• Where it all started–the safe withdrawal rate.
• My transition to the safe savings rate—the amount of income you need to sock away for retirement.
• A comprehensive financial plan is best, but off-the-shelf tools and two popular “rules of thumb” can help.
The Safe Withdrawal Rate
About 20 years ago, a financial planner and former engineer, named Bill Bengen, published a now-famous study about calculating the ideal annual withdrawal rate from a portfolio–a rate that could be sustainable over the long-term. This rate of withdrawal was calculated to be a little more than 4 percent and it became known as “the safe withdrawal rate ” and “Bengen’s 4 % Rule”. For example, if you invested $1 million in a diversified portfolio, you could safely withdrawal $40,000 per year over your remaining lifetime, say 30 years or more, without running out of money. Remember, the money that hasn’t been withdrawn is hopefully continuing to grow .
Over the last 20 years, there have been many studies attempting to refine Bill’s work and the safe withdrawal rate in light of changing economic conditions, rising healthcare costs and people simply living longer . But each of these studies tends to hone in on an annual withdrawal rate somewhere around 4 percent to 5 percent of the portfolio value.
In our practice, we don’t have much need for a safe withdrawal rate because we create detailed long-term financial plans to calculate what clients can spend over their remaining lifetimes. It is a much more customized approach than using a rule of thumb. Absent a financial plan created by a qualified advisor, the safe withdrawal rate is a simple technique for helping you with your planning.
The Safe Savings Rate
I recently reviewed financial planning software from inStream Solutions that used the term “the safe savings rate.” I first saw this term used by Wade Pfau, Ph.D in a May 2011 article in The Journal of Financial Planning. I found this terminology interesting because it put an official name on a mental transformation that I went through years ago. Very early in my career, when time was more plentiful than it is now, I kept track of my personal finances with programs such as Quicken and Andrew Tobias’s Managing Your Money. I would spend hours each week dutifully entering my transactions and tracking my expenses. Although technology at the time began to enable users to download portfolio transactions and household expenses automatically, I wasn’t convinced that it was accurate enough for me. As marriage, children, and career all took precedence over my detailed financial record-keeping, I needed an alternative.
The more I thought about tracking expenses, the more I realized that I didn’t have the time to do it well, and I needed to focus on maximizing my savings. As the old saying goes, “It’s not what you spend, it’s what you keep.” In a nutshell, the safe savings rate is the percentage of your income that you will need to save on an annual basis in order to fund your long-term retirement plan.
My industry colleagues have long been debating the merits of the safe withdrawal rate and the safe savings rate and I’m sure the arguments will continue for years to come. I’m also sure that both of these strategies have a place in conversations with clients. While I have never been a fan of using “rules of thumb,” concepts such as the safe withdrawal rate and the safe savings rate break down complex calculations into digestible ideas. These are ideas you can bring home to help you reach your goals and sleep better at night. Isn’t that what it’s all about?
If you need help calculating what you need to save or what you can spend, please call us at (610) 695-8070 or request a meeting. We might even help you get a better night’s sleep.