What You Can Control vs What You Can Not Control
You have spent your entire working career accumulating wealth so you could reach this point, retirement. Conventional wisdom might suggest, now that you have reached retirement, you need to be as conservative as possible with your investments in order to preserve them for the rest of your life. But, did you know that being too conservative can create more risk to the longevity of your assets than being more aggressive? Also, withdrawing too much in retirement will limit how long your savings will last. Let us look at some different factors and scenarios together that will give you an idea and hopefully some peace of mind on how long you can expect your assets to last.
There are several factors that affect the longevity of a portfolio’s assets. I like to look at it like this: what can we control and what can we not control? Factors we can control: withdrawal rates, asset allocation, taxes. Factors we cannot control: rate of return, inflation, time, and, well…taxes. In a Traditional IRA or any pre-tax account, you will need to pay income tax on any distributions taken. This needs to be considered when deciding on a proper withdrawal percentage. If you have a good mix of Pre-Tax, Roth, and Taxable assets then you can pick and choose where your withdrawals come from to limit your tax liability. For the sake of time, I will not get into that and just focus on withdrawals, inflation, returns, time, and how it pertains to asset allocation.
Withdrawals, Inflation, Rate of Return, and Time
On its surface, figuring out how long your savings will last is as simple as withdrawing less than what your portfolio is generating plus inflation. A common theory to ensure you never run out of money is withdrawing no more than 4% of the portfolio beginning balance at retirement. Say you have $1,000,000 and you withdraw $40,000 per year from it. How long will the savings last? In a vacuum, meaning 0% inflation and 0% rate of return, the savings would last 25 years. If you retire at 65, that gets you to age 90 before you run out of money. Not bad considering the average life expectancy for women in the United States is 79 and for men is 73. We need to factor inflation into the equation however and cannot assume everyone will pass at their expectancy (my default life expectancy for financial plans is 93 but can change to suit any client’s needs).
Unfortunately, inflation is one of the factors we cannot control so we need to use an average of what we would expect. Policymakers at the Federal Reserve believe an acceptable inflation rate is around 2% or below. The current CPI as of this writing is at 7.7%. Over the last 20 years, the average inflation rate has been about 2.64%. I will use 3% as the inflation rate for this scenario. So, you have $1,000,000 and you withdraw $40,000 per year from the portfolio with a 0% rate of return and 3% year-over-year inflation; how long does the savings last? 18 years. I call this the life savings under the mattress guy scenario.
So far, the longevity of the portfolio even with a 0% return does not seem that bad. I will do this scenario one more time and will add a 5% rate of return. $1,000,000 portfolio, withdrawing $40,000 per year, 3% inflation, and a 5% rate of return. How long do the savings last? 34 years. Not bad.
But what if you need to withdraw more than 4%? Here is the breakdown of how long the $1,000,000 portfolio would last assuming a 5% rate of return and 3% inflation rate:
5% Withdrawal Rate: 25 years
6% Withdrawal Rate: 20 years
7% Withdrawal Rate: 16 years
8% Withdrawal Rate: 14 years
9% Withdrawal Rate: 12 years
10% Withdrawal Rate: 11 years
The final factor is time. How long do you plan to live and do you want to have anything left when you die? If you are not taking any withdrawals and never intend to then theoretically your time horizon is infinite and you can be as aggressive as you want with your asset allocation. Most retirees do take withdrawals from their investments and most do not want to run out of money before they die. The need for some level of responsibility regarding asset allocation brings me to the next piece in the article, which is how different portfolio types may limit how long your savings will last.
Portfolio Types and Longevity
Portfolios can be broken into three categories: Conservative (Income), Balanced, and Growth. The most common portfolio for retirees is balanced with about 60% Stocks, 30% Bonds, and 10% Cash. Using historical returns from 1926 to 2020 of stocks, bonds, and cash and assuming a 5% withdrawal rate of the original balance and increasing withdrawals to account for inflation a study found that this type of balanced portfolio has a 97% probability of lasting 20 years, a 79% probability of lasting 30 years, and a 59% probability of lasting 40 years. The same study showed that a conservative portfolio (20% Stocks, 50% Bonds, 30% Cash) has an even worse probability of longevity with a 90% chance of lasting 20 years, 36% chance of lasting 30 years, and only a 12% chance of lasting 40 years. Alternatively, a growth portfolio (80% Stocks, 20% Bonds, 0% Cash) had a 96% chance of lasting 20 years, 82% chance of lasting 30 years, and 71% chance of lasting 40 years.
A lot of people are risk-averse and do not like stocks or investments in general. Possibly because they do not understand investing well enough to feel comfortable taking the risk but the fact of the matter is that risk is your portfolio’s friend and it is necessary to protect your assets. If you want to learn more about your current investments or review your current investments, reach out to your advisor or let me know and I will be happy to sit down and see if we can help.
ARE YOU BEING TOO CONSERVATIVE WITH YOUR RETIREMENT INVESTMENTS? HOW NOT TAKING ENOUGH RISK CAN AFFE
December 6, 2022
Whitaker-Myers Wealth Managers is an SEC-registered investment adviser firm. The information presented is for educational purposes only and intended for a broad audience. The information does not intend to make an offer or solicitation to sell or purchase any specific securities, investments, or investment strategies. Investments involve risk and are not guaranteed. Whitaker-Myers Wealth Managers reasonably believes that this marketing does not include any false or misleading statements or omissions of facts regarding services, investment, or client experience. Whitaker-Myers Wealth Managers has a reasonable belief that the content will not cause an untrue or misleading implication regarding the adviser’s services, investments, or client experiences. Please refer to the firm’s ADV Part 2A for material risks disclosures.
Past performance of specific investment advice should not be relied upon without knowledge of certain circumstances of market events, the nature and timing of the investments, and relevant constraints of the investment. Whitaker-Myers Wealth Managers has presented information in a fair and balanced manner.
Whitaker-Myers Wealth Managers is not giving tax, legal or accounting advice, consult a professional tax or legal representative if needed.
Copyright (c) 2023 Clearnomics, Inc. and Whitaker-Myers Wealth Managers, LTD. All rights reserved. The information contained herein has been obtained from sources believed to be reliable, but is not necessarily complete and its accuracy cannot be guaranteed. No representation or warranty, express or implied, is made as to the fairness, accuracy, completeness, or correctness of the information and opinions contained herein. The views and the other information provided are subject to change without notice. All reports posted on or via www.clearnomics.com or any affiliated websites, applications, or services are issued without regard to the specific investment objectives, financial situation, or particular needs of any specific recipient and are not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Past performance is not necessarily a guide to future results. Company fundamentals and earnings may be mentioned occasionally, but should not be construed as a recommendation to buy, sell, or hold the company's stock. Predictions, forecasts, and estimates for any and all markets should not be construed as recommendations to buy, sell, or hold any security--including mutual funds, futures contracts, and exchange traded funds, or any similar instruments. The text, images, and other materials contained or displayed in this report are proprietary to Clearnomics, Inc. and constitute valuable intellectual property. All unauthorized reproduction or other use of material from Clearnomics, Inc. shall be deemed willful infringement(s) of this copyright and other proprietary and intellectual property rights, including but not limited to, rights of privacy. Clearnomics, Inc. expressly reserves all rights in connection with its intellectual property, including without limitation the right to block the transfer of its products and services and/or to track usage thereof, through electronic tracking technology, and all other lawful means, now known or hereafter devised. Clearnomics, Inc. reserves the right, without further notice, to pursue to the fullest extent allowed by the law any and all criminal and civil remedies for the violation of its rights.