“Then there is the man who drowned crossing a stream with an average depth of six inches.”
The standard financial planner advice when it comes to how much you can spend in retirement is 4% of your nest egg when you retire, adjusted annually for inflation. Actually, the more accurate safe withdrawal rate is 3.88%. Click on that link to find out how we came up with that number.
However, if your grandparents saved and scrimped, and when they retired, lived off of the interest off of their money, then you might wonder why you can’t do something similar with your investments – just take what you earn each year and live off of that.
Are You Leaving Money on the Table by Only Withdrawing 3.88% in Retirement?
In a word, yes.
However, there’s a tradeoff that you’re making, which hinges on two words:
Why volatility impacts your withdrawal strategies
Volatility is the fancy financial term for the market going up and down. Some years, it’s up. Some years, it’s down.
So far, so good.
If the market always gained at least 3.88%, then you would be in good shape.
The problem is that a little more than one year in three, the market returns less than 3.88%.
When it does that, you’re eating into your principal.
Retirement planners like for your money to last at least 30 years in retirement. I looked at the historical annual returns from 1871 through 2013 and then determined if a retiree between 1871 and 1973 could last 30 years by either withdrawing the gains, or, when gains were less than 3.88%, withdrawing 3.88%. This strategy only worked 61.2% of the time. When I make plans, I will only approve them if they work 90% of the time in my projections.
Therefore, volatility kills off this idea.
Why inflation impacts your withdrawal strategies
The other issue that retirees face with managing their money is that they need to keep up with inflation. If you can remember when gasoline was under a dollar a gallon (or a quarter a gallon) or Cokes out of the vending machine were only a quarter (or a nickel), then you are thinking of the ravages of inflation.
However, you shouldn’t have debt when you retire, and you probably aren’t earning a paycheck, but the price of milk, eggs, and bread goes up each year. To keep up, you need your investments to beat inflation for you. Plus, healthcare and long term care expenses, a greater portion of a retiree’s spending, have a higher inflation rate than the standard number cited – which is usually for consumer goods and services.
As we can see here, 3% inflation – roughly the average inflation rate – means that $1 at the beginning of retirement buys only 41.3 cents worth of the same goods and services 30 years later. Put another way, after 30 years, you need $2.36 to buy what it took $1 to buy 30 years before.
That’s why you cannot put your money into CDs and money market accounts in retirement and expect to have enough to last, unless you have about three times the standard amount required.