Finding a fitting financial plan


What is a safe number to withdraw from your retirement portfolio?
That is an open-ended question.  Is it $1 million?  It might be, if your portfolio is worth many millions.  Or is it 8% annually?  That would be pretty aggressive unless your portfolio is steadily earning 12 percent.  Why do I say that?
Well, if your retirement portfolio is earning 12%, and we assume inflation is 3%, then it would be safe to withdraw 8% leaving a cushion of 1%.
But who is earning 12% on their portfolio over a sustainable period of time.  Not many people (or institutions) that I know.  So, what is a good number to withdraw from a retirement portfolio?  Drum roll…and the number is: 4%!
Where did that number come from?  Not from out of the blue, but from an academic study done at the Trinity College in San Antonio, Texas.  The study is well known and respected in the financial planning industry.  It was done in 1998 by three professors, Cooley, Hubbard & Walz.
According to a summary of their report on Wikipedia, “Four percent is a safe withdrawal rate rule-of-thumb.  The context is one of annual withdrawals from a retirement portfolio containing a mix of stocks and bonds.  The 4% refers to the portion of the portfolio withdrawn during the first year; it’s assumed that the portion withdrawn in subsequent years will increase with the CPI index to keep pace with the cost of living.
The withdrawals may exceed the income earned by the portfolio, and the total value of the portfolio may well shrink during periods when the stock market performs poorly.  It’s assumed that the portfolio needs to last 30 years.  The withdrawal regime is deemed to have failed if the portfolio is exhausted in less than thirty years and to have succeeded if there are unspent assets at the end of the period.”
The authors back tested a number of stock/bond mixes and withdrawal rates against market data compiled by Ibbotson Associates covering the period from 1925 to 1995.  They examined payout periods from 15 to 30 years, and withdrawals that stayed level or increased with inflation.  For level payouts, they stated that if history is any guide for the future, then withdrawal rates of 3% and 4% are extremely unlikely to exhaust any portfolio of stocks and bonds during any of the payout periods.  In those cases, portfolio success seems close to being assured.  For payouts increasing to keep pace with inflation, they stated that withdrawal rates of 3% to 4% continue to produce high portfolio success rates for stock-dominated portfolios.
There are dissenters from the “4 percent” rule.  One of them is economic heavyweight, William F. Sharpe, who won a Nobel Prize in Economics in 1990 for being one of the creators of Modern Portfolio Theory, which is heartily embraced by institutional investors.  Sharpe published an article in the Journal of Investment Management contending that “it is time to replace the 4 percent rule with approaches better grounded in fundamental economic analysis.”  Sharpe thinks that the “4 percent rule’s approach to spending and investing wastes a significant portion of a retiree’s savings and is thus prima facie inefficient.”  If a portfolio underperforms, he notes, you have a spending shortfall; and if it surpasses performance expectations, you end up with a “wasted surplus.”
So, in Sharpe’s view, by adhering to a 4 percent rule, you either risk living too large or short-changing yourself.  Therefore, it would be better to constantly fine-tune a withdrawal rate according to time horizon and market conditions.
Another dissenter is Peter Lynch, the storied manager of the Fidelity Magellan fund who achieved an average rate of return of 29.2 percent between 1977 and 1990.  In 1995, he wrote an article in Worth Magazine stating that, based on his professional experience and knowledge of the markets, a retirement portfolio with at least a 50% equity allocation would generally be able to sustain a 7% annual withdrawal rate.
To wind things up, I believe that rules of thumb depend on the size and type of the owner’s thumb, so the wise thing to do is to draw up a financial plan that fits you like a glove.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for the individual.  Randy Neumann CFP® is a registered representative with securities and insurance offered through LPL Financial.  Member FINRA/SIPC.  He can be reached at 12 Route 17N, Suite 115, Paramus, 201-291-9000.

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