The latest report from Morningstar talks about a retirement-income strategy with a 90% probability of success.
At the risk of stating the blindingly obvious, another way of describing this would be as a retirement-income strategy with a 10% chance of failure.
In other words, by this math there is a 10% chance that you will run out of money after 30 years â around about the time youâre in your 90s, or maybe just turning 100. A perfect time for a third career, perhaps.
It sounds like a Dirty Harry parody. Do you feel lucky?
Even these numbers are based on financial calculations known as Monte Carlo simulations, which assume that the future is some sort of randomized version of the past. Maybe it will be. Then again, maybe it wonât.
These exercises have been common since financial adviser Bill Bengen launched them back in the 1990s. He was the guy who came up with the 4% rule, referring to a 4% initial withdrawal rate.
All of these calculations depend on various assumptions, from asset allocation to future returns, that may turn out to be wrong. They are only ever indicative, or directional. The latest Morningstar analysis shows that the current outlook for those about to retire isnât great.
These are valuable exercises, but a retirement plan with a 10% chance of failure looks a lot better in a spreadsheet than it sounds in real life. The problem is that if it goes wrong, there is no â I repeat, no â way of undoing the damage.
Like most people, I want a retirement-income strategy with a 100% success rate. Every other priority â owning a vineyard in Napa, leaving a legacy, endowing a university chair in plant psychology â comes in a very, very distant second.
One obvious way to meet this goal would be to buy lifetime annuities â life-insurance contracts that convert a pile of money into the equivalent of an old-fashioned pension.
Right now, by purchasing immediate annuities, a woman of 65 can secure a 7.3% withdrawal rate and a man of 65 a 7.7% withdrawal rate. (Men get higher withdrawal rates because on average, they donât live as long.) Those withdrawals are guaranteed till you die.
These are way higher than the 3.7% or 4.4% rates discussed in the latest Morningstar report.
OK, these arenât apples to apples. Those annuities come with no inflation adjustment.
But throw in a 2% annual increase â matching the Federal Reserveâs long-term inflation target â and a woman can secure a 5.9% starting withdrawal rate, and a man a rate of 6.3%.
There are a couple of downsides to annuities. One is that if you die young, you end up subsidizing the people who live a long time. Thatâs how the insurance industry can produce higher guaranteed lifetime incomes than an individual portfolio can. Another is that when you die â whether after a few years or many decades â there is no money left.
But they let you squeeze a lot more lifetime income out of your portfolio without the risk of going broke.
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