How much should you take out of your portfolio when you retire?

Here’s a question: In these times of stock-market shock — when the market can be up or down in one day as much as it might be up or down in a year — who has the patience to think rationally about long-term retirement planning?

Here’s the answer: If you haven’t retired yet, you should find a way to do exactly that sort of thinking. Perhaps more than ever, this is a good time to get the help of a good financial adviser for this task.

While we hold our breath for the latest good or (more likely) not-so-good news, let’s wade into this topic a bit.

Most people look forward eagerly to retirement, but it’s a change that requires many important choices, some of which can have pretty big consequences.

Today I want to focus on one of those forks in the road: how much money you expect your life savings to provide every year for your living expenses.

The big trade-off

On the one hand, if you take out more money, you run a greater risk of running out of money. On the other hand, if you take out less money, you forego the retirement lifestyle you have looked forward to.

How you navigate this puzzling landscape is a bit of a challenge. But I’ll give you a “map” to make it easier.

Let’s start with a set of numbers I have developed over the years to show what would have happened to somebody who retired at the start of 1970.

There’s nothing magic about that year except that we have reliable data for the subsequent years — a period that included inflation, world crises, strong markets, weak markets and plenty of surprises.

Imagine that you retired in 1970 with a portfolio worth $1 million.

You chose a first-year withdrawal of $30,000, $40,000, $50,000, or $60,000, with future withdrawals adjusted annually for inflation.

Your portfolio was invested 50/50 between the S&P 500 Index and a mix of short- and intermediate-term U.S. government bonds.

Here’s how those choices played out.

Table 1: The first 10 years

The 6% withdrawal strategy worked only briefly. By 1980, it required withdrawals equal to nearly 16% of remaining assets — clearly unsustainable.

The 5% strategy lasted longer but still failed before 25 years. The 4% strategy survived comfortably. The 3% strategy grew dramatically — but at the cost of reduced early retirement spending.

A better solution

The bad news is that you cannot eliminate the trade-off between spending now and spending later.

The good news is that there are better strategies — especially if you have adequate savings.

One of the best is a variable distribution plan, in which withdrawals are calculated as a percentage of portfolio value rather than a fixed, inflation-adjusted amount.

When markets do well, you spend more. When they don’t, you tighten your belt.

This approach dramatically reduces the risk of running out of money and allows for higher long-term equity exposure.

Retirement can be tricky. But with ample savings and thoughtful withdrawal choices, you really can live it up without outliving your money.

For more, check out my recent podcast: “All About Fixed Distributions.”

Richard Buck contributed to this article.