What’s Your Number?

Planning for retirement is daunting. Something that many of us end up putting off in place of doing something else, anything else. We tell ourselves it is 10, 20, 30, or even 40 years in the future. Why is it that many of us, myself included, will spend more time researching a new TV purchase or our next vacation destination than planning for retirement? I’m here to tell you that it is better to start planning for your retirement now. We can strive for improvement, as I firmly believe that a doctor who is financially literate also becomes a more effective health care provider. When you have a solid grasp of your finances, you gain the capacity to make more informed decisions, not only for the benefit of your practice but also for the wellbeing of our patients.

Determining Your Retirement Number

Many of us delay retirement planning because it appears to be an intimidating endeavor. However, it doesn’t have to be. One of the initial steps is to determine your financial independence target, recognizing that this number is likely to evolve over the course of your career. Your number represents the amount of investable retirement assets required to maintain your desired standard of living throughout retirement. When you search for “how much do you need to retire,” you’ll encounter a wide range of responses, some of which may be inaccurate. Is it $1 million, $5 million, or even $10 million for a doctor to retire? Should it be 70% of your pre-retirement income, or perhaps 10–12 times your pre-retirement income? Regrettably, many of these responses fail to address the fundamental factor: how much you spend each year ultimately determines the amount needed for your retirement.

Safe-Withdrawal Rate and the 4% Rule

In order to comfortably retire, you will need about 25 times your annual spending to fund a 30-year retirement. To put another way, an investor who maintains a portfolio consisting of 75% stocks and 25% bonds can safely withdraw 4% of their portfolio’s value annually, adjusted for inflation, to support a typical 30-year retirement without the risk of depleting their funds. This is known as your safe-withdrawal rate and what has been known to many as the 4% rule of thumb. Now, this 4% withdraw rate and spending allocation must encompass all expenses, including taxes, health care costs, and financial advisory fees. If you spend $120,000 per year, you will need about $3 million in invested assets. For every $40,000 a year spending, you will need another $1 million in your retirement portfolio. This is based off “the Trinity study,” where Cooley et al. looked at historic safe withdrawal rate based on varying percentages of a stock/bond portfolio. This American Association of Individual Investors feature helped determine what percentage of money you could safely withdraw each year, indexed to inflation, and still have a reasonable chance of having money left after a 30-year retirement. In the majority of instances, individuals employing a 4% withdrawal rate during retirement will find themselves with a larger sum of money by the end of their retirement period compared to their initial retirement savings, frequently exceeding twice the amount they began with.

Informally referred to as “the Trinity study,” as all three authors were professors at Trinity University in San Antonio, TX, Cooley et al. updated their original 1998 paper in 2011 to include data from the Great Recession of 2008. The authors looked at historic, rolling 30-year periods from 1926–2009 to help determine what withdrawal rate, indexed to inflation, would sustain different retirement lengths using different portfolios that were invested in a mixture of stocks and bonds. This study challenged the long-held belief that if a stock portfolio maintained an average annual return of 9–12%, it would be safe to withdraw 7–9% annually in retirement, ensuring the portfolio’s sustainability indefinitely. The primary factor rendering this strategy unfeasible during various periods is the risk associated with the sequence of returns.

Sequence of Returns Risk

The sequence of returns risk relates to the idea that the performance of your portfolio early in retirement matters more than the performance late in retirement. The term “sequence” pertains to the adverse effects of experiencing low or negative investment returns during the early years of retirement, which can significantly influence the longevity of your retirement portfolio.

Consider, for instance, two retired investors who both achieved an average annual return of 7.75% throughout a 20-year retirement period, all while making annual withdrawals of $70,000 from their initial million-dollar portfolio (Fig. 1).

Fig. 1—Both investors initiated their retirement with a $1 million portfolio balance and achieved an average annual return of 7.75% over a 20-year period, while withdrawing $70,000 annually. Investor 1 (orange) experienced a 35% decline in their portfolio balance in the 15th year of retirement, while Investor 2 (gray) encountered the same 35% drop in the first year of their retirement. The sequence of portfolio returns during the early stages of retirement significantly impacts the probability of the portfolio lasting throughout the entire retirement period, necessitating a much lower withdrawal rate when compared to the average portfolio return.

In the case of the first individual, they consistently enjoyed returns of 10% per year, but in the 15th year, they experienced a significant negative return of -35%, resulting in an average return of 7.75% over 20 years. The second individual, on the other hand, also averaged a 7.75% annual return, but their portfolio started with a 35% drop in the first year, then averaged a 10% annual return for the subsequent years. It’s important to note that both individuals maintained an average return of 7.75% while withdrawing the same amount annually. However, the outcome differed significantly: the first individual concluded their 20-year retirement with nearly $400,000 more than their initial investment, whereas the second individual exhausted their funds in the 20th year. This highlights the critical importance of setting a withdrawal rate lower than your rate of return in retirement, as the sequence of returns can have a substantial impact on the outcome.

Accumulating 25 times your annual spending in investable assets serves as a general guideline for achieving a successful retirement. However, in practice, many retirees adapt their discretionary spending based on their portfolio’s performance. During prosperous years, they can afford to spend more than the 4% benchmark, while in challenging years, they have the flexibility to reduce discretionary expenses and withdraw less than 4%. Nevertheless, it all commences with gaining a preliminary understanding of your annual spending, as this forms the foundation for determining the retirement nest egg required.

So, I ask again, what’s your number?

Christopher M. Walker, MD

Glen and Karen Cox Endowed Professor of Radiology

University of Kansas Medical Center

The Glen and Karen Cox Endowed Professor of Radiology and a practicing cardiothoracic radiologist at the University of Kansas Medical Center, Christopher M. Walker, MD, is not a certified financial planner, accountant, or attorney. This information is presented for your entertainment only and does not constitute formal and personalized financial, accounting, or legal advice. Your personal situation may be different, so please consult your own tax attorney or fee-only financial planner for advice pertaining to your situation.

The opinions expressed on RadTeams are those of the author(s); they do not necessarily reflect the viewpoint or position of the editors, reviewers, or publisher.