You’ve worked hard your whole life preparing for retirement…

You’ve been financially responsible, lived below your means, and built a nest egg that should get you through your golden years.

Now, your first day of retirement is finally here. And you start asking yourself, “Now what?”

For most new retirees, the answer is simple…

Spend.

With no more clocking in from 9-to-5, it’s time to go on a vacation with your family. It’s time to work on house projects. It’s time to golf and play tennis at the local country club.

Most people dream about all the stuff they’re going to do in retirement – years before they actually retire. And most of those things cost money.

So how should you go about spending your nest egg? You don’t want to blow it all in the first few years.

To answer that question, it’s important to look at the current market environment – and plan wisely…

The traditional rule of thumb has been that you shouldn’t spend more than 4% of your savings in the first year of retirement. After that, you should simply adjust the amount you spend annually to keep up with inflation.

As an example, if you had a $1 million portfolio, you could only afford to spend $40,000 in the first year. If inflation were 4%, you’d have $41,600 as your spending limit the next year. The year after, $43,264, and so on…

The goal here is to limit your spending in year one, then maintain your purchasing power in the following years.

In general, if you follow this rule, your portfolio should last roughly 30 years… possibly longer. This assumes investors hold 50% of their portfolios in bonds and the other half in stocks (something we don’t recommend, of course).

The key idea is this: The number of years your portfolio will last has a lot to do with inflation and the return you can get on your investments.

Those factors can change, however…

In late 2021, investment-research firm Morningstar published a report that challenged the 4% rule. It said that given market conditions, you would run out of money before 30 years if you followed that advice.

Instead, you should spend no more than 3.3% of your savings in the first year, then adjust for inflation after that.

Morningstar lowered the spending limit because of expectations for future returns…

If you think back to 2021, markets were hot. The S&P 500 Index soared 110% overall following its COVID-19 low… And its valuation had peaked at over 30 times earnings earlier in the year.

When valuations are at record highs, you need to lower your expectations for long-term returns.

The folks at Morningstar seemed to agree…

Morningstar researchers simulated future returns over a 30-year period and found that in a quarter of the simulations – with a 50% stock, 50% bond portfolio – the portfolio would run out of money if withdrawals started at 4%.

They found that a retiree would only have enough money if they started with a 3.3% withdrawal rate.

Now, we’ve just entered 2023. And importantly, the setup has changed again since Morningstar released its 2021 report…

Valuations have come down quite a bit. The S&P 500 now trades for less than 19 times earnings. Take a look…

Yields are also much higher. Bond investments can finally offer a decent return – something we haven’t experienced in years. The 10-year Treasury is currently yielding 3.8%.

This means the outlook for investment returns is brighter. So last month, Morningstar updated its ideal starting withdrawal amount.

This time, it said that new retirees could spend as much as 3.8% of their nest egg in the first year of retirement. That’s a big jump from 2021.

Of course, no broad rule like this is perfect for everyone. But expectations for future returns are much higher today than they were.

That means you should be able to spend a little money if you start retirement today.

The market outlook is one piece of your retirement planning. Once you’ve taken that into account, the final step is to know where you stand…

Unfortunately, you’ll hear plenty of stories of folks who run out of money once they stop working. And a lot of it is because they spent way too much in the first year. They try to make up for lost time, in a sense.

Always have a plan for how you will spend during your retirement. You’ve worked hard for your nest egg… Take every step possible to make it last.

Here’s to our health, wealth, and a great retirement,

Jeff Havenstein with Dr. David Eifrig

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Source: Daily Wealth