Will my retirement savings support me for 30 years?
By Walter Updegrave
NEW YORK — What’s the best investing and withdrawal strategy to provide me a retirement income that will last 30 years? –Matt
Clearly, the way you invest your savings and the amount you withdraw each year are both important in determining how long your retirement assets will last.
Invest too aggressively and your nest egg might suffer losses so devastating during a major downturn or a prolonged bear market that it might not recover enough to generate sufficient income even after stock prices rebound. Invest too conservatively and your retirement portfolio may not generate enough capital growth for you to maintain your standard of living in the face of inflation over the course of a long retirement.
The same applies to withdrawals. Pull too much from your savings, especially early in retirement, and you increase the risk that you may run out of money while you’ve still got a lot of living to do. Being more cautious about how much you withdraw can reduce that risk, but it exposes you to another risk — namely, you could end up with a big pile of savings very late in life. That might not seem like such a bad thing, but it might mean that you lived more frugally than you had to early in retirement.
So a good retirement income plan must achieve a balance between how you invest your money and how much you withdraw. That said, when it comes to making sure that you don’t outlive your savings, I contend that how much you pull from savings each year is actually the more important of the two. Which means you want to take special care in setting an appropriate withdrawal rate.
To see why that’s the case, let’s look at a few scenarios involving different investing strategies and withdrawal rates.
Assume you’re 65, have a $500,000 nest egg, 60% of which is invested in stocks and 40% in bonds. And let’s further assume that you want to be reasonably sure that your nest egg will be able to support you for 30 years, or until age 95. If you withdraw 4%, or $20,000, the first year of retirement and then increase that dollar amount by inflation each year — that is, you follow the 4% rule — T. Rowe Price’s retirement income calculator estimates there’s an 80% chance your nest egg will be able to maintain that inflation-adjusted income stream for at least 30 years without running dry.
You would think that investing more aggressively or conservatively might dramatically increase or decrease your success rate, but that’s not necessarily the case. Indeed, for stock allocations from as high as 100% to as low as 30%, the chance of a $500,000 nest egg being able to sustain a $20,000 income — real or inflation-adjusted — for 30 or more years range between 76% and 80%. Not a big difference.
It’s only when you get to very low exposures to stocks — less than 30% of savings — that the success rate begins to drop off significantly at a 4% withdrawal rate.
And contrary to what you might expect, very high stock allocations (80% to 100% in stocks) actually had a slightly lower chance of success than more modest stock allocations (40% to 60%), largely because at some point adding more stocks makes a portfolio much more volatile and vulnerable to market setbacks.
And if you go to a lower initial withdrawal rate — say, 3% — you’ll also find that boosting your stock exposure doesn’t do much to increase your success rate, and high allocations to stock (70% or more) begin to pull your success rate down.
In fact, it’s only when you get to withdrawal rates of 5% or more that lofty stock holdings appreciably boost your chances of success. For example, a nest egg invested in a mix of 60% stocks-40% bonds has about a 55% chance of lasting 30 or more years at a 5% withdrawal rate. Going with a much more aggressive 90% stocks-10% bonds mix will boost your chances of success to just under 60%.
But the question is whether you would consider that rate of success acceptable, as it also means you have a greater than 40% chance that you’ll run through your nest egg too soon. In short, you shouldn’t expect that an aggressive investing strategy will support outsize withdrawals from your savings.
The upshot: As long as you set a reasonable withdrawal rate — say, 3% to 4% — you should have pretty wide latitude for how you divvy up your savings between stocks and bonds. Which means you can likely create a stocks-bonds mix that largely jibes with your tolerance for risk without putting you in too much danger of running through your nest egg too soon.
For guidance on how to build such a portfolio, check out this risk tolerance-asset allocation questionnaire.
Keep in mind, however, that these success rates aren’t guarantees. They’re estimates based on how the financial markets might perform in the future. So you should be prepared to be flexible about withdrawals, lowering them if your nest egg’s value takes a hit and perhaps increasing them if outsize gains in your investments causes your retirement account balances to swell.
If you’d like the peace of mind from knowing you’ll receive a payout every month regardless of how the financial markets perform, you can consider putting some (but not all) of your savings into an immediate annuity or a longevity annuity and keeping the rest in a diversified mix of stocks and bonds.
Remember too that the success rates above measure only the likelihood that your savings will last a specific amount of time, in this case 30 or more years. They say nothing about how much money you may have left in your retirement accounts in those scenarios when they don’t run dry. And the fact is that in those instances where your savings do last 30 or more years, a higher stock stake can leave you with a much bigger nest egg late in retirement.
So even if greater stock exposure doesn’t increase the chance that your portfolio will last longer, you might still prefer to tilt your asset mix more toward stocks if, say, you want to leave more money to your heirs or just want to have a bigger cushion to handle higher-than-anticipated medical expenses or other unexpected expenses late in life. Just don’t forget that investing more heavily in stocks also increases the potential for gut-wrenching drops in the value of your savings during periods of market turbulence.
You can see for yourself how different mixes of stocks and bonds and withdrawal rates affect your nest egg’s longevity by going to the T. Rowe Price calculator I used in the examples above or by using this retirement withdrawal calculator from the American Institute for Economic Research. If you go through this exercise, I think you’ll find that if you want greater assurance that your nest egg will last as long as you do, your primary focus should be on choosing a reasonable withdrawal rate.