Article by: Don DeBruin, Wealth Management Consultant

People use many different strategies to manage their funds during retirement, but a common question is: How much can I safely withdraw from my portfolio to cover living expenses, travel or even a new car? We all know that we need to be careful so that we don’t outlive our money but the inherent uncertainty of the future can make managing the withdrawal process quite stressful.

The general withdrawal rule.
As a general rule, if you can live comfortably while withdrawing 4% from your portfolio each year, your portfolio should last for a very long time and will be there during your older years. For many people, this approach is implemented by withdrawing a set amount each month or, over the course of a year. Since the effects of inflation are balanced by a gradual slowing down in living expenses as we age, living off a constant budget seems to work well for the short run.

The inflation dilemma.
However, with all of the progress that is being made on the medical front, many of us can expect our retirement to stretch for decades, and the inflationary impact over that period can be dramatic. At a 3% inflation rate, costs will double in roughly 23 years. For many retired people, whose medical expenses constitute a significant part of their budget, expecting only a 3% inflation rate may be overly optimistic. Medical expenses inflate at a higher rate than other expenses; at 5%, costs double every 14 years and for many of us, that means that costs could double twice during our retirement years. This is why an inflation adjustment will be necessary as we age.

Market downturns.
If we withdraw more from our portfolio because of inflation, the 4% guideline, which might have served as our baseline projection, may become 5% or even higher. This is especially true if our portfolio suffers during a market downturn such as the current one, which began in 2008. If the portfolio value drops and we withdraw the same funds, our withdrawal percentage will increase without affording us any higher standard of living. And if we are blessed with longevity, the latter years could become under-funded.

Income stability.
If we adjust for the changes in our portfolio, we could go from feast to famine during a down market if our plan is to always withdraw 4% from our portfolio. Income stability is a key component to any retirement plan. Just as it would make no sense to sell the car during a down year only to buy another car a few years later.

A strategic solution for withdrawals.
A disciplined and dynamic withdrawal approach can solve the twin problems of inflation and market volatility. The goal is to make constant and small adjustments to your withdrawal level which will provide income stability while protecting against both inflation and market adjustments.
During bear markets: When your portfolio actually decreases from year to year (which will tend to happen relatively infrequently,) forgoing the inflation adjustment for that year will help prevent you from digging too deeply into your existing funds.

During flat markets: Most retirement planning is done with an assumption of high single digit (7% to 9%) average returns. When the actual returns do not reach this level, the risk is that inflation-adjusted withdrawals will grow faster than the portfolio and will begin to eat too deeply into assets. The solution is to limit the withdrawal rate to 4.8%. As long as the withdrawal is less than or equal to 4.8% of the portfolio, we can let things unfold and wait for stronger portfolio growth to re-establish the proper balance. If the desired withdrawal rate exceeds 4.8%, an option is to reduce the withdrawal amount by 10% to keep everything on track.

During bull markets: If the withdrawal rate falls below 3.2% because of market out-performance, then we could increase our withdrawal amount by 10% to make a small but manageable adjustment in keeping with our good fortune. These small adjustments will allow for income stability and portfolio longevity.