In all of my years as an investment advisor, the question I am asked the most is:
How much money do I need to have to retire comfortably?
Certainly, this number is going to be different for every individual. But as a starting point, I like to share the concept of a safe withdrawal rate once people retire.
There has been a lot of research on how much money can people pull out of their investments without running out of money during their lifetime. The most popular research that was done was by Bill Bengen that was published in 1994 in an article called “Determining Withdrawal Rates Using Historical Data.” In his article, he made some assumptions that were using a 30-year retirement horizon and had approximately 60% of the money invested in equity and 40% in bonds.
In this particular case, he was using large cap growth for the equities, and intermediate government bonds for the fixed income part of the asset allocation. He went back all the way to 1871 and found that the sustainable withdrawal rate based on average returns would have been 6.6%. However, in the worst historical scenario, you could have withdrawn 4% and never run out of money, and therefore the phrase “4% rule” was born. Using the 4% withdrawal rate, somebody with $1 million could anticipate drawing around $40,000 per year. And in Bill Bengen’s article, he had also factored in historical inflation rates increasing every year by the historical inflation rate.
What should I focus on?
One of the key messages I share with clients is that when it comes to retirement, it’s not about how much money you have, it’s all about cash flow.
In other words, let’s assume that someone is receiving $1,800 a month in Social Security, and they have got a $2,700 a month pension. Between Social Security and pension, that’s $54,000/year. Using the 4% withdrawal rate, you would need to have a total of 1,350,000 at 4% to generate the same $54,000/year.
So back to the original question, how much money do you need in retirement? It really depends on several factors including other income sources as well as the withdrawal rate that you are using and certainly what type of retirement lifestyle do you want.