How Much Money Do I Need to Retire?
How to Manage with Less Money After Retirement
Every investor eventually faces the question of deciding "How much do I need to retire?" In the end, at some point you need to reach a conclusion about just how much is enough, and the problem is that it's one of those decisions that you don't get to do over. Here's a look at some of the traditional answers to that problem, and some things you can do to make the money you do have set aside last longer.
The standard answer is to how much is needed to retire is typically that you can withdraw 4% of your nest egg each year. So, if you had set aside a million dollars, you could withdraw $40,000 a year. That's an odd number, given that the stock market has returned about 11% annually over the last several decades, so let's look a the assumptions that make up that number.
Several years back there was a paper written by Cooley, Hubbard, and Walz. In their paper "Retirement Savings: Choosing a Withdrawal Rate That is Sustainable" they make the following observations and assumptions.
You will want to get the best probability that your savings will last at least 15 to 30 years (they run several scenarios over that time spread).
Assumptions About Your Portfolio
This is a statistical analysis that uses the annual historical returns from 1926 forward to generate the possible returns your portfolio might see. It assumes that you are fully invested with a mix of the stock market and a bond portfolio during all your retirement, and the ratio of stocks to bonds was one of the factors varied in the study.
Inflation is accounted for, and another assumption is that your required withdrawal will track the CPI inflation rate. In our example where you are withdrawing $40K a year, if after the first year the CPI is up 5%, then the next year you would be taking out 5% more, or $42K.
You never modify your withdrawal rate, even if the market has a down year. You continue to take out your $40K, adjusted for inflation.
No taxes or transaction fees are included in the analysis.
The goal was to have your retirement savings last at least 30 years. This matches a typical scenario of retiring at age 65, and even though your life expectancy at that point is not 30 years, half the population will last beyond the average life expectancy, so prudence dictates that you plan for several more years.
Results and Conclusions
With all that as background, the portfolio mix that gave the best probability of lasting 30 years was a mix of 75% stocks, 25% bonds, netting a 98% chance of lasting 30 years. It's interesting to note that the portfolio of 100% stocks gives a higher average return, but is significantly more volatile and hence probably will not last as long.
What to Do
Things you can do to reduce the amount you need (or increase the amount you take out)
1) Reduce the number of years you will need to have the money. Basically this means retire later. However, this has less impact than you'd think at first. Even if you reduce the number of years to 25 from 30 it doesn't allow you to increase the withdrawal rate from 4% to even 5%.
2) Don't plan to track inflation. If you are in a position where your house is paid for and you're not a big spender, as you age into your 90's your discretionary spending will naturally drop. However, your medical expenses may offset that drop. This can have big impact. Taking out inflation would allow you to increase your withdrawals from 4% to 6%, a 50% increase.
3) Increase the returns on your investments. This is the approach that many people pursue with vigor, but it's hard to keep an edge for 30 years.
4) Reduce the volatility of your returns. Less glamourous, but actually much more effective. Even if you kept the same level of returns, if you could reduce the volatility of the portfolios returns, the amount that could be taken increases 50% again.
A Personal Observation
My husband (who started this HubPages account) retired early at 52 years old after staying with the same employer for 31 years. He only lived for 2 1/2 years in retirement before passing suddenly at 55. We did not have a chance to share our plans for 10, 20 or even 30 years into retirement.
Whatever retirement plan you come up with, please share it with your spouse, partner, children or executor of your estate. His passing was not something we "planned" on so early and were literally just get used to being home together and doing things together. I was left to learn about our finances under much stress. I am also very proud of where I am today but It goes without saying that some conversation ahead of time between the two of us could have saved a lot of stress in the situation I am in.
Sit down and have a talk today.
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