Is Your Retirement Plan on Track?

The following is an excerpt from Christine Benz's recent webcast, Tune Up Your Portfolio in Uncertain Times. Watch the full webcast.

Christine Benz: The first step in the process is to ask and answer the question: How am I doing? And as I mentioned, this really depends on your life stage, the way that you would go about making this evaluation. If you're someone who is still accumulating assets for retirement, still working, the key things you want to look at would be your savings rate over the past year. Many people have in their minds that 10% is adequate. Actually, I think for many households, that's probably too low, that if possible, setting the bar at 15%, or even higher if you're part of a higher-income household, is a really worthy goal. So, look back on how much you've managed to save over the past couple of years and see whether you are in line with where you're hoping to be. Also look at how much you've managed to save so far. We've had very strong market performance, but investors might be hard-pressed to know whether they have saved enough so far. I would refer you to these benchmarks that Fidelity Investments periodically puts out that helps investors gauge the adequacy of their nest eggs based on their life stage. Fidelity's benchmark for someone who's aged 35 is that having saved 2 times your salary at that life stage is a worthy target. By the time someone is age 45, the target is 4 times salary; at age 55, the target is 7 times salary; and then at age 65, the target is 10 to 11 times salary. These aren't perfect benchmarks. In fact, my colleague, Amy Arnott did a deep dive on how investors might think about these benchmarks in the context of their own situations. But nonetheless, I think they're decent starting points for deciding whether you have saved enough or whether you potentially need to kick up your savings rate even more. I would also say for folks who are getting close to retirement, you can start thinking about withdrawal rates and the sustainability of whatever your withdrawal rate might be as a lens to decide whether you've managed to amass enough in savings. 

I think it also helps for people at this life stage to use some kind of a retirement calculator to see whether their plan is on track. A couple of calculators that I like are Vanguard's retirement nest egg calculator. I also have long recommended T. Rowe Price's retirement income calculator. Whatever calculator you use, I think ideally you would use a calculator that is somewhat holistic, that's taking into account your tax situation, that's taking into account all of your assets for a given goal–so your spouse's assets, your own assets, your nonretirement assets that you might bring into retirement, your nonportfolio sources of income, so Social Security will be an income-producer for many of us in retirement. So, you want to find a holistic tool. You also want to find a tool that's using what I consider realistic return assumptions. If you're looking at a tool that's assuming 10% equity market returns over the next decade, I think that's probably a little bit too aggressive. So, you'd want to take a look at what sort of return expectations the calculator is embedding and use that when deciding whether a tool is in the right ballpark in terms of your overall plan.

If you're in retirement, I think you want to come at this question of how you're doing in a little bit different way. And the key gauge of your plan's wellness, of your portfolio's wellness, is your spending rate in retirement. So, if you're looking at your spending rate, you want to start with your total spending and subtract out any nonportfolio income sources that you have. So, if you have Social Security, for example, that's supplying a portion of your spending, you'll subtract that out. The amount that's left over is your portfolio spending. You'll then divide that amount. So, assuming you've come up with an annual portfolio expenditure, you'll then divide that amount by your total portfolio to come up with what your withdrawal rate is. And then, you want to look at whether that is a sustainable withdrawal rate. Many investors are familiar with what's called the 4% guideline for retirement spending. I think that's still a decent starting point for thinking about your plan. The basic idea is that 4% guideline assumes that someone wants a more or less fixed withdrawal when adjusted for inflation in retirement. So, if someone has a $1 million portfolio, that means he or she could take $40,000 in year one of retirement and then just inflation-adjust that dollar amount thereafter. That's the basic system underpinning the 4% guideline. To use a simple example, if someone were taking 4% of an $800,000 portfolio, that would translate into a $32,000 withdrawal in year one of retirement, then if inflation runs at 3% in the next year, you'd give yourself a little bit of a raise to account for that inflation. So, you'd be up near $33,000 in year two.

We recently did some work on this topic of sustainable withdrawal rates at Morningstar. One thing we came away with was the idea that new retirees especially might want to be a little bit conservative with respect to their withdrawal rates. So, they might want to think about starting withdrawals in the low to mid-3% range, assuming that they have a balanced portfolio, a 30-year time horizon, and want a 90% degree of certainty of not outliving their assets. That situation may or may not match your own portfolio parameters, your own plan parameters. Certainly, for people who have been retired for 15 years don't need to be that conservative. They can certainly take more of their portfolios because their life expectancies are shorter. So, if you're someone who's 75, and you're looking at this, you don't necessarily want to assume a 30-year time horizon. In our research, which we've made available and discussed at length on Morningstar.com, we've talked about how asset allocation and how time horizon figure into this, and the print I'm afraid on this slide is quite small, but I'll walk you through some of the overarching takeaways.

One is that if you have a longer time horizon than 30 years, so if you have a 40-year time horizon, if you're a very young retiree, you'd want to be more cautious still than that mid- to low-3% range. You'd want to be probably under 3% with a balanced portfolio. On the other hand, the person who has a 20-year time horizon in retirement could reasonably take closer to 4%, or possibly even over 4%, possibly closer to 5%. So, time horizon matters a lot in all of this. One thing I would call out, though, is that swinging for the fences in terms of higher equity exposure really didn't move the needle in our research. So, even though equities have had a higher return than bonds, historically, and certainly, over the past 10 and 15 years, the issue with ramping up equity exposure to 80% or 90% is that the portfolio courts more sequence-of-return risk. That means that the portfolio, the person who's just embarking on retirement, could encounter a weak market environment and that would mean that he or she is pulling from depreciating equity assets. And that's not something that you'd want. You'd want to be able to draw upon cash and bonds rather than your equities at such a juncture. And that's the risk that having too much in equities sets you up for.

Dig deeper:
Accumulators: Is Your Retirement Plan on Track?

Morningstar's Guide to Setting Your Withdrawal Rate