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SNov 9, 2012

Life, Death and How Long Your Money Will Last

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When I talk to large groups I like to ask a peculiar question: If you have never been surprised, will you please raise your hand?

Whether the group is 100, 300 or 600 people the result is always the same. No one has ever raised a hand.

The question produces a lot of rueful smiles. People recall events they would, mostly, rather forget. It’s also pretty dramatic proof that somewhere between birth and age 65 most of us discover that life is full of surprises. That’s why one of the persistent themes in this column is adaptation. Just as Ronald Reagan said, “Trust, but verify”, I believe we should ‘plan, but adapt.’

Nothing brings this out more clearly than the “safe withdrawal rate” question. How much can we withdraw from our retirement savings without running out of money before we die? The question has been actively discussed and researched by financial planners and academics since the mid-1990s but there is still no hard, definite, answer. This happens because the answer depends on what you assume about the future.

If you start with a 60/40 equities/fixed income portfolio, for instance, history says it will be safe to withdraw 4 percent a year for 30 years 97.45 percent of the time, a failure rate of 2.55 percent. But if you withdraw more or if future returns are lower than historical averages, the failure rate will go up. 

It is important to know that financial planners are a persnickety group. They like to offer us security. Many cater to the idea that, with their help, it will be a 95 percent lead pipe cinch that we’ll be able to sustain our current standard of living for 30 years. They pick 30 years because that’s how long we might last.

As a practical matter, I’m not convinced this is a reasonable standard for ordinary mortals. While some people would like to leave big bucks to their kids, alma mater or favorite disease, the reality is that most of us will settle for squeaking through our last day just barely solvent. We also have a gut feeling that anyone talking about being 95 percent certain of anything 30 years in the future is probably delusional.

So I propose a different measuring stick: How long are we likely to live? Like portfolio survival, how long we live is uncertain. But as a practical matter, there is a 100 percent certainty that we will all die and, so far at least, we have all preferred to die well before reaching age 100. The longevity figures change over time, but the change is gradual.

You can start to visualize this by comparing portfolio survival rates with the percentage of people who survive for the same period of time.  Here are the major events, all focused on the 30-year period from age 65 to 95:

Portfolio Survival:

  • 97.45 percent of 4 percent withdrawal portfolios will survive 30 years
  • 86.18 percent of 5 percent withdrawal portfolios will survive 30 years
  • 69.83 percent of 6 percent withdrawal portfolios will survive 30 years

            Human Survival:

  • 84 percent of 65 year old couples will have no one survive 30 years
  • 16 percent of 65 year old couples will have one person survive 30 years
  • 1 percent of 65 year old couples will both survive 30 years

These figures convey some important realities.

  • 84 of the original one hundred 65-year-old couples needn’t worry about portfolio survival, because they won’t be around to experience it.
  • Although 16 of 100 couples will have one spouse survive 30 years, only 5 couples will face running out of money at a 6 percent withdrawal rate. They may be able to avoid running out of money when they support one person rather than two. In other words, they have an opportunity to adapt. 
  • Only 1 of 100 couples will have both survive 30 years.

Is this the last word on the running-out-of-money problem?

Absolutely not. If future returns are lower than historical returns, the odds change.

Similarly, if you are among the top 50 percent of all earners during your working life, you’re likely to live longer than average, so you’ll need to allow for that.

The bottom line, however, is that death reduces the risk of running out of money more than does portfolio management.

Filed Under: Retirement