I talk about the need to save for retirement all the time on the Money Guy Show. However, I have not done a show discussing what you can expect from these savings once you hit the retirement phase of your life. Before all of my young readers and listeners tune out or click to close this post let me remind you that retirement hits us all. If you are not personally approaching retirement age then you probably have friends and family that will be there shortly. I also have to believe that if you are listening to a financial podcast you are probably the person that your friends and family count on to know the answers to all of their financial questions. In other words hang in there with me and you just may learn something that could help you build your financial knowledge as well as understand what it takes to have a healthy retirement plan.
The Quick and Dirty Method: The 5 percent rule….
I am asked frequently how do you know if you have saved enough money for retirement. This is a very difficult question because there are so many variables that go into the answer, but there is a quick and dirty calculation that can let you know if you are even in the ball park of retirement. In order to ball park the answer you need to know how much money will be required annually to pay your bills as well as allow you to enjoy life. Is $50k a year enough or do you need between $100k to $200k? Based upon the answer you can then quickly determine how big your investment portfolio needs to be. I provide details below:
- $50k = $50,000 divided by .05 = $1 million dollar portfolio
- $100k = $100,000 divided by .05 = $2 million dollar portfolio
- $200k = $200,000 divided by .05 = $4 million dollar portfolio
Many of you are probably upset by these numbers because so much money has to be saved to generate resonable living expenses. Remember this is a very simple calculation and it is also designed to be conservative. Now if we ever entered into a prolonged bear market this calculation would not work but based upon historical market performance and a diversified portfolio with a moderate risk level there is a great chance the portfolio will generate enough growth and income to cover your retirement needs.
Now that I have provided you with the quick and dirty method there is a great article that gets much deeper into the discussion that help you pinpoint what your actual retirement picture will look like. Once you determine that you probably have enough money saved based upon the 5 percent method you may want to research and read the work of William P. Bengen, CFP®. William has written a book titled Conserving Client Portfolios in Retirement, as implied from the title this is a book that was written for advisors to use as a tool when evaluating their clients’ retirement savings. You can read the following articles and get a pretty good understanding of Mr. Bengen’s research and how you can use it to determine if you should expand your withdrawal rate percentage from 5 percent to 7 percent or maybe you even need to be more conservative and lower your withdrawal rate to 4 percent.
For my number lovers you are going to enjoy these articles:
FPA Journal, "Baking a Withdrawal Plan ‘Layer Cake’ for Your Retirement Clients"
Financial Planning Perspectives, "Conserving Your Portfolio in Retirement"
A few good findings from the reports:
- 4.15 percent assuming a 30 year time horizon is perhaps the ideal withdrawal rate when using a portfolio made up of two asset classes with 64 percent investing in large company stocks and 37 percent invested in intermediate-term Government bonds, and which is rebalanced at the end of each calendar year.
- Adding a third asset class with 17.5 percent in small comany stocks, 42.5 percent invested in large-company stocks and 40 percent in intermediate term Government bonds will increase the withdrawal rate to 4.4 percent
- If you have a shorter time horizon you can increase your withdrawal rate. The peak withdrawal rate for a person with a 10 year time horizon is 8.9 percent, about twice that for a person with a 30 year time horizon (time horizon for this discussion means how long you need the money to provide retirement funds).
- Increasing your withdrawal rate reduced your odds of a portfolio lasting 30 years. An increase of 1 percentage point above the calculated safe withdrawal rate reduces the probability that a portfolio will last 30 years by 15 to 20 percent.
- An initial withdrawal rate 2 percentage points above the calculated safe withdrawal rate results in just a 55 to 60 percent success rate.
- Investors can marginally increase their initial withdrawal rates by changing the frequency that they rebalance their portfolios during retirement. According to Bengen’s research, investors could rebalance every 75 months, or once every 6 years, and actually improve the initial withdrawal rate to 4.65 percent.
As you can see this was a very interesting article that provides lots of data to sink your teeth into. Enjoy and thanks for listening to my show!