Retirement Income Toolbox

February 15, 2016

     Our third retirement income strategy is called “systematic withdrawals.” This strategy is a basic tool for generating income during retirement from a portfolio that includes stocks, bonds, cash and their related proxies. Fifty years ago these were almost the only asset categories used for such portfolios but with the emergence of modern portfolio theory and the use of computers to analyze the effects of how different asset classes work together, portfolios being created today often have 9-15 asset classes represented. We will write more on this in a future blog.
     With systematic withdrawal programs you typically rebalance the portfolio once each year to generate income. Rebalancing also keeps your portfolio at the same risk and growth objective that you have determined is right for you for the next 20 years or so.
     Today’s planners would use a portfolio that has from 20% to 65% equities with the remainder being bonds and cash equivalents. When a retiree starts withdrawing income, they select a percentage of their total portfolio to withdraw annually, typically from 3% to 5.5%. Then in future years they increase their withdrawal rate by the rate of inflation. There have been studies by academics and financial planners that have used rolling 20 and 30 year histories to determine the starting percentages that can be used and have a statistically good chance of not outliving your money during these time periods. But just like the warnings given about never knowing the results of individual investment’s performance, so too of a mixture of investments—that is no one knows what future performance will be.
     From such studies two of the factors that affect whether your portfolio will last longer are the percentage of equities and the inflation rate used for each year’s increased withdrawal rate. Portfolios with 60-65% equities last longer than those with 20%-40% equities. The second factor is whether or not you are willing to put a cap on your inflation raise each year and be willing to freeze or even decrease your annual income in years when your portfolio performs poorly. For example, if you never take more than a 3% inflation raise, your portfolio will do better than when higher increases in withdrawals are taken.
     From our experience it is best to set up a systematic withdrawal program based upon your particular circumstances and needs and monitor it annually so that you can make adjustments if you find your portfolio is not growing adequately year by year. No one likes to take an income cut during some years, but it is preferable to running out of money.

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