In a prior post entitled ‘Retirement’s Volatility Bogeyman‘ we introduced the critical concept that volatility is the unsung villain of retirement sustainability. This article will reiterate the concepts we presented in the prior article, and demonstrate how an investor can tolerate lower returns so long as volatility is actively managed in the context of a more traditional balanced portfolio.
Safe Withdrawal Rate (SWR): the percent of your retirement portfolio that you can safely withdraw each year for income, assuming the income is adjusted upward each year to account for inflation.
Retirement Sustainability Quotient (RSQ): the probability that your retirement portfolio will sustain you through death given certain assumptions about lifespan, inflation, returns, volatility and income withdrawal rate. You should target an RSQ of 85%, which means you are 85% confident that your plan will sustain you through retirement.
Portfolio Volatility Determines RSQ and SWR
The chart below shows how higher portfolio volatility results in lower SWRs, holding everything else constant:
- All portfolios deliver 7% average returns.
- Future inflation will be 2.5%.
- Median remaining lifespan is 20 years (about right for a 65 year old woman).
- We want to target an 85% Retirement Sustainability Quotient (RSQ).
Steady Eddy and Risky Ricky
How Much Gain Will Neutralize the Pain?
- Withdrawal rate is 5% of portfolio value, adjusted each year for inflation.
- Inflation is 2.5%.
- Retirement Sustainability Quotient target is 85%.
- Median remaining lifespan is 20 years.
Focus on What You Can Control
Balanced portfolio is rebalanced monthly