By Paul A. Merriman
This is one of the most-often-asked questions posed by people in their 50s and 60s. There are simplistic answers (formulas, actually) that can tell you either "no way" or "maybe" or "for sure."
But you can't get much more precise than that without doing a bit of work and asking yourself some important questions.
One simple formula could be posed like this: Is your investment portfolio worth at least 25 times your current annual income? If the answer is yes, you're probably at least in the "maybe" category. If the answer is no, you might not be there yet.
Asking the right questions
The problem with such a simplistic formula is that it doesn't take into account all the things that make each of us unique. To get a really good answer, you should think about questions like these:
Is my current income enough to meet all my anticipated needs in retirement?
If I retire now, how many years do I need my investments to support me?
Am I comfortable planning to use up all my investments by the time of my death, or do I want to provide for others in my will?
Knowing that future investment returns are uncertain and could fall short of my expectations, am I willing to scale back my retirement lifestyle if necessary?
Can I reasonably count on being able to work part-time if necessary to make ends meet?
How anxious will I be if my retirement income varies from year to year depending on my investment returns?
That's a lot to think about, and we can't address it all at once. But we can start. I trust concepts more when I have numbers to back them up. And I have some useful tables of numbers that show hypothetical investment returns and withdrawal rates.
I suggest you refer to these tables as you go through this discussion in order to begin figuring out for yourself whether or not you have enough money to retire.
Let's start with Table 2 , which is based on several important assumptions: It's 1970 and you have just retired with $1 million in your portfolio. You have properly diversified your portfolio to include much more than just the most popular asset classes. You will withdraw $40,000 in your first year of retirement (a 4% withdrawal rate, in other words), and you will increase that amount every year based on actual inflation.
The table has 12 columns of annual portfolio values. Since each year's distribution is "fixed" by the $40,000-plus inflation assumption, the only reason the columns have different numbers is that the portfolios are invested differently. On the left is a portfolio entirely in bond funds. On the right is one that's entirely in the S&P 500 Index. The portfolios in between are widely diversified in equity funds with varying percentages of stock funds and bond funds.
When you look at the bottom of the table you can instantly see that the yearly portfolio values dwindle and disappear in three of the 12 columns — those on the left with the lowest percentages of exposure to the stock market.
The blank white spaces at the bottom of those three columns indicate years in which our hypothetical investor ran out of money because the portfolio returns were insufficient to keep up with constantly rising withdrawals.
So here's one obvious conclusion: A retirement portfolio based on these assumptions needed at least 30% in equities in order to keep supporting the retiree through 2015. In 2015, the "fixed" distribution was $250,090, only about one-fifth the value of the portfolio at the end of that year.
Barring a highly unlikely string of spectacularly successful market years, this withdrawal rate could not last very much longer.
In order to support a reasonable expectation of continuing much longer, the portfolio would need to be invested at least 40% in equity fund. A 50% equity stake would provide a much greater probability of having a good future.
And yet 50% in equities exceeds the comfort level of many retirees.
It's obvious, of course, that 46 years exceeds the life expectancy of most retirees. But if you want a portfolio to continue to support a surviving spouse or to end up with enough to make significant end-of-life gifts, some extra margin is necessary.
So it's reasonable to conclude that this plan — 4% withdrawals increased every year for inflation — is less than ideal for many retirees.
Fortunately, there's a good alternative, especially for retirees with ample savings. You'll find the evidence for it in Table 1 .
The numbers here are based on the same assumptions as the previous table, with one crucial difference: This time we assume the 1970 retiree had saved enough to get by with an initial withdrawal of 3% instead of 4%.
In this case, you can see that none of the portfolios, even the one invested exclusively in bonds, ran out of money by the end of 2015. However, even at this very conservative withdrawal rate, the all-bond portfolio would not have lasted much longer.
Fortunately, moving up to 20% in equity would in all likelihood have provided enough of a cushion to keep the withdrawals going for another decade, maybe longer.
The even bigger takeaway
I think there's a clear lesson to be learned from these two tables: If you save enough money before retirement so you can meet your needs with withdrawals of 3% instead of 4%, you can invest more conservatively, and without much risk of running out of money.
Some retirees want or need to take out more than 3% or 4%. In Table 3 , you'll see the results of 5% fixed withdrawals. This requires a portfolio weighted heavily toward equities, involving more risk than many retirees should take on.
And Table 4 follows portfolios at a withdrawal rate of 6%. In this scenario, only the 100% diversified equity portfolio would have made it through the end of 2015. And in order to make 2016's distribution, our retiree would have had to sell nearly 20% of the portfolio.
The original question
Do you have enough to retire?
An important part of the answer depends on how aggressively or conservatively you invest.
If you invest too conservatively, your returns may be unable to keep up with inflation.
But if you invest too aggressively to try and make up for inadequate savings, you may have an awful time getting through normal market declines.
This is a difficult tradeoff, and my advice is simple: If you can, save more than "just enough" before you retire.
Fortunately for people who do that, there's another very good option: Variable (instead of "fixed") withdrawal strategies. I'll take up this topic in my next column.
In the meantime you might like to listen to my podcast titled “ How much can you take out of your investments in retirement? ”
Richard Buck contributed to this article.