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Sound Advice: September 15, 2021

What’s a Safe Withdrawal Rate in Retirement?

If you are already retired or planning to retire soon, one of your biggest concerns will be having sufficient income from your investments (and Social Security) to cover your ongoing expenses without running out of money.  Another concern will be how you will spend your time, preferably in a satisfying manner. 

The financial part of the equation can be tricky since there are several variables that can change the outcome dramatically.  Those with children often are concerned about leaving a substantial inheritance.  Those without heirs can draw down the earnings on their assets and take distributions from the principal amount.

The former situation has a heightened emphasis on the prospective returns on assets invested and the ongoing flow of expenses.  The usually suggested withdrawal rate is 4% of assets in Year One, adjusted each year thereafter for inflation.  When inflation rises, the withdrawal increases . . . and vice-versa.

Viewed against nearly a century of returns on both stocks and bonds, a 4% target would appear to be easily attainable.  For the past 95 years, the average annual return on stocks has been about 10%.  Returns on bonds have been closer to 5%.  Given this information, one would think that a 4% target would be easy to reach.  It may or may not be.

A closer look at more recent returns on stocks will be helpful.  From 2000 to 2010, following the collapse of the stock market after the dot.com bubble, the market averages fluctuated widely, but ended the period with essentially no net return.  In the decade that followed, however, returns were well above the long-term average.

Bonds followed a dramatically different path.  Over the past four decades, interest rates on bonds went from the mid-teens to a notch above zero.  When interest rates drop, bonds rise.  Not surprisingly, 40 years of dropping interest rates led to unusually high returns on bonds.  Now interest rates are rising and bond prices are falling.

Where are we now?  Stock valuations are currently toward the upper end of their historic range, running above 20 times prospective earnings for 2022.  Although corporate profits have rebounded impressively from their Covid-depressed levels of 2020, much of the government stimulus aimed at economic recovery has passed.  And a hefty portion of the above average savings accumulated during the pandemic has been spent. 

With that said, it would be naïve to look for better than moderate returns from stocks going forward.  Plus, with interest rates on the rise over the next few years, bond prices will remain under pressure.

The response to this prospect points toward a higher percentage in stocks along with the acceptance of inherently greater volatility.  Bond allocations would be reduced; their primary role would be to provide overall stability, rather than enhancement of returns.

N. Russell Wayne, CFP®

Any questions?  Please contact me at nrwayne@soundasset.com


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