With the recent market volatility, some may question if their portfolio is recession-proof and if their retirement goals need a review. The internet provides many standard rules of thumb that span a variety of topics like income requirements, withdrawal rates, asset mix, and savings targets. Although we do not fully subscribe to any of the rules listed below, we feel they serve as a good initial starting point when thinking of retirement. Further personalization is required when considering these general rules of thumb.
Replacement Income: One needs roughly 70% to 80% of your current salary to maintain your lifestyle. There is also an assumption that certain expenses will not last in perpetuity (i.e. mortgages, supporting family members, commuting costs, and savings for retirement). However, this rule does not account for people’s individual spending patterns that occur over different stages of retirement. People early in their retirement tend to spend more than their working years going through the ‘honeymoon stage’ of being newly retired. They may spend more on travel and entertainment in the early stages, whereas ‘veteran’ retirees may spend less.
4% rule: To ensure you do not run out of money in retirement, you can withdraw 4% of your total portfolio per year. This rule makes an assumption based on historical market performance. However, as many recognize, past performance may not be a reliable indicator of how one’s portfolio will perform.
The percentage allocation in stocks should equal to ‘100 minus your age’: This rule is founded on the idea that as you get older, your exposure to the equity markets should be reduced as one has less time to recover from market downturns. This rule suggests that a 70 year old investor should only have 30% of their portfolio in stocks. However, this allocation does not factor in the current market dynamics (i.e. a low interest rate environment) nor your personal situation. For example, retirees who do not rely on their investments as a means of income can have more equity exposure if they plan to leave behind a legacy.
Saving 15% to 20% of your gross income: This rule of thumb encourages investors to pay themselves first before spending on discretionary items. However, it does not account for variables such as when one can start saving. The later one starts saving for retirement, the more aggressive one’s saving plan should be to catch up on lost years. It also doesn’t consider how much one’s after-tax take-home pay is. It may be more prudent to work backward by determining how much you need in retirement and how much to save to get to that goal.
These general rules of thumb can get the conversation started, but one should not rely on them solely for their retirement plan. Each person’s retirement will look different, which means a customized plan is essential to meet their goals. Everyone should have a financial plan to ensure their retirement goals are met.
A financial plan will help keep your finances on track to meet your retirement goals. It will offer a prioritized view of your financial goals and provide recommendations to achieve them through your current financial projections. Regular check-up on the plan is vital as market conditions change; therefore, it is important to regularly stress test the plan to ensure no surprises.
Our team helps many people with this type of planning, and it is a very valuable exercise that can impact both your short-term and long-term goals. It is never too early or too late to structure a plan. Your advisor can help with this process.