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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.


December 6, 2022

Kelly Kranstuber

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