Is there a low-risk way to avoid running out of money in retirement?


I plan to invest half of my savings in a Standard & Poor's 500 index fund, half in a total bond market index fund, withdraw 3.5% the first year of retirement and then adjust that amount annually for inflation. Is this a low-risk way to ensure my money will last throughout a long retirement?—J.R.

I can't guarantee that you won't outlive your money if you follow your plan. But I do think that if you embark on retirement with your strategy and are willing to make some adjustments along the way, there's a good chance that your nest egg will be able to sustain you throughout a post-career life of 30 or more years.

The most important thing is that you're starting with a reasonable initial withdrawal amount. As you probably know, the 4% rule, or withdrawing 4% of the value of your savings initially and then adjusting that dollar amount annually for inflation, has long been considered the go-to strategy if you want to ensure your savings will last at least 30 years.

But with many investment pros projecting lower investment returns in the years ahead, a number of retirement experts (although not all) believe that 4% might be too ambitious, and thus some recommend starting with an initial withdrawal of around 3% or so. Your 3.5% is a bit higher than that, but it's hardy what I'd consider profligate or imprudent.

As for your retirement portfolio, I don't see anything that would raise red flags there either. A 50-50 mix of stocks and bonds should be able to generate enough growth to maintain your purchasing power while also providing a decent level of protection during market corrections and bear markets.

Just to make sure that your asset allocation jibes with your tolerance for risk, however, I suggest you take a few minutes to complete this risk tolerance-asset allocation questionnaire. If it turns out that even a 50-50 mix represents a little more risk than you're prepared to handle, you might want to scale back your stock stake a bit. To see how your chances of depleting your nest egg too soon might vary based on different asset allocations and different withdrawal rates, you can check out this retirement income calculator.

I'd also note that, while I have no problem with the two index funds you already have, they don't give you exposure to small-cap stocks or the international markets. I'm not saying that you're jeopardizing your retirement if you limit yourself to these two funds. But you might consider broadening your diversification. You can do that pretty easily by adding a small-cap index fund to your portfolio or replacing your S&P 500 index fund with a total US stock market index fund (which includes small stocks) and by investing a portion of your savings in a total international stock index fund and a total international bond index fund.

You should know, however, that a retirement income plan requires more than just setting a withdrawal rate and coming up with an appropriate asset allocation for your savings. Fact is, the financial markets — not to mention your retirement income needs — can change, sometimes dramatically. So you have to be ready to make adjustments as you go along.

For example, even with the relatively modest withdrawal rate you're contemplating, it's possible that a meltdown in the market, especially if it occurs early in retirement, combined with withdrawals from savings could so deplete your nest egg's value that it might have trouble recovering even after the markets rebound. The result could be that you run out of money more quickly than projected.

Conversely, if the financial markets thrive, sticking to your inflation-adjusted 3.5% withdrawal strategy could leave you with a sizable nest egg late in life, possibly even one larger than you started with. That may not seem like much of a problem, and may not be if you'd planned to leave a large legacy to your heirs. But ending up with a big pot of savings in your dotage could also mean that you could have spent more freely and enjoyed life more earlier in retirement.

So how can you mitigate the risk of running through your money too soon while not stinting unnecessarily on withdrawals and spending?

Flexibility is the key. For example, if your nest egg's value takes a hit in a given year because the market dropped or because you had to withdraw a larger-than-scheduled amount to meet an emergency, you might forego an inflation increase or even scale back your withdrawal a bit the next year or two to give your portfolio a chance to recover. Conversely, if your nest egg's value starts to swell because of strong investment performance, you could use that growth as an opportunity to boost spending, perhaps take an extra trip or otherwise indulge yourself.

You can get a sense of what size adjustments, if any, may be in order by periodically revisiting the retirement income calculator I mentioned above and, depending on whether the chances of your money running out are rising or falling, reduce or increase withdrawals. Alternatively, you could employ a "dynamic" approach to retirement spending like the one outlined in this Vanguard paper, which lays out a "ceiling and floor" system of boosting or paring back withdrawals within specific limits based on the prior year's spending and your portfolio's performance.

Or, for a different perspective on drawing down your nest egg, you could try the new LifePath Spending tool that asset manager BlackRock has recently made publicly available on its website. Unlike other tools that attempt to answer the likelihood that a given level of spending will last a specified number of years, the BlackRock tool asks your age and how much you have saved and then estimates how much you can spend year by year throughout retirement based on longevity assumptions and the firm's forecast for market returns.

Of course, no withdrawal system can guarantee your money will last a lifetime (although, granted, if the amount you pull out each year is so small relative to the size of your nest egg, your chances of running out could be infinitesimal). But if you want to be sure that you can count on at least some guaranteed lifetime income in addition to Social Security, you can always devote a portion of your nest egg to an immediate annuity or longevity annuity, and then rely on a combination of annuity payments and withdrawals from your investment portfolio for your spending cash. If this idea appeals to you, you'll want to make sure you know how to choose an annuity before you commit to one.

The main point, though, is that you want your nest egg to last and you want to enjoy retirement as much as possible given the resources you have, you can't just set a withdrawal rate and put it on autopilot. You've got to be prepared to make adjustments in response to the shifts and changes that are a normal part of the financial markets and life.