by DAVID NOVAK
What is a sustainable withdrawal rate of a retiree’s investment portfolio? In other words, how much can one spend without running out of money?
Several white papers have been written on this topic, so we are only scratching the surface here. I will try, however, to point out a common misconception I believe too many
In my experience, most clients take the mindset of only spending the income generated from a portfolio, and wanting to avoid “dipping into principal.” While this conceptually
makes sense, I believe it is the wrong way to look at it, especially in this extended period of low interest rates. In this environment, it is challenging to generate reasonable income out of fixed-income investments, without either going out many years in maturity, or investing in lower-quality bonds that pay higher interest. For retirees, these options rarely, if ever, make sense.
Fortunately, there are other options for investors other than just collecting interest income. These include receiving dividends from stock investments, as well as selling assets that have appreciated. As an example, the Standard and Poor’s 500 Index returned almost 10 percent last year, only about 2 percent of which was from dividends. This other approximate 8 percent of return was from price appreciation.
So, if an investor needed to take 4 percent of the portfolio value for living expenses each year, in the above hypothetical, 2 percent would come from income, 2 percent would come
from realized gains, and the remaining 6 percent would be unrealized gains, or additional growth of the portfolio. Using gains as part of a distribution strategy has the added benefit of re-balancing the portfolio.
The sequence of returns in retirement is very important, albeit totally out of the investor’s control. Consider an investor in a balanced stock/bond portfolio, who had the
misfortune of retiring in March 2000 or October 2007. The steep stock market drop ahead of them would have decimated that portion of the portfolio, and likely impacted their
overall distribution strategy.
While there is no foolproof defense against bad timing, there is goal planning software available that can illustrate how an investor’s current portfolio would have performed
during the financial crisis of 2008- 2009. We use this with clients to show them a realistic “worst case” scenario for their investments, and how that would impact the amount they could take out of the portfolio every year.
David Novak, CFP® is a Certified Financial PlannerTM at Novak & Powell Financial Services in Pinellas County. Please note: he is not an attorney and this article should not be construed as one offering legal advice. For information about investment decisions and financial planning, contact him at (727) 451-3440.