Withdrawal Rates

Came across a great article about withdrawal rates. What is a withdrawal rate, you ask? Nailing it is the holy grail of financial planners and is in fact the only thing you really care about in retirement. It is the rate at which you withdraw money from your investments.

I say it is the only thing you care about in retirement because it is the actual reason for saving for retirement.  People often forget that having a lump sum (I need a million dollars in the bank to retire!) is mostly pointless. All we really care about is what the lump sum can *do* for you. Primarily, its job is to produce a stream of income that you can live on. We figure out what that stream of income is by looking at what “withdrawal rate” we can support.

I know, the article is from a United Kingdom website. But since we are dealing with percentages, you can just swap pounds for dollars and the ideas hold up. And yes, they compared it to the UK stock market, not the US — but they are close enough to illustrate the point. A couple numbers I’ll pull out:

  • At 3% inflation adjusted, there is only a 40% chance of running out of money after 45 years
  • At 4% inflation adjusted in that same time period, 45 years, sees a chance of 74% of running out of money

Remembering that inflation adjusted just means that the number of dollars you will withdraw every year will go up at the same rate inflation. So, we can translate a $3,000 and $4,000 dollar withdrawal on $100,000 to a 3% and 4% withdrawal rate.

“But wait, I’m planning to have more than $100k. And $4,000 a year is not nearly enough to live on!”

Right, but we can use these to back into the numbers we want to know. If we retire at 60 and want to have enough money to live until 100, we would look at the 3% withdrawal rate. It tells us that we have a 40% chance of running out of money. If we want, say $48,000 a year in income, we can just divide it out: $48,000/3% = $1,600,000. If I have $1.6MM in the bank I can take $48k a year for 45 years with a 40% chance of running out of money. If I want to take more, I need to either save more (which has the effect of decreasing the withdrawal rate, $48k/$1.6MM is a larger percentage than $48k out of, say $2MM) or increase my chances of running out of money.

The problem becomes, the default setting here is to do nothing, take what you think you need, and not think about the fact that you are increasing your chances of running out of money. Don’t let that be you! Understand the risks and trade-offs you make with your investment decisions. Every part of your decision affects our main metric “what is the likelihood of running out of money?” What I choose to invest in, how much I take out, when I take it out, how I take it out, etc. All of them play into the planning.

So use this as your rule of thumb and make purposeful decisions!

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