The cost of retirement income, also known as the amount of money you need to retire, is soaring. According to Morningstar, people who are retiring today and want “a high degree of certainty their money will last” should take no more than a 3.3% draw on their portfolio. Compared to the 4% draw that is commonly used as a benchmark to gauge retirement readiness, a 3.3% draw means that in order to generate $80,000 in retirement income, you must have $2.42 million instead of the $2 million required under the 4% rule. That’s a 21% increase.
A decade of misguided zero percent interest rate policy which has killed interest income and inflated stock market valuations to near records is to blame.
The WSJ has more.
Conventional wisdom recommends spending no more than 4% of savings in the first year of retirement and adjusting that amount annually to keep pace with inflation. The math behind that rule is changing as market forecasters predict lower returns ahead, potentially shifting the way that millions save and spend for their later years.
People retiring now who want a high degree of certainty their money will last should spend no more than 3.3% of their savings in the first year of a three-decade retirement, and adjust for inflation after that, according to a report released Thursday by investment research firm Morningstar Inc. So someone with a $1 million portfolio would spend $33,000 in the first year of retirement. Assuming 4% inflation, the investor would increase annual income to $34,320 in year two and $35,690 in year three, regardless of the market’s performance.
The 4% rule emerged as the wealth-management industry’s standard in the 1990s. In the subsequent decades, millions of Americans came to rely on that figure to guide their retirement spending, and with good reason. The 4% strategy would have enabled investors holding 50% in stocks and 50% in bonds to make their money last over the vast majority of 30-year retirements from 1926 to 2020.
That, however, is no longer as likely because future returns are expected to be lower following an extended period of above-average gains. Morningstar researchers simulated future returns over a 30-year period and found that in a quarter of the simulations a half-stock, half-bond portfolio would run out of money if withdrawals stayed at 4%.
One indication the current market may be overvalued is the S&P 500’s price/earnings ratio, which measures the price investors pay for a dollar of corporate earnings. It is 23.88 when calculated using recently reported earnings, according to FactSet. That is significantly higher than the 17.35 average over the past 20 years.