I am often asked by people, especially those in their 50s or 60s, how to safely withdraw money from their 401K and IRAs (Roth or Traditional) and how to get their money to last.
Here’s the answer, which may disappoint many of you: it depends on many, many different factors. We look at research from Morningstar regularly and they also send out a magazine to our office. Morningstar digs into research every year and comes up with new predictions. They looked into what has happened in the past, but as you know with any investments past performance is not necessarily indicative of what the future may hold. So, you always have to take even their information with a grain of salt.
In their first quarter issue, they have an article titled “Digging into The Research: An Analysis on Safe Withdrawal Rates”. I’m going to hit on some of the highlights from this article. They are assuming… “a new retiree with a 30-year anticipated time horizon” … would likely need a 4% withdrawal rate to securely get them through those 30 years. Here’s what’s interesting:
- They compared their 2023 findings with numbers from the past and they found that with the expected fixed income returns, the part of your portfolio that would be fixed income, which would be representative of bonds, they are anticipating that the rate of return on these securities would be higher moving forward at 4.81% as opposed to 4.44% in 2022.
- In regards to the equity portion of a portfolio, they believe that stocks will have a reduced significance as far as the rate of return moving forward.
- They forecasted inflation as going down to 2.42% from the 2.84% that they used in their calculations from 2022.
So, two of their main assumptions are trending positively. Their research now indicates that… “people heading into retirement today can reasonably use a higher starting withdrawal rate than indicated in 2022.” The key word there is “reasonably”. Again, they’re looking at 30 years of withdrawals, and they are saying that the retirees should be able to sustain a 4% withdrawal rate over those 30 years if the portfolio is 20-40% equity weighting.
This is what I thought was interesting. They believe that you should have a much larger part of your portfolio in bonds or fixed-income securities as opposed to equities. They say that... “Investors might expect that safe withdrawal rate would increase with higher equity weightings, but that’s not necessarily the case.” So, we have to change a person’s behavior. How many times have we heard the saying “More risk, more potential”? But that is not the case during retirement. When you’re taking money out, more risk means more risk.
They say “Stocks also court significantly higher levels of volatility” …that’s the problem... “which makes the outcomes for all of the withdrawal rates tested inherently less certain. In addition, we targeted a success rate of 90%, which is relatively high. This also tended to tilt the scales in favor of the less volatile assets of bonds and cash.” They targeted a success rate of 90%. Let’s just flip that a little bit. That means that they targeted a failure rate of 10%. So, 10% of the time, you’re going to run out of money. Most people believe that would potentially happen at the very end of their lives, but it really depends on when downturns of the market occur.
The question is, do you have an equity buffer? Do you have the right proportion of your money for retirement in what would be considered to be “safer” investments and at the time that it should be? Safer investments are less risky, more fixed, and have more of a chance to weather the storms. This is something that a person should not calculate on their own. The consequence of failure, if failure occurs, means there’s not a chance for a redo.
When you are looking at research, you’re assuming there was no emotional baggage put into the calculations. Their research is simply saying if you do this here, then this is likely going to be the outcome. But we know a 4th and very important thing that they didn’t talk about. They talked about stocks, they talked about bonds, and they talked about inflation, but the most important thing as far as I’m concerned is the emotions. That’s when people do things based on how they feel.
You may be concerned, not about the 90% probability of not outliving your money, but instead about the 10% possibility of running out of money before you run out of life. What’s the research that you’ve done regarding that fear? It might be somewhat frustrating to realize that 4% might be the annual withdrawal rate. Here’s an example, someone may say that if you have $1,000,000, you are a millionaire, but with a 4% withdrawal rate of $1,000,000, you are only $40,000-are. That’s also before taxes are taken out. If that is something that you are concerned about and you would like to crunch the numbers with us, then perhaps it’s time to schedule your Financialoscopy®.
Arnott, Amy C. “Digging into the Research: An Analysis of Safe Withdrawal Rates.” Morningstar, 2024, pp. 33.
