Retirement December 17, 2015

    After years of saving, you're ready to take withdrawals from your portfolio. How much can you afford to spend each month, and how can you be sure your portfolio income stream will last as long as you need it to?

    Retirement is the most common reason people take withdrawals, but you may need income for other situations, as well: living expenses while earning a degree, during maternity leave or to supplement your earnings while starting a business. In any case, your sustainable spending rate may vary based on a number of factors, including your portfolio asset allocation, risk tolerance, life expectancy, prevailing interest rates, market performance and your ability to adjust your spending as conditions change.

    The 4% rule

    To help calculate retirement income, a commonly used guideline is the 4% rule: the premise is to withdraw 4% of your portfolio in your first year of retirement, then continue to take that dollar amount—plus a bit extra to account for inflation—each subsequent year.1

    For example, let's assume a hypothetical retiree will begin retirement at age 65 with $1 million in savings. She plans to spend $60,000 before taxes in her first year of retirement, of which $40,000 (or 4%) will be withdrawn from her portfolio (the remaining $20,000 will come from Social Security payments). In each subsequent year, she will adjust the dollar amount withdrawn from her portfolio upward by the rate of inflation—for instance, if inflation has averaged 2%, she would withdraw an additional $800 the following year, or $40,800. The 4% rule assumes a 90% confidence level that her money will last during a 30-year retirement period (assuming a portfolio containing 50% stocks and 50% bonds, and having no other adjustments).

    However, the 4% rule won't apply in every situation. Factors that can alter how you calculate your income include your time horizon, portfolio composition and ability to reduce spending if conditions change. It's important to remember your portfolio should be based on your risk tolerance, time horizon and goals.

    It's also important to note that market conditions will affect outcomes, even for similarly constructed portfolios. If the market dips during early retirement, when you're first taking withdrawals, it can be harder to recover than if the losses had occurred later. Finally, investors are generally advised to reduce their exposure to stocks as they transition through retirement, and that shift is likely to lower returns later in retirement.

    The 4% rule is a good start, but we believe investors need a better way to monitor if they are on track to meet their monthly income goal and understand when to make adjustments. That's why we've introduced the Schwab Intelligent Portfolios™ Goal Tracker.

    How Goal Tracker works

    Goal Tracker is a tab in your Schwab Intelligent Portfolios dashboard that helps you set up a monthly income goal based on your risk profile, asset level and the length of time you'll need income. Using a well-known statistical technique called Monte Carlo simulation, Goal Tracker projects how your portfolio might perform under various scenarios, based on its particular asset allocation, your monthly income goal and long-term return estimates provided by the experts at Charles Schwab Investment Advisory Inc. (CSIA).

    Once you've set up your income goal, Goal Tracker will continue to track the range of projected outcomes, taking into account portfolio performance, market conditions and CSIA's projections, so you'll know whether you're "on target," "at risk," or "off target." If your plan has drifted off target, Goal Tracker will provide suggestions to help you get back on track.

    Goal Status
    Goal Status Definition Suggested Action
    "On Target" Between a 90% and 75% chance of your money lasting Looking good. Continue to monitor your progress.
    "At Risk" Less than a 75% chance but better than a 50% chance of your money lasting Your income goal is at risk. Consider lowering your monthly withdrawal amount.
    "Off Target" Less than a 50% chance of your money lasting Your income goal has gone off target. Lower your monthly withdrawal amount.

    Keep in mind that Goal Tracker's estimates are just that: estimates. Actual performance may vary, and typically is less predictable over time horizons shorter than 10 years. While these projections are not guarantees, they can help you consider how your portfolio could perform based on hypothetical projections. You can find more details on the Goal Tracker's methodology here.

    1. The 4% rule for spending in retirement was proposed by William P. Bengen, a financial advisor and planner, who published an article proposing the 4% sustainable spending rate in "Determining Withdrawal Rates Using Historical Data," Journal of Financial Planning, October 1994.

    Investing involves risks, including possible loss of principal.

    The information presented does not consider your particular investment objectives or financial situation and does not make personalized recommendations.

    There is no guarantee that the intended goal will be reached and changes to inputs and other assumptions may affect your potential to reach the intended goal. In addition, the projections and other information you will see here about the likelihood of various outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. The projections are based on estimates intended to be representative of the selected portfolio. The output of this tool may vary with each use and over time. The tool does not consider the specific securities or other assets held by you. This tool provides analysis based upon your inputs but makes additional assumptions detailed in the Goal Tracker white paper.


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