Finance 2. Endowment withdrawal (fixed %) It’s for this reason that many retirees opt for a withdrawal strategy based on a percentage of their portfolio, rather than a fixed dollar amount. With this strategy, you first identify a target portion of the portfolio to withdraw every year, regardless of how your portfolio performed. Many large universities take a similar approach with their endowment funds, withdrawing the same amount every year in order to maintain their tax-exempt status. The main advantage of this strategy is that it’s inherently more sensitive to market fluctuations than a fixed-dollar withdrawal. Let’s say that the stock market has a down year. If you withdraw 6% of your now lowerin-value portfolio, you’ll automatically be taking out less money, which gives your portfolio a chance to recover next year. In fact, with a fixed-percentage withdrawal, it’s mathematically impossible for you to run out of money – although your portfolio could become very small. On the other hand, basing your withdrawals on a percentage introduces a degree of income variability into your retirement. That can be unsettling for many retirees, particularly those in early retirement who want to utilize their savings to cross items off of their “bucket list.” Using a fixed-percentage withdrawal, it’s entirely possible (probable, in fact) that your lifestyle will be tied in some way to the performance of the financial markets. That’s fine when the market is rising to new highs. Not so much when it’s going the other way. 3. The 4% rule Perhaps the withdrawal strategy most discussed within professional circles is the classic “4%withdrawal rule,” so named for the percentage of the initial retirement portfolio which you withdraw every year. Why 4%? The figure came from financial research conducted more than 20 years ago by Bill Bengen, a California-based financial advisor. Bengen determined that, based on historical market data, 4% (with annual increases to account for inflation) was the maximum rate an individual could safely withdraw from a 50/50 stock/bond portfolio without running the risk of outliving his or her money. Interestingly, if you think about 4% constituting 1/25th of the total retirement portfolio, it would imply a retirement of 25 years. Since the original publication of the research, there has been considerable debate (and a lot more research) regarding whether 4% is a reasonable withdrawal rate. Some say that advancements in drugs and medical treatments have made it possible for people to live a great deal longer than 25 years in retirement; perhaps a 3% withdrawal target (implying a 33-year retirement) is more appropriate. On the other hand, for those with additional sources of income – government benefits, a pension, rental property, etc. – perhaps 4% is a conservative figure. Both arguments have merit. Perhaps the best way to think of the 4% rule is to consider it a rule of thumb. It can be a starting point for further thought about howmuch money you really need every year, as well as “big-picture” topics such as longevity risk and how much of a legacy you’d like to leave for your heirs. 4. “Spend the income” strategy One intuitive way for retirees to deal with retirement withdrawals is to establish a portfolio that generates a considerable amount of income, and then to spend the income without touching the core principal. For those who have a sizable retirement portfolio, this can be a very attractive strategy, one that secures a comfortable lifestyle while maintaining a large pool of assets that can be passed on to family members and other heirs. Unfortunately, the big problem recently has been the kinds of returns which income-generating investments have delivered. In the current ultra-low-interest rate environment, bonds, T-bills, GICs and similar investments have offered abysmally low yields, making it a real challenge for retirees looking to generate sufficient income to fund their retirement goals. Sure, it’s always possible to increase income by taking on more investment risk – by investing in dividend-paying blue-chip stock, for example, or by adding corporate or highyield bonds to a government bond portfolio. However, many retirees aren’t entirely comfortable with the added volatility associated with these investments: their income becomes less of a sure thing and depends much more on what’s going on in the stock market or the broader economy. Another potential problem is inflation. If your income payments don’t increase over time (and, with traditional income investments such as bonds and GICs, they typically don’t), your portfolio could be eroded by the steady and gradual increase in the price of goods and services over the years. That’s usually not a problem in any given year – inflation is currently about 1.5% in Canada, and just under 1% in the U.S. Over the course of several decades of retirement, however, that constant erosion canmean a dramatic decrease in your purchasing power. 5. Sell the winners, keep the losers There’s another intuitive strategy, one that’s well-suited for those who hold a large portion of their retirement portfolio in individual stocks. Every year, you identify those investments which have performed well over the past 12 months. You sell a portion of all of these winners and use the proceeds to fund lifestyle and routine living expenses. You leave the poor performers alone, giving them time to recover next year. The strategy works well with individual stocks – it’s a variation on the classic “Dogs of the Dow” strategy, in which investors sell the best-performing stocks on the Dow Jones index and reinvest the proceeds in the “dogs” of the index that didn’t perform well. But the general idea can also be applied to broader 26 | www.snowbirds.org
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