How Can You Make Your Retirement Money Last?

These spending and investing principles may encourage its longevity | June 8, 2016


Retirees want their money to last a lifetime. While there is no guarantee it will, in pursuit of that goal, households may consider adopting a couple of spending and investing principles.

Principle No. 1: Observing the 4% rule. This classic retirement planning principle works as follows: A retiree household withdraws 4% of its amassed retirement savings in year one of retirement, then 4% plus a little more every year thereafter. The annual withdrawals are gradually adjusted upward from the base 4% amount in response to inflation.

The 4% rule was first formulated in the 1990s by influential financial planner William Bengen. He was trying to determine the “safest” withdrawal rate for a retiree—one that theoretically could allow his or her savings to hold up for 30 years given certain conditions (more about those conditions in a moment). Bengen ran various 30-year scenarios using different withdrawal rates in relation to historical market returns, concluding that a 4% withdrawal rate (adjusted incrementally for inflation) made the most sense.1

For the 4% rule to “work,” two fundamental conditions must be met. One, the retiree has to invest in a way that will allow his or her retirement savings to grow along with inflation. Two, there must not be a sideways or bear market occurring.1

As sideways and bear markets have not been the norm, following the 4% rule could be wise in a favorable market climate. Michael Kitces, another influential financial planner, has noted that historically a retiree strictly observing the 4% rule would have doubled his or her starting principal at the end of 30 years more than two-thirds of the time.1

In today’s low-yield environment, the 4% rule has its critics. They argue that a 3% withdrawal rate gives a retiree a better prospect for sustaining invested assets over 30 years. Also, retiree households are not always able to strictly follow a 3% or 4% withdrawal rate. Dividends and required minimum distributions may effectively increase the yearly withdrawal. Retirees should review their income sources and prospects with the help of a financial professional to determine an appropriate withdrawal percentage given their income needs and long-term financial stability considerations.

Principle No. 2: Adopting a “bucket” approach. In this strategy, a retiree household assigns one-third of its savings each to equities, fixed-income investments, and cash. Each of these “buckets” has a different function.

The cash bucket is simply an emergency fund; it is stocked with money that represents the equivalent of two to three years of income the household does not receive as a result of pensions or similarly scheduled payouts. In other words, if a couple gets $35,000 a year from Social Security and needs $55,000 a year to live comfortably, the cash bucket should hold $40,000-$60,000.

The household replenishes the cash bucket over time with potential investment returns from the equities and fixed-income buckets. Overall, the household should invest with the priority of growing its money, though the investment approach could tilt conservative if the individual or couple has little tolerance for risk.

Since growth investing is an objective of the bucket approach, equity investments are bought and held. Examining history, that is not a bad idea: the S&P 500 has never returned negative over a 15-year period. In fact, it would have returned 6.5% for a hypothetical buy-and-hold investor across its worst 15-year stretch in recent memory—the 15 years ending in March 2009, when it bottomed out in the last bear market.2

Assets in the fixed-income bucket may be invested as conservatively as the household wishes. Some fixed-income investments are more conservative than others; they are less affected by fluctuations in interest rates and Wall Street turbulence than others. While the most conservative fixed-income investments are currently yielding very little, they may yield more in the future as interest rates presumably continue to rise.

There has been great concern over what rising interest rates will do to this investment class, but if history is any guide, short-term pain may be alleviated by ultimately greater yields. In December 2015, Vanguard Group projected that, if the Federal Reserve gradually raised the benchmark interest rate to 2.0% across the three-and-a-half years ending in July 2019, a typical investment fund containing intermediate-term fixed-income securities would suffer a -0.15% total return for 2016, but return positively in the following years.3

Avoid overspending and invest with growth in mind. While following that simple instruction is not guaranteed to make your retirement savings last a lifetime, it may help you to sustain those savings for the long run.

Citations.

1 – money.cnn.com/2016/04/20/retirement/retirement-4-rule/ [4/20/16]

2 – time.com/money/4161045/retirement-income/ [5/22/16]

3 – tinyurl.com/hjfggnp [12/2/15]

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