|
|
|
What withdrawal rate can your retirement portfolio sustain and how can the resulting income flow last as long as possible? Retirement advice depends to a great extent on the integrity of one number: the amount of an investment portfolio that can be safely liquidated each year to provide income during retirement. That estimated number determines the ideal size of your target retirement portfolio and also defines the entire accumulation process during your working years. How much income can be taken from your portfolio without leaving you broke in your later years? Since no one knows what future investment returns, inflation rates or the length of your life will be, you need to make educated guesses about how much income a retirement portfolio can ultimately provide. In 1994, Money magazine recommended spending 5.29% of your portfolio annually and the inflation-adjusted equivalent thereafter. But an analysis using historical returns shows that had you retired in 1972, you would have completely run out of money after 23 years. If you retired in 1966, you would have been bankrupt after 18 years. People who took Money's advice could have found themselves in financial difficulty. In analyses performed by universities and financial organizations, it appears that most investors cannot be confident of liquidating more than 4% (inflation-adjusted) of their retirement portfolios annually. By varying the mix of assets or by introducing other types of investments into the portfolio, is it possible to make the yearly withdrawals more sustainable? Since trends indicate that people retire earlier and live longer, is a 30-year retirement assumption adequate? These analyses found that the more aggressive (85% stock, 15% bonds) the portfolio, the more it almost always outperformed less aggressive asset mixes (20% stock, 50% bonds, 30% cash) in producing income. When it did underperform, the difference was relatively small. You would be almost always better off with the more volatile portfolios than with those that offered more year-to-year certainty but generally lower returns. These results reflect historical returns with no guarantee to repeat. The more conservative portfolios seem to offer only limited downside protection and to severely constrain the upside. This may come as a surprise since choosing a more conservative portfolio mix has generally been recommended to stabilize future returns. |
Using the historical record is limiting since it gives a single sequence of returns to evaluate. Monte Carlo analysis provides a large number of possible future sequences of investment returns and inflation, based on data from the past. Monte Carlo simulations show the more aggressive portfolio fails in just 8.4% of the 30-year trials, meaning that it was able to sustain a 4.5% yearly distribution factor in 91.6% of the trials. For shorter retirement periods, the less aggressive portfolios offer better chances of survival. As people live longer, the more aggressive asset mixes offer much higher probabilities that a 4.5% inflation-adjusted withdrawal rate is sustainable. Uncertainty still remain since, for example, the aggressive portfolio still fails in more than an eighth of all trials over a 40-year time period. Also, higher stock allocations significantly increase the variability in the portfolio's value. Even for those with the highest risk tolerance, at some point, we can no longer raise the stock percentage. The more risk-averse shouldn't be forced to tolerate the volatility of an aggressive portfolio. And for those who live longer than expected, this procedure would result in real poverty after the "planned for" period. One option these analyses looked at was to purchase an immediate annuity, which converts retirement assets into a guaranteed lifetime fixed income stream. At a 4.5% withdrawal rate, the conservative portfolio with no immediate annuity fails almost 25% of the trials after 25 years; 67.4% after 30 years. If 50% of the portfolio is annuitized, they fail 1.3% and 18.7% respectively. In a more aggressive portfolio, the chances of failure fall from 12.6% over 30 years with zero annuitization to 3.3% with 50% annuitization. In summary, portfolios with significant stock exposure had much higher
probabilities of sustaining systematic withdrawals longer into retirement,
and there is significant improvement in the "failure rate"
when including an annuity. For all time periods and for all portfolios,
the addition of the annuity leads to a decline in the portfolio failure
rates |
|
734 Miller Avenue, Freeport, NY 11520 |