A question that many people ask is how much money is needed for retirement. The answer is quite simple: you need a pile of assets large enough to allow you to withdraw no more than 5% from that pile each year to cover your lifestyle expenses and living costs.
Here is a simple example: You require $90,000 per year ($7,500 per month) to live comfortably in retirement, and you have sources of income totaling $90,000 from Social Security ($30,000), pension income ($10,000), and portfolio income ($50,000). In this scenario, $40,000 of your annual living expenses are already covered by Social Security and pension income. You will need to generate the remaining $50,000 from your portfolio. To generate $50,000 of income from your portfolio, it should be worth at least $1,000,000 at the time of your retirement. This is because $50,000 is 5% of a $1,000,000 portfolio.
Different experts may have varying opinions on what constitutes a "safe" withdrawal rate. Generally, the lower the withdrawal percentage, the more conservative and preferable it is. We recommend a maximum withdrawal rate of 5% from your portfolio. However, you may wonder why we consider 5% the maximum withdrawal rate. Why not 6%? We conducted calculations using a 5% withdrawal rate, even in unfavorable retirement scenarios. Let's assume you retired on January 1st, 1973, with $1,000,000. See the chart below for more details:
In 1973 inflation was above 6%, the Fed Funds rate was above 8% and the S&P 500 was down nearly 15%! What’s even worse is that in 1974 the S&P 500 dropped just over 26%. This means that between 1973 and 1974, right after you retired, your portfolio would have experienced a decline of more than 40%. That's a significant blow!
In 1973, you withdrew $50,000 for living expenses. In 1974, you adjusted for inflation and withdrew $51,550. Each year, you continue this pattern, withdrawing $50,000 plus an annual cost of living adjustment.
While withdrawing higher than 5% eventually would have depleted your savings, as the chart illustrates, a withdrawal rate of 5%, or less, allows your assets to grow despite these unfavorable retirement scenarios.
Ideally, you should aim to have a portfolio that allows for a withdrawal rate lower than 5% during retirement. It's important to note that this article does not address other risk factors or unexpected events that may occur during retirement. Its purpose is to provide general guidance on the amount of money needed for retirement. For personalized advice or if you have specific questions, please consult with a CPS advisor at Info@CPSInvest.com.