Retirement is a significant life milestone, and ensuring financial stability during this phase requires careful planning and strategic decision-making. One of the most critical aspects of retirement planning is determining the best way to withdraw money from your portfolio. In this blog, we will explore various methodologies and studies to assist in making informed decisions for your retirement withdrawals.
The 4% Safe Withdrawal Rate Vs Guardrail Approach
The 4% safe, in relative terms, withdrawal rate is a commonly recommended strategy. This approach suggests that retirees withdraw 4% of their portfolio annually to help ensure their savings last throughout retirement. For instance, with a $2 million portfolio, you’d withdraw $80,000 per year. This method has been popular due to its simplicity and historical success in various market conditions.
However, recent studies have questioned the safety of this rate, especially following significant market downturns such as the dotcom bust, the 2008 financial crisis, and periods of low interest rates. These events have led to reassessments of the 4% rule, with some experts suggesting lower withdrawal rates in the mid to low 3% range.
An alternative to the fixed withdrawal rate is the guardrail approach, which offers more flexibility based on market conditions in a given year. This method allows for adjustments in withdrawal amounts depending on portfolio values and returns. If the market performs well, you might be able to withdraw more; if it performs poorly, you would withdraw less. This dynamic strategy aims to keep your withdrawal rate within a potentially safe range, typically between 3% and 5%.
For example, with a $2 million portfolio and a 4% withdrawal rate, you’d start with $80,000 annually. If market conditions improve, you might increase your withdrawals slightly, whereas poor market conditions would prompt a reduction. This approach helps ensure that you’re neither under-withdrawing and missing out on potential increases in lifestyle nor over-withdrawing and risking early depletion of your savings.
The Impact of Asset Allocation
A key principle in retirement planning is asset allocation, which involves diversifying your investments across various asset classes like equities, bonds, and international markets. Proper asset allocation helps mitigate risks and optimize returns. Studies have shown that a diversified 80/20 portfolio (80% equities and 20% fixed income) significantly outperforms a portfolio solely invested in the S&P 500.
To illustrate, an industry study analyzed a $1 million portfolio from 2000 to 2020, with an annual withdrawal of $50,000. A portfolio invested entirely in the S&P 500 left $454,483 after 20 years. In contrast, a diversified 80/20 portfolio resulted in $890,308 remaining. Furthermore, if withdrawals were strategically made from the highest-performing asset classes each year, the portfolio ended with $1,362,867. This demonstrates the potentially significant benefits of asset allocation and strategic withdrawals.
Managing your retirement portfolio involves more than just setting a withdrawal rate. It requires ongoing analysis and adjustments based on market conditions and individual needs. Professional management can help you navigate these complexities, helping to ensure that you make the most of your investments while minimizing risks.
For example, a lifecycle fund might automatically adjust your asset allocation as you approach retirement, shifting from equities to fixed income. However, this can lead to suboptimal withdrawals if you’re forced to sell assets during market downturns. A professional manager can help you potentially avoid these pitfalls by selectively withdrawing from asset classes that have performed well, preserving your overall portfolio value.
Cash Reserves and Safe Money
A crucial aspect of retirement planning is also maintaining a portion of your portfolio in safe, liquid assets to cover your short-term needs. This “cash bucket” approach involves keeping enough cash and short-term bonds to cover several years (ideally, 7) of living expenses, ensuring you don’t have to sell volatile investments during a sustained market downturn.
For instance, if you need $50,000 annually and your Social Security and pensions cover $30,000, you’ll need an additional $20,000 from your portfolio. Keeping at least seven years’ worth of this amount in safe investments ($140,000) helps ensure you can potentially weather market fluctuations without taking withdrawal and possibly jeopardizing your long-term financial security.
Planning for retirement withdrawals is a complex but crucial aspect of ensuring financial stability in your golden years. Whether you follow the 4% rule, the guardrail approach, or another strategy, it’s essential to stay informed and adaptable. Professional management and strategic asset allocation can increase the potential for significantly enhancing your portfolio’s longevity and performance, to better increase your peace of mind and financial security throughout retirement.
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Important Disclosures:
Securities and advisory services offered through EWA LLC dba Equilibrium Wealth Advisors (a SEC Registered Investment Advisor).
* Government bonds and Treasury Bills are guaranteed by the U.S. government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value. However, the value of fund shares is not guaranteed and will fluctuate.
* Corporate bonds are considered higher risk than government bonds but normally offer a higher yield and are subject to market, interest rate and credit risk as well as additional risks based on the quality of issuer coupon rate, price, yield, maturity, and redemption features.
* The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. You cannot invest directly in this index.
* All indexes referenced are unmanaged. The volatility of indexes could be materially different from that of a client’s portfolio. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment. You cannot invest directly in an index.
* The Dow Jones Global ex-U.S. Index covers approximately 95% of the market capitalization of the 45 developed and emerging countries included in the Index.
* The 10-year Treasury Note represents debt owed by the United States Treasury to the public. Since the U.S. Government is seen as a risk-free borrower, investors use the 10-year Treasury Note as a benchmark for the long-term bond market.
* Gold represents the afternoon gold price as reported by the London Bullion Market Association. The gold price is set twice daily by the London Gold Fixing Company at 10:30 and 15:00 and is expressed in U.S. dollars per fine troy ounce.
* The Bloomberg Commodity Index is designed to be a highly liquid and diversified benchmark for the commodity futures market. The Index is composed of futures contracts on 19 physical commodities and was launched on July 14, 1998.
* The DJ Equity All REIT Total Return Index measures the total return performance of the equity subcategory of the Real Estate Investment Trust (REIT) industry as calculated by Dow Jones.
* The Dow Jones Industrial Average (DJIA), commonly known as “The Dow,” is an index representing 30 stock of companies maintained and reviewed by the editors of The Wall Street Journal.
* The NASDAQ Composite is an unmanaged index of securities traded on the NASDAQ system.
* International investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors. These risks are often heightened for investments in emerging markets.
* Yahoo! Finance is the source for any reference to the performance of an index between two specific periods.
* The risk of loss in trading commodities and futures can be substantial. You should therefore carefully consider whether such trading is suitable for you in light of your financial condition. The high degree of leverage is often obtainable in commodity trading and can work against you as well as for you. The use of leverage can lead to large losses as well as gains.
* Opinions expressed are subject to change without notice and are not intended as investment advice or to predict future performance.
* Economic forecasts set forth may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
* Past performance does not guarantee future results. Investing involves risk, including loss of principal.
* The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee it is accurate or complete.
* There is no guarantee a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.
* Asset allocation does not ensure a profit or protect against a loss.
* Consult your financial professional before making any investment decision.
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EWA, LLC dba Equilibrium Wealth Advisors, is an SEC-registered investment advisory firm providing investment advisory and financial planning services to clients.
Investments in securities and insurance products are not insured by any state or federal agency.
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In 15 minutes we can get to know you – your situation, goals and needs – then connect you with an advisor committed to helping you pursue true wealth.