Scott Burns: Stay safe on retirement spending

Hey--

If no one cared to post this column by Scott Burns, this horse really must be dead!
Glad we're all getting over it!

http://www.dallasnews.com/business/scottburns/

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Stay safe on retirement spending
New research suggests ways to withdraw more, but it could be risky

09:29 PM CST on Monday, November 29, 2004

By SCOTT BURNS / The Dallas Morning News

How much can you spend in retirement?

Nine years ago I took the legendary Peter Lynch to task for giving bad advice on that question. He had told readers of Worth magazine that they could invest 100 percent of their money in common stocks and safely withdraw an initial 7 percent a year, adjusting for inflation. Working with Ken Bingham, a friend and stockbroker at UBS, we showed that such withdrawals had a major chance of leaving you dead broke.

We weren't alone in our concern about portfolio withdrawal rates. Financial planner William P. Bengen had addressed the subject in the Journal of Financial Planning early in 1994, demonstrating that the maximum safe initial withdrawal rate from a retirement portfolio was about 4 percent. A few years later, three researchers at Trinity University tested different portfolios and found that initial withdrawal rates of 4 percent to 5 percent were about the best you could do.

Needless to say, no one likes to hear this.

We all want to be told we can have a starting withdrawal rate of 6, 7, 8 or 9 percent from our savings, adjust upward for inflation each year, and never run out of money. Many readers have suggested that you can withdraw more than 4 percent if you are flexible, e.g., not increasing your withdrawals when values are down, etc.

Well, some new research suggests you can take more than 4 percent.

In the October Journal of Financial Planning, certified financial planner Jonathan T. Guyton tests a variety of spending rules during one of the worst periods for retirement imaginable – 1973 through 2003. The period includes two major meltdowns and early years of heavy-duty inflation. Searching for a withdrawal rate that would be safe for a period of 40 years, he found withdrawals limited to 4.7 percent with an 80 percent equity portfolio and no rules. Apply two simple rules, however, and your initial withdrawal rate can be 6.2 percent.

Here are the rules.

Rule No. 1: There is no increase in withdrawals after any year with a negative total return and there is no "catch-up" for any missed increase in any subsequent year.

Rule No. 2: Regardless of the inflation rate, the maximum annual income increase is limited to 6 percent, and you cannot "catch up" in later years.

Retirees can apply those rules and safely increase their initial retirement spending by one-third!

Alas, before you start lining up for the spending parade, there is something you need to know. Other research, published in the September/October issue of the Financial Analysts Journal, will rain on your parade.

Starting with the idea that future portfolio returns are influenced by valuation levels when you start, researcher Robert Arnott examines returns of typical portfolios and finds that real returns have averaged about 4.2 percent in the postwar period. A portion of that real return, however, came from rising valuation levels. When valuation level changes are stripped out, the average real return on a 60/40 stock/bond portfolio has been only 3.4 percent since World War II. Since valuation levels are currently high and we can't count on them rising still further, Mr. Arnott believes pensions and endowments may be heading for trouble.

"Sustainable return and real return, not counting changes in valuation levels or yields, have averaged, respectively, 3.3 percent and 1.9 percent," Mr. Arnott writes. "This return is nowhere near the 5 percent spending required of foundations, nor does it approach the 5 to 6 percent spending rules that prevail for most endowments."

Since foundations, endowments and retirees are trying to do essentially the same thing – maintain constant spending power over a long period of time – it's very likely Mr. Guyton's rules give a dangerous sense of safety.

Bottom line: Withdraw more than 5 percent a year at your peril.

Now, this is why I like Scott Burns, you get some thoughtful info, whether you agree or not. Unlike the object of my considerable scorn (Bob Brinker) where
he uses nonsensical explanations, says buy
GNMAs, or as I heard the other day "Well, you may want to consider starting to draw your SS at 62 if you
have a terminal illness." Yep, that's real helpful.

John Galt

Quote:

If no one cared to post this column by Scott Burns, this horse really must be dead! Glad we're all getting over it!

There was a thread a week or two on this very topic. It has merit. I also beleive in a higher SWR in the early years, while waiting for SS to kick in and realizing that spending money at age 85+ won't be as fun as age 55

[REWahoo]

Quote:

I also beleive in a higher SWR in the early years, while waiting for SS to kick in...

Cut-Throat, I'm in agreement with your "take more in the early years" approach.

I'm 6 months from pulling the trigger and 4 years from SS eligibility. The plan is to carve out of our total savings enough to fund the annual amount we will receive (I hope) from SS until it kicks in. From the remaining fund we will start at the much debated 4% withdrawal rate, adjusting as necessary.

That's my plan and I'm sticking with it...

REW

[ESRBob]

Quote:

* I'm 6 months from pulling the trigger and 4 years from SS eligibility. *The plan is to carve out of our total savings enough to fund the annual amount we will receive (I hope) from SS until it kicks in. * From the remaining fund we will start at the much debated 4% withdrawal rate, adjusting as necessary.

REW --
Sounds like a reasonable plan-- I've long been intrigued by how the arrival of SS checks can and should change your perceived SWR or withdrawals generally.

My question is this: what % of your current spending (or of an inflation adjusted 2009 spending) will your SS checks represent? A quarter? A third? I'm trying to get a handle on whether that percent makes a difference in how you think about spending extra to 'bridge' the years from RE to SS.

ESRBob

[REWahoo]

Quote:

My question is this: what % of your current spending (or of an inflation adjusted 2009 spending) will your SS checks represent? A quarter? A third?

Adjusted for inflation, SS looks to be about 35% of planned spending.

REW

Excellent question. With only me drawing, I'm guessing
maybe 2/3 of our total. Just a guess, but over 50% for sure.

John Galt

[ESRBob]

Quote:

Adjusted for inflation, SS looks to be about 35% of planned spending. REW

In that case, the remaining Portfolio after you spend down over the next four years will need to support 2/3 of your living expenses. *Put another way (if you are going with a 4% SWR) your portfolio needs to be 2/3 * 25 * current annual expenses. *If your current annual is 45k, then SS will pick up 15k, and you pick up 30k from your SWR. *You'd need 30k*25 = 750k at the end of 4 years. *(you work out how to adjust these numbers to account for 4 years of inflation/earnings) .

Does this sound roughly like the methodology you are using? *If not, I'd like to hear if you think it's wrong or can be improved, and especially if you have a reliable model/ approach to account for the net effect of earning/inflation/spending down assets over the interim 4 years.

best,
ESRBob

[sgeeeee]

Quote:

. . .Does this sound roughly like the methodology you are using? *If not, I'd like to hear if you think it's wrong or can be improved, and especially if you have a reliable model/ approach to account for the net effect of earning/inflation/spending down assets over the interim 4 years. best, ESRBob

FIRECALC allows you to look at this kind of situation in detail. You can turn increases/decreases in income off and on at specific times and you can choose to adjust them for inflation or not. But here's another way to look at this situation. If social security is going to make up 1/3 of your expenses in 4 years, split your currrent portfolio value into two pools. One pool is the amount required to support 2/3 of your expenses from retirement to grave. Whatever remains needs to support 33% of your expenses from retirement until social security kicks in.

Example: You have $1M in assets. Your required withdrawal rate is $50K per year. Social security will cover 1/3 of that required withdrawal starting in 4 years.

So in 4 years you will only need 2/3 of the withdrawal from your portfolio which is $33K in today's withdrawal. A 4% withdrawal rate indicates that $33K initial withdrawal requires $825K (= $33K/0.04) of your portfolio. This leaves $175K of your portfolio to cover the remaining 1/3 of your expenses ($17K initial withdrawal) for the next 4 years. In this case it is clearly enough.

Although it clearly depends on your asset mix, and other details, here are some approximate safe withdrawal numbers for periods of less than 30 years. This can be useful in figuring out how much portfolio it takes to fill the gap until social security:

Number of Years . . . . . Approximate SWR
. . . . . 5 . . . . . . . . . . . . . . . . . .14%
. . . . .10. . . . . . . . . . . . . . . . . . 8%
. . . . .15. . . . . . . . . . . . . . . . . . 5.9%
. . . . .20. . . . . . . . . . . . . . . . . . 4.8%

Great post SG ! - I have done this with FIRECalc, but had not looked at it your way

[REWahoo]

ESRBob, your analysis of my methodolgy is correct.

salaryguru, I've run my numbers through FIRECALC, but I had not looked at it from the point of view you describe. I'll give it a try to see if it validates my estimate of how much I will need in my pre-SS bucket.

Thanks to all for the input.

REW

And another thing.............My SS will just about replace
my wife's wages. Thus, everything else being status quo, she could ER in 1 year, 9 months and 8 days
(but who's counting?), and we would just keep sailing along,
with the usual dangers. At that point, she will be 57,
so 5 years from SS, and I will be 3 years from Medicare.
I know from experience how fast that time will pass by.

John Galt

[Martha]

So John, did you ever talk to your spouse about retiring when you start collecting SS? Or no? As they say in Wisconsin.

There seem to be good reasons to want to spend more in the first years of retirement. You have the energy for travel, for doing projects, or whatever. However, I have also read that taking too much money out early in retirement is the enemy of the early retiree. I guess it is just finding the right balance and having a sufficient cushion. My problem is deciding when the cushion is sufficient.

Hello Martha (my first girl friend was a Martha).

Good post! First, I do not plan on drawing down any
of our net worth in retirement, but just living off the income and SS. This is subject to revision of course.

As far as talking to my wife about her retirement when
(if?) I reach 62, yes I have. From my point of view it is
not productive. She is just not a long range planner
in any way, so that is left to me. This is okay as it comes naturally to me. The problem arises when I try
to help her and insure her security and happiness
while not really knowing where she wants to be in a
year, or 2 or 5 or 10 or? Right now, the finances are
fine. She has her money. I have my money. The split
of who pays what is okay with both of us. I would like to make her life better in all ways. However, it's a bit difficult
with no real input from the other party. I have concluded with her "live for today" approach, she is just
incapable of viewing things the way I do. It's like I'm speaking English and she's talking Greek. Truly
though, I knew (and we discussed before we married)
that we were poles apart on money issues. Thus, neither of us can say we were unaware.

John Galt

[Shredder]

It's like I'm speaking English and she's talking Greek.

John, I know the feeling. My spouse and I are worlds apart, and I have not found a way to discuss money matters in a way we both can live/agree with. As an example I could pay my wife's car loan off (she is still working), but if I did she would in turn blow thru all her money. She spends all money left in her accounts, and is ussually broke at some point every month. As a result we have a system we can live with even if we don't agree on it. She pays for her car, cell phone, credit cards, I pay for the house things, insurance, and we have a joint account for monthly bill. I detest having a balnce on any credit cards, and try to pay cash for all purchases, she says why pay more if you don't have to. I guess our arrangment is like US and Russia during the cold war, you know mutually assured destruction, just kidding. Anyway this system just kind of evolved, even if we don't understand each others habbits....Shredder

Well Shredder, it's nice to kniow someone else is in
the same boat and making it work.
Peaceful coexistence?

John Galt

[BUM]

Quote:

*she is still she would in turn blow thru all her money. She spends all money left in her accounts, and is ussually broke at some point every month. As a result we have a system we can live with even if we don't agree on it.

Disclaimer this is a CHP (cocktail hour post)


All together now..."Theres a hole in the bucket..."

[Jarhead*]

[quote]

Rock: My wife has always been like that. Her hobby was taking care of house in whatever creative way she had in mind.
That is absolutely compatable with early retirement. As long as she has a house to decorate, the geography probably won't be as important to her as it is to you

[ESRBob]

Rock,
If she likes to decorate in creative (read: inexpensive) ways, then you may have a real winner situation for all parties. If on the other hand she is into high-cost decorating with some remodelling thrown in, and shoot, why not replace the windows with Marvin custom argon filled glass ones, (they'd go with the new marble topped wet bar), then you may have a serious threat to an early entry into ER.

Design On a Dime is a good show for getting the juices flowing on the right approach: on HGTV if you aren't already familiar with it.

Good Luck -- I've seen good plans for ER derailed over home decorating (and because the new Mercedes looks so much better in the cobblestone driveway next to the specimen trees.)

ESRBob

Now this is pretty interesting. I have all but given
up on discussing finances with my wife. Not only is
it non-productive, but it causes friction. In spite of my
obvious character flaws, I'm a smart guy and my wife
is intelligent. Yet, although I listen as intently as possible, many times I have no idea what the hell she
is trying to tell me. Ordinarily one might assume this
is due to my not really giving a damn. Sometimes that
is true, but not where my spouse is concerned.
Honestly, I've given it my best shot and very little
to show (planning wise). Go figure.................

JG