These days, people are living longer and may need income for 25, 30, or even 40 years. How much money does a retiree need to save?
Is $500,000 Enough?
For many people, that total may not be sufficient. But the right investment portfolio could provide enough income to get you by. Let’s assume that a person is receiving about $17,000 annually from Social Security, which is roughly the average payment for those receiving benefits today. The rest of their annual income must come from their investment portfolio of $500,000. That means that they will need to pull in about $33,000 from their investments just to have an income of $50,000 in their first year of retirement. We should assume that inflation will cause income needs to rise, so the retiree’s investment portfolio needs to increase as well. Thus, it’s important to have a portfolio that can protect your savings while also allowing it to grow faster than your annual withdrawals. This means finding the right balance between stocks and fixed-income investments. Some financial advisors recommend following the “four percent rule” regarding the withdrawals on accounts. This guideline suggests that to ensure retirement savings will last for the rest of their lives, they should not withdraw more than 4% of their portfolio on an annual basis. Note that other experts believe 4% may be too high and subject to risk. With $500,000 in savings, most investors will be forced to either violate the four percent rule or live on a very small income. Let’s examine some possible investment portfolios of $500,000 and a look at the potential income. Note that one risk for retirement savers is that of sequence risk. Sequence risk, or sequence of returns risk, analyzes the order in which your investment returns occur. It affects you when you are periodically adding or withdrawing money from your investments. In retirement, it can mean that you earn a much lower internal rate of return than what you expected.
20/80
20% equities and 80% fixed income
10% US Equities10% International Equities10% U.S. Treasuries15% Global Bonds15% Corporate Bonds5% Treasury Inflation-Protected Securities (TIPS)10% Mortgage-backed securities20% Cash and CD5% Other bonds
In this scenario, 20% of an investor’s portfolio would be placed into equities, with the other 80% invested in fixed income. The equities would be in a basic S&P 500 index fund or similar investments designed to mirror the movement of the overall stock market. The fixed-income investments would be largely comprised of bonds, with some cash and CDs. With this much money placed in fixed income securities, a person’s portfolio would be reasonably protected against a bad stock market crash. However, this portfolio might struggle to generate the kind of income the retiree needs. Doug Amis, the owner and CEO of Cardinal Retirement Planning, notes that between 1926 and 2018, a 20/80 portfolio generated an average annual return of 6.6%. That’s barely above the withdrawal rate needed to produce the necessary $33,000 and investors with shorter time horizons may see lower returns. This portfolio could work, Amis says, but “it’s not what we would recommend based on future expected returns.”
50/50
50% equities and 50% fixed income
25% U.S. Equities25% International Equities20% U.S. Treasuries10% Global Bonds10% Corporate Bonds15% Cash and CDs
Amis says a better portfolio would place involve placing half of the funds in equities and the other half in fixed income. The equities could be placed in a combination of U.S. equities, along with stocks and funds focused on international and emerging markets. Research from Vanguard suggests such a portfolio has generated an average annual return of 8.2% over time. That would bring about $41,000 in annual income the first year and give the retiree some extra cushion and allow some accommodation for inflation. However, it’s key to note that the additional equity does bring some additional risk. A 50/50 portfolio lost money in 18 of 93 years between 1926 and 2018, compared to 13 down years for the 20/80 portfolio.
40/60
40% equities and 60% fixed income
20% U.S. equities20% International equities20% U.S. Treasuries20% Global Bonds10% Corporate Bonds10% Cash and CDs
A split of 40% equities with 60% fixed income investments might allow a retiree to see portfolio growth as they retire but would also do a better job of preserving principal. An average annual return of about 7.7% would allow an investor to exceed $33,000 investment gains, but there’s no guarantee they’d get those returns in the short term. With 40% equities, it’s possible to have down years. In fact, Vanguard notes that negative years happened about 18% of the time between 1926 and 2018. Retirees may be wary of any portfolio that historically lost money once every five years, on average
100% Fixed Income
20% U.S. Treasuries20% Global Bonds15% Corporate Bonds10% Treasury Inflation-Protected Securities (TIPS)10% Mortgage-backed securities20% Cash and CDs5% Other bonds
With just $500,000, a retiree may be tempted to avoid stocks altogether. A portfolio consisting entirely of fixed-income investments would be shielded from any large market downturn, but it might not generate enough growth to offset withdrawals. Vanguard notes that an all-bond portfolio has historically generated about 5.3% in annual returns. That’s more than a full percentage point less than the 6.6% withdrawal needed to generate $33,000 in investments.
The Annuity Option
Annuities have their pitfalls and aren’t for everyone. But under certain scenarios, they may be a good retirement option. Amis notes that it’s possible to use less than $500,000 to get an annuity that pays out $33,000 annually. Any leftover money can be used as a hedge against inflation and be accessible for other needs. He also said that there are a number of potential portfolios that would mix an annuity with standard investments. “There’s likely a sweet spot where some of the portfolio is annuitized, and the remainder is invested close to 50/50,” Amis said.
