What's my Retirement Number?
What’s my retirement number?
It’s a catchy title but over-simplified. Is it the answer to the question “How big does my portfolio have to be so I can retire?” or “How much of my portfolio can I withdraw safely in retirement?” These two questions are still too oversimplified. Your unique personal circumstances, not generic formulas, should guide your retirement planning. Start by assuming you’ll need close to 100% of your current income. Subtract from this any pensions, Social Security or other income you’ll receive and the remainder is the “liability” that you need to generate with your investment portfolio.
So, how big does your portfolio need to be? What’s a ‘safe’ drawdown rate? It depends. A rule of thumb from the mid-1990’s is that 4% is a safe number. However, with current bond yields and equity dividend rates what they are, there are a number of scenarios in which you’d run out of money by withdrawing 4% of your starting balance every year.
Another rule of thumb is that a 65-year-old couple could purchase a joint annuity with inflation protection from an insurance company for 26 times their retirement income liability. Note that this also works out to an inflation adjusted income of about 4% per year. But, how sure are you that a systemic crisis won't affect the insurance industry's ability to meet their guarantees for the next 30 -40 years ? What if you want to withdraw a little bit for an emergent need? Hmm, annuities are insurance, not investments; the insurance company keeps your money.
So, we’ve just identified two 4% thumb rules but they both have substantial risks. How do you reduce these risks? Hint: there’s no free lunch.
A Treasury Inflation Protected Security (TIPS) ladder could yield up to 0.5% but, unlike traditional bonds, you’ll also have a capital adjustment equal to the inflation index. In other words, perhaps 2% along with protection of your nominal capital investment. Importantly though, it’s still your money. You can tap into it if necessary.
Many stocks yield dividends. Some S&P 500 index funds currently yield about 1.8%. Domestic high yield equity index funds can be found currently yielding about 2.7% (past performance is no guarantee of future results.) Some MSCI Developed Markets Index funds yield about 2.7%. Of course there’s no capital protection; as well as dividend declines you could lose principal. But even during the great depression, when stock prices fell by 90%, dividends fell by only 50%.
Other factors can change your “liability.” When will you start drawing Social Security? If you can hold out until you turn 70, you’ll maximize your benefit (possibly the best return available anywhere.) However, some people have doubts about Social Security's future. Can you give up some optional expenses when market forces reduce dividend and interest payments? Are you willing and able to take on post-retirement employment? What is your life expectancy? Are you married?
There’s no simple answer for a risk-free retirement. Rather than latching on to a simple (and possibly risky) “what’s my number” answer, most people would be well-served by a strategy tailored to their personal circumstances, risk tolerance, flexibility, life expectancy, and retirement goals.
The numbers above are approximations only for illustration and don’t represent the results of real people. The foregoing isn’t investment or financial planning advice; it’s only food for thought. Don’t make plans or invest money based upon this blog post. If you’d like to discuss how Lyon Park Advisors can help with your personal retirement strategy, please give us a call.