When it comes to creating a cash flow strategy for retirement you need the answer to one important question:
“Will I have enough money to last a lifetime?”
In today’s low-yield environment—and given most people’s longer lifespans—your retirement savings need to keep working for you long after your earning years are over. And you need to know how much of it you can withdraw safely to stay the course over the coming decades.
That may sound like a complicated formula—but Betterment has been working hard on this problem to make it easy for you to get the answers. We launched an online retirement income solution that features an automated, dynamic withdrawal strategy, built on top of a low-cost, fully liquid portfolio with dynamic asset allocation.
A Dynamic Approach to Retirement Income
Betterment’s investing team has developed an income solution to provide dynamic retirement planning. Unlike traditional services, our income advice and allocation adjusts over time with your age, portfolio value, risk, and your withdrawal rate. Your money is invested in our globally diversified portfolio of 12 asset classes.
Based on sophisticated algorithms, our Retirement Income service factors in your personal information to offer the optimal risk allocation across our globally diversified portfolio of ETFs and advises on the optimal amount for safe withdrawal for the coming year, while balancing the dual concerns of maximizing total income, and year-to-year income consistency. Both allocation and income advice are offered through Betterment’s existing portfolio and platform—so no matter your level of investing expertise, it’s time-efficient and easy to manage.
The result is that income is variable, changing from year to year depending on portfolio balance and other factors. Over time, this flexibility can extend your capital if necessary, preventing the portfolio from being depleted prior to the end of your selected time horizon. To be sure, this kind of variability might not work for every retiree, but as part of a total of a total return strategy, this income goal is designed to extend money for as long as you it need to last.
The design for Betterment’s Retirement Income was led by product manager Alex Benke, CFP®, who is a second-generation financial planner and spent 10 years at J.P. Morgan before joining Betterment, and Lisa Huang, who holds a Ph.D in Physics from Harvard University and worked as a quantitative strategist at Goldman Sachs.
Benke and Huang evaluated various withdrawal methods at a wide range of allocations using a Monte Carlo simulation for testing thousands of trial-run market scenarios. As part of their analysis, they tested the viability of the popular but flawed 4% rule—finding that a dynamic withdrawal and allocation strategy is clearly a better solution to maximize total income while virtually guaranteeing that the money will last for the specified period.
Why Betterment’s Solution Is Better
Many of the existing retirement services and strategies rely on static withdrawals—outmoded for today’s low-yield environment, global economy and people’s longer lives. The shortcomings of other services can mean that you may miss out on much needed growth, or, as with annuities, you get some predictability at the cost of liquidity, which can be constraining.
Consider the failings of the 4% rule—a popular retirement strategy developed in the 1990s and designed to provide a steady stream of income—which, under current conditions is expected to lead to portfolio depletion about 30% of the time, analysis by Benke and Huang showed.
Read more here on why the 4% rule is broken.
Betterment’s innovation is to make income advice fully dynamic—regularly adjusting in response to multiple variables—and to fully automate that advice, integrated with our efficient, low-cost global portfolio. Just as the income advice, so goes the underlying asset allocation, fully dynamic, adjusted along a glide path over time to reflect a shifting risk tolerance.
Our advice for a safe annual withdrawal rate would generally range from 2% to 10%, based over time on a host of factors, including your portfolio’s balance. We advocate a yearly adjustment to your auto-withdrawal setting (i.e. income) to stay on track with advice. Our model was designed to maximize total withdrawals while minimizing withdrawal variation.
What Do We Mean by ‘Safe’?
With the 4% rule, and other strategies, a less than 10% chance of ruin (i.e. your balance is zero) was historically considered safe. But our research showed that with current market conditions, the 4% rule actually leads to ruin about 30% of the time. Not so safe after all.
Betterment’s Retirement Income is designed so that you have less than 4% chance of running out of money. Furthermore, the chance of your withdrawal amount falling below a 2% threshold of your initial balance is only about 10%.
Using our advice means your chance of running out of money is 4% or less. In other words—you are more than 96% likely to have income throughout your chosen time horizon by following our advice. Unlike products like annuities, any remaining investments are fully liquid—meaning your heirs will have access to the money, even if income is no longer necessary.
Understanding Variable Income: An Example
Margaret is a 65-year-old college professor, and she is likely to live to 85 based on her family history and health. Using Betterment’s income service, her $500,000 Roth IRA is allocated for a 20-year time horizon at 56% stocks and her expected monthly withdrawal this year is $1,941—an annual rate of 4.65%. This is not her only income—she also has income from Social Security, a pension, and 401K.
If the markets go up: In the first year, her Betterment portfolio grows by 7% and her new balance is $510,000 even after a year of making withdrawals. She’s a year older, however, and now her new recommended allocation is slightly less risky. Margaret’s monthly withdrawal rate will now be about $2,062 (about 4.85% of the new portfolio balance, but about 4.95% of the original value).
If the markets go down: If instead the markets were down 7%, her new balance would be $443,338 after the withdrawals. The new withdrawal rate will be $1,791 per month, or $150 lower than the original starting withdrawal amount, and 4.30% of the original value.
Although the withdrawal amounts do change depending on Margaret’s portfolio performance, her average withdrawal over 20 years is expected to be around $2,503 assuming an average market return of 6%. It’s exactly this dynamic withdrawal strategy that virtually guarantees that her capital will last for the full 20 years. To be sure, every retiree can customize his or her time horizon.
How to Get Started
To get started, any Betterment customer who has designated herself as a retiree can access a goal type called Retirement Income. With this goal, Betterment’s algorithm then calculates a safe withdrawal amount and advises an allocation.
Lastly, retirees can set up an automatic withdrawal from their Betterment income goal to their checking account to maintain fluid cash flow on a personalized payment schedule.
Monthly income may be a formula after all—but the peace of mind knowing that your money is more than 96% likely to last for however long you specify goes far beyond a spreadsheet. Like all our services, our income solution receives all the benefits of Betterment—security, automated investment management, global portfolio diversification, and tax efficiency. We believe we’ve developed an innovation that works for you, combining personalization and control with security and trust.