One of the most common questions I hear is “How much do I need to save to retire?”

Think about how important it is to get this question answered accurately.

The correct answer to this question can mean the difference between retiring comfortably for the rest of your life… or retiring only to have to go back to work because you miscalculated how long your savings and investments would last.

This question of “How much do I need to retire?” was directly asked of me by a couple looking to retire within the next year.

The husband had already retired, but the wife was still working. She was going to continue working until she could draw Social Security in approximately 10 months.

I’m always more comfortable when a couple waits until they can start drawing some type of retirement income check. Having a guaranteed income source in retirement takes pressure off a portfolio to provide income.

And in today’s world I think it is even more important to be as prudent as possible when it comes to planning for retirement. That guaranteed income from Social Security (or any other source like a pension or annuity) just gives that extra bit of support to a plan that is so important.

Retirement Case Study

The couple had over $1 million in investments. And they needed to make sure they could generate enough income from this to supplement their guaranteed income they would get from Social Security.

In a case like this, the best way to help definitively answer the question, “How much do we need to retire?” is to go through The Retirement Confidence Roadmap (this is our financial planning process we provide).

And after going through the process I was able to tell them they had a 98% chance of meeting all their goals in retirement.98 percent chance of successSo what was it that made this couple have such a high probability of meeting their retirement goals? Well, it’s not just the amount of their assets. There were other factors that were crucial to their success as well.

So let’s get in to the details of this.

Goals for Retirement

This couple had a very simple goal for retirement. They needed after tax income of $67K per year for the rest of their retirement. This spending requirement is inflation adjusted 3% each year. Each year their spending requirements would increase by 3% in the plan. So in 14 years they would be spending $101K per year.

Spending requirementsIt’s important to consider what inflation will do to spending requirements. In the 20th century, inflation existed in 97 out of 100 years. Inflation must be accounted for when planning for the future. It does no good to have your spending requirements met presently, only to neglect to take care of them into the future.

Their Strengths

One of the biggest strengths the couple had going for them is the wife decided to continue working until she turned 62. That way she could draw Social Security upon retirement. The husband would be 66 at that time, so he would begin drawing his full Social Security benefit. They were both comfortable with the wife drawing her reduced benefit at age 62.

Their combined income from Social Security would start out at $32K/year. They only needed $67K/year to cover their retirement lifestyle expenses. So this covers 48% of those needs, leaving only $35K/year to generate from their savings.

Another strength they had was no debt. One thing that debt does is increase your fixed expenses. It essentially increases the hurdle you must leap over each month just to cover your required spending.

By eliminating debt payments, you are lowering the amount of income that you need each month.

By lowering your income needs it puts less pressure on your savings to generate income. This just adds an extra buffer of protection in your retirement plan.

Areas of Potential Improvement

The first place to start whenever doing a financial plan is looking at exactly where you are now. In other words, if you kept your current investments, made no changes to your current strategy, spending requirements, expected retirement date, and just stayed on the same course you are on right now, what would your probability of a successful retirement look like?

It’s good to know this before you even consider making changes.

In this case, after looking at their current path their probability of success was a bit on the low end at 64%.

64 percent chance of successThis was definitely an area that we needed to try and improve to help give them more confidence in their retirement success outcome.

They had a balanced, diversified portfolio with stocks and bonds. Looking at the historical performance of these holdings over the last 10 years we saw returns of 5.86%. But what was more important was the volatility of their portfolio was 10.10%.

Original portfolio risk and returnsThe returns were sufficient to meet their needs in retirement… if we knew they would get these exact returns every year. But it was the volatility that was a main factor in their lower success rate of 64%.

The higher the portfolio’s volatility the more uncertainty it introduces into the retirement plan. If we knew for a fact that the portfolio would generate 5.86% every year then we could know their retirement goals would be met.

But that’s not what portfolios do in the market. Some years they may be down -10%, or they may be up 15%. And depending on when that occurs can have a huge impact on the retirees’ probability of not running out of money.

If bad returns occur during the first few years of this couple’s retirement it could be disastrous for them. Not only would their portfolio be depressed in value, but they would also be withdrawing funds from it to cover their retirement expenses.

When this happens early in retirement a portfolio can have a hard time recovering from the dual effects of market declines and withdraws. This can lead to there not being enough funds left in the portfolio in the future to cover their income needs.

Seeing how this was an important area of improvement we looked at ways to help reduce the volatility.

Using an investment approach (called tactical asset allocation) designed to help reduce volatility, we were able to get this volatility number down. Please note, our software uses historical data when generating risk and return numbers.

New portfolio risk and returns

A Side Note About Retirement “Rules of Thumb”

This is a good place to talk about the shortcomings of “Rules of Thumb” when it comes to retirement planning.

I personally think that rules of thumb, like the 4% safe withdrawal rule, are quite handy to give us ballpark figures. It can be a good guideline and goal to help you know what approximate level of savings you need to strive for in retirement.

But this case study is a good illustration of when the 4% safe withdrawal rule may not work as well as one might think.

In this case study the required after tax income was $67K/year. Social Security was covering $32K/year of it. This left only $35K/year that needed to be generated from their retirement portfolio.

Since the couple had about $1.1 million in their investment portfolio, then starting their withdrawals from it at $35K/year would be the same as an initial 3.2% withdrawal rate. Based on the financial planning software we use, this gave them a 64% chance of not running out of money and meeting their spending requirements in retirement. That’s too low a probability of success in my opinion.

Why is this?

The 4% safe withdrawal rule is a good rule of thumb to give you some savings goals to attain for your own retirement. But when it was formulated back in the 1990’s, interest rates were higher and the stock market was generally very bullish.

Since 2000 the market has been different. It had a big decline in the early part of this century. It took until about 2007 to achieve its highs again. Then in 2008 it dropped again and didn’t reach its highs again until about 2013.

This type of performance has caused the buy-and-hold investor to ride up and down. This is what has caused more mediocre returns along with higher volatility when compared to the growth that occurred through the 1980’s and 1990’s.

And that’s why the 4% safe withdrawal rule should be used as a guideline. And it is best not to stick to it too rigidly.

Rules of thumb are good up to a certain point. After that it is better to get more specific detailed information to help you retire comfortably.

Retirement Success Rate

Using an investment strategy that is designed to help reduce volatility allowed the probability of success to increase to 98%. But what does a 98% success rate mean?

Our software includes the retiree’s assets, income, recurring spending requirements, any other unique one-time spending requirements (such as buying an RV if that’s the case), and investment strategy.

We then run 1,000 simulations, stress testing market volatility and other factors. How does the plan hold up if the portfolio performs poorly in the first few years? What are some tweaks that could be made to improve the success rate?

Taking this more holistic look at the situation gives much better information to know what course of action can improve a retiree’s ability to meet all their goals in retirement.

98 percent chance of successUsing this plan, the couple would have a 98% probability of not running out of money up until the wife turns age 91.

What Caused This Couple’s Plan To Work?

This couple had some great things going for them financially that allowed this plan to have a high probability of success. Here are some of the deciding factors:

  1. The wife waited until she turned 62 and could claim Social Security before retiring. The husband was also going to have his full Social Security benefit start at the same time when he turned 66. The extra income goes a long way to making the plan successful.
  2. They saved a good amount for their retirement nest egg. Their investable portfolio was over $1.1 million. This does not mean anyone can retire on this amount. Some people can retire comfortably on much less. Other people require more. But this large amount of savings considerably helps.
  3. They considered the benefits of an investment strategy that helps reduce volatility. Too much volatility in an investment portfolio can be very detrimental to retirees. Using strategies that have historically been shown to reduce volatility can help give more consistent results. And it also helps when making withdrawals from a portfolio to supplement income needs.
  4. They had a plan put together for them. A plan is essential. Our unique planning process, The Retirement Confidence Roadmap, allowed them to see different options available to them. It allowed them to stress test the results to see which path was going to be right for them to choose to have a comfortable retirement.

Is Your Retirement Plan On The Right Track?

Having a plan in place is essential when it comes to retirement planning. It can help you have the confidence that you will have a comfortable retirement. It can also show you if there are any different approaches you need to take to help you reach your retirement goals. If you don’t have this confidence in your retirement, then check out our firm’s process The Retirement Confidence Roadmap. It may be just the thing to give you the confidence you need to retire.