Why Retirees May Need to Tighten Their Belts
NEW YORK (TheStreet) -- Retirees have long struggled with a difficult question: How much can you spend annually without going broke? Financial advisors have suggested that typical investors can start by spending about 4% of their assets annually. So an investor with $1 million can withdraw $40,000 the first year. After that, retirees can raise their annual payouts along with the inflation rate. But in recent years, advisors have begun to question the traditional advice. Now some researchers suggest withdrawal rates of less than 3%.
Retirees should tighten their belts because of current market conditions, says David Blanchett, head of retirement research for Morningstar Investment Management. He says that many investors should only withdraw 2.7%. Blanchett says that earlier studies of withdrawal rates assumed that markets would deliver the same returns in the future as they had done in the past. But there are now good reasons to think that returns in the next decade will be subpar.
Blanchett estimated that intermediate government bonds will return 1.8% annually in the next decade, compared to the long-term figure of 5.5%. The reason for the gloomy outlook is that bond yields are currently low. Yields account for nearly all the returns produced by bonds. So when yields are low, returns are skimpy. Blanchett did his calculations in December 2012 when the yield on 10-year Treasuries was 1.8%. Today the 10-year Treasury yields 2.7%. The higher yield should help returns, but the 10-year outlook remains well below the historical average.
From 1926 through 2011, the S&P 500 returned 11.8% annually, according to Ibbotson Associates. It is possible that stocks will continue the double-digit pace, but Blanchett says that markets have often delivered much smaller returns. To be on the safe side, he assumes that stocks will return 9.8% annually. Using that forecast, a retiree who has 60% of assets in equities and 40% in bonds could be in danger of exhausting assets. If the retiree uses a withdrawal rate of 4.3%, there is a 50% chance of spending all the money in 30 years. By lowering the withdrawal rate to 2.4%, the retiree has a 95% chance of avoiding bankruptcy over 30 years.
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