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Retirement Income Revisited

Back in 1996 I noticed a trend among investors. Those that had pensions especially with cost-of-living adjustments were doing very well with their retirement finances and living comfortably within their means. Investors without pensions usually kept tabs on the back of an envelope. Some of you may remember the filing system our parents had with the envelopes that had the actual mail and/or statements in them. They started with their social security income amount, added their dividends and then the amount of interest they could get on their CD holdings, which at the time was usually around 5%.

Over the next 5-10 years we saw pensions for many people go away, interest rates trend down (driving interest income down), and the large increases of the Nasdaq (and its subsequent decline in 2000) luring many investors with dividend payers to give that up for the possibility to make some “real money” in the market.

Income Planning Begins

All these things led investors to wonder if they had enough money, and how they could turn their savings into their own personal pension and a comfortable retirement. Initially most firms didn’t jump at this because we were on the front end of the baby boom curve, but if you fast forward to today you can’t avoid hearing the phrase retirement income or planning, which are now common buzz words. I spent some time back in the 1990’s looking at some assumptions to help investors prepare reasonable plans with safe withdrawal rates. I want to dust off some of those numbers because I think it’s important to revisit now.

This chart illustrates the difference between a 5% withdrawal rate and an 8% withdrawal rate.

A Sample Illustration Withdrawing 5%

In 1996 I looked back at mutual funds that had a 30-year history, which is not many. I chose one that at that time had handily outpaced the S&P 500 index. I started playing with a term known as systematic withdrawals. Essentially one would invest an amount and take scheduled payments of the same dollar amount all year and then annually adjust it for inflation. The dollar amount came out of the total value of the fund while dividends and capital gains were reinvested into additional shares of the fund. After reviewing many funds, I chose one that was well known with a respected track record from a large mutual fund company. Here are the assumptions I used: $1,000,000 invested on 1/1/1965, which was not a great period to be investing because the market indices went sideways for 15 years! So, $1,000,000 invested on 1/1/1965 and an initial annual withdrawal of $50,000, or 5%. I increased that amount each year by 4% inflation at the end of the year. So, $1,000,000 taking out $50,000 year one, $52,000 year two, etc. By the time you fast forward 30 years that annual withdrawal amount is over $155,000. I know your next question is what about the principal? I selected a 30-year period because that is the amount of time an average person can expect to spend in retirement if they retire at 62. In this hypothetical example after 30 years the principal is up more than eightfold to over $8,000,000. It is worth noting that at the end of 1974, which was an awful recession the principal value stood at about $860,000. I often wonder at that time would someone have thought they should sell everything and hide their money under a king mattress.

MORE FOR YOU

Impact of Increasing Withdrawals to 8%

That result does sound fantastic, but we all know things come up and people like to live in the moment especially now that consumer habits have really changed since 1996. However, I did run one more set of numbers to make a point. Let’s go back to my numbers and keep everything the same except one thing. Instead of 5% withdrawals, let’s make them 8%. So, adding an extra $30,000 a year to be able to do something fun. After all the principal above did make it to about

$8,000,000! What’s an extra $30,000 a year? I chose 8% a year for this set of numbers as the fund selected over my 30- year time horizon averaged over 11.5% annual returns so quick logic might say what could go wrong, right? So back to

$1,000,000 invested, 8% withdrawals with an annual increase of 4%. I bet you are excited to see what it looks like, but this example does not look good. It’s the result no one wants. The principal is $0 by 1983. The withdrawal rate is too high, the spending is too high and those great returns which happened over a 30-year period are overtaken by withdrawals that the principal can’t keep up with.

The above illustrations are just examples, but they highlight how excess withdrawals can have a dramatic impact on a retirement income plan. Today we are seeing higher spending and higher inflation, and with the market’s recent declines I hope this article might sound an alarm and encourage people to evaluate their current plan and adjust if necessary.

Remember the world is not linear. A spreadsheet with the market averaging 10% does not mean it will make 10% a year. A baseball batter averaging .300 does not get a hit three times out of every ten. It is a statistical average over a long- time span. It’s important to remember that. Just as important is making sure you have a handle on your spending needs and withdrawals.

What Can You Do Today?

While 2022 may be one of those year that we look back on that ruins future projections, it’s a great time to sit down and review your own personal situation and recalibrate before you find yourself running out of money.