When you retire, you will need to switch your thinking from being a saver to being a spender. The trick is to balance your withdrawals from spending too little and potentially dying with too much money and spending it so quickly that you run out of money.
The term that describes how much money you take out of your portfolio is the withdrawal rate. It is the amount of income that you are going to draw off your investments.
The good old days
Back in the 1980’s retirement would have been a lot easier from the simple perspective that you did not have to think too much about your investments. Back then, you could stick your money in a GIC at 10% to as high as 21%. You could keep your capital guaranteed and live off the interest. Investing was pretty simple.
From 1990 to today, interest rates have fallen over 75% and GIC investors have had to look for alternative investments. People looking for income flocked in droves to income trusts, REITs and income paying mutual funds earning yields of 6% to 10% or more. Not bad either in a low interest rate environment but that did not last either. In 2006, Finance Minister Jim Flaherty announce that there would be a change in how income trusts would be taxed and income trust investors everywhere were left in disarray.
Back in the good old days, it was not uncommon to see projections using withdrawal rates of 7% or more. At the time, 7% actually seemed quite reasonable.
Tougher times ahead
Unfortunately for retirees of today and tomorrow, the future does not look too bright. With the amount of debt in the system at all levels, it is tough to envision high interest rates coming back. If retirees look to the stock market to find investments that produce income, they see more volatility and concern.
Gone are the days of a withdrawal rate of 7% or more. In fact, I remember conservative projections used to use a 5% withdrawal rate. Today, it’s probably more reasonable to use withdrawal rates of about 4%. If you put all your money in GICs, you might earn 1.5% to 3.5% depending on the term. Let’s say for simplicity sake you earn 2.5%. Logic would say if you earn 2.5% and you take out 4%, your capital will deplete in about 23.5 years. If you are 65, that takes you to almost 90 years of age.
Most investors will not invest 100% into GICs. Instead they seek to find some balance in their portfolio and diversify some into stocks, mutual funds, EFTs and alternative investments.
The problem with market-based investments is there are no guarantees. The market does what the market does. You cannot control the market and you cannot predict where the market is going to go.
As a result, most retirees need to find a balance in their portfolios. I call it goldilocks investing. Not too aggressive (hot) and not too conservative (cold). This is the key to success. Build a portfolio with some cash to create liquidity and short-term income, some fixed income to create income for the next 5 years and the balance can go into equities.
The higher the withdrawal rate, the more equities are needed in the portfolio. The more equity you have, the less control and predictability you have over your future income. With equities, there is a high probability you may need to decrease your income in tough times and give yourself a raise in good times.
The point is simple: make sure you choose your withdrawal rate carefully.