Heading into retirement the number one worry retirees have is will my money last. There is no concrete answer, but in pursuit of that goal retirees may want to adopt a couple of spending and investing rules.
The popular spend down strategy “the 4% rule” – a retiree household withdraws 4% of its amassed retirement savings annually has its merits, but given today’s low return environment achieving a return high enough to cover a withdrawal of that size may be difficult.
For the 4% rule to “work,” two fundamental conditions must be met. One, the retiree has to invest in a way that will allow his or her retirement savings to grow along with inflation and the first two years of returns can have an out sized impact on the strategy’s success. A bear market in the first two years can damage the strategy irreparably.
The strategy is meant to allow the retiree to withdraw 4% annually for 30 years, what once seemed like a conservative amount of time to plan for. However, now may retirees are living longer and need their savings and investments to stretch over a longer life span.
In today’s low return world, the 4% rule has its critics. They argue that a 4% withdrawal rate may be unsustainable over 30 years. In addition, retirees are not always able to strictly follow a 4% withdrawal rate. Dividends and Required Minimum Distributions (RMDs) may effectively increase the yearly withdrawal. Retirees should review their income sources and investment assumptions with the help of a financial planner to determine what withdrawal percentage is appropriate given their particular situation.
The Bucket Strategy: In this strategy, a retiree assigns one-third of their savings to equities, one-third of their savings to fixed-income investments, and another third of their savings to cash. Each of these “buckets” has a different function.
The cash bucket is to be used for withdrawals over the next two years, it’s stocked with money that represents the equivalent of 2-3 years of withdrawals the retiree plans to take to supplement retirement income.
The cash bucket is replenished over time with investment returns from the equities and fixed-income buckets. Overall, the household should invest with the priority of growing its money within the retiree’s risk tolerance.
Assets in the fixed-income bucket may be invested conservatively. Using a bond ladder or well managed total return bond fund will provide a hedge against rising interest rates.
Making your savings and investments last a lifetime through retirement comes down to the same basic tenets that apply during the wealth accumulation phase of life. Live below your means and continue to invest for the long-term. Following those simple, but not easy rules, will allow you to live the life in retirement that you planned for.