Retirement

Some people expect demand for stocks to decline given the large wave of Americans approaching age 65. This article questions this expectation.

Investment professionals often recommend that investors shift their investment allocation from stocks to bonds as they approach retirement age. The combination of the spike in people approaching retirement age, and growing longevity, may lead you to expect a big shift of demand from stocks to bonds. Below are several reasons why this big shift may never happen.

Bonds are too risky for the long run

While bonds reduce the short-term risk of stocks, they carry a risk of their own. The combination of inflation with increased longevity can erode the value of bonds, introducing the risk of running out of money, slowly and painfully. There are three ways to reduce this risk:

Work longer

People in good health, and with moderate assets, are likely to work longer. They may spend similar time in full retirement as retirees 50 years ago. They will do so by spending most of their increased longevity working, full time or part time.

Spend less

Those with health conditions that prevent them from working and without substantial assets will have to limit their spending to their social security income and whatever resources they have. Either they will reduce their spending early on in retirement, or they will gradually reduce their spending as they deplete their assets.

Invest in stocks, if you have the money

Those with substantial assets relative to their spending will benefit from the option to sustain a low withdrawal rate from their savings in retirement. When you can commit to a low withdrawal rate, stocks (globally diversified) are safer than bonds. Specifically, the risk of depleting the investments due to withdrawals during severe declines is very small. For those who happen to live long, the risk of stocks tends to keep declining, while the risk of bonds tends to grow.

Annuities do not solve the problem

Annuities are simply a window into bond investments (since insurance companies put money backing annuities in stable investments such as bonds), but with high administrative costs. They add the longevity protection and, in some instances, inflation protection, and reduce the income paid in order to finance these protections. Just as a retiree would not put substantial assets into bonds to finance increased longevity, he/she would not finance the bulk of retirement income using annuities.

Literature Support

A paper by the Congressional Budget Office (CBO), published in September 2009, provides evidence to support this article’s claims, with many interesting angles on the topic.

Summary

As people live longer, they have a choice between working longer, reducing spending, or investing more in stocks. Investment advisors and individuals are gradually realizing that bonds are too risky for financing the increased longevity. This realization may accelerate at times with elevated inflation.

http://www.cbo.gov/sites/default/files/cbofiles/ftpdocs/105xx/doc10526/09-08_baby-boomers.pdf

Disclosures Including Backtested Performance Data

Some people believe that the present is far more important to them than the future. This article argues that this is not true for most people.

Say you believe that the future, 5 years from now, is substantially less important to you than today. Please answer the following questions:

1. Did you hold a similar belief 5 years ago? If yes, read further.
2. Do you believe that the present is at least as important as 5 years ago?

If you answered “yes” to the last question (as most people would), there is a contradiction: 5 years ago you believed that the future 5 years away (i.e. today) will be substantially less important, yet, today, you disagree. This means that you had trouble accepting the importance of your future needs, and there is a good chance that you are acting the same way today.

More considerations:

1. While the present is tangible and certain, you have to be sure that you will not be around in 5 years in order to ignore this future. I haven’t met any person aggressive enough to ignore the possibility of living beyond a certain age.
2. Humans keep living longer. Please don’t underestimate this effect, and be wary of naming any age that you are certain to never reach.
3. Future needs are easier to finance thanks to the likely growth of your investments over the years (twice as easy after 6 years with 12% real growth, and 4 times as easy after 12 years).

Conclusion

You can assess for yourself the importance of the present compared to the future, but be aware of a psychological bias that may lead you to prefer the present too much, simply because you discount future suffering compared to present suffering.

Disclosures Including Backtested Performance Data

You can achieve financial freedom using an investment that provides income for as long as you live. A globally diversified stock portfolio with limited withdrawals addresses this need well, and has the side effect of likely leaving your heirs with a large pot of money. While you may be happy to help them out, you may prefer to enjoy more of your money during your lifetime. The article explains why this is impossible, and why it should not bother you.

If you can save a large enough amount, to allow you to make very limited withdrawals from your investments (typically 3%-4% per year) and cover your expenses, a globally diversified stock portfolio may be your best solution for income for life. It provides a unique combination of benefits:

1. Income for life . If you choose a low enough withdrawal rate, and keep the diversified portfolio with no individual stock selection or market timing, the portfolio may provide you with income forever, which, by definition, includes the rest of your life.
2. Automatic inflation adjustments . Since inflation is the increase of the cost of goods and services, and you own the companies that provide these goods and services, their income and value ultimately grows with inflation. This allows for the portfolio to withstand growing withdrawals that are adjusted for inflation.
3. Availability for unusual expenses . The entire investment is available to you at all times, and can support some level of unusual expenses, beyond the typical withdrawal rate. This flexibility can be very valuable if you want to move to a more expensive house, or face a large medical bill or any other extraordinary expense. (This applies to infrequent excess withdrawals – withdrawing a higher percentage for many years in a row will put you at risk of running out of money during your lifetime.)
4. Growing income, beyond inflation . The investment is expected to grow over time, despite the ongoing withdrawals. During declines you can keep the income constant (with inflation adjustments). In all other times, as the portfolio reaches new peaks, withdrawing the same percentage of the peak value provides growing income.
5. Money left for heirs or charities . A side effect of the money growth is that you get to leave a large pot of money to your heirs or charities of choice.

The problem : While most people are happy to take care of others through the money they leave, some may prefer to enjoy more of their money during their lifetime, while leaving behind a smaller amount.

No solution : Since you cannot know your lifespan in advance, you cannot plan to use up most of your money during your lifetime. Say you increase your withdrawal rate, with an aim to use up most of your money by age 95 (or pick any other specific age). There are problems with this approach:

1. You may live to be 100 or longer, and end up bankrupt. Lifespans have grown at a rapid rate in the past century, and it is impossible to know whether you will live to be 80, 100, or 120.
2. A major stock market crash early in your retirement can result in depletion of your money at a younger age.
3. Instead of seeing your portfolio grow throughout life, you are planning to see it decline over time. This means that instead of having greater means to deal with unplanned expenses, your means decline.
4. The difference between seeing your financial security increase over time and seeing it decline over time, is remarkable. Your choice will affect your feeling of financial security every day for the rest of your life.

Why it doesn’t matter : When comparing this lifelong income generating investment to the alternatives, even when ignoring the leftover money, this solution seems superior and pleasing. Let’s review two common alternatives:

1. Annuity : This product is designed specifically to address the need for income for life. While it can work very well, it has several flaws: (1) no flexibility for large withdrawals; (2) income grows with inflation at best – you lose all the excess income growth obtained through stocks; (3) the income depends on the solvency of a single insurance company (compared to thousands of stocks around the world).
2. Real Estate : Owning several properties can provide income for life, but does not allow easy access to the principal. In addition, it has no flexibility for large withdrawals. On the contrary – you may incur shortfalls in income through repairs and vacancies. There are some ways around these limitations, including selling a property to cover a large expense, or borrowing temporarily from a home equity line of credit, but they tend to be more difficult to implement and limited than the easy accessibility to a stock portfolio. Despite the limitations, this solution is legitimate, and many people swear by it.

Summary

Using a globally diversified stock portfolio for generating lifelong income has many benefits, and one of them may be seen as a downside by some people – a substantial pot of money left for your heirs. There is no way around this outcome, but when comparing this solution to common alternatives, the benefits clearly outweigh this negative (for those who see it as a negative).

Disclosures Including Backtested Performance Data

Financial success is often measured in terms of high income or high net worth. This article offers an alternative measure that focuses on the freedom to choose what to do with your time, and is stated as a low withdrawal rate from a diversified stock portfolio.

High Income is a powerful tool for covering expenses. An individual making $1M per year is considered financially successful. While high income can allow you to live comfortably as well as prepare for substantial surprise expenses, it does not capture financial freedom:

1. It ignores expenses. If you make $1M per year, and spend $1M in a normal year, you will be in trouble as soon as a surprise expense comes up. Considerably more modest income of $60k with expenses of $30k would leave you with a greater cushion for surprise expenses.
2. It depends on willingness to work. Whether the income is from employment or self-employment, it depends on your willingness to work. A portion of your time has to be spent on work, and you are not free to do as you wish with your time.
3. It depends on ability to work. Even if you love your job and cannot think of any other way to spend your working hours, you may not be able to work forever. Risks include disability, aging, business failure, and layoffs.

Note that guaranteed income that does not depend on work or on a company’s solvency can count as a contributor to financial freedom, but is still subject to your spending relative to the income amount.

Net Worth can be calculated by adding the value of your bank accounts, brokerage accounts, retirement accounts, real estate including your own home, art collection and anything else of monetary value (assets), and deducting all mortgages, business loans, student loans, car loans, and any other financial obligation (liabilities).

High net worth means you have plenty of money that you can potentially spend as you may choose, and may seem like a good measure of financial freedom. Anyone with $10M or even less can buy a private jet, but may not have financial freedom. The problems with net worth as a measure of financial freedom are:

1. It ignores expenses. A person with a new worth of $10M would typically be considered wealthy, and would be expected to have financial freedom. If $5M is invested in a nice home, and supporting staff, maintenance and all other living expenses total $500k per year, the person is not financially free, given the spending of 10% ($500k of $5M) of the investable assets per year. This withdrawal rate cannot be sustained reliably at all times, no matter which investment you choose.
2. It ignores the investment approach . Continuing the example above, say that expenses were cut down to $200k per year, limiting the withdrawal rate to 4%. This withdrawal rate could be sustained given the right portfolio. But if the entire portfolio is put into bonds or into a concentrated stock portfolio, the withdrawal rate cannot be sustained.

An alternative measure: very low withdrawal rate from a diversified stock portfolio . Limiting the withdrawal rate from a globally diversified stock portfolio provides a high probability of financial freedom – the ability to sustain life for as long as needed with no need to worry about work. With the right portfolio, a withdrawal rate of 2%-4% can be sustained through major declines. At 2%-3%, there isn’t much that can affect your financial stability and freedom. Specifically:

1. A prolonged and deep decline in your portfolio is not likely to be a problem. At 2%-3% you should have been able to sustain the 2008 recession as well as the Great Depression without any problems. This still holds true if you never reduce your withdrawals (the withdrawal rate is measured from the peak value of the portfolio), and adjust them for inflation.
2. Unexpected expenses can be supported to a large degree given that the entire investment is liquid, ready to be sold at any time with no notice.
3. Inflation is not a problem given that companies’ earnings grow with inflation. It may not happen instantaneously, but over time stock prices grow well beyond inflation.
4. Growing income beyond inflation is an extra bonus, given the high long-term growth of stocks. Whenever there is a growth spurt, you get a nice increase in your income, while maintaining the withdrawal rate.

Great news! Now you have two ways to achieve financial freedom – build up your savings, or reduce your spending.

Focus on the positive. You may feel constrained by limiting your spending, in the face of advertising and seeing others living more lavishly. The comfort of not being stuck in the rat-race and not depending on work can give you the strength to keep your expenses at a low percentage of your assets.

In addition, while most people spend most of their lives trying to keep up with their expenses, you can get handsome ‘raises’ to your income once you reach the low withdrawal rate for the first time. This is thanks to the growth of stock investments, combined with the fixed percent withdrawal.

A practical progression: While most 20-year-olds don’t have the assets to generate lifelong income, they can establish a certain standard of living, and raise it more slowly than their income. With every raise, they can save a greater portion of their pay. If they ever get to earn a substantial income, they can stop raising their standard of living until they reach financial freedom. This is in line with the idea that living off of $40,000 can make you much happier than $30,000, but going from $200,000 to $210,000 will not have nearly as much of an impact, and may not make you happier at all in the long run.

Assumption about investing: The financial security of a low withdrawal can be obtained only if the stock portfolio is highly diversified, and held with iron discipline through all declines, however deep or long, with no market timing or individual stock selection.

Summary

High income and high net worth do not guarantee financial freedom. Financial freedom can be obtained by maintaining a low spending rate (2%-4% annually) compared to your assets, if they are invested with discipline in a diversified stock portfolio, with no market timing or individual stock selection.

Disclosures Including Backtested Performance Data

After living through the Great Recession of 2008, you might ask: “What is the best way to provide myself with retirement income that can sustain through future catastrophes?” This article answers this question, when considering extreme cases, including severe and prolonged declines, far worse than 2008.

Imagine that you are a retiree and are fully dependent on your investments to provide you with income for as long as you live. The amount can be your total estimated expenses minus any social security income and pension plans. You would like to receive a certain amount of income each year, with adjustments for inflation in subsequent years.

The ideal investment would survive all of the following:

1. Withdrawals during a prolonged decline.
2. Withdrawals growing with inflation, as well as hyperinflation.
3. Withdrawals lasting for as long as you live.
4. All local damages including natural disasters, theft, confiscation during a war, and legal changes.
5. Change in supply and demand.

The risk of a short life: While longevity introduces the financial risk of running out of money, the risk of a short life is not a financial risk. By definition, if your money can support you for 30 years, it can support you for 29 years, 3 years or 3 days. Therefore, we limit the discussion of need #3: “Withdrawals lasting for as long as you live”, to the case of a long life. While this may sound trivial, some retirees confuse the health risk of a short life with a financial risk. To be clear – a short life, by definition, cannot be riskier than a long life, financially speaking.

When testing various investments, we can weed-out the ones that cannot survive any of the above:

1. Cash, Checking, Savings, Money Market, High-Grade Bonds: These all have very low growth rates (#2, #3). Some even have negative real growth. Putting substantial portions of your money in any of these may help you temporarily during stock declines, but they all share longevity risk – running out of money. For a high enough allocation you are actually guaranteed to run out of money.
2. Fixed annuities: A fixed annuity with inflation-adjusted income is exactly the product that should provide you with income for as long as you live. The problem is that it is backed by an insurance company. Bankruptcy of the company could hurt your annuity income. Given that your income depends on the solvency of a single company, the risk is too big to bear, no matter how stable the company seems. Additional problems are:
   1. Annuities with inflation protection tend to provide a very low payment.
   2. Nothing is left for your heirs, unless you accept an even lower payment.
   3. If you have a surprise expense at some point, there is no way to make a bigger withdrawal at one point, and make up for it later.
3. Work: While not an investment, it is a way to provide retirement income. It is nice to work for as long as you enjoy it and are able to, but you cannot count on this for life. You may lose your job during an economic contraction (#1), or at any other time. Most people are not able to or do not want to work for as long as they live (#3).
4. Tangible assets: Anything you can touch (tangible) is subject to local damages (#4). It can be stolen or lost, and therefore cannot be useful. The one exception is a limited amount of cash to keep you going, in case of no access to an ATM.
5. Gold and other commodities: These do not generate any value (#3). Any change in real-price reflects changes in supply and demand (#5), making these speculative investments with zero expected real returns. In fact, after a 28% tax on long-term holding of gold (taxed as a collectible), storage costs and high transaction costs, you should expect negative real returns. None of these assets appreciate in value reliably during declines. Gold has been especially risky with a nearly 30-year decline to recovery period in recent history. Commodities tend to be highly volatile, and may decline in value irreversibly whenever replacements are found.
6. Real Estate – Individual Properties: Any individual property is subject to local damages (#4). It can be destroyed in a natural disaster or war. Insurance may not cover all types of damages, and the insurance company may not stay solvent and able to repay all homeowners, in case of a large scale disaster. Even if all damages are covered, no rental income is available during the rebuilding of the property. Vacancies can occur also during economic downturns. Another risk is a drop in property values and rental income due to local changes, including irreparable structural problems, and change in demographics or job opportunities.
7. Real Estate – Dispersed Individual Properties: Geographic dispersion can alleviate most of the problems described above, if the number of properties is large enough. To account for country-wide problems (including confiscation during wars), international dispersion is necessary. Structured correctly this may be a viable solution, but it is impractical for most individuals. If ownership is leveraged with mortgages, the risk of dropped income gets magnified. To own tens of properties with no leverage, you may need substantial resources, and still need an array of professionals to help with management, repairs and taxation. The result is not too appealing, because income after all expenses tends to be limited, and the growth of property values is not spectacular. In the very long run you can expect real estate to grow only in line with wage increases. In the past 100+ years, this was about 1% higher than inflation, providing minimal real growth.
8. Real Estate – Pooled (REITs = Real Estate Investment Trusts): These investments are similar to stocks in terms of their volatility and returns. They can be held as a part of a diversified stock portfolio.
9. Real Estate – Own Home: Owning your home has value beyond investment considerations. It can be a good idea, as long as you have large enough investments to supply you with ongoing income as well as money for maintaining your home.
10. Stocks, concentrated portfolios: Concentrated stock portfolios may decline for many years, and may never recover.
11. Stocks with a high withdrawal rate: Globally diversified portfolios have recovered from all declines, but with a high enough withdrawal rate, you may not live to enjoy the recovery period.

One investment that can survive all of the above: Globally diversified stocks with a low withdrawal rate, no market timing and representing entire markets . Below is a description of how it can survive the different risks:

1. Withdrawals during a prolonged decline: Globally diversified portfolios have recovered from all declines, and it is reasonable to expect this trend to continue as long as people will want to get things in the cheapest and easiest way possible. With a low enough withdrawal rate, you can weather extreme declines.
2. Withdrawals growing with inflation, even in the face of hyperinflation: Inflation represents the rise in cost of goods. By owning the companies that provide these goods, your investments grow with inflation over time.
3. Withdrawals lasting for as long as you live: Given that company ownership provides the highest growth rate in the long run, diversified stocks provide the highest chance of lifelong income.
4. All local damages including natural disasters, theft, confiscation during a war, and legal changes: Thanks to the global diversification, no local damage can decimate your entire portfolio.
5. Change in supply and demand: A global stock portfolio holding companies in all industries, does not depend on demand for any specific product or service. If there is weaker demand for a specific product or service, this demand gets replaced by demand for an alternative that other companies in your portfolio provide. As long as people keep looking to get things done cheaply and simply, they will use the products and services of companies in your globally diversified portfolio.

Psychological Risks: Given the volatility of stocks, investing large portions of your money in them requires iron discipline. Many individuals lost substantial parts of their life’s savings during major market crashes due to fear. The best way to minimize this risk is to get the help of a professional that demonstrated iron discipline during stock declines, and kept his clients’ money as well as his/her own fully invested during those times.

Withdrawal Rate : The acceptable withdrawal rate from the stock portfolio depends on the portfolio. Some portfolios can withstand withdrawal rates of up to 4%, and survive substantial declines. To be prepared for very extreme and rare declines, that may occur less than once in a lifetime, you may want to go down as low as about 3%. The exact percentage depends on the portfolio.

Low Withdrawal Rate: If you can limit yourself to a very low withdraw rate from your globally diversified stock portfolio (with inflation adjustments), you may have the best plan for your retirement income, even at hypothetical times when people on the streets are begging for food.

With a very low withdrawal rate, putting a portion in more stable investments like cash or bonds will not help your already high short-term security (very low withdrawal rate), but will hurt your long-term security in the face of longevity and inflation.

Making up for a Higher Withdrawal Rate : For higher withdrawal rates, a limited allocation to bonds may provide you with income during severe declines and improve your security. Once you withdraw much more than 4%, there is nothing that can save you from extreme catastrophes.

What if this Solution is not Good Enough? You may feel that no matter how low you bring the withdrawal rate, there could always be a case that will result in a depletion of your assets. This is true, and it would be nice to get a perfect guarantee. Unfortunately, all alternatives fail under certain conditions. While no solution is perfect, the diversified stock solution is likely to withstand the most extreme scenarios.

When comparing the different risks, the odds for the global stock portfolio are much higher than the alternatives, thanks to the combination of high diversification and high average growth rate. Most other solutions fail in the face of inflation combined with longevity and/or concentration risks.

Summary

During substantial stock market declines, you may be concerned with the security of a diversified stock portfolio, and look for more stable alternatives. There are investments that suffer less extreme declines, but they suffer from other risks including inflation, longevity and various localized risks. When considering the entire bag of financial risks, diversified stocks provide the highest likelihood of success in providing lifelong retirement income. This is all subject to you or your advisor having iron discipline in staying invested at all times.

Disclosures Including Backtested Performance Data

Have you ever heard about the principle of shifting the portfolio allocation from stocks to bonds as you approach retirement? This article presents an alternative to the principle above that may be more in line with a retiree’s needs.

Before continuing, you are encouraged to read the article “What is your Time Horizon?” (Hanoch, Apr. 2006). It demonstrates several cases in which the principle above does not work.

When was the principle above appropriate? The idea of having most of your portfolio in bonds as you near retirement worked in the days when people retired at age 65 and typically lived for another 5 to 10 years. Under those conditions, and assuming limited resources, it was very important to protect the income for the upcoming few years, even at the expense of long-term depletion of assets.

Can you do better? The article mentioned above presents a more accurate approach to evaluating the time horizon of any person regardless of their age:

Your time horizon is the time until you will need to use your money. Each person may have several time horizons for different parts of their savings.

If you are about to retire, and have a very short life expectancy and limited resources (the case described above), your time horizon is short, and most of your money should be invested in bonds, as suggested before.

In any other case the principle above fails, and the more accurate definition of time horizon, provides a better guideline for investment. Let’s review several cases:

Case 1: Your income needs are very small compared to your portfolio size . If you withdraw a small enough percentage of your portfolio every year, even a high (as high as 100%) allocation to diversified stocks can be the most conservative plan. Depending on the portfolio, once the withdrawal rate becomes as low as 2%-4%, the stock portfolio can handle severe declines without depleting over time. In such a case, given your high short-term security in retirement, it is better to keep a very high allocation to stocks, to retain and increase your financial security over time, for as long as you live.

Case 2: Your income needs are fairly high compared to the portfolio size. If you expect to need, say 10% of your portfolio each year, you cannot afford having all of your money in stocks, because a big decline early in your retirement can deplete your whole portfolio in the first decade of your retirement. In such a case, the rule above should be applied as follows: leave enough money in bonds and cash to cover a number of years of living expenses, depending on how diversified your stock portfolio is. To maximize your financial security, the bond allocation should be used whenever the portfolio experiences a severe decline, and at no other time. As your portfolio grows, resulting in a lower annual withdrawal rate, you can reduce your allocation to bonds and shift into stocks, despite (actually, regardless of) your growing age. This is because your short-term security increases with your portfolio size, and you better address the now bigger risk – outliving your money.

Case 3: Guaranteed income that covers all expenses. If you are expecting guaranteed retirement income to provide for all your needs, your portfolio time horizon is infinite. You will not depend on any of the money while you are alive, and your heirs cannot depend on your money at any specific point, since they don’t know how long you will live. In this case a high allocation to stocks (up to 100%) may be the most appropriate, providing the highest potential future extra cash for any desire or unexpected need.

Lifelong Security in Retirement

When people talk about retirement, the immediate thought is that the time horizon is short and emphasis should be given to providing money for short-term needs. Given the growing longevity of humans, this proposition has become incorrect and even dangerous. The average life expectancy of an individual retiring at age 65 is currently around 20 years, and this number keeps growing over time.

Say you spend 8% of your money per year, and you put most of it in bonds at age 65, with a growing allocation to bonds over time, you have a risk of going broke. Based on my analysis above, an allocation of more than 50% to stocks is likely to be appropriate, and should provide short-term security throughout extreme declines, as well as much higher security for as long as you may live.

Just as you don’t count on your portfolio to grow every year by its average growth rate, you shouldn’t plan on dying according to your life expectancy. The portfolio Long-Term Component has average returns greater than 10%, yet any conservative plan should not count on withdrawals much greater than 4%. Similarly, I would not recommend on planning to die (or alternatively go broke) anytime before age 100. As explained in the article “Preparing for a Long Life” (Hanoch, Dec. 2006), the difference between the withdrawal rate that will deplete your money in 30-40 years and the withdrawal rate that will never deplete your money, is relatively small. This leads me to construct retiree investment portfolios to last forever, in nearly all cases.

If this seems extreme to you, think about the hundreds of thousands of 100+ year-old people alive today, and imagine the millions that could reach this age group in upcoming decades, if you project the historic longevity growth. Preparing for life at this age, is no less important than preparing for a big crash in your stock portfolio starting precisely as you retire.

Assumptions

The ideas in this article depend on several important assumptions:

1. Your stock portfolio is globally diversified, and you do not individually select stocks or try to time the market.
2. You are highly disciplined, with nerves of steel, or your Investment Advisor has such nerves and you listen to him/her at all times. Specifically, you use stocks for living expenses when the stock portfolio is growing, and bonds when the stock portfolio is at a decline. Only if you depleted all your bonds at an extended decline, and there is no other source of money, you go back to selling stocks, and replenish your bond reserves when, and only when, the portfolio is recovered.

If these two are not true for you, please disregard this article.

Disclosures Including Backtested Performance Data

[Updated February, 2011]

This article will help you answer the question: when can I retire? In order to retire you need sources of income to support you for the rest of your life. Part of your income needs can be covered using Social Security payments, pensions and any other lifetime guaranteed income you may have. The rest depends on periodic withdrawals from your investment portfolio.

For example, let’s say you need $100,000 gross income per year, social security provides you with $30,000 and you have pension payments of $30,000. Your portfolio should supply you with $100,000 – $30,000 – $30,000 = $40,000 per year.

If your portfolio can handle annual withdrawals of $40,000 without depleting, you may be able to retire. If your portfolio is worth $1,600,000, your portfolio should handle a withdrawal rate of: $40,000 / $1,600,000 = 2.5%.

If you have a portfolio that consistently tracks certain asset classes, your investment advisor may be able to determine a conservative withdrawal rate that should allow it to survive the withdrawals every year, including severe recessions, and never deplete. For example, this rate is 4% (growing with inflation) for the portfolio Long-Term Component by QAM. Note that this is a measure based on historic behavior and cannot be guaranteed. Therefore, it is important to choose a conservative percentage.

If you withdraw 4% of Long-Term Component annually, growing with inflation, your portfolio is likely to last forever. You may withdraw a larger percentage of the portfolio, if you want it to support you for the rest of your life and not have any of the principal left. For any given number of years you choose to support, your investment advisor can calculate the withdrawal rate allowed. Here are a few examples:

For a portfolio that can survive 4% annual withdrawals without depleting, what is the withdrawal rate that will deplete it over different time periods?
Life Expectancy	Percentage Withdrawal Allowed
20 years	7.36%
25 years	6.4%
30 years	5.78%
40 years	5.05%
50 years	4.66%
100 years	4.08%
200 years	4.002%
Infinite	4%

Most planners prepare their clients for at least 30 years of retirement (e.g., ages 65 to 95). The total difference between the annual income available for 30 years of retirement and an infinite retirement is 23% (= 1 – 5%/6.51%). If you are preparing for a 30-year retirement, you can delay your retirement by less than 2 years (statistically) and be prepared for an infinite retirement.

This low added cost is a reason to always prepare for an infinite retirement.

There are 3 important benefits:

1. As you grow older, instead of seeing your available money deplete, you can see it grow indefinitely. This can increase your financial peace of mind throughout your retirement.
2. This is a conservative approach that provides an extra cushion in case there is an extreme recession that has never been seen before.
3. Your heirs and/or your favorite charities can enjoy the full principal of your retirement savings.

Note that the analysis above was prepared for a specific portfolio, but the general results are the same regardless of the portfolio assumed. In reality, the referenced stock portfolio is likely to grow much faster than 4% per year (even in real terms), but you should keep the withdrawal rate at this level or lower because there may be very bad years in the beginning of the retirement period. A detailed analysis should be performed for the specific portfolio used.

To Summarize

Preparing for an infinite retirement is much cheaper than you might expect and can have huge rewards in terms of added peace of mind and the ability to provide a handsome heritage.

Disclosures Including Backtested Performance Data