Will your Money Last as Long as you Do?

For how long do you expect to live? It’s anybody’s guess but seriously, lifespans are steadily increasing and building a nest egg for your retirement is only one aspect of retirement planning; the other important aspect, is ensuring that those savings you have been accumulating over decades, actually last at least as long as you live.

One of the greatest challenges to financial security is the transition from earning regular income and accumulating assets to actually drawing down on those hard-earned assets over what could end up being almost a third of your lifetime, with improved healthcare, diet, exercise and education.

As we continue to hope and pray for long life and prosperity, we must consider the “risk” of longevity and its implications for retirement planning. With medical advances, it is increasingly possible that today’s healthy 60-year-olds may live well into their 90s and beyond. In some countries there are calls to increase the retirement age to 65 or even 70.

Withdrawal risk keeps many retirees awake at night, as they must determine how much they can realistically afford to draw down from personal savings and investments without seriously depleting their capital. The rate at which you withdraw money from your assets is one of the most important factors affecting how long they will last. If you underestimate your needs, your money could run out too soon leaving you unable to live the standard or quality of the lifestyle you envisaged, or leave you dependent on your children or other relatives.

For years, financial advisers have presented the 4% rule for retirement, which is a rough guide for portfolio withdrawals in retirement. The basic premise is that you withdraw a conservative 4% to 5% of your portfolio in the first year of retirement and then every year afterwards you withdraw the amount you took out the previous year with an inflation adjustment.

Many investors end up withdrawing well over 10% of their portfolio each year to support the lifestyle they have become accustomed to. Indeed many people spend more in their early years of retirement when they travel and “enjoy the fruits of their labour.” This can rapidly deplete that portfolio. However, even though this initial outlay can seem a little worrisome initially, it does tend to even out in later years.3

Others are very pessimistic and scared of the prospect of being dependent on family in their later years and after building a portfolio of Certificates of Deposit, Bonds and dividend yielding stocks only withdraw interest and dividends and are too scared ever to touch principal or liquidate stocks; this also has implications for their living standards.

So what is a safe withdrawal amount? It is virtually impossible to give precise guidance as to how much you can afford to spend from your savings in any given year; no simple solution exists and investors’ withdrawal rates will vary from person to person and according to the vagaries of the markets and their particular needs.

Clearly there are many considerations to be taken into account including, your age and health, the overall size and composition of your retirement portfolio, your objectives, your spending pattern and lifestyle, and the fluctuation of your investment returns, the impact of inflation and the exchange rate on your assets and cost of living. Retirees must naturally be cautious particularly where portfolios are not well diversified and investments under-perform for long periods and interest rates remain relatively low.

Developing a plan for this spending phase can be difficult, as obviously no one knows how long he or she might live. It is important to seek professional advice to plan with the appropriate timing that makes sense given your overall goals and your own unique situation.

In the past, conventional wisdom was to begin to divest from stocks as one approaches retirement, and then migrate to bonds and cash as safer guaranteed investments, stocks being volatile in the short term. Several studies have been carried out using various portfolio compositions to see what withdrawal rates would leave portfolios with positive values after say 20 years. Some of these scenarios assume 100% cash, 100% bonds, 100% stocks along with 25/75, 50/50 and 75/25 mixes.

One rough rule of thumb is the “100 minus age” rule, which suggests that you subtract your age from 100: The result is the percentage of your assets to allocate to stocks; this means a 65-year-old should retain only 35% of his or her money in stocks; this could put a retiree at risk.

An investment strategy that is too conservative can be just as dangerous as one that is too aggressive, as it not only exposes your portfolio to the effects of inflation but also limits the long-term upside potential that stock market investments offer. If you are too aggressive about cutting exposure to stocks too soon, you could hinder the growth of your nest egg and this could leave you with less than you need. 

Yet as you approach retirement, you badly need growth and have so much to lose if there is a prolonged bear market. Being too aggressive can mean assuming too much risk in volatile markets. Nowadays one is encouraged to continue to retain stocks and stock mutual funds in a portfolio to have any prospects of long-term growth.

The “artificial” deadline that retirement appears to present is becoming less practical and should not be what rigidly drives planning decisions. What is thus required, is a strategy that seeks to keep the growth potential for your investments without assuming too much risk. After an "official" retirement age of 60, there is a real possibility that you may need 30 more years of retirement income and the ideal should be to find a balance between growth and capital preservation.

Can you afford to retire at the traditional age of 60? The truth is that most people can’t. In your fifties, it is already becoming clear whether or not you have enough money to last a lifetime and then some. If you know that you aren’t ready for retirement financially or otherwise, then you will simply have to work for longer than planned, and its time to think of what you will be doing in the years ahead. 

The generation approaching retirement age, have to a large extent redefined the traditional view of retirement; they are radically reshaping societies views of how “older” people are supposed to behave. From the traditional view of relaxation, leisure, and comfort, it is a time for renewal, growth, new opportunities, self-fulfillment and brand new challenges. But this does need planning.