What is Your Reliance Rate?

Written by Jeff Helms

The financial world is complex and constantly changing. Those changes can impact our clients and their plans for the future. As the firms founder and Managing Partner, making sense of these changes is my job. We try to simplify communication on market dynamics to make it meaningful and useful for our clients.

July 20, 2015

 

What is Your Reliance Rate?-media-1

What do you plan to do when you retire? What type of lifestyle do you desire? Have you spent time identifying your spending goals and key concerns? If these questions are on your mind, then it is time for you to learn the difference between your portfolio withdrawal rate and portfolio reliance rate. These two metrics are key components in determining your spending strategy, which is instrumental in ensuring a successful retirement.

  • Portfolio Withdrawal Rate — To determine the sustainability of your intended retirement spending strategy, you must first determine the exact dollar amount that you can withdraw each each year. Withdrawal rates must take into account unpredictable circumstances. It must also take into account increases for inflation and living to at least the age of 90. Finally, the portfolio withdrawal rate must be catered to your unique circumstances; no two portfolio withdrawal rates are ever the same. In short, the portfolio withdrawal rate is a great starting point for determining if your strategy is realistic.

  • Portfolio Reliance Rate — The portfolio reliance rate is a financial value that indicates the extent to which you rely on your portfolio for additional income. For example, if you need $80,000, and $40,000 comes from your portfolio, your reliance rate is 50% ($40,000 ÷ $80,000). With this in mind, it is important to remember that the more that you rely on your portfolio generating your retirement income, the greater the chance of financial risks as markets fluctuate.

Calculating Your Withdrawal & Reliance Rates

Here is the method for determining what your portfolio withdrawal rate and reliance rate would be:

A. Expected spending (ex: $100,000)

B. Outside sources of income (ex: $40,000)

C. Income gap: Income from investments = A – B (ex: $60,000)

D. Total investment portfolio (ex: $1,500,000)

Initial portfolio withdrawal rate = C ÷ D (ex: 4%)
Portfolio reliance rate = C ÷ A (ex: 60%)

Keys to Understanding Your Reliance Rate

The true key to translating your reliance rate from simply a number on a page is to learn how flexible you can be with expenses. For example, if you can reduce expenses during a market decline, then you might be in a better position to handle a higher reliance rate. However, if your expenses are set in stone, then your reliance rate should be lower, so that you can better handle the market fluctuations. With this in mind, annuities plus a lower withdrawal rate can help you to better accommodate a rigid expense structure.

By starting out with a more modest withdrawal rate, you should be in a better position to handle market ups and downs. Before you can make financial retirement decisions, you must determine where and how much you will be able to cut back on spending should the need arise. The latter mentality will help you to be in a better position to capitalize on a strong market. It will also help you to restock or grow your portfolio through the use of equities during a strong market. If you can make sure that your current income needs are met during both strong and declining markets, then you will be less inclined to make emotional (and potentially harmful) decisions during a market downturn.

Learning a Few Trade-Offs to Better Determine Retirement Financial Security

Finally, as you begin to plan for your retirement, keep the following financial trade-offs in mind.

  • Higher reliance rates can increase the likelihood for emotional (rather than fact-based) decisions during a declining market.
  • Higher reliance rates forces retirees to be more flexible in spending habits as markets fluctuate.
  • If you have a lower tolerance for risk, consider having a lower reliance rate.
  • If you want to leave a legacy behind, then your withdrawal rate should remain at a conservative figure.

Remember, the more flexible that you can be, the easier it will be for you to accommodate both strong and weak markets. Working with a trusted financial advisor at First Coast Wealth Advisors will help you to ask the right questions, so that you can determine your unique portfolio reliance rate and meet your retirement financial needs for years to come.