Run Out of Money?
It's the most frequent concern of retirees, "will I run out of money?"
You have various options to withdraw income from your investments and how you do that will impact how long your money lasts.
If your portfolio contains interest or dividend bearing securities and you are able to live on that income, then it's likely your financial situation is secure (this post assumes you have made allowances and plan for other contingencies as increasing health care costs, long-term care and other unforeseen events that can erode your principal).
But some retirees will not find their portfolio income sufficient, especially in years when the financial markets may decline and as inflation erodes purchasing power. And thus the valid concern - will I run out of money?
The question then becomes how much of your principal you can afford to spend and still provide for inflation, and not run out of money before you die.
Just a few short years ago, Peter Lynch, a well-respected mutual fund manager advised retirees that if they invested 100 percent of their money in common stocks, they could withdraw 7 percent a year (assuming a 10 percent average annual return) and still have lots of money left over.
The problem with that logic is that it just isn't true. Using an average rate of return (ROR) to project future income doesn't work because your investments will not deliver that ROR each year.
If your early retirement years are marked by less than average, or worse yet, negative returns, you
will reduce the principal that remains to grow. This could result in you having to either reduce your income in later years, which inflation will make difficult, or you could run out of money.
The sequence of returns has a big impact on how long your money will last.
For example, if the first 3 years of your 25 year retirement you lose money or have no return, that has a bigger impact that if those same bad-investing years were at the end of your 25 year retirement. Since that cannot be predicted in advance, it is important that you plan your withdrawal rate to allow for market fluctuations.
The Trinity Study
The Trinity Study helps solve how to best think about these issues. In fact, the study was done to specifically answer the question, "will I run out of money?"
This study was conducted by three professors, at Trinity University, a decade ago to study what withdrawal rates were least likely to erode an investor’s retirement next egg, and how the holdings of the portfolio, stocks versus bonds, would impact the longevity of the portfolio.
The study looked at the impact of withdrawal rates ranging from 3 – 12 percent, on five different portfolios ranging from one hundred percent stock to one hundred percent bonds, over all rolling withdrawal periods of 15, 20, 25 and 30 years. One of the salient aspects of this study is that it used actual historical market data and not average rates of return which provide a distorted view. It also took the effect of inflation into account and adjusted the withdrawal rates upward each year accordingly to cpompensate for inflation.
The results provide superior guidance to avoid running out of money.
Revelations Of the Trinity Study for Retirees
This study found that over all 30 year time periods from 1946 through 1997, that a 100 percent stock portfolio would have been able to provide a 6 percent income, increasing each year with inflation, only 57 percent of the time.This means that a senior who relied on a stock portfolio for this level of income ran out of money, before 30 years had passed, 43 percent of the time. Given that life expectancies have risen, and many people retire earlier than age 65, this represents a sizeable risk.
The authors reached these five general conclusions:
- Early retirees who must finance longer retirement periods must plan on reduced withdrawal rates.
- Bonds increase portfolio longevity for lower to mid-level withdrawal rates but the majority retirees will benefit from a stock allocation of fifty percent or more.
- Retirees who desire inflation-adjusted withdrawals must tolerate lower withdrawal rates from the initial portfolio (i.e. in the early years of retirement).
- Equity-dominated portfolios using the lower end of three percent or four percent withdrawal rate may create rich heirs at the expense of the retiree’s current consumption.
- For payout periods of fifteen years or fewer, a withdrawal rate of eight to nine percent from an equity-dominated portfolio appears to be sustainable.
See for yourself.
Here are the links to the 4 tables of data created by the study.
- Table 1 illustrates the success rate of various portfolios for different time periods measured against the full time span of the Ibbotson data used, 1926 – 1995.
- Table 2 illustrates the success rate of various portfolios for the time period after WW II, from 1946 – 1995. As expected, market returns were better during that period and thus success rates improved significantly.
- Table 3 illustrates the success rate of various portfolios for different time periods, adjusting for inflation/deflation during the period. As you might expect, this one provides the gloomiest results.
- Table 4 illustrates the variations in the amount of money you might have left at the end of each time period. Remember, that the success rates of the above tables only show what portion of time a given withdrawal rate avoided depleting the portfolio. In fact, each different time period produced a different result, and the range is enormous. This table best illustrates the risks of using a static assumption for ROR.
Your best defense against running out of money is a solid, well-thought out retirement plan.
We cover other factors that impact "will I run out of money" in other posts of this blog.