You’ve waited years to quit your job. Every month, you’ve piled as much as you could afford into a responsible, diversified portfolio. This year, 2020, was supposed to be your big Hurrah! Then COVID-19 hit.
You’re worried for friends and family. You’re worried about the economy. You’re worried about your health. You’re also worried about your retirement. Could you really afford to retire this year?
Loughborough University and the Pensions and Lifetime Savings Association (PLSA) suggest British retired couples require about £33,000 (€36,760) a year to enjoy retirement. That’s supposed to provide decent housing, a car, and a couple of holidays abroad. This pigeon-holed number assumes we’re all the same. But not everyone retires in Britain. And even among those who do, not everyone lives in the same neighborhood. Not everyone has the same costs of living, or the same dreams. How much you’ll spend depends on your lifestyle and where you choose to retire. You might be happy with less, or you might require more.
But for the sake of example, let’s use this figure as desired retirement income. Assume this couple would receive a combined annual retirement income of £18,000 (€20,043) from government and/or corporate pensions. If the retirees want to spend £33,000 (€36,760) a year, their retirement portfolio would need to make up about £15,000 (€16,702) a year.
If this were you, with £375,000 (€417,562) in your investment portfolio, you could retire today. Yes, I know the economy is in a freeze. Unemployment is hitting record levels. But this too shall pass. And we’ve had some horrible events in the past that set a precedent for my logic.
First, to give the investment portfolio the best fighting chance, it should include exposure to stocks and bonds. A globally diversified portfolio comprising 60 percent in a global stock ETF and 40 percent in a global bond ETF would probably do the trick.
Now let’s come back to that £375,000 (€417,562) and how it could generate £15,000 (€16,702) a year. Several backtested studies show that investors should be able to withdraw an inflation-adjusted 4 percent of their portfolio every year, and not run out of money during a 30-year retirement. Here’s what that means. Assume you have £375,000 (€417,562) today. If you withdrew 4 percent of that, you would take out £15,000 (€16,702) in the first year of your retirement.
In your retirement’s second year, you would withdraw slightly more…no matter what the stock market was doing; no matter how the economy was performing; no matter what the level of unemployment. You would withdraw slightly more to match inflation. If inflation were 2 percent in 2021, you would withdraw 2 percent more than £15,000 (€16,702). In this case, it would be £15,300 (€17,036). In the years that followed, you would continue to withdraw more, to keep pace with inflation.
This is known as “the 4% rule.” It was back-tested to 1926. That means it would have worked even if somebody retired in 1929…right before stocks took their biggest-ever dive. U.S. markets fell 86 percent between 1929 and their low in 1932. It coincided with the Great Depression: history’s worst economic mess.
But the 4 percent inflation-adjusted withdrawals would have seen the money last at least another 30 years.
It’s important to note, however, that the 4 percent rule only backtested U.S. stocks and bonds. During the vast majority of rolling 30-year periods, it also worked for globally diversified portfolios, too.
If this rule of thumb makes you nervous, you could withdraw slightly less. Some people settle for 3.5 percent inflation-adjusted withdrawals. Others stick to 4 percent, but they don’t give themselves inflation-adjusted raises during years when markets fall.
Depending where you retire, also consider taxes owed on withdrawals.
So, if you could retire on 3.5 percent or 4 percent of your current portfolio’s value, you should be able to retire today. Evidence-based research says your investments should last at least 30 years...despite these crazy times.
There’s just one major caveat. No matter how stocks perform or what economic news you hear, don’t speculate with your money. Stay the course. Stick to your long-term plan and enjoy your retirement.
Andrew Hallam is a Digital Nomad. He’s the author of the bestseller, Millionaire Teacher and Millionaire Expat: How To Build Wealth Living Overseas
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