Withdraw Conservatively While Investing Aggressively to Preserve Your Income and Portfolio’s Purchasing Power
by Shane Flait

Projecting how much reliable income your savings will give you concerns every potential retiree. Since you have a 50% chance of living more than 20 years at age 65, you really must plan to avoid dipping into principal until you’re quite old. But inflation over this time will eat into your principal.

In this article I’ll show you just how conservatively you must withdraw income from your savings and how aggressively you must invest your savings to maintain the purchasing power of both your withdrawal income and your savings portfolio.

Inflation eats away at the value of your money. Historically it’s averaged about 3%. That means if you put all your money under your mattress, its purchasing power would be halved in a little over 20 years. So, just to maintain the ‘real’ value of your portfolio, you must let it earn – as denominated in dollars – at a rate equal to the inflation rate.

Now if you’re interested in withdrawing some savings for income each year yet preserve the purchasing power of your savings, you can only withdraw your saving’s earnings that grow in excess of the inflation rate.

So you can see you can’t hold all your savings either under your mattress or in a bank account that earns you little more than the inflation rate. You’ve got to invest for greater earnings.

So what kind of earnings has the markets historically given us? Historical returns for various asset classes (1926-2006) show average annual returns of

·         (equity) large company stocks: 10.4%

·         (debt) long term government bonds: 5.4%

·         (cash reserve) Treasury Bills: 3.7%

 

Realize that volatility increases significantly for the higher average returns. This means to weather the ups and downs of holding equity, you need to invest for the long term (greater than 10 years) to count on getting these average returns.

 

If you divide your saving equally between debt and equity investments, you’d average about 8%. More appropriately, I suggest you put 10% in cash reserves, 45% in debt and 45% in equity. That’s give you about 7.5% for your saving portfolio’s average annual return – based on historical returns.

 

So with that allocation you can expect just over 7% annual growth of your portfolio – but only ‘on average’ over the long run – especially for those equities. That gives you earnings in excess of inflation of just over 4% (i.e. 7+% less 3% inflation). 

 

And that 4% is what you can pull out – on average- each year and still preserve the purchasing power of your portfolio. And the 4% you pull out will increase at the inflation rate of 3% (on average) preserving your withdrawal income’s purchasing power too.

 

So to preserve the purchasing power of both your savings portfolio and what you withdraw annually, you must follow two requirements:

·         Withdraw conservatively at 4% per year – i.e. the excess that your portfolio earns over inflation and

·         Invest a significant (45%) portion of your portfolio in solid equities to significantly outgrow inflation.

 

You should keep your portfolio balanced and slowly feed it into cash reserves from which you’ll make your withdrawals for income.

 

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