There is no shortage of information available for people to become educated about finances. Despite this, I hear the same misconceptions today that I heard 27 years ago when I first started working with retired clients.
As the baby boom generation continues to retire, more and more financial planners will be dealing with the distribution phase of client’s financial lives. I thought I’d share some of the most common issues that are not understood by those in or approaching retirement. Today we’ll highlight some investment-oriented issues.
If I Start Spending X Percent Of My Money And Earn At Least X Percent On Average, I’ll Be Fine
Despite all the volatility in the markets, I still hear this frequently. Even if you can get x percent steadily, if you spend it all, inflation will erode your purchasing power and the sequence of returns can matter a lot.
A 5 percent or 6 percent rate, sounds modest. However, historically, a significant allocation to stocks has been required for a portfolio to compound at rates like that. Many retirees find that posture too aggressive for their liking.
Mathematically, when volatility strikes, and distributions are made on top of the losses, bad outcomes can result. Even if you correctly predict the compounding rate over a prospective retirement, spending that percentage of the initial portfolio and increasing each year for inflation produces a significant chance of failure.
Most sustainable withdrawal studies I’ve seen would put the success rate over 30 years for a 6 percent initial withdrawal rate with an all S&P portfolio in the low 60 percent range. This despite the worst 30 year annualized average return for the S&P500 being just under 7 percent (starting September 1929).
I Will Just Live Off Interest And Not Touch Principal
This is an all-time classic. The sentiment makes perfect sense. Be conservative and preserve wealth. Unfortunately, this strategy has never really worked, at least over any substantial period of time.
Sure, interest rates of the late 70s and early 80s were high but often forgotten is the economic environment at the time. CD and Treasury buyers got a nice nominal rate, but net of the higher taxes and inflation of the day, conservative investors were running to stand still.