What is the correct percentage of income that I can draw down from my post retirement investment today and still ensure that I don’t run out of money and can live comfortably? This is a question I have been dealing with quite a lot lately as clients are either entering into their form of retirement or are already there and are worried that their capital is not going to last. Let me start by saying that I don’t have a single answer to that question. I have many, but none of them are the answer that your typical retiree would want to hear.
This is not a new question and in the past the answer has been represented by a simple answer, 4%. Ok, so if you draw only 4% p.a from our retirement capital your funds should last at least 30 years, that’s the rule, its even called the “4% rule”. But, how relevant is that to YOU and YOU and YOU? 4% of your capital is completely different to 4% of your friends capital, which is different to 4% of your neighbors capital. The rule doesn’t address YOUR needs, it merely says that if you draw 4%, you wont run out of money. The problem with the rule is that it doesn’t take YOU into account, it takes the industry into account. The industry has a product for your retirement (of course they do) and if this product does not deliver then people won’t buy it. So, the industry came up with a draw down level that ensures your income will last based on a set of assumptions and then they conditioned you into thinking this is the level you must draw down if you don’t want to run out of money. Unfortunately what’s really happened here is that people have been working their whole lives for this big event, this one big event which society has termed “retirement” and what does society mean by “retirement?” Well, the day you get to stop working and start living and when is that day? Well, it’s 60, 63 or 65 says society. It’s the day that you no longer earn an income from your employer and start drawing one from your “Pension”.
Now, there are so many things in the above statement that make the hair on my neck stand up, but let’s just address the “retirement” issue. Previously the retirement world was built around a defined benefit scheme, meaning when you retired you would get a predetermined amount of income, based on a set of rules, for example, the number of years you worked at the company, your position, your number of dependants etc. and this drove loyalty. The longer you worked the higher your “pension”, but this became unsustainable. The companies were running out of money to fulfill there commitments to their retirees, so what did they do? They handed over the responsibility to the employee and called it a defined contribution scheme. In short, they were in the predicament most retirees are in today, they had not accumulated enough or couldn’t achieve a high enough return to fulfill the income demands, so they just passed the buck and made it your responsibility and problem.
4% means different things to different people, because we spend our money in Rands and not percentages. So how much can you drawn down? Well, how much do you need in rands every month? My version of a simple answer is: The correct level to draw is the amount you need. Now, you can see how that poses its own set of problems, but we’ll get to that. Firstly, for those already in retirement, you need to take a hard look at what you have accumulated and your current income drawdown and assess if you are going to be ok? If the answer is NO, the only thing you can do, is reduce the draw down, or you will run out of money. I don’t think you can look to the markets for an enhanced return, the hay days of 15% p.a from a balanced fund are GONE. The markets are the markets and they go up and they go down, you can’t live your life based on the markets, there is just too much uncertainty. Control what you can control and implement a drawdown strategy which speaks to this.
- Determine the level of income you absolutely need (think debit orders, fixed costs in one bucket and then living costs in another).
- Only increase your draw down by the increase % of the fixed costs bucket and only increase the % of the living costs bucket by the amount of growth achieved over and above inflation, if at all.
- Make sure your portfolio has exposure to the growth assets and is also delivering an income.
- Other than that, I don’t think there is too much else you can do.
For those leading up to their retirement, whatever that may look like, you need to get a better idea of what it’s going to cost you. Once you know that, well then you will know how big your pot needs to be, wouldn’t you prefer to have a pot big enough to not have to take on too much risk to deliver the income you need with certainty? As opposed to having to put your entire pot at risk so that you can live a life you want, but haven’t really saved enough for?
These are the conversations that I am having with my clients, identifying what their current lifestyle means to them and what it’s costing them NOW and what it will cost them into their “retirement”. If I can help them understand this, I can help them plan for it and they are then in a position to make informed decisions during their lives and understand the impact those decisions will have.
I imagine a “retirement” where I don’t have to look to the markets to deliver an unrealistic return to provide me with an income. I imagine a “retirement” where I have made informed decisions of the things that are important to me and have planned accordingly. A “retirement” where I can still work if I want to, but not because I have to. This “retirement” doesn’t have to be a dream, it can be a reality and if we have the right conversations and make the right decisions because we are informed, it will be YOUR reality.