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What Most People Get Wrong When Determining Retirement Income Withdrawal Rates Thumbnail

What Most People Get Wrong When Determining Retirement Income Withdrawal Rates

Many seniors have a "retirement number" stuck in their heads.

It could be a net-worth goal that you want to hit so you can live an affluent, carefree retirement. Or it could be an amount you want to see compounding in your savings account.

Maybe you've run some “4% Rule” calculations or plugged your financial info into a free "Monte Carlo Simulation Tool" to figure out your probability of running out of money.

Unfortunately, focusing exclusively on these kinds of numbers could be more harmful than helpful when it comes time to plan for withdrawals in retirement. I think discussing four different approaches to financial planning may help folks see the bigger retirement picture and feel more confident about how they will spend their money.

1. The 4% Rule

If you google "How much money should I spend in retirement?" the 4% Rule will probably be one of the first "answers" you find. Spending around 4% of a portfolio balance per year caught on the 1990s after financial advisor William Bengen conducted a study of historical stocks and bonds return data going back to the 1920s. Bergen concluded that the 4% Rule would protect the typical nest egg for about 30 years, which, of course, is more than enough to cover a typical retirement.


Well, if you read our blogs and listen to our podcasts regularly, you’ve probably spotted one big problem with the 4% rule in 2023: there's no such thing as a "typical" retirement anymore!

In the 1990s, retiring at 65 was a fairly automatic decision for many folks who had been working at the same company for 40 years, secured a good pension, and reached Medicare eligibility. As these folks began to wind down and settle in for their golden years, 30 years of financial security sounded pretty good.

That's just not what retirement looks like now. Folks are retiring earlier or cycling in and out of the workforce. Today's seniors are also healthier and more active. They don't just want their nest eggs to pay their monthly bills, they want to use their assets to see the world, take up new hobbies, learn new things, and give back to their communities. And as more and more seniors live into their 80s, 90s, and even 100s, they're going to need more than 20 or 30 years of financial security to make sure they're properly cared for.  

Planning this kind of dynamic retirement around a static annual withdrawal rate probably isn't going to work for most seniors, especially as we're all adjusting to higher interest rates and inflation. You can use the 4% Rule for some back-of-the-napkin “guestimating”. But your retirement spending plan needs to be able to adjust with your life.

2. Monte Carlo Simulations

Monte Carlo simulations are a much more sophisticated tool that many financial pros utilize, including my team at Keen Wealth. Named after Monaco's famous casinos, these computer programs analyze a person's financial data, historical market returns, and statistical probabilities to generate a series of potential outcomes. By reviewing a broad range of possible scenarios, advisors can identify ways to tweak portfolios to increase the likelihood of reaching certain goals or avoiding certain problems.

But as powerful as Monte Carlo simulations can be, their conclusions are often overly simplistic. Their models tend to judge financial planning strategies in a very binary way: success or failure. A Monte Carlo simulation can also produce numbers that lack context. What does it really mean if a computer concludes that your financial plan has a 75% chance of succeeding? Does the remaining 25% represent failure? Does it mean reaching a goal but clearing a lower threshold? Does this particular simulation place higher importance on certain financial numbers than you do? If you spend less, will you push your probability of success higher?

Much like the 4% Rule, Monte Carlo simulations have their uses. But they also share a key limitation: they're analyzing numbers, not the complex relationship between a person's life and how they use their money.

3. Risk-Adjusted Coverage Ratio

Javier Estrada, a financial advisor and professor of finance in Barcelona, has proposed a new financial planning concept that tries to close the gap between older planning metrics and modern retirement. Rather than calculate a financial plan's chances of success or failure, Estrada's risk-adjusted coverage ratio tries to assess when a specific strategy will most likely exhaust a person's portfolio. This ratio doesn't just project when a withdrawal strategy might fall short, it also estimates by how much, creating a more nuanced and manageable expectation of what "failure" could really mean.

For example, let's say a senior is shooting for a 30-year retirement. If their withdrawal plan is projected to cover 30 years of spending with nothing left over, then their risk-adjusted coverage ratio would be one-to-one or 1.0. An alternate withdrawal plan that only covers 20 years of a 30-year retirement would yield a ratio of 1.2. The higher that ratio creeps above 1.0, the more conservative folks would likely have to be about their spending to stay on track. And if that ratio dips below 1.0, folks would probably have the means to spend more or pass on more of their assets in a legacy plan.

4. Comprehensive Financial Planning

While I like that risk-adjusted coverage ratios can help folks gain a fuller understanding of how their withdrawal rate and spending will affect their financial plan over time, the end result of all that math is still just a number. In my 30-plus years in finance, I've yet to meet a person whose entire life so far and all their goals for the future could be summarized by a number.

Our comprehensive financial planning process at Keen Wealth takes in every available data point. But the first time you sit down with one of my advisors, we're not going to talk about your numbers. We're going to talk about your life: your family, your health, your hobbies, everything you've accomplished so far, and everything you want to accomplish through your retirement.

Get in touch with Keen Wealth and let's start this conversation. Once we understand who you are, we'll start running your numbers and work out a plan for where you want to go.

About Bill

Bill Keen is a financial advisor with nearly 30 years of industry experience. As the founder and CEO of Keen Wealth Advisors, a registered investment advisory firm, he focuses on providing personalized retirement planning designed to help people thrive before and during their retirement years. With a passion for educating others, Bill regularly blogs about retirement planning, hosts the podcast Keen on Retirement, and has contributed to Forbes, U.S. News and World Report, Reuters, Wall Street Journal’s Market Watch, Yahoo Finance, and other publications. Based in Overland Park, Kansas, Bill and his team work with clients throughout the greater Kansas City area and across the nation. To learn more, connect with him on LinkedIn or visit www.keenwealthadvisors.com.

KWMG, LLC’s dba Keen Wealth Advisors (“company”) is an SEC Registered Investment Advisor located in Overland Park, KS. The company and its representatives may only conduct business in those states where registered or where excluded/exempt or from licensure. For registration information please contact the SEC or the state securities regulators for the states where the company is notice filed. A copy of the company ADV is available upon request. Advisory services are only offered to clients or prospective clients where the company and its representatives are properly licensed or exempt from licensure. No advice may be rendered by the company unless a client service agreement is in place. This information is not intended to be investment advice or construed as a recommendation or endorsement of any particular investment or investment strategy and is for illustrative purposes only. Clients and prospective clients must consider all relevant risk factors involved with each strategy, including costs or fees, and their own personal financial situations before trading.

The views outlined in the book, Keen on Retirement Engineering the Second Half of Your Life, are those of the author and should not be construed as individualized or personalized investment advice. Any economic and/or performance information cited is historical and not indicative of future results. Economic forecasts set forth may not develop as predicted.

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