Those who are the hardest hit by the market losses of the last few months are retirees. For many investors, there is time to recover from these losses. In five or ten or fifteen years, the markets should have come back and their nest eggs should have regained their value.
Those counting on their nest eggs for today’s omelets, though, don’t have that kind of time. For them, losing 25% or 35% of their investments isn’t a matter for the future. It’s a frightening reduction in the source of their current income.
What we’re seeing right now, in unpleasantly dramatic fashion, is the strongest argument anyone could make for being conservative in the amount you withdraw from your investments in retirement. If retirement accounts, IRAs, and taxable investments will make up the bulk of your retirement paycheck, it is wise to make your retirement plans based on a conservative withdrawal rate.
If at all possible, you should provide for your essential needs with no more than four percent. Some advisors are comfortable with five or six percent. This, in my opinion, is pushing your luck. You always want to plan to withdraw less than the average amount you expect your portfolio to earn. Since six to eight percent is a reasonable average to expect over the long term, withdrawing five or six percent is not necessarily going to be sustainable.
Some advisors are even more optimistic. A company whose software I use estimates a 14% annual return on its most aggressive portfolio and a 9% return on its most conservative portfolio. I stopped using this company’s retirement projections years ago. Instead, I estimate my most aggressive portfolio at 7.5% and my most conservative at 6%.
Even worse, Dave Ramsey, a well-known radio personality, has long recommended an eight percent withdrawal rate. He talks about expecting “good growth mutual funds” to return 12% to 15% a year—a return rate not supported by the statistics during the past ten years. Ramsey’s excellent program has helped numerous people get out of debt, but that doesn’t necessarily mean his investment advice is the best way to go.
Suppose you had retired 10 years ago with $500,000. Had you followed Ramsey’s advice, investing in a “good growth mutual fund” and withdrawing eight percent a year, or $40,000, you would have run out of money in November of 2008. In South Dakota terms, you would be dead broke. Had you followed the conventional wisdom of every reputable financial planner I know and withdrawn four percent a year, or $20,000, you would still have $156,433.
However, I don’t think investing all your money in one asset class, like good growth mutual funds, is a good idea. That is going against the proverbial wisdom of not putting all your eggs in one basket. I prefer a diversified portfolio of different asset classes like U.S. and international stocks, bonds, TIPS, real estate, cash, market neutral funds, and commodities.
Had you invested your $500,000 in a well-rounded portfolio like this and withdrawn $20,000 a year over the past 10 years, today you would have $556,341—even with the recent market losses. That’s pretty remarkable. It’s actually more than remarkable, it could be the difference of literal financial life and death.
It’s foolish to plan your retirement around projections that are unreasonably rosy. Positive thinking is all well and good, but counting on unrealistically high returns or withdrawal rates is taking optimism too far. When it comes to your retirement income, it’s better to be a pleasantly surprised pessimist than a dead-broke optimist.