By Kathleen M. Fisher and Tara Thompson Popernik
Sometimes things fall into place nicely, and you can chart your course to a comfortable retirement relatively easily. You choose a suitable asset allocation, using tax-deferred accounts to their best advantage and optimizing your Social Security payouts. But what if things don't work out so well?
Then you have to review your starting assumptions: your retirement date, your spending level and (if you're still working) your savings rate. These may lead to less-comfortable planning choices, but compromises here can help ensure that you'll have everything you require to meet your spending needs in retirement, even in dismal markets. That is, making compromises can help you meet your core-capital requirement.
The Power of Spending Less
Suppose that instead of asking "how much core capital do I need?" you ask a different, but related, question: "How much can I sustainably spend from my portfolio?" Your age and asset allocation and prevailing market conditions will all have a large impact on your answer, as the display below shows.
Given today's market conditions, we estimate that a 65-year-old couple with a moderate asset allocation can sustainably spend 3.4% of their initial portfolio each year, grown with inflation. That's less than the 4% spending rate we estimate would be possible under "normal conditions," because we foresee lower stock and bond returns going forward than in normal markets.
Now we can start turning dials. Assume, for example, that the couple can postpone spending from their investment portfolio for another five years. We project that, at age 70, they'll be able to get much closer to that classic 4%-withdrawal bogey. If they wait those extra years and ramp up the risk in their portfolio, they're virtually at 4% (though they'd probably feel uncomfortable about holding a very stock-heavy portfolio at that point in their lives).
Delaying retirement may not be a pleasant decision to make, but it can have a big impact on sustainable spending once you do retire, for two reasons. It gives your portfolio additional years to grow, and the portfolio will not have to last as long. These are intuitive concepts, but let's anchor them in some numbers.
Suppose a 55-year-old couple had always expected to retire at age 65-but they're not on track to reach their core-capital requirement until age 67. The display below shows that working those two extra years can get them to their funding goal.
But what if the couple hates the idea of working until age 67 - or wants to retire earlier, say at age 62? Can they possibly advance their retirement by three years? The answer is yes - if they save more until retirement.
By saving 5% of their portfolio's initial value annually, grown with inflation, we project that the couple can meet their new goal. Still, saving that much - $50,000 a year, adjusted for inflation for every $1 million in their initial portfolio - is a high hurdle to clear. Should they do it? The choice is theirs to make; it may or may not be a sensible path for them.
These hypotheticals illustrate that retirees and those approaching retirement have key "levers" at their disposal. Getting what you want in retirement is not a matter of luck and it's not the product of a computer-driven black box. It may require making some difficult trade-offs, but it may well be within your power to reach your goal.
For more information, read our recent black book, All the Right Moves: Retire with Confidence.
Bernstein does not offer tax, legal or accounting advice. In considering this material, you should discuss your individual circumstances with professionals in those areas before making any decisions.
The Bernstein Wealth Forecasting SystemSM uses a Monte Carlo model to simulate 10,000 plausible paths of return for each asset class and inflation, producing a probability distribution of outcomes. It projects forward-looking market scenarios, integrated with an investor's unique circumstances and taking the prevailing market conditions at the beginning of the analysis into account. The forecasts are based on the building blocks of asset returns, such as yield spreads, stock earnings and price multiples. These incorporate the linkages that exist among the returns of the various asset classes and factor in a reasonable degree of randomness and unpredictability.
Kathleen M. Fisher is Head of the Wealth Management Group at Bernstein Global Wealth Management, a unit of AllianceBernstein. Tara Thompson Popernik is the Group's Director of Research.