Every day 10,000 baby boomers reach the age of 65. They have worked all their lives to save enough to live comfortably and enjoy retirement. That is far easier said than done. Changes in the economic environment can play a big role in whether or not someone is actually prepared for retirement. Is the environment in 2019 good or bad for future retirees?
It is now 2019, you are 65 years old, have done some planning for retirement and determined that you require $40,000 per year during your golden years. By utilizing the old 4% withdrawal rule adage, you decided your magic number is $1,000,000 in investable assets, which you’ll have by year’s end. You’ve determined a 60% stock / 40% bond portfolio will get the returns you need while still being in line with your risk tolerance. Easy peasy lemon squeezy. However, there are assumptions embedded within this scenario that could derail this well-thought-out retirement plan. So, before you punch your timecard for the last time, there are some things you want to consider.
The 4% rule was a result of William Bengen’s 1994 study of historical stock and bond returns from 1926 to 1976. He focused heavily on the severe market downturns during the 30s and early 70s. Bengen concluded that a four percent annual withdrawal rate, even during the worst downturns, a portfolio would last at least 33 years. It is important to note, prior to Bergen’s study, the prevailing consensus among personal finance experts considered five percent to be a safe amount for retirees to withdraw each year.
The 25 year old study might need to be reevaluated to reflect current market conditions. Low interest rates, lower stock returns, and low inflation have a direct impact on the viability of sticking to the 4% rule. Vanguard recently updated their expectations for stocks and bonds returns over the next 10 years. Their expectations are far below the returns that investors have grown accustomed to in the past.
Vanguard highlighted the average return for a 60/40 portfolio since 1970 was 9.4%. However, if we look at returns since 1990, the average return on a 60/40 portfolio dropped to 7.3%. Their expectations for a 60/40 portfolio over the next 10 years is 4.9%.
We analyzed how Vanguard’s lower returns would affect someone using the 4-percent rule. Our analysis compared how the 4% rule fared during different market conditions based on Vanguard’s average returns for a 60/40 portfolio using the following assumptions:
- $1,000,000 portfolio
- $40,000 annual withdrawal indexed for inflation
- 30 year time horizon
- Market Historical Returns (As provided by Vanguard):
- 1970- present historical perf. (Avg. Return = 9.4%, standard deviation = 9.5%)
- 1990- present historical perf. (Avg. Return = 7.3%, standard deviation = 9.0%)
- Vanguard Expected perf. (Avg. Return = 4.9%, standard deviation = 9.4%)
We ran these figures through a Monte Carlo simulation and found, depending on when you retire, prevailing market conditions have a huge impact on your ability to fund retirement. For those who don’t know, a Monte Carlo simulation runs a retirement plan through thousands of trials to determine the probability of success.
If you retire and your returns are equal to the average returns since 1970, you have a 96.38% probability of not running out of money over 30 years. Applying the returns experienced since 1990, that likelihood drops to 80.40%. However, by applying Vanguard’s projected returns, the odds of not running out of money fall to just 35.20%. Meaning, there’s a 65% chance that your million dollar portfolio goes to zero before year 30 of retirement.
In order to achieve an 80% rate of success, you’d need to apply the 2.75% rule instead, dropping your anticipated $40,000 in retirement to only $27,500. However, if you wanted to maintain a $40,000 spend rate, you may need as much as $1,450,000 to avoid running the risk of running out of money in retirement. That’s 45% more than the anticipated $1,000,000 in investable assets.
Another variable to consider is how longevity and early retirement can affect your overall plan.
There is a long standing correlation between wealth and health.
A study, according to the Journal of the American Medical Association, the mortality gap between the richest 1% of men and the poorest 1% of men in the United States is 14.6 years. For women, the discrepancy was 10.1 years. The Harvard Gazette corroborates the 10-15 year longevity gap in favor of the wealthy. Beyond the implications of socioeconomic inequality, the fact remains, people with financial means live longer. Utilizing DQYDJ.com’s 2017 UNITED STATES NET WORTH QUANTILES, an individual with a $1,000,000 net worth is in the 82th percentile amongst US households. Therefore, an individual with $1mm of investable assets will likely have other assets, vaulting him/her into the top 15% of US households and be considered rich enough to be the beneficiary of the longevity gap.
Though the average age of retirement for current retirees is just under 60 years old, those with financial means tend to retire early. The earlier you retire, the longer your money will need to last you. Compounding both observations of longevity of the wealth and early retirement, your money might need to last longer than 30 years.
Another risk investors should be aware of is what’s called “sequence of return” risk. During a retiree’s first couple years in retirement, they typically have more capital invested than they do later in retirement. If a large market decline occurs during those first few years, they will be forced to sell a larger portion of their investments in order to generate the income they need to live on. Those withdrawals leave less money invested and able to grow when the market eventually recovers.
It’s been 10 years since the last recession and some people are saying, “We’re due for another one.” If a recession does happen over the next couple years, the likelihood of a retiree depleting their savings rises considerably. To demonstrate this, we used a scenario where we applied Vanguard’s expected returns and made the worst year, performance wise, the first year. This is essentially simulating retiring in 2007, right before the financial crisis. This analysis reduced the success rate from 35.2% to 15%.
As a reminder, the last recession caused the stock market to decline 57% from September of 2007 to March of 2009. There were countless retirees who were blindsided by the downturn and forced to make some tough decisions about their retirement. The severity of the 2008 recession was very rare. In fact, it was the biggest decline in the stock market for more than 70 years.
While there are many factors that could adversely affect one’s retirement, there are some arrows in the quiver you can utilize.
- Work longer – An extra year or two can really shift the odds of a successful retirement in your favor. Even carrying a part-time position during semi-retirement can have a big impact to your retirement plans.
- Save more before retirement – Setting aside more while you still have the capacity to earn is always a good idea.
- Spend less in retirement – Adjusting your expectations on what you’re going to spend during retirement is tough, but it is a very good exercise on determining your discretionary versus your non-discretionary retirement spending.
- Take a more aggressive stance on investments – Though not the most favorable option because it might put your retirement in a more precarious position, is still an option.
- Guard against the big declines. As mentioned above, large declines in your investments can have a devastating impact on your ability to fund retirement. Explore ways to minimize those risks. Our business cycle indicator is one example.
In conclusion, “Is 2019 a bad year to retire?”, the answer is maybe. You definitely want to reconsider the underlying assumptions and factors around your retirement plan. Take stock of your annual withdrawal rate from your retirement investments as well as the rates of return assumptions your current plan is utilizing. Plan for a longer retirement, either from early retirement or the fact that you are likely to live longer than the average US citizen. There are some things you can do now to ensure you aren’t blindsided in retirement, such as working longer and saving more. It’s probably a good idea to reevaluate your financial plan to decide what solution or combination of solutions works for you.
Our planning process can help tackle many of these questions.