Dave Sather's Money Matters: Make retirement funds last
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Often these days, we are asked: "How much money can I pull from my portfolio and not run out?"
With interest rates at multi-generational lows, there is plenty of reason to worry. Further challenging this equation is the fact that we are living longer, more expensive lives.
Over the years, many studies have analyzed this topic. The Bengen study in 1997, the Harvard University study in 1973 and the Trinity University study in 1995 all concluded that a "safe" withdrawal rate was between 4 and 4.4 percent.
The problem with these studies is that interest rates were significantly higher at that time than they are now.
For instance, if today you invested in a 10-year U.S. Treasury bond, the government would pay you interest of about 3.5 percent per year. At the beginning of 1995, however, this rate was nearly double today's rate.
That large of a decrease in rates should certainly give a fixed-income investor a reason to rethink the 4 percent withdrawal rate.
Given the low rates, we attempt to hedge our bets by telling clients to limit withdrawals to only 3 percent of the market value of their portfolio. As such, if you have a million dollar portfolio you can plan to withdraw about $30,000 before taxes.
Although this formula sounds good, it has its limitations. Investors must be disciplined to keep withdrawals to 3 percent if market values should fall off. Consider that if the market fell by 20 percent, you would need to cut your dollar withdrawals by 20 percent also. That is pretty hard to do.
If you cannot have this discipline, then you risk taking a substantially higher percentage distribution when markets dip.
As such, a separate approach is to limit your withdrawals to only the amount of interest and dividends that are actually produced. This limits withdrawals to just the cash produced by a portfolio.
This approach also helps to insulate your cash flow from the day-to-day price swings of the financial markets.
In today's investing climate, this probably means relying more heavily on stock market assets, which obviously bring greater volatility to a portfolio. However, it should also give a portfolio the opportunity to grow, too.
Assuming you have a healthy portfolio of blue chip type stocks, you may actually see your cash flow increase regularly.
A good example of this was highlighted by Warren Buffett in Berkshire Hathaway's recent annual report. Buffett said that when he stopped acquiring Coca-Cola stock in 1995, they were paid dividends of $88 million from this one investment.
For 2011, the anticipated dividend paid from the same original investment will have climbed to $376 million. That is better than a 300 percent increase over 15 years.
Obviously, not all companies will provide an investor with the dividend and cash flow stability needed for retirement. However, with a bit of research, an investor can uncover numerous names that have paid dividends consistently for more than 25 years in a row.
Using the consistent dividend strategy, along with limiting withdrawals to just the cash produced by your portfolio, gives an investor a fighting chance of making their cash last throughout their golden years.
Dave Sather is a Victoria certified financial planner and owner of Sather Financial Group. His column, Money Matters, publishes every other Wednesday.