In this economic environment of low interest rates, there have recently been a number of articles published about how much retirees can annually withdraw from their investment portfolio without depleting their nest egg. Opinions vary among financial professionals, but the general consensus appears to be 4 percent.
In other words, retirees with $100,000 in their nest egg could withdraw
$4,000 (4 percent) without worrying too much about depleting their nest
egg. Of course, this is an oversimplified method of determining your
annual investment income, but it is a useful guideline.
That being said, while I consider withdrawing four percent to be a
helpful benchmark, I believe that strictly following this method could
possibly turn out to be a mistake.
For example, what if a retiree’s entire nest egg was in a safe, but
low-yielding bank account? In that case, withdrawing 4 percent from a
$100,000 account would more than likely put the value in year two below
the initial $100,000.
Then, in year two, a 4 percent withdrawal from $96,000 would result in
income of less than $4,000. Continuing to follow this method will result
in decreasing annual income until or unless interest rates suddenly
In a similar fashion, if a retiree had his or her nest egg invested
strictly for growth, the market’s performance in recent years should
have created an increase in the value of the nest egg. The result of
that, of course, would also be a slight increase in the amount of annual
income withdrawn, utilizing the 4 percent strategy.
Again, I feel that the 4 percent withdrawal strategy is a helpful
guideline. Nonetheless, as a financial adviser, I think simply focusing
on how much you can withdraw every year might cause you to overlook a
very important factor.
Before I explain, let’s set the table. As I’ve written many times, most
retirees would be best served by maintaining a diversified,
well-balanced portfolio. What I’m concerned about for my readers and
clients more than the 4 percent withdrawal rule is the sequence of
Looking at historical data from 1989 through 2008, the unmanaged
Standard and Poor’s 500 Index had an average rate of return of 10.36
percent. Back then, interest rates were also higher, so for example
purposes, instead of withdrawing four percent annually, let’s withdraw 5
One of the best years in this 20-year cycle was a positive annual return
of 31.6 percent. The worst year saw a negative annual return of 37
percent. If the negative 37 percent were in the first year, a retiree
would run out of money in year nineteen.
If, on the other hand, the negative 37 percent were in year twenty of
the mathematical cycle, the retiree would still have a significant nest
In other words, it’s the early years of retirement income that are the
most critical. It’s crucial for a retiree to avoid an immediate downturn
to his or her nest egg. It’s crucial to keep a close eye on your
returns, and adjust your withdrawal percentage accordingly.
The debate over what the proper amount a retiree can withdraw may
continue indefinitely. In my mind, however, based on history, what’s far
more important is the sequence of returns and avoiding an early tumble
in your nest egg.