Wednesday, May 17, 2017

It's Your Nest Egg

Something is happening out there. When I see an unusual editorial position in the financial press twice in two days from two different sources, I have to ask, “Why?” I don’t have an answer to that question, but I do want to bring it to your attention.

For those of you who are new to the blog, let me tell you about the 4% rule, an almost universally accepted method of spending down your nest egg in retirement.

Here is how it works. Add up all your savings and investments. Multiply that number by 4% for the first year of retirement. Then adjust it for inflation every year thereafter. If your nest egg consists of 50% bonds and 50% stocks, there is a 98% chance you will not outlive your money, assuming that you live for 30 years after the date of your retirement.

Example: You have a total of $1,000,000 in your 401(k), Roth IRA, bank accounts, and taxable brokerage account.

In the first year of retirement, you can withdraw and spend $1,000,000 X 0.04 which equals $40,000.

Let’s say inflation for that year was 3%. That means in year two you can withdraw $40,000 X 1.03 which equals $41,200.

This calculation, backed by numerous peer reviewed studies, approaches an article of religious faith in the personal finance community.

Yet yesterday, Bloomberg reports that “Rich Retirees are Hoarding Cash out of Fear.”

Well, since I no longer have a job to replace any savings I spend on an E Class Mercedes or lose in a market crash, I would think I need to be a bit cautious. If the market continues to go up as I grow older, obviously I will have more money to spend in less time, but what if the market goes down as fast as the cost of living increases? Then what? This is exactly what happened in the 1970s.

The author, Ben Steveman, tries to make the case that the money the Baby Boom saved for retirement is somehow preventing younger Americans from saving any money.

Huh?

He goes on to encourage me to buy a second home and an expensive car. I do plan on buying a reasonably expensive car when it is time to retire my 2010 Acura TSX, but given the way I buy a car, that isn’t going to happen anytime soon. He believes that after a lifetime of thrift, someone needs to train me how to spend more on luxuries. He would be happy to learn that my wife and I are planning a Mediterranean cruise, but how that is going to put more money in the retirement accounts of the thirty somethings is beyond my comprehension.

For today’s entertainment Charles Schwab offers an article entitled “Beyond the 4% Rule: How Much Can You Safely Spend in Retirement” by Cooper Howard and Rob Williams. The authors go through all the assumptions that underlie the 4% rule that have been reported ad nauseam in this blog and innumerable other publications, assuring us they are just assumptions. What if your life doesn’t end up fitting the assumptions? Then what? You could have taken more risk with your money.

Then your next car might be an S Class Mercedes instead of some trifling $60,000 midsized sedan.

The authors offer a tool to help you guess the date of your appointment with our Lord, in the hope that you can convince yourself to spend more money and take greater risks with your investments.

Check it out!

Actuaries Longevity Illustrator

The authors believe that a 98% confidence level is too high. They think a 75% to 90% confidence level is more appropriate. They conclude that, “75% provides a reasonable confidence level between overspending and underspending.”

If I come up snake eyes at age 85, will the authors support me at my then current spending level for the rest of my life, or will I become totally dependent on the taxes of those young people mentioned earlier in Bloomberg article?

Personally, I would prefer to underspend and leave the balance to my heirs and favorite charities rather than becoming a burden on society.

The questions remain, “Why would the financial press suddenly change direction after hectoring us Baby Boomers to save more money over the last two decades or more? What’s in it for them?”

If you are unfamiliar with the 4% Rule, the Schwab article does provide a pretty good introduction to the assumptions contained in this method of estimating a safe spending rate in retirement. While I think a 75% confidence level is way too low, their suggested allocations and withdrawal rate chart is really not all that out of line with my opinions.

Beyond the 4% Rule