Make Sure Your Money Lasts
A new strategy to tap extra cash in retirement is appealing—but may be risky
(MONEY Magazine) – When it comes to tapping your retirement savings, conventional wisdom holds that you should limit yourself to modest withdrawals of just 4% of your portfolio's value a year, adjusted for inflation. So if you have, say, $1 million socked away and inflation is running at around 3%, you'd take out $40,000 during your first year of retirement, $41,200 the following year, about $42,440 the next and so on. That way you can keep up with increases in the cost of living yet still be reasonably sure your savings will support you over a retirement that could last 30 to 40 years.
But do you really need to be so parsimonious? A recent, intriguing article in the Journal of Financial Planning by Minneapolis planner Jonathan Guyton suggests you do not. By boosting the amount that older investors typically keep in stocks and applying strict rules about how money is withdrawn, Guyton's system could allow retirees to tap as much as 6.2% of their savings annually without running out of money for at least 40 years. What's more, he tested this more generous withdrawal rate against one of the most volatile economic environments imaginable—a stretch starting in 1973 that included a long period of exceedingly high inflation and two punishing bear markets but that also boasted nearly two decades of some of the best stock returns in history. (Guyton projected results for the remaining nine years to conclude that the draws would last 40 years.)
Figuring out a way to boost income from savings during retirement is certainly a worthy exercise. But before you start loosening the purse strings, consider whether you'd really be comfortable with the strategy Guyton outlines. Sustaining that higher 6.2% withdrawal rate, for instance, demands that you hold as much as 80% of your assets in stocks—and a pretty volatile mix of stocks at that (see "Too Racy for Retirement?" below). Even a more modest boost to a 5.4% withdrawal rate would still require devoting half your portfolio to stocks. You'd also have to hold a very broadly diversified portfolio, with eight different asset classes. While I'm a big fan of diversification, most retirees, I suspect, aren't quite this meticulous about spreading their money around.
Adding another layer of complexity, Guyton's system involves strict adherence to a particular pecking order for withdrawals: First you sell off gains in profitable investments; then you pull money from bond holdings; as a last resort, you draw money from stocks that had a losing year. "You want to avoid selling equities after a down year so you can give them a chance to recover," explains Guyton. If your overall portfolio suffers a loss in any year, you'll also have to forgo your inflation increase the following year. And no matter how much the consumer price index might rise, you can never boost your draw by more than 6% in any year.
In theory, I agree with these rules. Limiting withdrawals during tough economic times, for example, makes perfect sense. I'm just not sure how diligently investors will follow them year in and year out. I'm also wary of drawing conclusions from research based on any historical period, even one as challenging as 1973 through 2003. Before I considered using any system to tap more cash from my savings, I'd want to see what's known as a Monte Carlo analysis, basically a stress test of that withdrawal rate performed by running it through thousands of computerized simulations of different economic and investment conditions.
Guyton has told me he's considering doing just that. Until we see this more nuanced research, however, I suggest sticking with the traditional 4% withdrawal rate. True, by limiting your draw you might end up spending less money in the early stages of retirement than you could have afforded in retrospect. But I'd much prefer to take that chance than run the risk that my savings might simply run out late in my life, just when I need the money most.
Too Racy for Retirement?
Safely boosting initial withdrawals to around 6% vs. 4% would require investing 80% of your portfolio in stocks, with significant amounts devoted to volatile small-cap and international issues. By contrast, a more typical retirement allocation might have 50% or less in stocks.
Source: Jonathan Guyton, Cornerstone Wealth Advisors.