Never Go Broke, It Is Easy to Self-Annuitize

Whether you are super wealthy or just the average retiree, you might be concerned about outliving your current income or preserving your wealth. To avoid outliving your current retirement income, you first need to determine how much of your nest egg you need to invest to generate the amount of income you need over your desired time horizon. Since we are talking about not running out of money in the future, we have selected a 40-year period which should be sufficient for our example which could probably apply to most individuals concerned about outliving their retirement income.

Let us assume you have a million-dollar retirement fund, or any decent amount to invest, and would like it to last over the 40-year period without completely burning through your initial investment. In the example below, we also show how to adjust for investments of any size.

First, let us discuss the portfolio that you will likely need to accomplish your goal of not running out of money. We use a portfolio consisting of 80 percent stocks and 20 percent bonds. The underlying equity portfolio used is the S&P 500 index while the bond portfolio could be any aggregate long-term bond index. We chose a long-term corporate bond index in our analysis. There should be no reason to use more than these two products to accomplish your goal as both products are tax efficient, inexpensive, and outperform most professionally managed mutual funds that try to beat these indices.

The reason we have chosen to allocate 80 percent of the portfolio to stocks is purely because of the higher rate of return. Our focus was less on attempting to dampen volatility since that is really not an issue if your goal is to maintain a sufficient amount of annual income while preserving or growing your wealth over a 40-year period. In our example, volatility is your friend as the stock market is biased toward the long-term investor hence the strong allocation to stocks.

So, what income can you expect to generate with an initial investment of one million dollars? Let us take a look at the table below.

First, if you use the S&P 500 as your equity solution in the 80/20 allocation you can expect an average annual payout of about 105K annually over the 40-year period but using the Investoristics’ equity solution you can get about 163K annually on average with a higher minimum payout over the same 40-year period. Note, the payout shown is conservative in that we did not assume our 10% plus outperformance versus the S&P 500 would persist over 40 years, although we have no reason to think it would not. Additionally, you never lose your initial investment over the same period if your withdrawal rate stays at the breakeven rates above. For both examples above we specifically chose a conservative return assumption for an 80/20 allocation which reflects a percentile rank of 16% over the 40-year period. This means that if you create a withdrawal plan using these assumptions today, you would likely do better than the results shown here 84% of the time. Even if you were unlucky enough to do worse, your wealth would not fall much lower than your initial investment after 40 years.

If your initial investment were 250K then you could adjust the payout amounts in the table by multiplying by a factor of .25 to get the appropriate payouts for your personal situation. The point of this exercise is to get you to understand the power of simplicity and how it makes things more efficient and cost effective. When you actually understand what drives returns then your fear of running out of money during retirement should be reduced. The key is to accept and expect volatility and understand that if you have a properly constructed portfolio that is rebalanced annually to reflect your desired asset allocation then you should be worry free. As always, if you are seeking a better equity solution to take full advantage of your equity portfolio, join “The Collective.”