This is a question that many people consider and may cause some level of concern. Individuals may decide to put off retiring for “just one more year” in an attempt to ensure they have enough money in their retirement pot. This may stem from the issue of not knowing how much is needed and what they could expect from investment returns.
Some individuals take a different approach and decide to endeavour in the “5% rule”. The idea is that withdrawals of 5% per annum should mean that, with average investment returns, a retirement pot is kept approximately stable.
However, many individuals worry about the impact investment returns will have on their ability to withdraw from their retirement pot. Some individuals may choose not to withdraw any capital in periods of poor performance, whilst others may be under the assumption that withdrawing 5% is sustainable, but does the “rule” tell the full story?
The short answer: no. The reason is explained in the following example and smaller sums have been used for more straightforward maths:
- Take a portfolio value of £100,000
- Which drops by 10% over one year to £90,000
- During which time an individual has assumed they can withdraw 5%
- Meaning the total value of the portfolio is £85,000
Now, in a year of reverse fortunes, the 5% withdrawal rule assumes the portfolio should recover to the same level, but does it?
- If we assume the individual wants to keep £95,000 in the portfolio to bring them back to where they should be
- £85,000 now needs to grow by approximately 11.8% – not 10%
- Therefore, additional growth (on top of the previous year’s loss) is required to maintain the value of £95,000
- But this does not take into account this year’s 5% withdrawal
- The portfolio would need to grow by approximately 17.6% to maintain this value
However, investments are meant to grow over time, aren’t they? Yes, is the short answer.
But this simple scenario assumes 5.8% additional growth net of charges. As charges could be around 1% for the cost of investment, this would mean that returns need to average approximately 7% per annum which is a high growth rate and likely means taking relatively high risk.
Many retirement pots are not set up for such high growth and investors may see the value of their pots reduce over time if this scenario plays out again and again.
However, there are various options that individuals can take if unsure about how/when they should withdraw from their retirement pots or if they would like to keep the value stable over time. If this is of interest to you, please contact one of our professional advisers who can help you navigate the most suitable option.