How Much Do You “Pay” for Various Improvements to Your Retirement Plan?

I enjoyed writing last week’s column, in which we looked at how changing various elements of your retirement plan permits you to leave more or less money for your heirs when you die. One of the most exciting things about Valuation-Informed Indexing is that it permits you to see what sorts of trade-offs are associated with any investment choice. Let’s do more of that sort of thing!

Here a graphic showing the default results for The Retirement Risk Evaluator:

How Much Do You “Pay” for Various Improvements to Your Retirement Plan?
How Much Do You “Pay” for Various Improvements to Your Retirement Plan?

Let’s focus in on the result for the retirement that begins at a time of fair prices (a P/E10 value of 14). The safe withdrawal rate for a retirement plan that begins at a time of fair prices for an investor who is willing to see his portfolio depleted to zero at the end of 30 years and who goes with an 80 percent stock allocation and who assumes he can earn 2 percent real on his non-stock assets is 5.4. That means that that retiree can take $54,000 in inflation-adjusted dollars out of a retirement portfolio with a starting-point value of $1 million with virtual certainty that he will not run out of money for 30 years (that’s age 95 for someone who retired at age 65).

There are lots of possible changes you might want to make to this plan to suit your personal preferences. You might want to be sure to have money to leave to heirs when you die (that’s the change we examined in last week’s column). You might want to take out more money each year and still have a reasonable chance of seeing your plan work out. You might want to be able to retire at a time when valuations are higher than fair-value levels. You might want to go with a higher or lower stock allocation. You might want to assume a better or worse return on your non-stock assets.

I’ve looked at ten possible changes to the scenario I described above and report below on how each of those changes affects the amount you will take out of the portfolio to live on each year.

* If instead of retiring at a time of fair prices, you retire at a time when prices are where they were in 1996 (when the bull market first went out of control), you need to reduce your annual spending amount to $31,000.

* If you retire at a time when prices are where they were in 2000 (the top of the bubble), you need to reduce annual spending to $20,000.

* If you retire at a time when prices are where they were in 1982 (the beginning of the bull market), you can increase your spending to $91,000.

* If you lower your stock allocation to 50 percent, you must lower your annual spending to $50,000.

* If you lower your stock allocation to 20 percent, you must lower your annual spending to $44,500.

* If you are willing to accept a 20 percent chance that your plan will fail, you can increase your spending to $60,000.

* If you are willing to accept a 50 percent chance that your plan will fail (I don’t recommend this!), you can increase your spending to $66,000.

* If you want to be sure to be able to leave at least $300,000 to heirs, you must reduce annual spending to $51,700.

* If you want to be able to spend $52,000 each year but are retiring at a time when prices are what they were in 1996, you can do it if you are willing to lower your stock allocation to 20 percent.

* If you want to be sure to be able to leave $1 million to heirs and you retire when prices are where they were in 1982, you can still take out $84,600 each year.

Understanding the trade-offs inherent in making various investment choices is the key to becoming a successful long-term investor. Spend some time playing with the calculator yourself!

Rob Bennett has written about the shame (and pride!) of expecting an inheritance. His bio is here.

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