Here’s a historical analysis that will help your clients breathe a huge sigh of relief. Not only that, if you follow me through the following simulation it will help you prove they can stop freaking out about having enough money in retirement.
Since 1926, there have been 33 distinct “client lifetimes.” By following a simple investing strategy, all 33 would have been left with millions of dollars if they lived to age 95. Let me explain:
Consider a client lifetime as a 60-year window, starting at age 35 when the person seriously begins to invest for retirement. The client retires at age 70, and then lives to age 95. Thus, this 60-year lifetime includes a 35-year period of accumulation, followed by a 25-year period of distributions.
Ideally, some people will begin investing even earlier, and of course, some will live beyond age 95, but for the purposes of this analysis, we assume the above parameters are true. I also base my calculations for the retiree’s distributions on the required minimum distribution guidelines, assuming the retiree only withdraws the RMD amount each year and nothing more. And, that each year’s RMD withdrawal is adequate for their needs.
The starting income at age 35 is assumed to be a modest $50,000, with an increase of 1.5% annually through age 70. In the accumulation phase, the client saves 8% of their annual income every year and invests it in 60% equity, 40% fixed-income portfolio. More specifically, the portfolio — which is rebalanced annually — includes the following:
- 40% large U.S. stocks represented by the S&P 500 Index,
- 20% small U.S. stocks represented by the Ibbotson Small Companies Index from 1926 to 1978 and the Russell 2000 from 1979 to 2017,
- 30% U.S. bonds represented by the Ibbotson Intermediate Term Bond Index from 1926 to 1975 and the Barclays Capital Aggregate Bond Index from 1976 to 2017, and
- 10% cash represented by 3-month Treasury bills.
Here’s the tricky part. A client who began their investing life in 1926 at age 35, had a far different experience than another client who, at age 35, began their investing life in 1940. Why? Because the sequence of returns experienced in each client’s portfolio will be different based on the historical moment.
Thus, we need to study each rolling 60-year period from 1926 through 2017 to account for each cohort of clients. In fact, I’ve analyzed 33 distinct rolling 60-year periods over the 92-year period from 1926 to 2017.
“The Big View” chart below uses red dots to show the retirement portfolio balance at age 70 for each of the 33 different clients. The dark blue line represents the total dollar amount of RMDs withdrawn over the 25 years from age 70 to 95, and the light blue bars represent the ending portfolio balance at age 95.
Using the assumptions outlined above, over the entire 1926 to 2017 time period, the average 35-year rolling return for this four-asset, annually-rebalanced portfolio was 9.97%.
But of course, there’s variation in people’s experiences.
A client who began their investing life at age 35 in 1926 accumulated $1.18 million in their retirement portfolio by the end of 1960 at age 70. Meanwhile, their portfolio had an average annualized return of 8.31% using the actual returns of the four indexes used in this analysis.
This same client began their retirement in 1961 and after withdrawing the RMD each year for the next 25 years, had withdrawn a total of $3.16 million by the end of 1985. At the start of 1986, as a 95-year old, they still had a balance of $3.1 million in their retirement account. We need to remember that they maintained a 60/40 portfolio not only through the accumulation phase, but also through retirement.
As "The Big View" graph shows, each of the 33 different clients (the first one turned 35 in 1926, the last one turned 35 in 1958) accumulated an average of $1.3 million in their retirement portfolios by age 70. The largest balance at age 70 was $1.76 million over the 35-year period from 1958 to 1992, while the smallest balance was roughly $860,000 over the period from 1940 to 1974. (You may recall that 1973 and 1974 were very bad years for U.S. equities). So, all in all, our 33 clients had very impressive outcomes by age 70.
The average 25-year total RMD withdrawal between ages 70 to 95 was $4.8 million, or roughly 3.7 times more than the average starting balance of the retirement portfolio at age 70. The average annual RMD-based withdrawal over all the rolling 25-year periods was $193,014. Of course, there is variation around that average. You will recall that the RMD fluctuates based on the portfolio’s performance in the prior year, combined with the escalating mandated withdrawals as the client ages.
For example, during one particular 25-year period from January 1961 to December 1985, the average annual RMD withdrawal was $126,244 — which was the lowest average over all the rolling periods. In contrast, during the 25-year period from 1977 to 2001 the average annual RMD was $236,843 — which was the highest average due to a favorable sequence of returns in the portfolio.
This particular 25-year distribution period from 1977 to 2001 came after a 35-year accumulation period that started in January 1942 and ended in December 1976, when the client turned 70 years old. The starting balance for this particular client in January 1977 was $1.15 million.
Over the next 25 years, a total of $5.9 million was withdrawn based on RMD guidelines (which averages out to $236,843). At age 95, this particular client had a portfolio balance of $4.6 million. Do you think they will run out of money? I certainly don’t think so. Of course, every story won’t have such a happy ending, but the RMD methodology guarantees that a portfolio will not be liquidated prior to age 116.
Simply put, a retirement portfolio that is built for growth during both the accumulation years and the distribution years (meaning that it has at least a 60% equity allocation), can distribute far more to the retiree than its starting balance at the beginning of retirement.
This big picture is important for retirees to understand so that they don’t fret and fester over what they feel is too small a retirement portfolio. A portfolio that has a material equity allocation can grow to meet the withdrawal demands over time, much like a young man or woman who matures to become the person they need to be to meet the challenges of their life.
Finally, the average portfolio balance at age 95, for all 33 different clients, after enduring 25 years of RMD-based withdrawals, was $3.7 million. The maximum figure was $5.89 million and the minimum figure was $2.53 million.
Is this not amazing? Even more than amazing, this is incredibly comforting if the stipulated RMD each year is adequate to meet your client’s needs during their retirement years. Your clients will likely have enough if they budget reasonably, but all the anguishing in advance robs them of the joy that can accompany the new opportunities in the final chapter of their lives.
In summary, a growth-oriented portfolio combined with an adequate savings rate during the working years (in this analysis I used 8%, but I would suggest at least 10% going forward) produces a retirement nest egg at age 70 that simply cannot be liquidated prior to age 95 if the client withdraws only the amount stipulated by the RMD.
Note, this analysis did not rely upon a Monte Carlo simulation. Rather, it was based on actual historical performance over rolling 60-year periods. The variability in the sequence of returns was fully accounted for.
Unless you believe the future will be radically different from the past, this analysis should be reassuring to your clients. Share it with them.