MD Cents: I know how much (history says) you need to retire!

Many people spend inordinate amounts of time planning for their retirement. I applaud people who take time to plan for the future, but wondering how much money you need to retire is something that you can know reasonably well. Of course, no one can predict exactly how much you need in retirement, but history gives us a great guide.

Bill Bengen originally suggested that someone could withdraw 4% of an investment portfolio, adjusted for inflation, per year and not run out of money for 30 years. This means that if you want a 30-year retirement (i.e. 65-95 years old) you must do two things:

  1. Determine what your annual expenses are
  2. Determine what number your expenses are 4% of

Here is an example:

Ann has annual expenses of $80,000, what amount does she need to fund a 30 year retirement?

$80,000=0.04(X)

=$2,000,000

This means that Ann needs 2 million dollars in her retirement accounts in order to withdraw $80k each year adjusted for inflation. What does adjusted for inflation mean? It mean that she will actually take out more than 80k each year because the price of things goes up each year. This can’t be true you say—what if you retire and the great Financial Crises or the Great Depression happens where stocks (and people’s retirement accounts) lose over half of their values? The important thing about this number is that it held true over every 30 year period since the advent of the stock market. Meaning no matter what, you could follow this strategy and still be okay.

People will likely say that past performance is no indicator of future return. This is completely true, but if this formula holds true in the worst economic conditions our country has ever faced, I am willing to bet that it will be okay no matter what comes our way. If our stock market goes to zero, we have much larger problems than how much money one can withdraw for retirement.

The devil is always in the details in financial formulas. In order to replicate the portfolio in this study you would need 60% large stocks and 40% intermediate term government bonds. Today many people hold a much more diversified portfolio. In an earlier post, I told you about index funds and the ability to hold every stock/bond sold in the U.S., every stock/bond in the developed world and safer emerging markets with just 4 mutual funds. The yearly return of this portfolio is expected to be higher than one made up of only U.S. based assets. This portfolio would be expected to make it more likely that you could withdraw your 4% yearly without trouble.

As you see, you can know how much money you need to retire for 30 years, but what if you want to retire for an even longer time, i.e. you want to retire early? The same work determined that if you want to retire for 40-45 years you could withdraw 3.2% of your portfolio each year, adjusted for inflation and not run out of money.

 

So using Ann again:

80,000=0.032(X)

=$2,500,000

 

You can see that if Ann wants to retire at 55 years old she needs to have $2.5 million in her accounts to fund this length of time. This also assumes that Ann never decreases her withdrawals but this is not what rational people do. We all flex our spending based on our budget (i.e. if we don’t work as much one year, we don’t take as nice a vacation, or we put off a home renovation, a big purchase, etc…). These numbers assume you never change your spending no matter what. This means that even if your accounts lose half their value due to changes in the stock market, you keep on spending the same amount and don’t cut back like most of us would do!

As you can see, based on history, you can know with as much certainty as possible how much you need to retire and fund a certain level of spending in retirement. This assumes, you have your budget down and know how much you actually spend each year!

What do you think? Do you feel comfortable knowing your “dollar number” needed in retirement?

As always this post is for educational purposes only and you should always consult a professional regarding your personal situation for specific, tax, investment, legal, or other advice.
Brian Wagers

Brian Wagers

Assistant Professor of Emergency Medicine at Indiana University
Brian's academic interests include injury prevention, quality improvement, and global health. He is from Cincinnati, Ohio (go Reds and Bengals). Brian loves to travel, run, and is interested in the intersection of business, medicine, and health policy.
Brian Wagers
Brian Wagers

Brian Wagers

Brian's academic interests include injury prevention, quality improvement, and global health. He is from Cincinnati, Ohio (go Reds and Bengals). Brian loves to travel, run, and is interested in the intersection of business, medicine, and health policy.