How to Withdraw an Annual Income but Maintain Your Portfolio Value
By Shane Flait ©2008

Statically you have some 20 years more to live at retirement age. But you never know; you could live 35 more years. That means if you want to withdraw income every year to live on, you should withdraw only at a rate that keeps the ‘real’ value of your portfolio at least constant.

Inflation eats away at the value of your money. It has historically averaged about 3% [1].  To maintain the ‘real’ value of your portfolio, you must let it grow – as denominated in dollars - at the inflation rate. But if you're going to withdraw money annually, the annual growth rate of your funds must equal at least the sum of the inflation rate and your withdrawal rate to achieve this.So your withdrawal rate has to be less than the growth rate of your funds.

Stocks have given an average annual return of about 11% over most of the last century. So, if you counted on getting an 11% growth rate for your assets, you’d withdraw at 8% (= 11% -3%). Unfortunately, recessions occur occasionally. You’ll most likely run into one over your 20 year investment horizon. Starting out or maintaining a high withdrawal rate could seriously deplete your assets when market returns go down for a couple of years. You may never recover from it.

I suggest you should play it safe with about a 4% withdrawal rate. This implies a 7% (= 4% + 3%) average annual growth rate of the market. If your investments grow faster, then splurge a little – but not a lot! Let me show you how the numbers work.

The table illustrates how a 4% withdrawal rate per year from your funds will sustain the real value of the funds under a 3% annual inflation rate throughout a 20 year investment time frame. A hypothetical 7.5% annual growth rate is assumed for the fund’s value. This is a fairly reasonable growth rate.

At a 3% inflation rate, $100,000 would have to increase as the projected inflation value shows to maintain its same ‘real value’. See this value at 5 year intervals in the table. As long as you portfolio increases at least this fast while withdrawing money, you’re maintaining it value.

The next line shows the growth of a $100,000 investment that grows at 7.5% but from which a 4% withdrawal is made at the beginning of each year. The actual withdrawal amount is shown in the last line of the table. Recognize that the amount withdrawn actually increases with the inflation rate since the 4% is taken from the current value of the portfolio.

The second to the last line of the table that compares – by ratio - the invested funds value to the projected inflation value. You can see that the invested funds real value is slowly increasing beyond even the inflation projected value.

Play it safe. Withdraw at a lower rate in the beginning. This will help you maintain your fund’s value through any near term market downturn that occurs. As the years go buy, you can with draw at higher rates because of the extra build up or your funds, or the fewer years left that you’ll actually need them.

Shane Flait is a writer and educator. Get more info at www.EasyRetirementKnowHow.com