Many Singaporeans would like their investment portfolio to fund their post-retirement lifestyle. This can be a tricky balancing act: if you withdraw too much money from your portfolio, you risk running out of money before you’re done (generally defined as the end of your life). If you don’t, however, you may be unnecessarily depriving yourself a good retirement. As the saying goes, you can’t take it with you! Here’s how you can work out ways to make regular withdrawals from your portfolio:
A Note For Younger Investors
As a rule of thumb, younger investors (before they are 50) should not be making withdrawals from their retirement investments.
When you repeatedly withdraw money from your retirement fund (e.g you spend your insurance benefits instead of reinvesting them), you can significantly lower your returns. You are also amplifying the negative effects of market downturns if you withdraw the money when times are bad.
It is only when you are nearing retirement, in your 50s or beyond, that you should consider making regular withdrawals from your investments. The more you save now, the sooner you can start winding down (without impacting your qualify of life).
The Three Basic Philosophies
There are three common schools of thought, regarding how much you should withdraw from your portfolio. Most financial advisors or wealth managers will apply one of these three, although some may have methods customised to your needs.
1. Pure Passive Income
With this method, you live off the yields generated by your existing assets. A common example is a property that you rent out: you derive rental income from the property, but do not actually sell the house to get money out of it. Other examples of these include living off dividend yields from stocks, or the interest generated from bank accounts and bonds.
This is the most favoured approach. The assets in your portfolio do not diminish if you just live off their yields, so there is very little chance that they will “run out” by the end of your life.
Unfortunately, this method may not be accessible to most regular Singaporeans. Assets that generate substantial yields tend to also be expensive, and require a lot of capital to obtain.
For example, living off the rental income of your property is a great idea; a 1,400 square foot condo can be rented out for over S$3,500 a month (higher in central regions). But this assumes you can afford to buy such a property. At this time of writing, a typical mass market condo is around S$800,000.
Likewise, the amount of stocks and bonds needed to generate even S$1,000 a month is substantial. For example, say you use bonds with a coupon rate of around five per cent per annum. You would require close to S$250,000 worth of these bonds, to have a chance of generating the equivalent of S$1,000 a month from them.
For the average Singaporean, with a modest portfolio (and no property to rent out), yields may only come to a few hundred dollars a month. You will have to save and invest very aggressively – or have ambitious income goals – to be able to use this method.
Also, note that the withdrawal amounts will probably fluctuate. Dividend payouts are not always the same, interest rate change, and the rental income of property changes with the rental market.
2. Fixed Withdrawal
You choose to withdraw a fixed amount, at regular intervals. For example, you can decide to withdraw S$25,000 per annum, regardless of what happens in the market, or how your portfolio performs.
In this instance, you will usually need a wealth manager, who sells off your assets as appropriate in order to produce the amount needed.
This method is attractive because it gives you a regular income after retirement. However, there are some significant drawbacks. One is that, if you do not have a qualified wealth manager, it can require significant financial knowledge to understand what to sell and when. Doing it yourself may be out of the question, and that means paying fees to someone.
The second issue is that you must avoid volatile assets. Their fluctuations make it difficult to always withdraw a predictable amount, and it can be difficult to build a retirement fund when you must completely exclude high-risk assets.
During market downturns, it might become necessary to revise the withdrawal amount, lest the portfolio runs dry.
3. Percentage Of Portfolio
This method means you withdraw a percentage of your portfolio, in order to provide for your retirement. An example would be withdrawing seven per cent of your portfolio every year. If the portfolio’s value is $100,000 that year, you would get $7,000 that year (approx. S$583 per month).
A common method is to use the “four per cent rule”. This comes from a study done in 1998 (Retirement savings: Choosing a withdrawal rate that is sustainable, AAII Journal, pg. 16-21). Without going into the study itself, it has been calculated that a portfolio which is 50 per cent stocks and 50 per cent bonds, with a withdrawal rate of four per cent per annum, has a 95 per cent chance of lasting 30 years.
Note that not all wealth managers believe this approach. There have been arguments that such a method is too conservative (unless it’s your intent to die with a large amount of retirement money left, perhaps to pass to your children). Four per cent is a meagre amount to retire on, even for upper middle-income Singaporeans.
The other problem with this approach is that the payouts are irregular. When the portfolio loses value during a downturn, for example, the withdrawal amount will fall accordingly.
Even If It’s Not Time To Make Withdrawals Yet, You Should Start Planning Now
It may be a while before it’s time to tap your retirement investments. However, it pays to plan your approach even now. Do you want to use a percentage of portfolio, to ensure your fund lasts, or do you dislike the thought of a fluctuating retirement income?
Or perhaps you want to live off the yields of your assets, in which case you will have to start saving and investing much more aggressively (you can set clear goals, such as having at least S$500,000 in stocks and bonds by the time you are 55).
Speak to a qualified wealth manager about the assets you’ll need, based on the retirement you want.
This article was contributed by SingSaver.com.sg, Singapore’s #1 personal finance comparison site for credit cards and personal loans.