Financial Opinion and Insights

Beware of Easy Answers

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen, CFP®, AIF®

There I was with my feet up on a Sunday afternoon watching football when a commercial break came.  As I started for the refrigerator, a friendly voice asked the question many people ask:  “How much can you withdraw from your nest-egg without worrying about running out of money?”   

Since this is an issue I’ve been dealing with for more than twenty years, I was interested in their answer.  So, I postponed my trip to the refrigerator; but, then the voice then said, “The answer in a moment…” and went on with the commercial.  That was my cue; but, I returned in time to hear their answer.  It was their belief that investors should be able to draw between 4-5% annually.  I won’t tell you which company aired the commercial – okay, it was Fidelity.

4-5%?  Really?  Well, maybe. 

Morningstar published a hypothetical 50% stock/50% bond portfolio and the effect various inflation-adjusted withdrawal rates had on the end value of the portfolio over a long payout period.  Each hypothetical portfolio has an initial starting value of $500,000 and assumed that a person retired at age 65 and withdraws an inflation-adjusted percentage of the initial portfolio wealth ($500,000) each year beginning at age 66.  Morningstar concluded that someone withdrawing 4% annually would have a 95% chance of achieving his/her goals.  At a 5% withdrawal rate, the investor would still be somewhere around an 87% confidence level.

Here’s a point worth noting:  Annual investment expenses were assumed to be 0.83% for stock mutual funds and 0.64% for bond mutual funds.   Interesting, since most stock mutual funds have much larger expenses.  It’s also worth noting, they were using historical data covering for the 1926-2010 in a Monte Carlo simulation.  Monte Carlo does test all possible outcomes, but often it assigns the same weighting to events that happen often as it does to those that may have happened only once in all of human history.  Sophisticated planning platforms not only weight outcomes, they also allow you to perform ‘stress-tests’ by performing some `worst-case’ scenarios on timing.

The commercial, however, reminded me of when I opened my first office in Winter Park, Florida in the early ‘90s.  In those days, the stock market was doing extremely well and there was a local independent broker who used to buy a lot of radio ads promoting his retirement seminars – Florida has a lot of retirees.  His commercials used to promote attendance by saying something like, “You can withdraw 8% a year with possible growth of principal!”  He packed them in.   

Commercials seem to do well when they tell people what they want to hear.  The problems came, of course, for those who clung to that belief when markets weren’t so friendly.  While I think most advisors would feel comfortable with the 4% figure, few are likely to be comfortable with the 5% figure, at least for a 65-year-old in good health; and, the wealthier you are, the less likely you’ll have significant stock exposure, which would likely result in a withdrawal rate closer to 3%, or maybe less.

As usual, it depends.


Jim Lorenzen is a Certified Financial Planner® and an Accredited Investment Fiduciary® in his 20th year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California.   IFG provides investment and fiduciary consulting to retirement plan sponsors and selected individual investors. Plan sponsors can sign-up for Retirement Plan Insights here.  IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description.  Nothing contained in this material is intended to constitute legal, tax, securities, or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader.  The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.