Will My Retirement Savings Support Me for 30 Years?

40324156_sWhat’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% ruleT. 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%.

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