THE RATIONAL INVESTOR: Can you make your nest egg last for your lifetime?
Few, if any retirees, want to spend their golden years working under the golden arches of McDonald’s. In general, they want both a comfortable lifestyle and no worries about running out of money. This requires building a sufficient nest egg and carefully managing it. Managing a nest egg to accomplish both can be difficult, as decisions must be made about asset allocations and withdrawal-rates.
Readers may be familiar with the 1998 study that arrived at a 4% guideline as a safe withdrawal-rate (SWR). That is, withdraw 4% of the initial balance at retirement and increase the amount annually by inflation. They concluded that this rule gives retirees a reasonable chance of their nest egg lasting 30 years if their nest egg is about 50% in stocks. Unfortunately, the data this study is based on is now stale. At that time, interest rates on government bonds were in the 5% range and stock valuations as measured by P/E ratios were much lower. Recent statements from the Federal Reserve suggest interest rates that are now less than 2% will increase only gradually. The S&P 500’s P/E ratio in the mid-1990s was around 15; recently it was around 22.
Some recent studies came to uncomfortable conclusions. One concluded no matter what the asset allocation, there is no static inflation-adjusted withdrawal-rate that will allow most retirees to have both a comfortable retirement with no risk of running out of money. Another study by Wade Pfau concluded that for an investor taking moderate risk, 2.4% was a SWR. Other studies have come to more disturbing conclusions. One concluded 1% was a SWR. Few retirees could maintain a comfortable lifestyle at either withdrawal-rate.
As disturbing, many retirees believe they can safely significantly exceed the 4% guideline. One study by Fidelity discovered that 38% of respondents thought they could annually withdraw at least 7% and half of those thought 10-15% and still have their money last a lifetime.
However, taking account of mortality provides for better scenarios. The 4% guideline and most other studies of a SWR ignore it. Most retirees won’t live 30 years. Consider, of 100,000 65-year-old men only about 6,000 will live 30 years. That means 94,000 men potentially had a less desirable lifestyle then they could’ve afforded using any of the preceding withdrawal-rates.
Research indicates taking mortality into account allows for higher withdrawal-rates with similar risk. One study shows an inflation-adjusted 5% withdrawal-rate has about a 20% failure-rate when success is measured by lasting 30 years. However, the failure-rate for a 65-year-old man with a 5% withdrawal-rate is less than 10% when success is measured by the nest egg outliving the retiree.
Other research suggests another way to partially mitigate the empty nest egg problem, a dynamic withdrawal-rate. One strategy is to forgo inflation-adjustment for the withdrawal-rate is in any year the market increase does not exceed the inflation rate.
For retirees expecting a normal lifespan that are risk-averse and want a simple guideline for a SWR, 3.5% and ignoring inflation-adjustment as just mentioned is prudent, but there are no guarantees.
All data and forecasts are for illustrative purposes only and not an inducement to buy or sell any security. Past performance is not indicative of future results. If you have a financial issue that you would like to see discussed in this column or have other comments or questions, Robert Stepleman can be reached c/o Dow Wealth Management, 8205 Nature’s Way, Lakewood Ranch, FL 34202 or at rsstepl@tampabay.rr.com. He offers advisory services through Bolton Global Asset Management, an SEC-registered investment adviser and is associated Dow Wealth Management, LLC.
This article originally appeared on Sarasota Herald-Tribune: ROBERT STEPLEMAN: Can you make your nest egg last for your lifetime?
