Transitioning to retirement …

withdrawal1You’re hard at work, trying to to reach Your Number, and you’ve cranked up your Perpetual Money Machine to make sure that you get there …

… now, there’s not much to do except work the plan.

So, let’s fast-forward a few years and think about what happens when you finally reach Your Number.

If you recall, you calculated your Number simply by:

Taking your Required Annual Living Expenses (which you adjusted for inflation) x 20.

Now, where did this Rule of 20 come from?

It is simply the same as withdrawing 5% from your Number each year.

Picture your Number as a pile of cash that you made by saving, investing, or even selling your real-estate and/or business portfolio, and now it is sitting safely in the bank as cash or CD’s, earning bank interest each year. The question is, how much can you safely withdraw each year to live off (like paying yourself a wage) so that you never run out of money?

When you are busy ‘working’ (be that on a job, in a business, or on your actively-managed investment portfolio) you will dream of nothing but having that pile of cash that equals Your Number just sitting there.

But, when you have that pile – hopefully, very large pile – of cash you will suddenly realize:

1. You have to pay taxes on the interest,

2. You have to beat inflation,

3. You have to spend some of your capital to live,

4. You have to survive market downturns.

You have to hope this money lasts as long as you do!

… all of a sudden, you have to be VERY protective of Your Number.

When you are working, you fear losing your job. When you start to invest, you fear losing some or all of your investments. When you start or buy a business, you fear closing down. The reality is that you can recover from any/all of these scenarios given a little extra time and work. But, if you lose Your Number, you have lost everything … and, the longer it takes to lose it, the less time/chance you have of recovering it.

So, a key question becomes: what is a SAFE percentage of Your Number to withdraw each year? Usually, a great place to start is by looking at what ‘the experts’ recommend …

Unfortunately, there is support out there for just about any annual % of Your Number (i.e. your retirement nest egg) that you may choose to spend, for example:

7% – Not so long ago, the financial services industry proposed spending as much as 7% of your portfolio each year in retirement.

6% – More recently, Paul Graangard wrote two books proposing a combined bond-laddering and stocks strategy that, he suggested, supported a spending rate as high as 6.6% of your portfolio each year.

5% – Investment funds routinely allow spending of 5% of the portion of their investment portfolios dedicated to simply keeping up with inflation. Indeed, my Rule of 20 appears to support this withdrawal rate, too.

4% – A large number of studies – probably, the most famous of which is the so-called Trinity Study – advocate spending up to 4% of your initial portfolio (ideally, 50% stocks and 50% bonds, rebalanced each year), which provides somewhere between a 90% and 100% certainty that your money will last at least 35 years.

3% –  A whole slew of new retirement planning tools (generally using a Monte Carlo approach to modelling tens, hundreds, or even thousands of potential economic scenarios) have been released over the last 4 or 5 years by the financial services industry, purporting to analyse hundreds of alternative economic scenarios to try and model what would happen to your retirement portfolio (i.e. simulating changes in interest rates, market booms and busts, etc.) to find the ideal ’safe’ withdrawal rate. A lot of these advocate very low withdrawal rates, typically in the 2.5% – 3.5% range.

2% – Some even advocate a totally ‘risk-free’ approach to retirement savings by investing close to 100% of your retirement portfolio in inflation-protected bonds (e.g. US Government Inflation-Protected Bonds – TIPS; Municipal Inflation-Protected Bonds – iMUNIs); historically, these have provided less than 2% return, after inflation but with total protection of your starting capital.

So, which is right?



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13 thoughts on “Transitioning to retirement …

  1. Assuming that this is the stock/bond portfolio is the sole source of your income in retirement, you are relegating yourself to either:
    A) having marginal returns on investment in hopes of preserving capital, or
    B) drawing a sub-par living allowance with the same goal.

    Why would you not consider the same diversification strategy that you used to reach “Your Number”? Plan for multiple income streams and reduce your feeling of need on having CASH in the bank.

    1) Maintain the businesses you have invested in, but reduce yourself to consultant status with a salary and/or sell of the vast majority of your ownership but retain dividends or royalties that are ongoing.

    2) Move some of your investment dollars into other forms of lower risk investments, like real estate (commercial or residential) and farm out some or all of the operations to a property management firm. This has the added benefit of a built in inflationary hedge.

    3) Take the remaining 35-60% of your total net worth, and invest it into those
    stocks and bonds with consistent (but still marginal) returns. Again, this is still part of the diversification of your portfolio.

    At this life stage, you cannot expose yourself to high risk investing, just like you cant buy into the aggressive growth stocks of your youth. You cannot go out and become a venture capitalist or angel investor as you just don’t have the time to recover from a major loss at this point. Be content to find multiple ways to have income rolling in, but diversify outside of those low yielding stocks & bonds!

  2. @ Dustin – thanks for your well-thought out comment. In a future post, I’ll be following up with my thoughts on your ‘diversification’ recommendation and all your points 1), 2) and 3).

  3. Why retire?
    If you have created a business that provides your required income why bother selling it for a ‘number’? You will rarely achieve the same return on that money in the stock market or passive real estate. Just get people to help you run the business until you drop dead. By all means save excess cash created from the business. What if the business goes bust? Start another one. Do you agree?

  4. If you have enough, keep the risks low and wait till the market drops something like 50%. Then move in, with 20% of your net worth, and double or triple it.
    Over here in Europe, in real estate most of the downhill movement still has to come, and as to businesses, social laws are very much in contrast to the US situation.

  5. I had a bad shock on the retirement front this year with my mom (she is doing ok, but there were some scary moments). In Canada you are looking at $6K/month for 24-hour “private” care, with an average increase of 3%/year, and that is after-tax dollars.

    So your number had better handle it. Even in a what is considered a more socialist country, the government can afford to subsidize everyone, and in the US, you had better be looking after it yourself.

  6. I’ve read a lot of experts lately who say 3% is the right number – I think it all depends on how good of a job you’ve done getting your other financial cards in place. IF you own your residence and don’t have a lot of medical expenses, it’s totally doable – otherwise, 5% is probably more realistic.

  7. @ Elizabeth – “a lot of experts” have also said 5%, then 4%, and now 3%. It seems there’s a lot of market timing in their advice 😉

  8. As an average fund managers say in a downhill market they can only guarantee a return of 0.15%/ year. In bull markets they go to 14.5%/year. So yes, there is a lot of market timing in their advice.
    Never forget if the market value of your funds or stocks drop by 50%, they (the glitter boys) still EARN half of what they did when things went right, whie you lost 50%, and the martket has to double getting your money back.

  9. A good question since I will be retireing later this year.

    The objective is to at least maintain the real value of the cash flow that I can spend. After allowing for an adequate margin of safety, that more or less requires me to invest in a manner which should result in the real value of my assets increasing over time.

    I’m going with most of my assets invested in a portfolio of real estate and equties that will produce sufficient rents/dividends to not only meet my living expenses but also allow for some reinvestment over and above the long term growth that I expect/hope will come out of the underlyig risk assets. There will also be at least a couple of years worth of expenses held in cash/short term bonds/bullion/fx to cater for emergencies and/or any times where there is any disruption to the cash flow from my investments.

    With a 40+ year retirement to cater for, there is very little room for a subsbtantial allocation to bonds or annuities. Also, I have no interest in running a business in retirement – I have other plans fo my time.


  10. @traineeinvestor I think you’ve hit the nail right on the head. You can have a portfolio of highly profitable investments outside of what the bank sells that will help you accomplish your goals… it sounds like you’ve found a balance that will work nicely for you.

    The key comment from you here is “the real value of my assets increasing over time” which you should still be able to (and we should all be striving to) accomplish most years in retirement.

  11. “the real value of my assets increasing over time” which you should still be able to (and we should all be striving to) accomplish most years in retirement.

    @ Dustin and/or TraineeInvestor – Why? Shouldn’t the aim be merely to MAINTAIN the real value of your retirement income (which should be achievable by similarly maintaining the real value of your underlying assets a.k.a. your Number)?

  12. Adrian

    The problems with just aiming to maintain the real value of the retirement income are that: doesn’t leave much room for error. If I get my expenses wrong, then I could find myself in trouble late in life when I am least capable of doing something about it. I’m looking 40-50 years into the future. I know what I spend today but can only guess what I will spend in 10 years time and have no idea what my expenses will be like in 30 years time

    2. I hope that the real value of my investments will keep up with my personal inflation rate over the long haul – but I can’t be sure that it will. The could vary by a lot

    3. sequence of returns matters. Investment returns can and will fluctuate and may do so to a greater extent that my expenses. Quite often inflation in expenses will lead increases in income. My utility bills may go up today but I will have to wait a while before the utility company starts paying higher dividends

    4. taxes. Governments are raising taxes around the world in a desperate effort to prop up unsustainable entitlement programmes and to pay for debt that they are, in many cases, unable to ever repay. I can guess future tax rates but I could get it wrong

    IMHO, it is far safer to grow my investment income at more than my personal rate of inflation than to take the risks inherent in trying to merely match inflation.


    PS – Adrian – could I trouble you to remove my e-mail address from my comment above? Many thanks.

  13. Basically, you want to have assets that throw off income that also track with inflation.

    These would be: real estate / rental income and dividend paying stocks.

    Bonds and CD’s are good at keeping up with inflation in the annual payments(rates vary with current inflation forecasts) but do not increase with inflation.

    Stick with assets that increase payments over time and you will be fine. Your own ability to work is one of these assets as well…


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