Bogleheads’ Retirement Planning: Determining a Retirement $$ Goal

This is the first of my Bogleheads’ Retirement Planning series.

The ultimate question is simple: how much do I need to have when I “retire” to be able to live for decades on the proceeds?

It’s worth getting over the hump of the definition of retirement, because it always seems to come up as a side topic in retirement discussions. Retirement, to me, isn’t buying a boat and spending all day golfing.

…Especially since I’d rather just take a group walk through a park instead of hitting and chasing a small ball in the process.

To me, retirement is getting out of a 40 hour a week job and working on things I love, even if they’re less profitable. That might mean I only work 15 hours a week for pay. Or that I publish a novel every couple of years, rather than racing to meet deadlines. Or that I join the Peace Corps and do something, you know, useful.

Whatever. Retirement is being out of the crunch.

Bogleheads’ provides a little formula:

1. Get your current after-tax spending as your needed income. (Personally, I wouldn’t include mortgage/rent if I were planning on owning a home 100% by then.)
2. Subtract off your future income sources, like Social Security (ha!), pensions, that 15 hours per week of work, etc. That answer is how much you need per year from your retirement savings.
3. There’s conventional wisdom somewhere (see below) that drawing 4% of your retirement accounts (adjusting for inflation) every year will result in a self-sustaining fund, so take the amount in #2 and divide by 4%, or 0.04.

For $40k per year, that’s $1 million saved before you start withdrawing. Ka-ching! Let’s start saving!

The 4% rule is tossed out in the book without a whole lot of explanation, although the authors give a reference to Lee Eisenberg’s The Number (which I need to read). It looks like even Bill Bengen (the name associated with this rule of thumb) has backed off the rigid 4% rule, though:

Bengen now suggests that the 4% figure–actually 4.1% for a 60/40 portfolio of large caps and bonds and 4.5% if you toss in small caps–merely seems impressive when plugged into Excel spreadsheets. In practice, the strategy, which Bengen stopped using with his own clients about three years ago, is inflexible and unrealistic he says–and the formula is too stingy.

It’s clear to me that the 4% would need to be adjusted on a case-by-case basis, but that makes coming up with a rough number pretty difficult. For instance, drawing down 4% to get $50k year requires a $1.25 million portfolio, but having that $50k only be 3% requires $1.67 million. An extra $400k isn’t exactly peanuts, even at those numbers.

Planning for depletion ($50k/year income from age 65 to 100, with no inheritance left behind) is another way to do it, but since I’m still planning to live forever, that doesn’t quite jive with me.

All of that said, there are various studies that look at a variety of portfolio builds and withdrawal rates, including this nifty study by some folks at Trinity back in 1996. Looking at the inflation-adjusted portfolios makes it clear where the 4% rule came from: in a 50% or more stock portfolio, 4% withdrawal is 95%+ “sure” not to deplete over 30 years:

For stock-dominated portfolios, withdrawal rates of 3% and 4% represent exceedingly conservative behavior. At these rates, retirees who wish to bequeath large estates to their heirs will likely be successful. Ironically, even those retirees who adopt higher withdrawal rates and who have little or no desire to leave large estates may end up doing so if they act reasonably prudent in protecting themselves from prematurely exhausting their portfolio. Table 4 shows large expected terminal values of portfolios under numerous reasonably prudent scenarios that include withdrawal rates greater than 4%.

For short payout periods (15 years or less), withdrawal rates of 8% or 9% from stock-dominated portfolios appear to be sustainable. Since the life expectancy of most retirees exceeds 15 years, however, these withdrawal rates represent aggressive behavior in most cases. By definition, you have a 50% chance of living beyond your actuarially determined life expectancy, so it is wise to be conservative and add a few years.

For myself, I’m inclined to take an approach that’s a mix of conservative and risky: keep about 50% in stocks, even during retirement, but plan to draw down only 3%.