Understanding How Much Money You Need to Retire – finding a better answer than “more”
Marcus Schafer (00:05)
Hey Pat, great to see you again. This is our latest edition of Greenstream where we are looking at the real research and the evidence behind top questions, providing our perspective so that everybody listening and watching can go out there and live your ideal life. The topic for right now is, what’s my number? Pat, we hear this all the time.
What are the different ways that you’ve heard clients and investors ask this question?
Patrick Collins (00:35)
Yeah, it’s a great question. I’m excited to talk about this. I’d say this is probably the number one reason that clients end up coming to Greenspring and probably other advisory firms is trying to figure out what their number is or maybe put different ways. Am I okay? Am I on track? What do I need to do to get to be able to retire at a certain point? It’s all a variation of this idea of what is my number? I would say,
More times than I can count over my career though, people have come in with an idea of what their number is. If I could just get to $5 million of assets, I think I’ll be able to retire. If I could just get to $2 million of assets, it varies. And I think what’s kind of interesting is when you ask people, how’d you come up with that number? How did you come up with your number?
very little kind of has gone into the thought process. It’s just kind of more of a feeling that it is an actual number, or it’s a very back of the envelope type of number that they’ve come up with. So I think our hope on this podcast is to really help people think about this idea of like, how much do I really need to accumulate to be financially independent? And I think it’s going to be a really interesting topic. And we’re going to talk about research that’s been done in this area. And actually I want to.
say we’re, it’s really a two-part topic. We’re going to talk about the high level theory behind it today. But our next episode, we’re going to get into the practical implications of how do you actually do this once you have the money and you figured out what your number is, how are you actually withdrawing that money, you know, in a real way out of the portfolio to be able to meet your needs.
Marcus Schafer (02:00)
Yeah.
Yeah, I think the two part approach is going to be super interesting. It’s the research around understanding what is that number and different ways to look at that question. And then how do you actually generate that number? the shortest, you you mentioned people tend to have an idea of some number. And I would say the shortest answer that most people come up with is more. They’re like, how much do I need more? And the number changes over time. So I hope this will be.
really, really helpful to think about what is that number? And the first kind of framework I think about is goals, needs, and feels, right? So what, you say a number, what are you trying to do with that number? It’s really important to understand your aspirations, what that means. Needs, what do you really need? Like what is the minimum outcome that you are willing to accept is a critical one.
and then feels like your money at this stage in life should not be the primary source of stress for you. It should be helping to de-stress you. So understanding, hey, those, ⁓ those goals and those needs, how do we match your portfolio and your comfortability to make sure that it’s not stressing you out of which markets are risky. So there will be some amount of stress in it.
Patrick Collins (03:30)
Yeah, to your point of more, all the people that have not done the calculations probably and just have come up with a number, it’s always interesting because we’ll put that in our notes. And when they ultimately hit that more times than not, I found that clients come back and say, well, it was 3 million, but it feels maybe a little bit better to be at four. It’s going to make me feel a little bit more comfortable. So I think, you know, the number itself.
is kind of a fluid number and it’s based on a lot of factors. And I think if you go through the exercise, probably we’re going to talk a little bit about today. Hopefully it gives you a sense of what that number is and it’s rooted in some level of evidence and data and understanding that there’s some math behind it.
Spending vs. Asset Retirement Targets 1,2,3,4 – two sides of the same coin when it comes to calculating how much you need to retire
Marcus Schafer (04:13)
Yeah. Yeah. And that framework to try and, know, this is why it’s always really helpful to look at a question through different angles. It’s what’s my number. Okay. And then you kind of unpack, what are you trying to do with that number? And you’re trying to replace a salary that you’re no longer drawing on because you’re trying to retire and you don’t want to work as much or you’re going to be working less. And then, so let’s think about what that stream of income you need is.
what that spending rate is. And this is kind of in the literature, this is what they call replacement rates. So it’s trying to understand what percentage of your previous income do you now need to replace with your portfolio? That helps you understand, okay, how much money do I need? And then you can back into what type of total portfolio value can I get to? And in a sense, this is where we get to the withdrawal rate.
and all the research that we’re gonna talk about, which is what percentage of my portfolio can I take out every year to replace a salary I’m no longer drawing synthetically from my portfolio? And then what’s sustainable and how do I think about iterating that to make sure I’m comfortable with it in the long term?
Patrick Collins (05:26)
Yeah, there’s we were talking about this earlier. There’s two elements or two ways you could think about this number. But but at the end of the day, it really always comes back to spending my number. You know, we have clients that have over 10 million dollars. That’s not enough for them because they have a really high rate. They spend a million dollars a year. So if you have 10 million dollars, again, when we start talking about the math, you’re going to look and say that may not be enough.
We have other clients that have a million dollars of assets and that’s enough to sustain them through retirement. So there’s a direct correlation between how much money you’re taking out and how much assets you need, what your number is. And there’s two ways that we’ve kind of talked about of how you can kind of approach this and it comes from different angles. So on the one side, you can come at it from spending. So you can look at your current spending and say, what essentially multiple of that do I need to be able to sustain that spending?
The other way you can look at it is from the asset side. And so you could say, I have this level of assets — How much can I actually withdraw from that so that it’s sustainable and I don’t run out of money? And so those are the two ways. My personal belief is that the first way that you come at it from a spending level is probably a better way to come at it from purely from a quality of life standpoint. Because if you’re just solely going based on your assets,
And let’s say I have $2 million dollars and I do, you know, we’ll get into the math on the rates and whatnot, but let’s just say I calculate that I can take out $80,000 a year and do that sustainably through my retirement. Well, if my spending pre-retirement for what I’ve calculated is a hundred thousand dollars, there’s some problems with that. All of a sudden I need to have a cut in my lifestyle to be able to kind of make this, this number work. And for most clients.
Marcus Schafer (07:02)
Yep.
Yeah.
Patrick Collins (07:19)
that’s not really what they’re looking to do is to say, I want to go into retirement and really have a different lifestyle or do things or really cut back on the things that I want to do. So I think it’s probably a good idea to get into, you know, how do you calculate what your spending is in retirement? Cause that’s kind of the foundation for what your number should be. But I’ll stop there and see if you have any thoughts on that.
How to Calculate Your Retirement Spending 5 – spending decreases but by how much depends on your previous income
Marcus Schafer (07:44)
No, I think you’re spot on. This is why rules of thumb and cookie cutter advice kind of sometimes break down a little bit. a great example is spending in retirement. Even the research isn’t certain on the proper replacement rate. So when you’re working and you’re drawing a salary, there are certain things you’re doing with that money that you don’t expect to do in retirement.
So you don’t expect to really save anymore, right? Because you’re doing the opposite of saving, you’re withdrawing. So that’s something back. Your income has changed, so you don’t really pay income taxes in the same degree. So that’s kind of decreased. Hopefully your mortgage has kind of expired. So your real estate costs are different. So they’ll have to pay property taxes, but that kind of drops. And somewhat counter-intuitively,
When you look at the research and you think about those buckets, oftentimes the expectation is the more money you make before you retire as a percentage basis, the lower your replacement rate needs to be. And I think that’s kind of counterintuitive for individuals who, if you’re just saying, hey, I need to replace 75 % of my income for a lot of these higher income individuals, it could be as low as 50%.
of the income just because your taxes are so high, you’re saving so much. Do you need new cars if you’re no longer commuting to work every single day? A lot of these things are different.
Patrick Collins (09:14)
Yeah,
absolutely. I think maybe it’d be good for the listeners to hear kind of how we go about thinking about their spending numbers, because again, if that’s the foundation of how much you’re going to need to retire, trying to zero in on those numbers is really important. there’s maybe I’m going to give the very simple way to do it. And then maybe the way we look at it, it’s a little bit more complex and probably gets a little bit more accurate. But the easiest way to figure out what your spending is
Marcus Schafer (09:35)
Yep.
Patrick Collins (09:39)
and what you could do in a minute or so is pull out your last pay stub and look at what your net pay was. That’s basically it because if think about that, your pay stub is going to have your gross income. It’s going to subtract for taxes. It’s going to subtract for your savings because it’s most likely in a retirement plan. And then whatever the net is, assuming you spend that, now you’d have to adjust that. The only adjustment would be something like, well, I actually save a thousand dollars a month into my brokerage account. Well,
Marcus Schafer (09:51)
Yeah.
Yeah.
Patrick Collins (10:06)
then if your net pay was $10,000, take $1,000 off that, because that’s not really spending that you’re doing. You’re putting that away into a brokerage account. So really your net pay is $9,000. And that’s really the number that you’re probably going to want to replace, at least in the very beginning of retirement, to make sure your quality of life stays the same. That’s a really, really simplified way to do it. The way that we tend to do it, and I’ll step back for a minute. Most of the people we talk to,
do not have detailed budgets. And I don’t know why that’s the case, but just most of our clients do not have a very detailed budget. And the ones that try to do it, what we found is they vastly underestimate what they spend. Because you’ll see their budget and they’ll say, I’ve got my cable bill and my phone bill and my utilities and my car payment or whatever it is. But they forget about all the one-time expenses. Oftentimes you look at it say, well, did you go on vacation last year? Yeah, I forgot about that.
It was just a one type thing. we had to replace our roof a year ago. That’s not in there. So really what we found is that when people try to just off the top of their head, think of their budget and write it all down, usually it underestimates their actual spending. So what we tend to do, and we talked about this actually in episode three, when we talked about kind of what’s a financial plan. But the way we think about it is there’s five categories for your spending. There’s giving.
taxes, debt reduction, general spending, and savings. And so if you want to go through the exercise to figure out what do I really need to replace, what I would say is you can kind of narrow a lot of these down from readily available documents. So first, giving. If I want to continue giving in retirement, or even if I don’t, I just want to figure out what my giving is. You just pull out your tax return, look at the line item and says how much you gave to charity.
Bam, right off the bat, you know that there’s not gonna be any kind of fudging on that. That is what it is. Second, taxes. Taxes again, pull out your tax return, look how much you paid to the Fed, to the state. You can pull out a pay stub, look at how much you paid in payroll taxes. That’ll give you all your tax information. Debt reduction, pull out your mortgage statement or your car loans and figure out what your payment is every month. You know how much goes out for debt.
Savings again look at your 401k how much did you contribute to that do you have any other for savings put that in there whatever’s left over so I covered four out of the five the only one I didn’t cover is general spending whatever is left over that’s your general spending and that’s the amount that you’re going to need to replicate If you don’t have any debt in retirement now if you have debt in retirement maybe those payments are going to continue for some period of time but that’s really the number
for general spending that you should be thinking about when we start talking about these spending rates, withdrawal rates, things like that.
Marcus Schafer (12:50)
Exactly. And, you know, this, this exercise is helpful to also think about, are you spending on things that you enjoy? Budgeting for a millionaire tends to be vastly different than budgeting for different income levels. And a lot of this is trying to say, Hey, maybe you look at something and you really go in depth and you say, Hey, I really want to understand that general spending. And maybe we need to
Maybe we should eat out more. You know, we’ve been trying some new restaurants lately and that’s been really fun. And maybe we should try and do that or, hey we have this opportunity to travel more. And so I don’t think, you know, the perspective on a lot of times is budgeting. answer is spend less. And what’s most powerful is to figure out what you really enjoy and think about also shifting spending. I enjoy this less. I enjoy this more. Make a conscious decision to spend some money. And if you think about a lot of.
our clients, you’ve been diligent your whole life. You’ve been working hard, you’ve been saving, and you might have more than you need. And that’s what a lot of this, these exercises are also helpful to understand is, maybe I could shift some of my spending up in, years as opposed to delay it. So I think that’s, that’s super, super helpful. The, other thing on, on spending in retirement.
is, as you kind of mentioned, the basket of goods you buy pre-retirement, versus post-retirement, that does change a little bit. So you tend to see a decrease in spending, but the types of spending that you do might be a little more inflationary in retirement. And we kind of talked about this last time as well, where hey, healthcare, the inflation rate of healthcare is higher than the inflation rate on most everything else. So
That kind of happens, but in general you expect a reduction from pre-retirement spending.
Should the 4% Withdrawal Rule be the 2-3% Range? 6,7,8– we unpack the assumptions and research behind one of the most cited rules of thumbs in personal finance
Patrick Collins (14:42)
Yep. so, so kind of coming back to the number, once we have a dollar amount, this is where again, it kind of can get tricky. I think this idea of trying to distill everything down to a number, if I get to this level, I’m going to be okay. It’s really challenging because we’re dealing with investments with uncertainty.
And there’s a lot of uncertainty around what the future holds. And I think people inherently know that. But I will say this, that there is probably a really simple way to come up with your number. And that is you could basically go to an annuity or an insurance company and say, I want to buy a stream of income that matches my spending rate. And it’s not exactly this easy because there’s inflation and things like that. But they will come back to you and say,
Here’s how much money you need to give us to generate this amount of income every year for the rest of your life. Now, at the end of that, you’re going to have zero because when you pass away, whether you pass away a year from now or 30 years from now, you’re going to have zero, but you’re pulling all of that risk, that longevity risk with other people and the insurance company will pay you a set amount for that. So that’s a really simplified way to come up with a number if you’re looking for one to say, how much money do I need to generate this amount of income?
once you start investing in assets like stocks, bonds, things like that, there’s a vast array of different outcomes that can happen depending on a lot of different scenarios. And so that’s why when you get into this idea of the number, there’s a lot of uncertainty and there’s a lot of outcomes that can happen that is really hard to plan for. So you end up having to build in
a lot of kind of conservative assumptions in a lot of ways, which many times means that you have more money at the end of your life than when you started with, or at least you don’t draw it down, down to zero. And that makes it really hard because most clients might say, gosh, I’d love to, know, if there was a book out there, you know, essentially die with zero, but it’s, I think a lot of clients don’t mind that outcome.
It’s really hard to do in real life though, because nobody knows when they’re going to die. So when we’re sitting here saying, uh, clients says, I want to spend down all my assets and enjoy them while I’m alive. Unless you know the date of your death, it’s hard because you don’t want to get to, let’s say your average life expectancy is 84. You don’t want to get to 84, be healthy and be like, that’s what I was planning for. What, what next? So the longevity piece makes it really challenging to come up with a number that you can spend out zero.
Marcus Schafer (17:09)
Yes. Yeah. And all of this that we’re talking about is kind of you have assets, how much can you spend of those assets every single year? This gets back to what I’m sure most everybody has heard, which is 4%. The 4 % rule, you can spend down in year one, 4 % of your assets. You can adjust that number for inflation to hedge out some risk, but for the rest of your life, you can withdraw 4%.
and you should be okay. That research goes back over 30 years. It’s been well studied. So there’s a lot of researchers picking apart whether or not that is an actual number or not. But I thought maybe it would be helpful just to talk about when they first did that study, what were some of the constraints that were existing? And then that helps us understand
Hey, is that 4 % number a good baseline, a good reference point or not? So the first thing that they did was they assumed a 30 year life horizon. So if you think about it from my age group, it’s like this fire, this retire early, that’s not going to apply to the same degree because the time horizon is likely greater than 30 years. Health expectancy is increasing. Health expectancy for affluence is increasing greater.
So that’s kind of a no-no. It’s a two portfolio system. So it uses US stocks and US bonds in a 50-50 portfolio. And we’ll probably have a discussion around whether or not using US historical returns is the right forward-looking estimate for returns. But again, it uses a 50-50 portfolio.
of those things and a few other things that does not include fees, which have admittedly gone down a lot, but also taxes to think about, I’m going to have to pay some taxes on this portfolio. So that’s just a little bit of history of Bengen’s 4% from 1994.
Patrick Collins (19:16)
Yeah, and it’s been really kind of gospel in the industry to some degree. There’s been lots of offshoots of the research of how to improve the 4 % withdrawal rate and the 4 % rule. I think it’s important to note, you know, when you look at a 50-50 portfolio, US stocks and bonds over the period that he researched, you would look at it and say the average return’s probably around 8%, somewhere in that range. So most people think
hear that and say, well, if the average returns 8%, why can’t I take out 8 % or maybe even a little bit more than that if I don’t mind drawing down my assets? Because if I have $2 million and I’m growing at 8%, that means I have $160,000 growth each year, but I’m only taking out 80. So I’m gonna have way more money at the end of my life because I’m not taking out all the growth. So why is it 4 % versus 8%, which has been the average return? And that comes down to
the sequence of return risks that happen in the markets. don’t get, unfortunately, we don’t get an average 8 % return or or that at least during the period that they studied, it was not an average 8 % return every year. I everybody knows this, that you have long stretches where the markets can go down. And yes, it may average 8 % over time, but if the first half of your retirement are horrible, you may have drawn down your assets to a level where even when the good times come later,
there’s nothing left for it to grow basically. So I think that is an important aspect of the 4 % rule is, you know, he was looking at periods like the Great Depression and saying, you know, if we have one of these, could the 4 % rule still hold up? And that’s what they were looking at. But the vast majority of the time, actually the research, there’s been research after this, two thirds of the time, if you follow this 4 % rule,
you’re going to have more money when you die than when you started retirement and that might be okay for some people that might be something that’s great but for others that means you have probably less utility or less use of your assets during your lifetime and that may not be a great outcome for people to think through because you know on one hand you could look at that and say you know I wish I would have
been able to do more during my life instead of just following this rule blindly. So there’s some negatives. And the other part that I would just say on the 4 % rule that just is a challenge with the methodology itself is you think about the retiree who retired in 2007. They had a 50-50 portfolio. Let’s just say for ease of they had a million dollars. So they’re starting with a 40,000 withdrawal rate.
The retiree, so what the research and the rule says is the next year after that, they can take out the 40,000 plus inflation. And then you have to add another inflation adjustment and so forth. The retiree that retires in 2000, at the end of 2008, maybe has seen their balanced portfolio go down by 20%. So that million dollars has gone down to 800,000. Now I do the 4 % rule, okay, I get 32,000.
Marcus Schafer (22:22)
No.
Patrick Collins (22:26)
Well, the retiree who retired a year before me is spending 40,000 plus inflation, maybe 41,000. I have to spend 32,000. Where, how do you rectify that from the standpoint of just using this rule blindly? So I think there’s some challenges with it in trying to figure out your number, but it’s a good back of the envelope start, but there’s things that, you know, there’s some shortcomings to it.
Marcus Schafer (22:50)
Yes, absolutely. I have that by the way, 8 % Dave Ramsey came out and he said, the S&P 500 has done about 12%. Inflation has been about 4%. That means 8%. You should spend all your, all your gains. I would say if you want your portfolio to go to zero, that would be one, one approach. I think that’s at the extreme, but what’s great about, I would say if you’re using it as a rule of thumb, there are some catches to it.
If you’re using it as a benchmark, I think it’s very helpful because there’s been so much research done around likelihood of different outcomes that you could say, okay, well, you know, to your point, two thirds of the time you’re going to have more money. Hey, is that acceptable to me? I think some other, you know, some other things about the research in ’94 that’s definitely changed. When you start to add things like international
diversification, more diversified portfolios than what Bengen had available in 1994 that should increase your expectations on survivability of your assets. The other big trend has been really thinking about, I kind of just referenced this, but US stock market returns. The US stock market is now the largest stock market in the world. It was not always that case.
So what must have been true is we must have been better than all the other stock markets. There’s an immense amount of survivorship bias in that. If you take an individual from America and you plot them in different countries with longer data sets who have survived through different time periods, that 4 % rule all of a sudden becomes a 2 or a 3 % rule.
So I do think that you have to take some amount of humility to say, we’ve done amazing. Do we still, should we still adjust our expectations to that level that we’re going to keep doing as amazing as we’ve done historically? If I’m planning for the next 30, 40 years of my life, I might want to take a smaller number than that just to hedge out some risks that.
we might have stock market returns like everybody else got as opposed to the exception to the rule.
Patrick Collins (25:16)
Yeah, it’s a great point in that we really do need to kind of divorce the past with what’s expected in the future and can we expect this moving forward? And so no one really knows, which is again why there’s some certainty you want to build that into your portfolio. But ultimately, when you are coming back to our original kind of take on this is
what’s my number, starting with somewhere in this, you know, 4 % range is probably a decent start. But what I would say is, is that there’s like all the things we talked about of having more money at the end of your life, most likely if you follow that rule, kind of the, the, the importance of the year that you start was our bad, really bad year that will dictate the spending for the rest of your life based on the 4 % rule. So there’s all these things that you have to really factor in.
Marcus Schafer (25:44)
Yeah.
Patrick Collins (26:13)
A lot more research has come out around trying to be a little bit more variable with that 4 % rule. When can you move it up? The other part too, I would say is that people are working longer and we’ve just found that people kind of are staying in the workforce. They’re consulting, they’re doing other stuff past 65. Maybe they finally retire at 70 or 75. Do you still need to use a 4 % rule? Is that your number if I have to figure it out or can I use something higher because my, that 30 year…
window that they were using in their research has now shrunk. Maybe it’s only 20 years. So realistically, my withdrawal rate should be higher. Therefore, my number should be lower in those scenarios. So, you know, that’s an easy thing when people are looking at retirement planning and figuring out their number. If they don’t have enough, one of the easiest things is just work a little bit longer because you are shrinking the amount of time that you need your money to last. And therefore you can have a little bit less money to kind of make sure you’re secure.
Marcus Schafer (26:51)
Yep.
Yes. Yeah. And you, you mentioned variability that I think is really important to highlight because what’s a, what the research doesn’t assume is it doesn’t historically, it doesn’t assume you’re going to change your spending patterns based upon what you see in the economy. it does not take in into any account. It just assumes you’re going to get the expected return of the portfolios. And we can tell you from
Variable Spending Rates 7 – the answer to problems with the 4% Rule and why they are so hard to implement
talking with thousands of individuals, it is really tough to get index returns. It’s like, you got the index return, then you have the active management return that’s below that, and then investors tend to get a return below the active managers’ return. And so you kind of have to do some discounting. Well, maybe what if I don’t get the expected returns because the US might not be as good going forward as it was in the past or…
What if me as an investor, might make small decisions along the way. We call this portfolio leakage. That’s really tough to manage. And then the great thing about an advisor, like if you were to tell somebody, hey, you have to establish this dynamic withdrawal rate where, hey, the market’s good. So you could take 10 % more of your income. Next year, the market’s bad. So you actually have to take 10 % less than you did last year.
Adjusting those numbers in practicality is just really difficult unless you’re having somebody help you think through that and make those changes for you because I think we’ve probably talked about this in the past. A lot of times when we’re working with clients and we’re sending checks into the account, it’s just like your salary. You’re going to spend what comes your way. And that could also be a really, really good thing where the economy is down. Your dollar might go a little further.
It might get you things that you weren’t able to get before. So all this stuff is just super flexible. It’s why cookie cutter is just so difficult.
Patrick Collins (29:07)
Yeah, and there’s a couple points I wanted to touch on there. One was this idea of variable spending rates based on what your portfolio is done. So that’s a lot of the research has come out after Bill Bengen and his original 4 % rule. People tried to build on that and say, well, gosh, what happens when the market does really well? You’re still only spending for, you know, you’re that original dollar amount that you talked about some inflation adjustments that
Marcus Schafer (29:18)
Yeah.
Patrick Collins (29:30)
feels like you should be able to spend more. mean, two thirds of the time you have more money. Why not adjust it upward? And that makes a lot of sense. But in practicality in the real world, I don’t see clients actually acting that way where they’re saying, ⁓ this year I can spend more or, they have real world expenses that come up and they just sometimes have to spend more. And so there’s some variability in the spending that you just can’t plan for.
that you kind of have to build into the plan to some degree, but just knowing that, we need to have a little bit of margin here. The other thing I just think is really interesting, I think it’s kind of an interesting story. Bill Bengen who did this research, was groundbreaking at the time, because I think a lot of people didn’t really understand, and he went back and bootstrapped and looked at all these data, these time periods and said, when would this have worked? And he came up with this 4 % number.
The Role of Advisors in Navigating Market Downturns – how a good advisor helps keep investors on track
There’s been now multiple times where he’s come out and said, and again, going back to his research, it assumes a basic static portfolio of 50, 50 stock bonds. When you started to look at what he did in practice, though, in ’08 he talked about moving his clients into cash. In 2022, he’d already retired at this point, he talked about his own portfolio moving from 50 % stocks down to 20 % stocks. So he was moving things around.
to try to outperform the market in a lot of ways. And when you talked about portfolio leakage, I don’t know what his returns are. Maybe he could do it. knowing when I said, at least when you read the articles and when they happened, it’s like, wow, that seems like he moved at the bottom of the market or close to the bottom. I wonder if he got back in or when he got back in. And so these things I think are really important because all of the research is this theory that you’re going to get market returns.
everything we’ve seen either anecdotally or just other research around, you know, not around withdrawal rates, but just around who earns the market return. It’s tough. It’s really, really tough because you have fees. Like you said, you have people that just deviate. They don’t even realize it from the market. So yeah, I own five mutual funds. Well, I didn’t realize that I’m overweighting these 10 stocks more than the market is. And therefore I could do better or worse.
Marcus Schafer (31:32)
Yeah.
Patrick Collins (31:44)
But again, the other part of that is maybe I’m adding even more variability to my returns too, because I’m more concentrated. mean, we’ll have clients and investors and prospective clients come into this all the time. And you look at their portfolio and they feel like they’re diversified, but they’re not, you know, they have a huge weighting in one or two stocks. you know, there’s some research out there. I’d love to have this person come on the podcast. have this, this professor from Arizona state who’s done research on stock returns and he’s found that.
a very, very small percentage of stocks have driven the majority of the stock market return over the last 100 plus years. And I think that’s interesting again. So if you are not owning the market, there’s a really good chance you’re underperforming the market. And therefore the 4 % with the rule may not apply to you because you’re not earning the returns that is assumed in that study.
Marcus Schafer (32:35)
Yeah, fantastic points. And it’s also, you know, these are, we’re talking about in good times, right? In good times, there’s potential for portfolio leakage. Zoom in, you’ve kind of advised clients through really difficult market time periods. Like how tough is it to stay invested in a ’07 to ’09? Because that’s what the 4 % rule assumes.
Yeah, you just put money in and you’re going to stick to your plan. No problem. I think that would be really interesting for people to hear about that too.
Patrick Collins (33:12)
think this is probably one of the biggest values an advisor brings to the client relationship is perspective, kind of coaching through the tough times. It’s easy to stay invested when the market’s going up. The risk you have when markets are growing up is you get too excited and you put stuff into things that have already gone up too much and you end up maybe getting greedy basically. But that’s much less of a risk I found over time, maybe because we’ve survived
As you know, at least as our firm’s been in business, I’ve been in business 25 years. I went through the 2000, the 2002 crash. I went through the 2008 crash, COVID. And there’s other things in between there. Most of our clients recognize that markets kind of go up and down. And so I don’t want to get too greedy. It’s the risk I think is more on the fear side. When things go down and you’re retired, that’s the big thing. You could be in the midst of retirement. The 4 % withdrawal rule is…
is basically saying you’re going to stay with this asset allocation. And not only that is if the market goes down, you’re to rebalance back to that target allocation. So you’re going to buy stocks in the midst of a downturn. And so I found almost I want to say never, but it is a very rare situation where a client calls us in the midst of a downturn and says, let’s sell out of that stuff that’s doing really well and buy this buy stocks that are doing terribly. It rarely happens. We do it because
We’re managing portfolios for clients and we have a disciplined way that we do that, but it’s rare for people to wake up in the morning and say, Pat, the market’s down, let’s buy more stocks.
Marcus Schafer (34:46)
Well, and this is where the stakes get higher, the more money you have. You know, it’s kind of like how the newspapers reference the Dow dropping. It might be the same percentage drop that it was 20 years ago, but the number is multiples bigger. And we kind of see the same thing with dollar values, where now the dollar values that people have are really, really high. You know, the old goal used to be, I want kind of a million dollars.
Now it’s, hey, it might be a little closer to two. But if you think about a 50 % market pullback, you’re kind of like, in your diversified portfolio, that might be $500,000 your portfolio goes down. That’s a little bit tougher to stomach. It’s a different type of risk than when you’re an accumulator and you have a $500,000 portfolio and it goes down to 250 or
300,000, but you’re contributing to your 401k. You’re kind of adding $30,000. You’re buying loads. It’s a little bit different mentality. So I think that’s, um, something that’s also really interesting is how do you hit the right asset allocation mix for your ability to stay disciplined, to stay invested. What’s also really comfortable for you and, uh, Bengen’s research kind of highlighted
75 % equity, 25 % stocks was about where you kind of wanted to target. Some new research has come out around 100 % stocks. I kind of view that as that’s just another input that you have to evaluate around your own personal comfortability with investing through uncertainty. And the world is far more uncertain as we are seeing right now than we would think it is.
Patrick Collins (36:35)
Yeah, the again, that’s why the coming up with your number is such a difficult thing because there’s so many variables. How long are you going to live? What’s your asset allocation? I mean, I think it’s intuitive. Most people would say, like, if you told me, I don’t want to take any risks. I’m putting all my money in my checking account, my savings account. I’m to earn 2%, 3%, whatever it is. Um, your number.
is different than another investor’s number who says, actually, I’m willing to have a balanced portfolio. You’re going to need more money because you don’t have as high of an expected return. Even though you have less variability in your returns, you’re going to have a much lower expected return. And so I think understanding yourself, what your risk tolerance is, is going to have an element of determining what your number is, how much money do you need to retire successfully. Then there’s all sorts of other things of
Asset Allocation Determines Withdrawal Rate Ability 8 – why taking more equity risk counterintuitively means less risk of running out of money
timings of cash flows when they come in. So maybe I start out retirement and I’m 65, but I want to wait till 70 to start taking my social security, which is a reasonable assumption for a lot of people, a reasonable plan. Then, I have a withdrawal rate that I need to take for the first five years, but maybe my withdrawal rate actually drops a little bit later in life because now social security is replacing a big chunk of my income. So thinking through all that is important.
I’m a big believer that the number this like I know we’ve used this as a headline, but I don’t think it’s a really helpful exercise for a lot of clients to go through because of this variability that and this uncertainty that happens. So one of the things that we do and a lot of other firms do is we’re looking at what are all the potential outcomes that could happen. And let’s get instead of the number being a dollar amount.
Marcus Schafer (38:03)
Yeah.
Patrick Collins (38:25)
let’s make the number more of a probability-based number to say what’s the probability that I can retire successfully with this amount of money? And that is a little bit better in my mind if you start thinking about things in more probabilities and odds versus black and white numbers. And you know what that’ll say might be might be like you know my number is 80 % meaning
80 % of the time we’ve kind of measured this in different market conditions and 80 % of time I’m okay. I don’t have to change anything. 20 % of time I’ll have to make some adjustments to my plan. That’s more real life than just saying you need five million dollars. And because again if you use a rule of thumb like the four percent rule that means you know two-thirds of the time I’m gonna have more money and that might not be you know for some people that’s great.
For others, they might say, that means I got to work another few years just to get to that $5 million. It’d be nicer to know I have some flexibility here. And if I could retire with $4 million, but also know that maybe I might have to adjust some spending later on in life if things don’t go well, if the returns are worse than expected, or I spend a little bit more than I thought in the beginning of retirement.
That’s a good trade off for me. So I think that number, you know, a set dollar amount as much as we, everybody loves it. It’s like the, you know, the thermometers that like when you’re, you know, the United Way has their, their campaign. It’s like, we just need to get to this number and we’ve hit our goal. I think a lot of people think that way. Like, I just want to get to this number and there’s just so much more that goes into it.
Marcus Schafer (39:59)
Yeah, yeah, I think that’s an amazing, amazing perspective to think about probability and what I do think switching the framework away from absolute dollars into different measurements like probability, withdrawal rate, I still think is really helpful, right? Like maybe if you think about 4 % as a benchmark, I would kind of say, hey, if you’re withdrawing less than 2, 2.5 % from your portfolio,
Using Withdrawal Rate to Guide Increasing or Decreasing Spending – low withdrawal rates might be a license to spend
You might have an opportunity to accelerate some spending in your life. And maybe that’s something that we should look through. Two and a half to 4%, maybe your gray area, right? Like the newer research is coming out two and a half to 3 % tends to be a better target for sustainable withdrawal rates given all the changes we’ve had. Okay. So maybe that’s kind of your cautionary. And then anything above that, I would really think about.
This might be a little bit too extreme, but also, you know, if you’re going with the Dave Ramsey 8%, I might take you back to when we talked about annuities and think about a SPIA annuity because that withdrawal rate will probably take you very close to zero. And you might be able to do that with more comfortability if you just outsource the management of something like that. So I kind of think that maybe there are some benchmarks that we can glean from all the
research to help guide people to understand, should I accelerate spending? Should I slow down? How should I think about changes over time? So let’s maybe wrap up unless you have any other thoughts.
Patrick Collins (41:39)
Yeah, just
a couple of thoughts on what you just mentioned. I chuckle because the 8 % kind of was a big splash in the news. Dave Ramsey came out. And I think Dave Ramsey has some good things that he encourages, know, debt pay down and whatnot. But all the professionals in the industry were up in arms because they know the data, they know the research and how unlikely that is and how much of a disservice that is to clients.
Marcus Schafer (41:50)
Yeah.
Patrick Collins (42:06)
because of the sequence of return risks and everybody knows that it that 8 % will work in certain environments and it won’t work in others and the likelihood that you’re going to in a 30-year retirement you’re going to have some really bad stretches is high I mean at least if you look at research and so that 8 % rule is going to fail and that 8 % withdrawal rate will fail at some point and it has a high likelihood of failing so
I think again, thinking about that in the context of variability, I mentioned we do this probability testing for clients and you know, it’s kind of fascinating when you look at retirement and you put more of the potential outcomes that can happen and you try to test that over and over again to say, well, there could be some 30 year periods that are amazing and some 30 year periods that are horrible. And we want to look at all of those and figure out, you know do you have enough money to kind of
can weather any of those types of storms. And when you look at it, a lot of times you’ll do the math and you’ll show the client, well, we ran a thousand different trials, let’s just say, of all sorts of different environments. And the range of outcomes for you is anywhere from zero, you’ll have zero at the end, to 50 million dollars. And, you know, I’ve had a few clients chuckle and be like,
I really appreciate how much you’ve really narrowed this down for us. it’s kind of like you telling me I’m going to have somewhere between zero and $50 million when I die. It doesn’t sound like you went out on much of a limb there, And so, but it’s, kind of the accurate truth. Now, the one last thing I will say to that, I say this to every client is the things that it doesn’t factor in is the real life adaptability that you have when, when you’re living your life and you’re going through these periods. So, you know, the people that,
because in these plans, we have to make some assumptions on what your spending is going to be. Usually it’s that we’re increasing your spending by inflation each year. But we get to these points in our lives where if things are going really bad, we tend to adapt. You know, we we downsize our home a little bit sooner than we thought we would. We don’t go on the extra vacation that year. We don’t give as much money to our grandkids, you know, through through gifting, whatever it is, as our goals are. But we just
We adapt to our situation and the other side happens as well. And that’s really what I think we’ve been seeing more than anything the last 10 years or so things have gone so well that clients are adapting the other way. saying, wow, I’m trending so far above what we thought we were going to be at. Why am I, why am I only still spending a hundred thousand dollars? Let’s move it up to $150,000 and we can rerun the plan. That’s why having a number is not super helpful.
you need to have some dynamic aspects to that to iterate and say, okay, things are better than we thought they’d be. Where there’s uncertainty, uncertainty worked in our favor, let’s adjust. And it can go both ways. So I think that’s the one thing about the idea of picking a number is it feels like it’s a point in time that you’re making a decision around your spending and how much you need. And that’s going to change over time based on your situation and the markets and all those different things. you know,
kind of revisiting the number is an important aspect, not just doing it when you retire, but coming back and saying, is the amount that I have now, is that still a good number? And if it is good, can I spend some more off this? And maybe I can do more, or things have gone a lot worse than I thought. Maybe I have to tighten the belt a little bit. And those are things that I think in the real world most people do.
Marcus Schafer (45:34)
Yes. Yeah. And the, think that was just a great summary because where we’re going next is we’re going to talk about how do you actually kind of synthetically create a salary once you stop drawing or you produce your salary in our next conversation? I think that’s super, super interesting, right? A lot of, a lot of topics. How do we think about income? What does that mean? What are the sources of income, income versus total return? What are the different ways to structure?
portfolio and then we talked about this our job is to get you from A to B in the most efficient way possible so how can we accelerate some of that efficiency and make that process as certain as as possible in an uncertain world.
Patrick Collins (46:18)
Great, I’m really looking forward to the next conversation. I think we’re gonna get into this is probably a lot of theory and research and I think the next conversation is gonna get into practical. How do you actually do this? Once you have your number, how are you implementing it? How are you making sure you’re being efficient with taxes, withdrawal cash flows, all those different things. So looking forward to it.
Marcus Schafer (46:37)
Right?
Let’s get into it, Pat, next time.
Sources:
1 What is a Financial Plan?: https://www.youtube.com/watch?v=y_PX-HyRW-Q&t=267s1
2 Retirement Replacement Rates: What and How (Briggs, 2015): https://www.researchgate.net/publication/345818788_Retirement_Replacement_Rates_What_and_How
3 The Retirement Income Equation (Lee, 2013): https://my.dimensional.com/asset/622/the-retirement-income-equation
4 How Much Should I Save for Retirement (De Santis and Lee, 2013): https://www.dimensional.com/us-en/asset/556/how-much-should-i-save-for-retirement
5 Exploring the Retirement Consumption Puzzle (Blanchett, 2014): https://www.financialplanningassociation.org/article/journal/MAY14-exploring-retirement-consumption-puzzle
6 Determining Withdrawal Rates Using Historical Data (Bengen, 1994): https://www.financialplanningassociation.org/sites/default/files/2021-04/MAR04%20Determining%20Withdrawal%20Rates%20Using%20Historical%20Data.pdf
7 20 Years of Safe Withdrawal Rate Research—A Literature Review & Practical Applications (Kitces, 2014): https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4445517
8 The Safe Withdrawal Rate: Evidence from a Broad Sample of Developed Markets (Cederburg, 2023): https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4227132