- Sustainable Withdrawal Rate (SWR)
- Should Everyone Use 4%?
- Crash Test
- Wealth Zones
- What is Your Wealth Zone?
- Important Rates
- Green Wealth Zone Strategies:
- Gray Wealthy Zone Strategies:
- Red Wealth Zone Strategies:
Your Wealth Zone determines whether or not your financial future will be abundant. Which Wealth Zone are you in?
Ask yourself. Do I have enough to retire? Have I hit “my number”? Will I run out of money? Am I financially independent? Did I save enough?
Do you feel fear and uncertainty? Many of us have an image of what it is we fear: being old and getting evicted from a smelly apartment. Or not having enough money for decent food. It is a deep dark fear that many of us harbor.
That fear may keep us working longer than we would like. Longer than we need.
Sustainable Withdrawal Rate (SWR)
So how do we know how much is enough? If you start poking around the internet, you will hear a near-universal response: Use the 4% rule. It is the most quoted rule of thumb for how much money you can safely withdrawal from your portfolio.
A million dollars in stocks and bonds would provide $40K for your first year of not working. That is 4% of $1M. You can then increase the 40K based on the inflation rate.
Or you could go at it in the opposite direction. This direction is more useful since it tells you how big “your number” needs to be. The 4% rule implies that you will need 25 years of expenses. If you need to cover $40K of expenses each year you would need $1M ($40K x 25).
Should Everyone Use 4%?
But does everyone need exactly 25 years of expenses (YOE)? Likely not. Some need more and some need less. A 55-year-old woman will need much more than a 75-year-old man. It doesn’t seem that they both need 25 years, right?
Also, it is a little inaccurate to call it years of expenses (YOE). With investing the money will last longer. Instead, I will call it your Spending Multiple (SM).
Jim Otar is an engineer turned financial planner who studied this issue. He thinks it unwise to recommend an SM of 25 for everyone. We should adjust it based on age and gender. He backs up his opinion with extensive research, reasoning, and modeling. See his book, “Unveiling the Retirement Myth.”
I reproduced some of his data in the tables here. To use this, you need to know how much you spend each year. The question is: If you stopped working today, for how long could you live off the money you have? Is it 25 years? (e.g. Portfolio value / annual spending = 25). If so, you may be ok (using the 4% rule).
Otar divides your status into zones. I will call them Wealth Zones.
If you are in the Red Zone, you don’t have enough money.
If you are in the Green Zone, chances are you will be fine.
The Gray Zone is in the middle. You risk running out of money without changes or a careful strategy.
Figure out which Wealth Zone you are in. Red, Gray, or Green. Let’s practice this concept with a few examples.
Let’s say Dr. Modesto is a 55-year-old male who spends 88K per year. He has $3M in his portfolio. After 25 years of clinical practice, he feels burned out. How much longer will he need to work?
Since he has $3M and spends $88K, his Spending Multiple (SM) is that ratio. Divide the spending into the total portfolio value. That is $3M divided by $88K. $3M/88K = 34. So, his SM is 34.
The Good Zone
Is that good for a 55-year-old male? What Wealth Zone is that? We look at Table 1 for the answer. The cut off for the Green Zone is an SM of 33 and he is above that. He is in the Green Wealth Zone and can stop working whenever he likes.
What a pleasant surprise? He may choose to phase into semi-retirement with part-time work. Or he could stop working completely. He has options.
Dr. Grey is a recently divorced 64-year-old OB-GYN. She hopes to retire next year but fears running out of money. She doesn’t want to make the mistake that a friend of hers did. Her friend Mary retired in 2000. After stocks declined Mary needed to return to work. Dr. Grey knows she can’t live on social security and she has no pension.
Since she has no one to provide for her she is afraid of outliving her money. Can she take money out without risking everything? Should she work until 70 instead? Although she still likes patient care, her call nights are becoming unbearable. She doesn’t bounce back from being up all night like she did when she was 30.
So what Wealth Zone is Dr. Grey in? Her accumulated nest egg is $3.9M. Even after the divorce, her lifetime of surgery and office work has served her wealth well. It is a lot of money. Still, she enjoys spending money. Nothing wrong with living well, right?
$3.9 Million Must Be Enough
Currently, she spends $150K per year. She expects to spend less on work expenses and health care. Travel and hobby costs will go up. On the whole, she may still spend the same amount per year.
She has $3.9M. Each year she spends $150K. Her SM is that ratio. Divide the spending into the total portfolio value. That is $3.9M divided by $150K. $3.9M/150K = 26. So, her SM is 26. Over 25 is good, right?
The So-So Zone
But is that good for a 65-year-old woman who likes to spend? What Wealth Zone is that? We look at Table 2 for the answer. Her SM of 26 places her in the Gray Wealth Zone.
She has a big portfolio but there is still a risk when factoring in her gender, age, and spending. She may be okay with a good strategy (e.g. annuitize some of her assets).
Or she may want to drop OB and continue a part-time GYN practice for a couple years. Working a few more years part-time would push her into the Green Zone.
Dr. Rubor is a 75-year-old pediatrician. He still loves his work. He works slower than he used to and needs more recovery time. So he downshifted to part-time at 65.
His wife thinks it is ridiculous that he keeps working at this age. Everyone they know retired.
A few of their best friends recently passed away and she thinks they have more than enough money at this point. He isn’t sure they have enough.
Is he being a fearful worrier or a workaholic?
Millionaire Two Times Over
After working for more than 45 years they have two million dollars. When he was a kid he dreamed of becoming a millionaire one day. He gave up on that dream to become a pediatrician but now he is a “double millionaire.”
He is proud of that but also not sure if it is enough. If he passes away will his wife be able to live with assets until age 90 or 95? A million bucks aren’t what they used to be.
The Trouble Zone
He started tracking his spending for a few months since he had no idea how much they spend. It was about $10K per month. He doesn’t see that changing anytime soon whether or not he continued to work.
He has $2M. Each year they spend $120K. Their SM is that ratio. Divide the spending into the total portfolio value. That is $2M divided by $120K. $2M/120K = 17. So, their SM is 17.
Is that good? It sounds low, but then again, they are 75 and have 2 million bucks so they might be okay.
What Wealth Zone is that? We look at Table 3 for the answer.
The SM of 17 places them in the Red Wealth Zone.
Even though they have a large portfolio there is a significant risk of running out of money. As a couple, they can now have an informed discussion about the role of work, wealth, and financial risk.
“People just haven’t saved enough for retirement. And they’re going to outlive their money.” – Sallie Krawcheck
What is Your Wealth Zone?
If you are in the Green Zone, you are set.
The Red Zone indicates there will be trouble ahead.
The Gray Zone means you likely will be okay with a great strategy and careful planning.
Here is some more helpful advice for members of each zone, thanks to Jim C. Otar, CFP.
None of us know how long we will live. That makes the question about running out of money a bit tricky.
Most relevant are the Withdrawal Rate, Sustainable Withdrawal Rate, and the Annuity Rate. They provide answers to questions. Which questions do they answer? Here they are:
Withdrawal Rate (WR) is the answer to, “How much income do I want to withdraw from my retirement savings?”
Sustainable Withdrawal Rate (SWR) is the answer to, “Portfolio, how much income can you pay me for the rest of my life?”
Annuity Rate (AR) is the answer to a specific question. “Insurance Company, if I were to give you all my retirement assets, how much would you pay me for the rest of my life?”
Several important factors determine your Wealth Zone. The keys are your spending and withdrawal rates. Based on historical rates we can see how likely you are to run out of money.
Step 1. Calculate your Wealth Zone.
Step 2. Pick a Wealth Zone Strategy.
“Knowing where you stand in your quest to accumulate enough money for retirement is an incredibly important part of the planning process.” – Jean Chatzky
Green Wealth Zone Strategies:
• Congratulations, your wealth is abundant.
• You are in the best zone.
• Almost any income allocation strategy will work.
• Nearly any withdrawal strategy will work.
• Your money management skills are good.
• Financial disaster risk is low.
• Expect lifelong income.
• Your portfolio can finance your retirement.
• Time-value of fluctuations risk will not destroy you.
• Money reserves are abundant – enough to cover longevity, market, and inflation risks.
• Focus on future dreams rather than fears of running out of money.
• Assets will grow rather than diminish. Think about your estate and charitable giving plan.
• If you are at the border of the Gray Wealth Zone, consider long-term care insurance.
• Every year conduct a review. Look at your budget, portfolio performance, and income allocation strategy.
• Focus on the tax bite, rather than your portfolio expense costs.
Gray Wealthy Zone Strategies:
• You have enough, but you must be careful.
• Expect a lifelong income, but you must export the risk.
• Funds are not enough to cover longevity, market, and inflation risks.
• Export these risks to an insurance company.
• Your money may grow or shrink. Only time will tell.
• Avoid expensive or complicated investments.
• To leave an estate, buy life insurance.
• Buy long-term care insurance. Cover the costs of your final years.
• At least once a year spend an hour reviewing. Look over your income and spending, investment returns, and risk levels. Are they still appropriate given your current life and family?
Red Wealth Zone Strategies:
• I’m sorry to tell you, but your wealth is insufficient.
• The Red Wealth Zone is the worst zone.
• You are not alone. The average baby boomer is in this Red Wealth Zone.
• Your portfolio cannot finance your retirement.
• You have no reserve to cover longevity, market fluctuations, or inflation risks.
• Trying to fund your retirement with investments will diminish your portfolio. Most likely you will run out of money before you die.
• Don’t count on having any money left over for your children or beneficiaries.
• Keep working.
• A few extra years of accumulation can mean all the difference.
• Cut back your expenses.
• Export the risk to an insurance company.
• Consider annuities. It may be your only hope.
The Red Wealth Zone is indeed a bleak place to end up. Take action now to ensure that won’t be you.
Calculate your Spending Multiple (SM) and determine your Wealth Zone. Then review the strategies appropriate for your Wealth Zone.
What about you? Do you often ask yourself, “Can I Retire Yet?”
What do you think of this Wealth Zone Strategy? Will you be in the Green Wealth Zone at retirement? Do you still fear running out of money?