Decision time. You have cracked open the nest egg, counted up what is in there and now you have it well invested. Now you need to decide: how much will you be able to take from your investment to be able to live well and make your money last as long as you do?
This is a hard decision: remember that you are unlikely to be able to simply take the income from dividends and interest payments: these returns will almost certainly be too low for this. Instead, you will need to take a set proportion from a diversified portfolio regardless of the returns that you get and, almost, regardless of what happens. This decision on ‘the set proportion of your portfolio’ (i.e. your rate of drawdown) is both hard and important.
It is hard, and the hardest thing of all is that there are two conflicting goals:
1. The desire to be able to spend as much as you can to enjoy some of the good things in life during retirement.
2. The desire to protect your money from running out and the fear you will spend your final years in penury.
These two goals weigh heavily against each other. They largely depend on how long you think you will live and investment returns. The risk is that you will get this calculation completely wrong and either outlive your savings or leave a lot of your savings unspent.
As well as these conflicting goals, there is a third problem: you need to have steady, consistent drawing. You cannot simply take from the portfolio the total returns that you get each year and spend that amount. Investment volatility means that if you try to do that, there will be times when you could live like a king and times when you would not live at all. The rules of thumb and your own planning need to give amounts that you ought to be able to draw each year, even with the ups and downs of the markets.
Your drawdown rate will likely be 4–6% p.a. of the capital you have at the point of retirement. The rate you finally choose will be based on your personal situation and will take into account things like your likely life expectancy and perceived investment returns in the first few years of retirement.
There is no guarantee that you will get your drawdown perfectly right — there are too many unknowns for that. We all want to draw as much as we can to live as well as we can. We also want the money to last just the right amount of time. However, there are several variables that need to be estimated and none of these is likely to turn out exactly as planned. These variables include your longevity, investment returns and inflation, and you cannot expect to predict any of these perfectly over a 20- or 30-year period.
Your drawdown rate will always have to be an approximation and needs to be monitored and possibly changed over the decades that make up your retirement years. The right drawdown rate is not a precise science — there are simply too many unknowns for that.
Fortunately, there have been others who have gone before — the rate at which you can draw down on your savings in retirement has been a known problem for decades and various people have done work to help people just like you. These people have calculated guidelines that make sense; they give varying rates that you can use depending on your circumstances and the degree to which you seek the safety of knowing that the money will last, or the desire to spend more heavily.
This edited extract is from Cracking Open the Nest Egg by personal finance expert Martin Hawes. The book sets out to help people with the way they should invest when the nest egg has hatched, and how they draw down from their savings to give a good retirement. The book is available now where all good books are sold ($39.99 RRP, Upstart Press). Buy it here