4 Retirement-Withdrawal Strategies

hi I'm Christine Benz for morningstar.com a sustainable withdrawal rate is one of the linchpins of a successful retirement strategy joining me to discuss various withdrawal rate strategies as well as their pros and cons is David Blanchett he is head of retirement research for Morningstar Investment Management David thank you so much for being here out of me retirement withdrawal rates are a really hot topic among our morningstar.com users like to cycle through some of the strategies that people use to get cash out of their portfolios and retirement talk about their pros and cons and you say there's really no one-size-fits-all answer it really depends on the variables that that appeal to you and that makes sense for you so let's start with the most intuitive way to think about extracting money from your portfolio and that's to focus on income producing securities and just spending whatever those kickoff let's talk about the positives and the potential drawbacks associated with that kind of strategy I think that a lot of retirees view income that way those that have saved enough for retirement they have portfolio the goal is to live off of the income I think that that's definitely a very valid strategy you know one potential con there is that if your portfolio isn't growing you're going to have less and less than come throughout retirement based upon inflation so that's kind of a concern if you are thinking about maintaining the contents in your living you might not do that through that kind of portfolio unless it's growing over time okay and let's talk about the current yield environment how that has made income focused strategy somewhat challenging for retirees unless they've been willing to kind of edge out on the risk spectrum a little bit well one issue we see today is that you know historically the average yield from from from large cap stocks has been about 5% okay the problem today though is about half of that yield is going to repurchases and so more companies are rebind shares versus giving dividend yields and so today is a very trying time for investors focused on income because as we all know bond yields are low and so are the average dividends from stocks and so it really is something tough today to create you know a higher income than say maybe four or even five percent from a portfolio focused on nor in campaign securities okay the next strategy this is one that I know a lot of our morningstar.com users are familiar with this is the the 4% rule and that really involves a static dollar withdrawal amount that then gets inflation adjustment in subsequent years let's talk about that one sure so that came about over 20 years ago research by Bill Ben Gannon there's been a lot of research since then I think that you know one one issue with the 4% rule that's called as it's often misunderstood as you said the 4% rule applies to the initial withdrawal rate where that amount is increased by inflation so I actually call it 25 times well you need 25 times your initial income goal 1/4 percent is 25 and that's this kind of the starting point for retirement I think that that's an excellent place to start for most retirees I've done some research with Wade fallow Michael Fink are talking about you know maybe lower withdrawal rates are a better starting point today I think that the key issue for a lot of retirees though is how does your income profile change over your lifetime and what is your required level of certainty you know do you really have to have the same amount of income in today's dollars every year for 30 years and if not other strategies might work better and you have done research about how retirees spending needs tend to fluctuate over their life cycles let's talk about that I think that you know one assumption that almost everyone makes when it comes to retirement is that your income need increases every year by inflation in retirement so if you spent $10,000 last year inflation 3% you're going to spend ten thousand three hundred the following year and if you actually look at the actual spending of retirees that isn't actually the case where people actually tend to reduce their consumption in today's dollars as they move their retirement okay so you said and you referenced a paper that you had worked on with some co-authors where you kind of poked at the 4% that initial 4% withdrawal rate suggested that potentially that's too high for some retirees is that the case for everyone or should some retirees feel okay about taking that 4% initial withdrawal so I think that you know if you are a retiree who has to have a guaranteed amount of income that increases every year by inflation for 30 years then 3% is the new or person you have to have effectively about thirty three times your income when you first retire however for most people they have they have social security they have defined benefit plan benefits they have other sources of income and so if their portfolio were to fail so to speak it wouldn't be disastrous so I think that you know four percent is a great starting point for a lot of people five percent even six percent can work based upon your overall kind of level of risk tolerance and it also depends on your age direct the course that as you get older you could arguably take more from yes and if you're single versus married all these factors look at you know how long is retirement going to last you know if if you're 65 years old married joint couple maybe thirty years if you're if you're retiring at sixty it could be thirty five years so all these things plan to what is that right withdrawal rate based upon the remaining duration of retirement okay so the the next strategy that we want to discuss is what you call the endowment approach this is where you take a fixed percentage of your portfolio and you take that year and you're out regardless of what your balance is so let's talk about the positives and the potential drawbacks associated with that strategy one obvious drawback is that you have that fluctuating income stream which may not be agreeable so I think that I call it the endowment approach because endowments like the College endowment takes out a fixed percentage every year and I think that it can make a lot of sense one benefit with the endowment approach is you know if four percent say is the right number for a constant withdrawal amount six percent is actually the right number for the endowment approach and you know one one benefit you know of that is that you kind of know your ongoing withdrawal and rate from the portfolio a pitfall is that it possibly will decrease over time if you take out 6% per year you know without you know healthy market growth it's not going to maintain that six percent you know level of income every year I think that you can do things that are kind of smooth it out over time one example is for example endowment me to be average the last three years value so look at you know what was your account value what is it now versus you know a year ago and then two years ago and average those three values to figure out what the actual withdrawal should be the last strategy I want to discuss is the endowment approach but with a twist so you say I'll tell focus on this percentage per year but I won't take any more in dollars than X amount and I won't take any less than Y amount let's talk about the pros and cons of that strategy I think the key really is for a lot of people is to figure out you know what do you need right not just today but also throughout retirement and obviously things change the markets haven't behaved very well over the last decade and so I think that if you don't go back and revisit what is your withdrawal amount or rate thanks in the net of whack and so going back and saying hey you know this year I can take out say five percent but I need six percent okay well you can do that but that means at some point in future you may have to take off less I think the key is really kind of figure out what those boundaries are over time and then readjusting your withdrawal amount based upon portfolio performance so flexibility it sounds like is key well and then if you don't have flexibility to mean you have to take out less right oh that's where I think that you know four percent is a good starting point but if you if you absolutely need the income if do more conservatives say two and a half or even three percent okay David such an important topic thank you so much for being here to share your insights thanks for having me thanks for watching I'm Christine Benz for Morningstar calm

Channel: Morningstar, Inc.

Views: 107,509

Keywords: morningstar, investing, stocks, funds, etfs, mutual, market

Id: pJu_HVMWxpA

Length: 7min 37sec (457 seconds)

Published: Tue Oct 06 2015