But will it last?

A sizable retirement portfolio doesn’t just happen. Building one requires effort, knowledge, and resolve. It typically takes decades of disciplined savings, sensible asset allocation, and the courage to hang in there when markets get dicey.

And even then the work’s not done. Because after amassing a nest egg, the big question looms: How long will it last?

Three factors determine how quickly a nest egg depletes — the rate of return that the portfolio earns, the inflation rate, and the withdrawal rate. An investor can only control the third — how much of the portfolio is sold each year to meet cash flow needs.

The math

Small changes in withdrawal rate have a huge impact on portfolio longevity. The chart below provides a hypothetical example of how long investments may last when withdrawn at different rates. It is based on a diversified portfolio of 40% stocks, 45% bonds and 15% money market securities, with performance and inflation based on historical data since 1971.

Figure 1: How long nest egg will last (years), based on withdrawal rate*

Withdrawing 8, 7 or 6 percent each year quickly exhausts the entire portfolio. In just 12 to 18 years, there’s nothing left. A 5 percent annual draw stretches the nest egg out to about 25 years. And with a conservative 4 percent withdrawal the hypothetical portfolio should outlast even the hardiest retiree, with something left over for the next generation.

This 4 percent withdrawal rate – $40,000 per year per $1 million starting balance – has become a rule of thumb for retirement planning. Like most rules of thumb, it’s a good place to start, but it’s far from foolproof. Because the math can be disrupted or derailed by big market swings, the best retirement cash flow planning considers not just this static balanced portfolio, but a wide range of potential asset allocations and the diverse returns they may deliver over time. The Windham Capital Management portfolio software we use at Osbon Capital lets us do just that. I find it to be an extremely powerful planning tool.

Safe, not sorry

With increasing life expectancies, retirement now lasts thirty or more years for many. As it impossible to predict what markets and inflation will do over such an extended period, we recommend building as large an investment nest egg as possible, and keeping the one controllable variable — withdrawal rate — as low as possible.

If you like to play with numbers you may enjoy this simple withdrawal calculator. Tinker with the variables and see how it affects the life expectancy of your portfolio.

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* Source: American Century Investments
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