← Ready For Retirement
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What is everyone's number one concern with retirement? It is, am I going to run out of money before I run out of life? And it doesn't matter whether you have $100,000 in your portfolio, a million dollars in your portfolio, $10 million in your portfolio. I have spoken with people at all these different asset levels and that fear does not automatically go away. There's not a magic number where you no longer have this fear or this concern that you might run out of money. That's why in today's video, what I'm going to do is I'm going to tell you the actual likelihood that you will run out of money based on various withdrawal rates. And then I'm going to walk you through an alternative approach that you can take. What actual things within your control that you can do to minimize the likelihood that you ever run out of money. There was a study done by Michael Kitces. And in this study, Michael Kitces looked at a 60, 40 portfolio, so portfolio that was invested 60% in U.S. stocks, 40% in bonds. And he looked at this going all the way back to 1870. And he said, what if you were to take 4% per year out of this portfolio and then of course increase that number with inflation? And what he wanted to understand was what is the actual likelihood that you would run out of money? And of course, this is going to depend upon the time period. If you retire and you have a wonderful 30 years of market environment, you're probably going to do well. But what about those instances where you don't have a great market environment? What about when inflation is spiraling out of control? What about when there's horrible growth in the market? What about when there's terrible crashes in the market? What about those experiences? What's the likelihood that you run out of money there? Well, here's what that study found. Not only did that study show that almost never. And again, this is back tested data, this is historical data. This is in no way a guarantee that this will be the same going forward. But almost never did the retiree actually run out of money if they took that 4% withdrawal. But what's even more surprising is not just that you almost never ran out of money, was that it was also incredibly rare for you to have less money in your portfolio at the end of a 30 year retirement than you had at the beginning of your retirement. What he then went on to show is that actually in two out of every three events when you back test this, you're going to have more than double the amount in your portfolio at the end of your retirement, at the end of your life than you had going into your retirement. And you are more likely to 5x your money to quintuple your portfolio balance than you are to have less money at the end of retirement than you did going into retirement. So what this showed was clear. The odds of you running out of money using data going all the way back to 1870 as our guide are incredibly low. Now keep in mind, this included the Great Depression. This included two world wars. This included periods of incredible inflation. So this was not just 150 plus years of really rosy markets. This was terrible markets, great markets, everything in between. And here's why that was the case when we look at the 4% rule. The 4% rule is not like a median rule of you should start with this and you might be okay, you might not be okay. That 4% rule, the decision take 4% of your portfolio out at the beginning retirement and adjust it for inflation. That was done based upon research by an individual named Bill Bangin. And what Bill Bangan wanted to solve for is he wanted to solve for just that. If you don't want to go into retirement and think maybe I'll be okay, but maybe I won't be okay. So he wanted to solve for what's the most you could take from your portfolio using a certain set of assumptions and that regardless of what market environment you are retiring into, you would not run out of money for at least 30 years. That's where that 4% came from is it's almost the lowest common denominator. It's the amount that you can take. And you can't guarantee this, but using history as a guide, you're probably going to be okay over time. And not just probably, but you're almost certainly, when you look at the statistical chances of you increasing your portfolio balance or at least not running out of money over the course of your retirement. Here's what my bigger concern is though. Yes, on the one hand, we want to ensure that we are not over withdrawing from our portfolio such that we run out of money before we run out of life. That is an objective definition of failure in retirement. If you run out of money, you're not going to go back to work in your 80s or 90s. So we need to ensure that your portfolio is going to be sustainable for you and meet your income needs as long as you live. However, I often see people over indexing for that. I often see people overemphasizing that particular risk and they miss out on an equally bigger risk or different type of risk. And that risk is what are you actually retiring to? Of course, you can increase the odds of your portfolio lasting forever if you keep spending lower and lower amounts. But. But what have you sacrificed in doing that? I see so many people with very healthy portfolio balances and they don't allow themselves to spend those balances because of this fear of running out. And what they end up doing is they end up waking up one day. This could be 10 years into retirement, 15 years into retirement, 20 years into retirement, and they look back and their portfolio balance has continued growing the entirety of their retirement. Of course, there's been some ups and downs along the way, but they look back and say, I actually missed out on what this portfolio was designed for. Sure, I now know I'm not going to run out of money. But what was this portfolio good for if I didn't actually use it to live the life I wanted to live, if I didn't actually use it to take those trips with my family, if I didn't actually use it to do the things that I want to do, to actually feel like I'm living the retirement that I would be most excited for? So let's go back to that 4% rule research. Here's what a lot of people are actually unaware of when it comes to that research around the 4% rule. That 4% initial withdrawal rate, as I mentioned, that's the most that you could spend and still be okay in any of the market environments that were explored in this research. However, there were some years that you could have spent up to 10% per year of your initial portfolio balance and still had been okay for that 30 year time period. The challenge, of course, for people retiring is you don't know what 30 year time period you're going to get. If you're sitting here today, easy enough to look back on the last 30 years, you can perfectly solve for what's the most you could have spent and not have run out of money in the last 30 years. We have no idea what the next 30 years are going to bring. But if you use 1975 as an example, if you go into 1975 and you retire that year and you have a million dollars, which I know adjusted for inflation, is worth a whole lot more back in 1975. But just use that for a simple example. If you just spent that 4% per year, you lived on $40,000 per year from your portfolio, combined with whatever Social Security or pension or other income sources you had, and you did so for 30 years. Well, here's the thing. In retrospect, you could have actually spent 7.5% per year of that initial portfolio balance and still been fine for that 30 year time period. Now, you might look at that and say, well, that's no big deal. I had more margin at the end, I had something left at the end to pass on to children or friends or whoever it's going to be. And that's fine if that's your goal. But if your goal is not to leave a giant portfolio at the end of the day, what that actually means is that you spent a full 35,000 fewer dollars every single year for that retiree that retired in 1975 than you otherwise could have. Meaning what could you have done with an extra $35,000? What trips could that have supported? Who could you brought along in those trips? What giving could you have done? What could you have done to enhance life for you and those around you with the extra $35,000 per year? So yes, it's a risk to run out of money, but so too is a risk. There's an opportunity cost to not understand what you could fully spend. So how do we reconcile that? This sense of wanting to be prepared for the future, but also the sense that if we're too conservative, we're going to end up with these opportunity costs, with these regrets. At the end of the day, looking back, saying, I can never get those experiences back, I can never get back that time that I could have had to spend some of this on things that were meaningful to me. Well, there's a few things. Number one is have a withdrawal strategy that's tied to your specific investment strategy. This 4% number, this is not in any way a silver bullet. This is not something that every single person should take in their portfolio. This is just kind of like foundational research to say, where's a nice starting point for what you might be able to spend from your portfolio? That 4% rule, it's based upon someone who had half their money in US stocks called the S&P 500 and half of their money in intermediate treasury bonds. There have been some revisions to this paper to where now they include small cap stocks to now they actually withdraw more from that portfolio can still be sustainable for 30 plus years. But that initial research that launched this 4% rule, it was based on investing just like that. What it was also based upon is whatever that dollar amount that you take out that first year, you adjust that for inflation. Well, what if you did things a little bit differently? What if you weren't just invested 50% in the S&P 550% in intermediate term government bonds, because my guess is most of you aren't actually invested exactly that way. What if you diversified a little bit more? What if you didn't just have large cap US Stocks, you also owned smaller companies? What if you had some of your money split between value and growth investments? What if you owned some domestic companies, but you also owned international developed companies? What if you also owned emerging markets and real estate? This isn't just diversification and spreading out your money for no reason. What this is doing is the more places you have your money invested, the greater your flexibility. Assuming those places are appropriate for you and your investment objectives, the more flexibility you have when it comes time to retiring, where you can draw income from the 2000s. For example, from 2000 to 2010, horrible time for the US stock market. On average, the S&P 500 lost 1% per year over that decade. So if that's where all your money was and you were having to sell your investments when they were down on average, that's a terrible thing for your portfolio long term. Well, international investments, emerging market investments, smaller companies, they all did a lot better in the 2000s. So what if you had those assets to draw from instead of just drawing from US assets? Well, then the opposite happened. In the 2010s, US investments performed significantly better than international investments. So in those years, those might have been great years to pull money from your US investments, more so than you pulled money from international and emerging market investments. So the principle here is, if you don't just have all your money invested in one specific place or two specific places, it gives you more flexibility to not have to sell your investments when they're down, which is key to being able to take out more from your portfolio without jeopardizing the long term sustainability of your portfolio. So that's concept number one. Can you diversify a bit further than what the initial 4% rule was based upon? But then there's a follow up concept that goes along with that. So once you're diversified, can you apply more of a dynamic, rules based approach to where you're going to take income? What if inflation's up or down? What if your portfolio is up or down? Are you just blindly pulling money every single year adjusted for inflation? Or are you intentionally pulling money from the parts of your portfolio from the asset classes that have the highest relative performance as compared to other investments in your portfolio? What if there is a major market downturn? Are there rules for when you don't give yourself an inflation adjustment the next year? Are there rules for when maybe you take a little bit of a spending cut year to year while things are down? Then on the flip side, what if things have gone really well? Do you continue to maintain the same exact level of spending or, or there are thresholds at which you can give yourself a raise to ensure that that success that you're having in your portfolio is leading to a higher quality of life. So when you can do this type of a thing, when you can apply a more dynamic framework to the way that you approach withdrawals, there is research, it's commonly referred to as Guyton's guardrails, that you can actually take out a higher initial percentage of your portfolio and still be reasonably assured that that portfolio is going to last for 30, 40 plus year time period. So what doing that allows you to do is it allows you to go into retirement and say, yes, we're going to be prudent, we're going to plan for the future. We have a framework follow to make sure that if things aren't going well, we're adjusting our spending strategy to ensure we don't run out of money. But on the flip side, we're also making sure that we're going to fully enjoy this portfolio that we've worked for. We're going to fully translate this financial success we've had into the adventure, into the comfort, into the things that we want to do in retirement. And we're not going to unnecessarily sacrifice that because we're spending too little a portion of our actual portfolio. So that's what you can do on the investment piece. Then what I like to encourage people to do on the other side, the things that you can control is what people get thrown off by is they think, okay, I'm going to spend X amount of dollars per year. And they factor that in and they say this translates to a withdrawal rate of whatever that might be. But they don't take into account maybe those big one off expenses. What happens if there's a major health event? What happens if there's a major long term care event? What happens if there's a major expense related to your house, related to something that comes up? What happens in those instances? Or are you prepared for that? Because if you're fully spending every bit of income that your portfolio could possibly generate, you don't have margin or you don't have extra funds set aside to deal with those one off expenses that might put you in A difficult position. So how can you both understand what your portfolio can generate for you so that you can spend everything you want to spend without running the risk of running out of money, or at least with dramatically reducing the risk of running out of money? But how can you also plan those contingencies, those what ifs, the what happens when life comes at you fast? You need to be in a position to be prepared for that. And then finally, at the end of the day, the best thing that you can do here is have an actual financial plan. That financial plan starts with understanding what do you actually want life to look like. Then it moves to what's that going to cost on a yearly basis to be able to support that? Then it moves to what income sources do you have to meet those expenses? This could be Social Security, pension, real estate, et cetera. Then it moves to what role does your portfolio play in that? Your portfolio being that thing that's going to supplement Social Security in many cases. And that's the piece that we're talking about today. With that portfolio piece. With that portfolio income, how do you understand what a safe withdrawal rate is? And not just safe from the standpoint that you're going to keep expenses as low as possible to preserve that portfolio value, but safe from the standpoint that we're going to take prudent amounts out of our portfolio such that it will be okay in the future, but we're also going to fully support the lifestyle that we want to live today. Understanding some of these rules is key to doing that. Some people think there's something magical about the 4% rule. That's all you can ever do. That's not the case. It's a great place to start. But understand that if that's all you're ever doing, you're probably not a guarantee, but probably going to end up with a lot more money at the end of your lifetime than you actually even have today. Not the worst thing in the world, but you have to ask yourself the question and be intentional about this. Is your goal to end up with large amounts of money at the end of your life, or is your goal to use the money that you have to live the retirement that you want to live? So that is it for today's episode. Thank you, as always, for listening. If you're watching on YouTube, make sure that you subscribe. If you're listening on Apple Podcasts or Spotify, make sure that you're following along and subscribing as well. Thank you for listening and I'll see you all next time. Once again, I'm James Knoll, founder of Root Financial. And if you're interested in seeing how we help our clients at Root Financial get the most out of life with their money, be sure to Visit us at www.rootfinancialpartners.com.