In this segment of the Motley Fool Answers podcast, Alison Southwick, Robert Brokamp, and special guest Ross Anderson from Motley Fool Wealth Management consider an ideal world question: Should a retiree leave the principle in his portfolio alone, and try to live off the income it generates? The answer might seem obvious, but it's not.
A full transcript follows the video.
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This video was recorded on Nov. 7, 2017.
Alison Southwick: The next question comes from Jason on Twitter. Jason writes, "Is it foolish to mentally ignore any savings and only think of my investment dividends as the only money I have to live on?"
Robert Brokamp: Whenever you use the word "foolish" around here, I'm not sure if you mean whether it's bad or it's good.
Ross Anderson: It needs an uppercase "F."
Brokamp: That's right, and this is a lowercase one. I assume, Jason, what you're asking is if you are retired, is it fine to just live off the interest and dividends and not touch the principal. And I would say if you can do that, more power to you. I mean, the S&P 500 yield is now 1.9%. If you focus on some higher-yielding stocks -- maybe some bond funds -- you could maybe get 3.0-3.5% of a portfolio. If you can live off that, great!
But most retirement plans assume that you will sell some of your assets gradually throughout your retirement. Ideally it's not too much more than the income you get, 1-2% or so, but hopefully the growth of those will compensate for it.
But certainly people, particularly people who want to leave a legacy, they want to leave a large inheritance for their kids or maybe to charities, those folks tend to focus on just getting the income from the portfolio and leave the principal alone.
Anderson: I want to throw a stat out for this, because I think this is interesting. Generally 4% is considered a safe withdrawal rate. And if you were withdrawing 4% of your portfolio over a 30-year retirement, only 10% of the time do you end up with less money than you started with.
And that's a really powerful statistic. That means that if you're withdrawing 3% and just living off the dividend yield, for example, you're materially underspending what you could. You're probably going to end up with a pretty large account balance, so it would be very safe to do that, but it means that you're probably living a little bit more conservatively than you need to.
Brokamp: But the 4% safe withdrawal rate really is a worst-case scenario. Historically, you could withdraw more. Now the counterpoint to that today is interest rates are low. Dividend yields are low. Valuations are high. Maybe 3-4% actually makes more sense. But certainly, historically, people could have spent more than 4% and been fine.
Anderson: The math I get into on this is let's say, just for example, we're using a $1 million portfolio and you're going to take 4% out of it, so $40,000 a year. If we were going to take five years of that up front and just set it aside, we're going to take -- I can't do basic math now.
Anderson: $200,000 out of that portfolio. What does the $800,000 have to do to get back to a $1 million after five years? And it's like 5.5%. It's a pretty low return threshold that you should be able to achieve. So even if you've removed all of the risk on the money that you need in the first five years, it's not that hard to make it back up.
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