Over the last ten years or so, there’s been a great deal of discussion about what constitutes a “safe withdrawal rate” during retirement. The most common rule of thumb (resulting from the famous “Trinity Study“) is to start with a withdrawal rate equal to 4% of your portfolio value on the day you retire, and adjust your withdrawals upward each year for inflation.
Using the 4% rule, the amount you need to have saved in order to retire is 25 times your annual investment-funded spending needs (that is, spending needs not already met by social security income or part-time job income).
Adjusting for Costs
The catch is that the Trinity Study doesn’t account for investment costs at all. It assumes that investors receive the entire return earned by the market. Not exactly the reality for most investors!
According to Deloitte, 401(k) administrative fees average roughly 0.72% per year.
According to the Investment Company Institute, fund expense ratios and sales loads together constitute an average annual cost of 0.99% for stock funds and 0.75% for bond funds.
According to data from the Investment Technology Group cited in Bogle’s new Common Sense on Mutual Funds, portfolio turnover costs average approximately 1.6% annually for equity funds. (I’d guess that it’s lower for bond funds, but I can’t find any good data either way.)
When you add all that up, it’s not hard to imagine an investor paying roughly 2% per year in investment costs. If you’re paying 2% per year, that 4% withdrawal rate won’t be “safe” in any way. You’ll need to look at something closer to a 2% withdrawal rate.
…and at a 2% withdrawal rate, you don’t need to save 25 times your annual spending needs. You need to save 50 times your investment-funded annual spending needs before you can retire retire.
Frugality Where It Counts
Since the economic downturn began a little over a year ago, frugality has been trendy to write about. I think that’s wonderful–I’m all for living a simple lifestyle and cutting costs where you can.
But there are few things you can do that will have as much of an impact on your financial future as being frugal with your investing. Two easy changes can literally halve the amount of money you’ll need saved in order to retire: