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Dollars & Percentages

In my opinion, one of the biggest issues with retirement planning is the assumption of a static withdrawal rate from retirement accounts.  This withdrawal is stated in percentage terms and is routinely based on the starting value of the retirement assets.  Further, the percentage is derived from the needed dollars the retiree needs to maintain their lifestyle.  “Mr. Smith, you have one million in retirement assets and need to withdraw $3,000 per month for living expenses.  That is a reasonable 3.6% withdrawal rate.”

The problem is that in real life we live in terms of dollars, not percentages.  If your million-dollar retirement account declines 10%, you are not calling the power company and telling them you have to pay them 10% less this month so you can maintain your 3.6% withdrawal rate.  You’ll have to continue withdrawing the same dollar amount which will inflate your withdrawal percentage.  

On the contrary, many people get too hung up on percentages in the other direction as well.  For example, a few years back I debated a family member vehemently.  I could not get him to understand my recommendation to sell a particular security and buy another.  The one we held had a higher yield, yet we would take home more dollars buying the new one.  The following is how the scenario roughly played out:

We purchased 100 shares of ABC stock at $50.00 per share and the stock paid an annual dividend of $2.50 per share.  At a 5% yield, we took home $250 per year ($2.50 * 100 shares).  ABC stock appreciated over the years we held it, reaching a price of $70.00 per share.  My suggestion was to sell ABC and invest the proceeds into XYZ stock.  XYZ paid an annual dividend of $2.00 per share and was trading at $50.00.  The yield was 4%.  Here is where the confusion took place.  While we would be lowering the yield on the position, we would be increasing the amount of dollars in our pocket.  $7,000 of the proceeds would by 140 shares of XYZ which resulted in an annual take home of $280 which is $30 more than ABC.

Financial/Retirement planning is a work in progress and should never be locked in stone.   There are so many variables that can change over time – for the good and for the bad.  We recommend reviewing your financial plan at least annually to make sure the dollars and cents make sense.