Retirement Income - Will You Have Enough?
By Rafael Velez
You could spend as much time in retirement – 30 or even 40 years – as you have spent
saving for it. That is why planning for your retirement savings to generate income
is critical. Developing a solid plan and appropriate investments for years of income
is well worth your efforts.
For example, switching your investing approach from growth to conservative to protect
yourself against volatility on the eve of retirement may not be the most prudent
financial decision anymore. After all, because of inflation and the increased odds
that you could live well into your 90’s, conservative thinking may threaten your
long term financial security. Preparing your portfolio for retirement is, in large
part, about finding the right balance of growth and income to keep your assets working
throughout retirement. It is about trying to protect against inflation and trying
to make sure you will have income if you outlive the averages. Finally, it is about
an appropriate asset allocation, including equity investments, to meet both your
current and future income needs.
Equity investments generally involve greater risk than other investments, including
the risk of possible loss of principal. However, we would like to present you with
some alternative options that may keep your portfolio working hard as you enjoy
retirement. It is more than just a retirement portfolio…it is your future income
source. If you are concerned about income throughout retirement, it may be time
to re-engineer your portfolio to generate an income stream for 30 to 40 years.
So what is a reasonable percentage to withdraw on an annual basis? One study looked
at that question based on actual market returns from 1926 to 1976. The study concluded
that to ensure your assets lasted for 50 years, your initial withdrawal rate should
be no higher than 3% to 3.5%, with subsequent withdrawals adjusted for inflation.
To ensure assets last 30 years, the initial withdrawal rate could increase to 4%.
These withdrawal rates assumed a stock allocation of 50% to 75% of the total portfolio.
Due to the possibility of a major market decline soon after retiring, the study
did not recommend stock allocations over 75% (Source: Journal of Financial Planning,
Another study took a different approach to this question. By adding other asset
classes to the portfolio, including international equities and real estate, and
establishing fixed rules for rebalancing the portfolio, this study concluded that
to last 40 years, the initial withdrawal rate could be 4.4% with a 65% weighting
in equities and 5% with an 80% weighting in equities. If the retiree was willing
to forego increases in withdrawals in certain circumstances, such as when the portfolio's
ending balance is lower than its beginning balance, and limit inflation increases
to 6%, withdrawal rates could increase to 5.1% to 5.8% (Source: Journal of Financial
Planning, October 2004).
What conclusions can be drawn from these studies?
1. Your withdrawal percentage should be modest to ensure you don't deplete your
assets. While the two studies reach different conclusions, they advocate initial
withdrawals of modest amounts ranging from 3% to 5.8%. With a $1,000,000 portfolio,
that means your initial withdrawal will range between $30,000 and $58,000. You need
to carefully look at your assumptions before deciding between the high or low end
of these estimates.
2. Equity need to remain a significant component of your portfolio after retirement.
Both studies were based on stock allocations of at least 50% and up to 80% of the
total portfolio. With lower allocations to stocks, you would need to decrease your
withdrawal percentage even further.
3. Buy “quality” while emphasizing income and dividend growth. Focus on acquiring
globally dominant businesses with high returns on invested capital and a long history
of dividend growth. Examples in early 2006 would include Bank of America 4.3%, Pfizer
4.0% and Coca-Cola 3.0%. All three companies have paid increasing dividends for
decades and doubled their dividends in just the last 7 years.
4. Review your calculations every year. This is especially important during your
early retirement years. If you're depleting your assets too rapidly, you can make
changes to your portfolio, reduce your expenses, or consider going back to work.
As you age, your options become more limited.
5. Work as long as you can. Supporting yourself for a retirement that could span
25 or 30 years requires huge sums of money. Consider working at least a couple of
years longer than originally planned. Many skills you acquired during your career
transition well into consulting or seasonal work. During those years, you can continue
to build your retirement assets and delay making withdrawals from those assets.
Once you do retire, consider working at least part time to reduce withdrawals from
your retirement assets.
Rafael O. Velez III is the Managing Director and Registered Principal of Summit
Financial Advisors, LLC, based in San Mateo, California. Additional resources and
ideas are offered on their Web site, http://www.summit-advisors.com