amount of money we’re taking out of our portfolio.”
Resources in Today’s Episode
“What’s a Safe Withdrawal Rate Today” by Christine Benz, Morningstar
“What’s a Safe Retirement Spending Rate for the Decades Ahead? by Christine Benz, Morningstar 2021 Research
Matthews + Associates Guide to the Top 5 Retirement Risks
Ep # 6 – YRPS – “Retirement Risk # 1 – Sequence of Returns and Why the Game Changes in Retirement
Ep # 14 – YRPS – “Dynamic Withdrawal Strategies”
Ep # 15 – YRPS – Retirement Income Bucket Strategies
Ep # 19 – YRPS – Investing in Retirement
What Is The ‘Retirement Spending Smile’?
Bill Bengen: Revisiting Safe Withdrawal Rates
Do I Need $1 Million to Retire? Pt. 2
What do declining stock and bond prices and soaring inflation rates mean for your retirement income? New research published on safe withdrawal rates from Morningstar indicates a 3.8% safe withdrawal rate. Is this research relevant?
Building on our earlier podcast: Do I Need $1 Million to Retire? We think it’s worthwhile to take a closer look at this research. We ask the question: Does my $1 million retirement portfolio only support $38,000 of annual income per Morningstar’s safe withdrawal rate?
What is the sequence of returns risk?
We’ve done an entire episode on sequence of returns risk. We also have a guidebook necessary for anyone concerned about retirement called “Top 5 Retirement Risks” .
Firstly, in terms of the sequence of returns risk, it is the order in which your investment returns occur. In other words, the sequence of returns risk is the potential that the market declines at the beginning of your retirement. This could mean a reduction in the longevity of your portfolio. Because we don’t know when we’re going to get good or bad returns, we need to figure out what the safe withdrawal rate is. In the financial planning industry, the rule of thumb is 4%.
Flexible Strategies for $ 1 Million
Secondly, flexible strategies mean not being stuck to a hard, fast amount that you must take out every year. As a result, if you don’t increase your portfolio withdrawals when it’s a negative year, your portfolio doesn’t keep up with inflation when the portfolio doesn’t increase in value. Moreover, another flexible strategy is to slightly decrease the amount you’re taking if your portfolio is down. Ultimately, accepting the tradeoff of not adjusting with inflation every year on your income means having a slightly higher initial withdrawal rate.
Dynamic Withdrawal Systems for $1 Million
In past episodes, we’ve addressed dynamic withdrawal systems. The best among these is guardrails. Keep the word “dynamic” in mind. It means we can move and adjust based on the circumstances.
The 3.8% safe withdrawal rate begs the question: If you’re retiring this year, why can you take 3.8% whereas someone retiring last year could only take 3.3%?
What we need to remember is, for the person retiring this year, their portfolio has probably taken a hit over the last year. In other words, they’re probably starting with less than they would have if they retired a year earlier. Additionally, we know inflation has been the highest we’ve seen in 40 years. Subsequently, not only has their portfolio probably taken a hit, but the cost of everything is higher as well. Ultimately, the person retiring with a 3.8% safe withdrawal rate will need to take a higher amount out of their portfolio. Whereas someone who retired last year at the 3.3% safe withdrawal rate would have experienced lower interest rates and the valuations were higher on stocks.
The Guardrails
If your goal is to spend the most money possible, the guardrails are a perfect strategy. They perform two functions. Firstly, they allow you to live life to the fullest, meaning that if the portfolio’s doing well, you have a plan for when you can spend more money. Secondly, you won’t run out of money because you’ll just keep hitting the lower guardrail and adjusting the amount of money you can take out of your portfolio.
Leftover Assets on $ 1 Million
This is a factor that’s important to bequest-minded adults.
With the safe withdrawal rate, the goal is purely to leave as much money as possible to children or charity. Further, the safe withdrawal rate is great because it means you’re not going to run out of money. In fact, more than likely, you’ll increase the value of what’s going to be left over for the next generation or charity. However, if your goal is to spend more in retirement, the guardrails are a better option.
Real-World Case Study on $ 1 Million
For example, let’s look at our own case study based on real-world experience.
Bob and Sue came into a lump sum of money for retirement through the liquidation of their business. They are now trying to figure out their retirement plan. Specifically, they want to live out all their goals and dreams but not run out of money. They were talking to a couple of financial planners. This certainly included one of the big banks which was holding their money from the sale of the business.
Comparing Retirement Plans
In comparing different retirement proposals, an issue that comes up repeatedly is that they do not consider the sequence of returns risk. We know what the safe withdrawal rate is. We just want to make sure we don’t run out of money. If we’re not going to plan to make any adjustments along the way, then we really should be looking to be close to that sequence of returns risk.
In this case. the competing plan suggested that Bob and Sue could take out between 6 and 7% of the portfolio and increase with inflation all the while not running out of money until age 90. If everything works out exactly the way they entered it into the software they get that every single year until they pass away by the age of 90.
Most importantly, the issue with this is there’s a reason there’s a safe withdrawal number. If they want to make sure they don’t run out of money within the next 30 years, they shouldn’t be taking 6 to 7% of the portfolio. For instance, this is where dynamic strategies could enter the picture. If they want to maximize spending, then there should be a plan for not running out of money before running out of life.
The Safe Withdrawal Rate
How will they know there’s enough there that they can spend some more money? The safe withdrawal rate.
Again, it’s a good starting point, not necessarily relevant for most people once you get into the planning process, but a good place to start planning.
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