If you think you’re confused about how best to accumulate assets for your financial future you haven’t seen anything yet. This is my takeaway from reading a recent Globe and Mail article about “decumulating” wealth.
Academic research seems to show that withdrawing 4% of your portfolio every year, and increasing your withdrawals with the rate of inflation, will ensure you not only have enough income to cover expenses but you likely won’t outlive your money either over a 30-year retirement span. This of course assumes you’ve saved “enough money” for retirement in the first place to cover expenses. I’ve estimated what our retirement number might be and here it is.
William Bengen, a financial planner with a background in aeronautical engineering, was the father of the 4% rule – stress-testing over decades what a safe withdrawal rate might be. His conclusion:
to weather any sort of market storm that includes a Great Depression or a Great Recession retirees should withdraw no more than 4% of their portfolio in any given year.
This seems appropriate so I have little issue with the 4% rule. I suspect aspiring retirees however might have to account for various headwinds in the coming decade though. Rising healthcare costs, lower portfolio growth and cuts to various government programs top the list of my future expectations. This means when it comes to our portfolio planning we’ll want some extra buffer to avoid spending less or simply working longer to meet our financial obligations.
Choosing a retirement income strategy is not easy but I’m confident a mix of fixed-income, available cash savings and owning dividend-producing securities with growth-oriented ETFs is the way to go for us. This means we’ll employ a modified cash wedge approach, something like the following:
- Treat any income from our pensions like it is: fixed-income and ensure this allocation is about 30-40% of our total portfolio. Use the fixed-income for living expenses.
- Keep about one-year worth of living expenses in cash savings in case the market goes haywire.
- After the one-year cash fund is established split the portfolio this way for retirement income:
- 50% invested in dividend-paying stocks from Canada and the U.S. (about 30-40 stocks in total) and use the dividend income generated from these investments for living expenses, and
- 50% invested in a couple of low-cost, diversified, equity ETFs that invest in thousands of stocks from around the world. We will spend the distributions from these investments and keep the capital intact to use as we please.
The 4% rule is a nice safety-first approach but an even more conservative approach is living off your dividends or distributions. This should ensure we can weather horrible and prolonged market downturns but also have more freedom to spend the capital at our leisure. Each retiree is unique and needs a plan that is tailored to their needs. While academics should be proud of the 4% rule it’s far from what you might need for your retirement spending patterns. Figuring out how to build wealth is difficult enough these days but I suspect how to spend your wealth in retirement and keep it for as long as necessary brings the lack of consensus on retirement withdrawal strategies to an entirely different level.
As a retiree – how did you come up with your retirement income approach?
As you plan your retirement – what’s your income game plan?