# How to Spend your Retirement Savings (1): How much can I spend from my investments?

*How much can I spend from my investments in retirement? That is a question financial planners try to address in retirement planning, but they often fail to answer how this money is to be drawn down over time, i.e. the spending profile. It turns out that people don’t actually want to spend a constant dollar amount over the 30 years of retirement, or a constant real amount (inflation adjusted) either. More complex spending profiles, which may have more spending at the beginning, less in the middle, and more again at the end of retirement for healthcare, can be tailored based on the asset allocation in the investment portfolio, and simulations can be used to test whether these spending profiles are sustainable over 30 years or more. It’s time to put some imagination into planning for retirement and make it fit for actual retirement!*

After a lifetime slogging and socking away money into investments, retirement beckons! While retirement can mean freedom from toil and the daily drudgery of routine work, it can also mean uncertainty, as there is no longer a steady stream of employment income. This is why retirement planning is so important to get right – we need to ensure that the amount of money we are spending from our savings and investments can maintain the lifestyle we want is also sustainable in the sense that we do not run out of money. In other words, how much can I spend from my investments?

We have quite a few resources in this blog on the various Safe Withdrawal Rates (see below), so we won’t go through all that again:

The 4 percent rule:

- The Four Percent rule for Financial Independence
- Does the 4 percent rule work in Singapore?
- 4 ways the 4 percent rule can work in Singapore
- Does the 4 percent rule work with the S&P 500?

Sequence risk:

- How Sequence of Returns Risk Messes Up Retirement and the 4 percent rule
- Does the Yield Shield protect retirement finances?
- Does borrowing help the 4 percent rule to overcome Sequence Risk?

Suffice to say, all that we know about the 4 percent rule (or how 25 times your annual expenses will get you through retirement) are all based on historical US data (up to 2000’s), and that is all rather dated by now. In today’s world of higher stock market volatility, lower interest rates, lower inflation overall but higher healthcare inflation, only Safe Withdrawal Rates in the region of 3% can be considered safe enough to last through a long retirement of 30 years or more.

#### How financial planners assume we spend in retirement

But that is not the focus of this blogpost. Instead, we want to point out an anomaly in how all these discussions and research on Safe Withdrawal Rates for how much to spend from investments has been conducted – they only talk about two types of spending profiles or patterns in retirement. Which is that you can either choose a constant dollar amount, or a constant real amount. This is best illustrated using the payouts to our CPF Life, where you can choose between the Basic or Standard Plan (constant dollar amount for life), or the Escalating Plan (constant real amount for life).

###### Payouts to the different CPF Life Plans for the Full Retirement Sum of $181,000 in dollar amounts

Most of the discussion and research around Safe Withdrawal Rates recommend maintaining a constant real amount of spending every year. After all, we all prefer to consume roughly the same amount every period, rather than go from feast to famine. And going from feast to famine is essentially what a constant dollar amount of spending gets us, since at an inflation rate of 2% per year, prices double roughly every 30 years or so, which means that by the end of our retirement, we will be only be able to buy half the amount of stuff we had 30 years ago, even before accounting for healthcare costs (see chart below)!

###### Payouts to the different CPF Life Plans for the Full Retirement Sum of $181,000 in real (inflation adjusted) amounts

#### How people actually spend from investments in retirement

The problem is, nobody spends money in retirement in either of these two ways! Most people would prefer to start off retirement with a higher level of spending, as they get to live out their dreams of travel and holidays (for a few years at least). Thereafter, they might settle down to a more domestic routine of looking after the grandkids and catching up with friends and family as they age, and have less energy to do all that travelling. Finally, at some point in the later years, they may prefer to have more money again, as healthcare costs rise. It is clear that neither the constant dollar amount (which meets the needs in the 1st half of retirement), or the constant real amount (which meets the needs of the 2nd half of retirement) is a one-size-fits-all plan. But we can only choose one from CPF Life!

In some interesting research from the US, Blanchett (2013) shows that over a thirty year retirement, people actually spend less and less in real amounts from investments over the first 15 to 20 years, before increasing spending again towards the end of retirement to cover rising healthcare costs. A constant real amount of spending over time will correspond to a flat line at zero in the chart below. Instead, what we see is a dip initially, followed by a rise over time.

###### Annual Real Change in Retirement Spending from Blanchett (2013)

Source: Blanchett, David (2013) *Estimating the True Cost of Retirement*, Morningstar

When we transform this and plot it out in terms of actual dollar amounts, the actual observed spending over time looks something like the red line in the chart below. Now, compare that to the constant real amount (orange) line, which just keeps going up over time. So, the actual observed spending looks a lot more like a constant dollar amount over time, except at the start and end. However, as this data comes from the early 2000’s at best, it may not take into account the way medical and healthcare inflation has been going over the last 10 to 20 years.

###### Example of actual observed spending from Blanchett (2013) in dollar amounts

#### You can plan your retirement spending the way you want to spend from your investments!

How might we actually want to spend our hard-earned savings in retirement? Apart from the three examples given above (constant dollar amount, constant real amount, actual observed amount), we might want to take the actual observed amount (red line) and adjust it a bit, so that it rises at the start of retirement, just when we are getting the hang of travelling and enjoying retirement, flattens out in the middle of retirement, and then rises quickly again towards the end of the period to cover the healthcare costs. We illustrate this using the yellow line (“Actual Adjusted”) in the following charts.

Or, we might want to start off initially with a flat and constant dollar amount (so that we start with a higher amount in the first few years of retirement), and then sometime later, have it rise with inflation. We show this using the green line (“Healthcare Inflation”) in the charts below.

But we also need to make sure that these desired spending profiles or patterns are feasible, in that they can be sustained over 30 years without running out of money. So, using our previous work on Safe Withdrawal Rates, we test various combos of spending patterns to find out how much a person with an investment portfolio of $1 million can draw per month, over 30 years without running out of money. As before, the input assumptions of our 10,000 run Monte Carlo simulation are in the table below:

###### Yield Shield portfolio returns and risk assumptions

Annual Returns | Standard Deviation | Annual Fees | |
---|---|---|---|

Stocks | 3.32% | 26.32% | 1.00% |

Dividends | 4.55% | 0.00% | N.A. |

Inflation | 2.00% | 0.00% | N.A. |

Notice that we assume that the full amount of the $1 million in retirement savings is put into the Yield Shield portfolio from our previous blogpost. We further assume that a feasible spending plan will have a 5% or less chance of running out of money over 30 years of retirement. So, how much can we expect to withdraw from the portfolio every month? We show this in the chart below, in dollar amounts.

###### Monthly sustainable spending amounts from a $1 million Yield Shield investment portfolio in dollar amounts

In numbers, the different spending profiles from investments look like this:

###### Monthly sustainable spending amounts from a $1 million Yield Shield investment portfolio

Spending Profile | Year 1 | Year 10 | Year 20 | Year 30 | Ending Amount |
---|---|---|---|---|---|

Flat | $4,308 | $4,308 | $4,308 | $4,308 | $597,000 |

Inflation Adjusted | $2,829 | $3,381 | $4,122 | $5,024 | $831,000 |

Actual Observed | $3,929 | $4,296 | $4,243 | $4,504 | $616,000 |

Actual Adjusted | $3,523 | $3,954 | $4,095 | $4,846 | $695,000 |

Healthcare Adjusted | $3,421 | $3,421 | $4,102 | $5,004 | $783,000 |

Note that “Ending Amount” refers to the median expected value left in the investment portfolio after 30 years. The trade-off between the different spending profiles in retirement is clear when we consider the numbers. The flatter spending profiles have a higher spending amount in the first half of retirement, but have less in the second half, and will also leave behind a smaller portfolio. The steeper spending profiles sacrifice higher spending in the first half of retirement for a larger war chest in the second half, which will be useful for dealing with healthcare and medical needs. Obviously, we can’t have the best of both worlds with only an investment portfolio to rely on, hence there needs to be a trade-off done at the start of retirement!

And to make this trade-off, the retiree should also be aware of what happens to real living standards under each of these spending profiles, as shown below. Clearly, the flat spending profile suffers a continuous fall in living standards over time, but this may not be a bad thing, as consumption of leisure activities in retirement take not just money, but energy, effort and time as well. As energy and effort may be in short supply as one ages, a falling standard of living, meaning fewer activities and spending, may actually suit the ageing process better, as long as there are other arrangements for healthcare.

###### Monthly sustainable spending amounts from a $1 million Yield Shield investment portfolio in real amounts

#### Is how much I can spend in retirement affected by the investment asset allocation?

How would these monthly sustainable spending amounts change if the investment portfolio changed? Previously, our conclusion after trying out different asset allocations, is that a 100% Yield Shield portfolio works best for retirement, but for some, it may come across as unduly aggressive and lacking diversification across different asset classes. So, let’s look at an alternative, where we put 50% of the portfolio in the Yield Shield, and the other 50% in bonds, which we proxy using the 4% interest rate paid on CPF Special Account balances.

Once again, we are looking for sustainable levels of spending monthly, from a $1 million investment portfolio over 30 years, with a 5% or less chance of running out of money. The assumptions for our 10,000 run simulation of the 50-50 portfolio are:

###### 50-50 portfolio returns and risk assumptions

Annual Returns | Standard Deviation | Annual Fees | |
---|---|---|---|

Stocks | 3.32% | 26.32% | 1.00% |

Dividends | 4.55% | 0.00% | N.A. |

Bonds | 4.00% | 0.00% | N.A. |

Inflation | 2.00% | 0.00% | N.A. |

The results look like this in dollar amounts:

###### Monthly sustainable spending amounts from a $1 million 50-50 portfolio in dollar amounts

Now, note that the monthly amounts which we can spend from investments seem a bit lower with the 50-50 portfolio, and this is borne out when we look at them in detail:

###### Monthly sustainable spending amounts from a $1 million 50-50 portfolio

Spending Profile | Year 1 | Year 10 | Year 20 | Year 30 | Ending Amount |
---|---|---|---|---|---|

Flat | $3,767 | $3,767 | $3,767 | $3,767 | $858,000 |

Inflation Adjusted | $2,708 | $3,237 | $3,946 | $4,810 | $915,000 |

Actual Observed | $3,458 | $3,782 | $3,735 | $3,964 | $863,000 |

Actual Adjusted | $3,200 | $3,592 | $3,719 | $4,402 | $884,000 |

Healthcare Adjusted | $3,000 | $3,217 | $3,926 | $4,790 | $908,000 |

These outcomes actually supports our early recommendations that a Yield Shield portfolio is better than a 50-50 portfolio for retirement, mainly because the bonds component of the 50-50 portfolio has little room for growth over 30 years, and will struggle to keep up with inflation over 30 years. The trade-off which comes with this is of course that bonds are safer and less volatile from year to year. Also, the 50-50 portfolio would likely have a larger value at the end of 30 years compared to the Yield Shield portfolio, due to paying out less over time.

To round off, here’s what the spending profiles from the 50-50 portfolio look like in real terms:

###### Monthly sustainable spending amounts from a $1 million 50-50 portfolio in real amounts

#### So, how much can I spend from my investments?

Does this mean that the retiree wishing to spend from $1 million in investments is confined to choosing among these spending profiles? Of course not! The purpose of this exercise is to show that they need not confine themselves to the standard flat or inflation adjusted spending profiles which every financial advisor seems to recommend. No, they can vary it according to the financial milestones which they wish to attain in retirement, for example planning for a big trip to mark an anniversary, or making a gift to the grandchildren at a certain age, or even just making sure that the remainder of some liabilities like mortgages or insurance premiums are paid off early in retirement. As long as the simulation analysis shows that the chosen spending profile is sustainable, then they should go for it!

And that’s not all. In Singapore at least, we are all going to retire with a tidy sum in our CPF Retirement Accounts which will be put into CPF Life. As we show up top, the curious nature of an annuity like CPF Life is that it can protect against inflation very well, thanks to the longevity returns in later years baked into its design (see here for how an annuity works). So, there is scope for pairing the mandatory CPF Life Escalating Plan annuity with a Yield Shield portfolio to increase the amount we can spend profiles in retirement from our investments! This is what we will look into in our next post.

We shall also look at putting all these findings together to work out how much it costs to retire early in Singapore. Also, what happens after you are retired and start to wonder if you still have enough to carry on, especially after going through a market downturn? We address this question here. Stay posted!

## References

Blanchett, David (2013) *Estimating the True Cost of Retirement*, Morningstar

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