Recently we discussed a modified 4% rule where we base the size of monthly withdrawals from retirement savings on the current portfolio size rather than the portfolio size at the beginning of retirement. Let’s follow this up by looking at actual market data to see how monthly retirement income is affected.
Because US data is more readily available, I’ve gathered returns on the S&P 500 (including dividends) since 1988, adjusted for inflation. Let’s consider the case of Rita who retired in 1988 with a portfolio worth $750,000 in today’s dollars. The actual figure in 1988 was a little over $400,000.
Rita has 100% of her money in the S&P 500 index. This is obviously a more aggressive portfolio than most retirees would want, but let’s see what happens to Rita’s income.
Using the modified 4% rule, Rita would start drawing 1/12 of 4% ($2500 in today’s dollars) per month. But this amount gets adjusted each month depending on whether the portfolio grows or shrinks. Assuming that Rita managed to stay alive for nearly 32 years, here is how her income changed over the years:
Rita had only one month where her inflation-adjusted income dipped below $2500 to $2479. By the year 2000, the buying power of her income had tripled. However, this was followed by one big drop from 2001 to 2003, and then another big drop in early 2009 where it reached $2711.
It seems that Rita fared rather well over the years considering that her income started at $2500 per month. However, if her lifestyle had expanded to consume her income when it was over $7500, she may have found the subsequent drop painful.
Things would have been far different for Ray who retired in 2001. Just two years later his retirement income was chopped in half. This may seem to be an argument against modifying the 4% rule, but if Ray had stuck to making monthly withdrawals based on his 2001 portfolio size, he would run out of money fast. Ray’s situation isn’t so much an indictment of the modified 4% rule as it makes it clear that a portfolio 100% in stocks is risky.
One thing that this experiment has left out is that it makes sense for retirees to increase the percentage of their portfolio that they spend as they get older. If Rita turned 65 in 1988, then she is 96 now with a portfolio worth over $1.1 million as of the end of October. She can probably afford to spend more than 4% each year now. How much more is an interesting question.
[Update: Reader Blitzer68 pointed me to an excellent article by William Bernstein on this subject that I highly recommend.]