By Dr. Jim Dahle, WCI Founder
When it comes to planning for retirement, there are three concepts that physician investors often misunderstand. Unfortunately, two of these three constitute “bad news” that I hate to deliver to the “patient.”
However, just like in medicine, you have to understand the bad news to plan your life and treatment plans appropriately.
The Bad News for Physician Retirement
The 4% Rule
As an investor begins learning about investing for retirement, one of the first concepts they come in contact with is the idea of a safe withdrawal rate (SWR). This is a percentage of their initial portfolio, indexed to inflation, that they can withdraw each year which will give them a very low chance of running out of money in retirement. Many investors (and their advisors) thought this number was as high as 6%, 8%, or, even, 10% before they were disabused of this notion by a Trinity University study first published in the 1990s. The most important table from the Trinity Study is Table 2, reproduced below with data updated through 2009.
As you can see, if you want your portfolio to last 30 years, you can’t withdraw 10% of it a year. You can’t even withdraw 6% from a typical 50/50 portfolio and expect it to have better than a 50% chance of lasting 30 years. Experts like to argue about whether the SWR is 3% or 4% or even 4.5%, but that wasn’t really the point of the Trinity Study. The point was that the SWR isn’t 8%.
The implications of this fact are that on the eve of retirement, you need a portfolio approximately 25 times as large as your desired annual income from the portfolio. This is far more money than most beginning investors generally think they will need. A million dollars seems like a lot of money—until you realize a portfolio that size can really only support an income of $40,000 per year.
For a physician who has been making $200,000, $300,000, or even $400,000 per year, the thought of living on only $40,000 per year might be downright depressing. If a physician wanted to replace their entire $200,000 income, they would need a $5 million portfolio. To achieve that over a 30-year career with a 5% annualized return, they would need to put $73,000 per year toward retirement—or nearly 37% of their income! If they wanted to retire early after 20 years of practice, that number rises to 72% of their income—a nearly impossible figure.
This is bad news indeed.
Returns Must Be Inflation-Adjusted
To make matters worse, many novice investors use nominal return figures when making calculations. While that is probably fine for short time periods, inflation must be taken into account if you are making plans that span several decades (like retirement planning).
Historically, inflation has averaged around 3% per year. At that rate, $1 million worth of purchasing power today will require $2.4 million in 30 years. If you decided you needed a $2 million portfolio in today’s money to retire in 30 years and estimated your portfolio would earn 8% annualized returns, you might make the erroneous assumption that you only need to save $17,000 per year. However, if you properly take inflation into account, you would adjust that return down for inflation, perhaps to 5%, and realize you actually need to save $29,000 per year.
More information here:
How Big Does My Nest Egg Need to Be to Retire?
The Best Way to Create a Retirement Income Plan (and a $1 Million Example)
The Good News
You Need to Replace Much Less of Your Income Than You Thought
If this is the first time you’ve read about the concept of an SWR and the perils of inflation, you might be reaching for the Prozac. Hold off for just a minute while I share one of the few pieces of good news out there for physicians planning for retirement.
Many physicians mistakenly assume they’ll need to replace their entire income with their portfolio. Even if they ask a financial advisor for a rule of thumb, they might be told they will need 70%-80% of their pre-retirement income to comfortably retire. The truth is that the vast majority of doctors will need a MUCH lower percentage of their pre-retirement income to retire comfortably.
For a typical physician who plans well for retirement, their expenses will decrease dramatically by the time they retire. Consider all the expenses you’re paying now that you won’t be paying in retirement. 
Now, everyone’s situation is a little different, and a few expenses may even go up (such as greens fees, travel expenses, and healthcare costs). But these pale in comparison to the biggies, such as a mortgage, the high tax burden most doctors pay, and retirement savings.
Most physicians who go through this exercise will realize they probably only need 20%-50% of their pre-retirement income to have a very comfortable retirement. Things look even nicer once Social Security is taken into account. While Social Security will replace a much lower percentage of a physician’s pre-retirement income compared to a lower earner, a typical doctor can still expect it to replace about 10% of their pre-retirement earnings.
If you put all this together, a physician now earning $300,000 may find that they will have a very comfortable retirement if their portfolio will provide an income of just $100,000. They can achieve this by saving a very reasonable 15% of their income every year for 30 years and earning a 4% after-inflation return on that savings.
More information here:
Are Physicians Who Retire Early Abusing the System That Made Them Rich?
The First 9 Months of Semi-Retirement: The Good, the Bad, and the Ugly
A comfortable retirement is within reach for any physician willing to start early, learn a little about investing, and be disciplined about saving a reasonable portion of their income each year.
What do you think? Does the 4% rule reflect bad news to you? Did you think you could take out 10% of your portfolio every year? Are you comforted that you don't actually need to replace your entire annual income with your portfolio? Comment below!
[This updated post was originally published in 2013.]
No FICA or Medicare taxes withdrawal in retirement.
Less commuting cost.
The 4% SWR is threatened by extremely low (high quality) bond rates. These low rates may last for decades.
Paul Merriman suggests a 4% of remaining portfolio withdrawal rate, rather than a fixed amount. Maybe more withdrawals in good years, tighten your belt in low return years. Total return investing makes more sense than investing for income only. Capital Gains “income” is just as spendable as interest payments.
Maybe File and Suspend Soc. Security and start drawing only if the Market tanks to avoid selling in Bear markets.
A taxable account gives you much more flexibility at retirement.
Keep in mind when considering the threat to the 4% rule that low rates also generally mean low inflation. If inflation were 0%, even if your portfolio had 0% returns it’ll still last 25 years, longer than most people will need it to. The threats to the 4% SWR are wildly overstated. Sure, it might be 3.5%, but it isn’t the 2% a lot of paranoid people are talking about. The key is remaining flexible and monitoring the plan, limiting fixed expenses so you can spend more in good times and less if things aren’t working out.
Bonds are for safety, stocks are for growth. If you need bonds, you need bonds! Going out on the credit curve is way too risky as bonds are meant to be portfolio stabilizers. Any return is gravy.
Docs close to retirement should move toward a 30-40% Stock allocation for the 5 years preceding and 5 years following full retirement. The risk of another 2008 debacle is too great when you have less time to recoup losses.
Rates on Treasuries are essentially zero. Inflation is running say 2%. College tuition inflation 6-7%. You says there is no inflation?
Everyone should read Wm. Bernstein’s book “Deep Risk:How History Informs Portfolio Design” Great insights from a very smart doc.
Geez, I wish I was going to Bogleheads 13. A comprehensive summary of the meeting is in order when you get back.
im not sure what i would learn at a boglehead meeting? Maybe i just dont understand but it would seem to me to primarily be a meeting where people just agree with what they already know. Just to be clear, im in favor of a boglehead approach.
Well if you “need” bonds to feel good about your investments you should get them and take the security and lack of return that they have currently. I use dividend paying stocks instead of bonds. I also spend less than the investments earn in the early years of my retirement and when Medicare kicks in my costs will decrease. Now I have a minimal cost lifestyle since I am happy with simple pleasures.
Mark-
I’m not saying inflation is 0%. The example was discussing a SWR in a situation with 0% inflation. College tuition inflation only matters if you’re paying college tuition. Personal inflation rate is key, but obviously nearly impossible to calculate, much less forecast.
There are lots of different reasons to hold bonds, including return. P2P lending is way out on the credit curve for example, but has had some exceptionally good returns. Treasury returns suck, but they’re not 0%. The current 10 year treasury rate is 2.66%. Even the 5 year is paying 1.42%. It’s not great, and it’s pretty similar to current inflation, but it surely isn’t 0%.
Thanks for the book suggestion. I’ve been meaning to read Bernstein’s newer shorter books but haven’t gotten to any of them yet. I do plan on getting some posts out of Bogleheads 13 and am looking forward to it.
Barry-
Dividend stocks are not bonds. They are very different financial instruments. If you understand that and decide a high equity allocation is right for you, I have no problem with that, but I see far too many people thinking that anything with a high yield is bond-like, and it just isn’t. I also agree with Benjamin Graham that everyone ought to have some bonds in their portfolio.
Dividend stocks correlate closely with Large cap stocks. Value stocks have historically out-performed Growth stocks…could this be the reason why dividend paying stocks seem to do well? However a value stock is not necessarily a high dividend stock. Within the Stock universe, small caps don’t correlate well with value.
WCI, as a parent of three, you will definitely feel the effect of tuition inflation.
Larry Swedroe says a high dividend strategy is a poor Value strategy.
Bernstein recommends TIPS,Foreign stocks, fixed rate mortgages ( and to a much lesser degree; annuities) as hedges as protection against inflation.
I agree that hedging against inflation is very important in a portfolio as it is a serious risk. I suppose I should feel pretty good about the fact that I hold sizable chunks of TIPS, foreign stocks, and unfortunately, fixed rate mortgages.
I agree that tuition inflation is part of my personal inflation, but for many people, it isn’t.
As per your earlier post on the “buckets” retirement strategy, having an ongoing passive income stream can save a great deal of angst. There is no set rule as to what percentage of your portfolio can be withdrawn since there are too many individual variables. I have been retired for about 5 years & it is painful to watch your assets get smaller each year. A passive source of income whether it be maximizing social security benefits or a real estate investment, examples of which you have detailed, has greatly helped me go from the accumulation phase to the spending portion of my life such that my family does not have to adjust their lifestyle depending on what the stock market is doing.
Of course it’s psychologically hard for lifelong savers to switch gears into spending a portfolio. The risk of keeping your portfolio from shrinking during retirement is that you’re going to be underspending / over-saving. It’s awesome to have diversified assets and income streams. But did you really save all those years so you could take a nice big portfolio to your grave?
I agree that it’s easier to spend it when we can put it into the “income” mental bucket. But let’s be honest…it’s the same thing. A strict 4% SWR approach does not require your family to adjust its lifestyle based on what the market is doing. However, I actually recommend that you do adjust because it allows almost everyone to spend more than 4%.
Wm Bernstein says 25X in safe assets in retirement, while Nick Murray says 5x
ANYONE read Murray’s book, Simple Wealth, Inevitable Wealth
I call it a MUST READ
One nice thing about retirement is that you’ve got easy levers to pull if you need: part time work, spend less, decide to leave less to posterity. The risk comes in pigeon holing yourself with a scant retirement portfolio which either forces you to work or shop Sam’s club for neck bones and spam for dinner. A bit more in the bank than you think you “need” reduces a lot of worry
Love the conversations and the chart in the blog. I’ve been a believer that it’s not how much you accumulate but how much you keep in retirement. Taxes play a big part in the distribution phase of your retirement. Many tax-deferred accumulation strategies are simply kicking the can down the road and depending how much is pulled out in retirement years you could still be in a high-income tax bracket.
Location of distribution is also key. I had many executives who deferred compensation while accumulating money while working in California only to retire in Nevada and qualified for the source tax rules which eliminated CA tax (as high as a 13.5% pick-up). Also, some states don’t tax retirement income, and freeze property taxes at age 65. You need to research these.
There are more variables than just simply following a 4% withdrawal strategy. I liked the comment about real estate income coming from rentals, which provides cash flow and tax benefits.
I guess the first thing to note is that IF your income were 200K/year and you needed to save 73K/year to meet a 5 million savings goal your retirement income of 200K would continue to allow you to save 73K. You don’t really need to save (at least that much) in retirement. This is why “feedback”is a necessity. In retirement you need to generate you spending, not your income.
The second thing of note is that the 4% rule is a planning tool only. In retirement spending will not be a level 4% and market changes can and will effect that 4%.
The good news is pretty close to truth. I did the appropriate calc for a friend and showed that he would have the same level of spending on a mere 30% of his income. There are many things that can effect this. You (hopefully) have a home paid for, no longer are student loans a burden, your kids are grown, you are not saving for retirement, taxes are generally much more favorable for the retired. Well you get the idea. See https://shawnpheneghan.wordpress.com/2018/02/23/retirement-planning/
It’s not how much you withdraw, it’s how much you spend.
Drop me your email address and I’ll send you a link for an incredibly powerful Withdrawal Rate calculator. Great for a future article.
Easily found on the about page.
I will appreciate the link to the Withdrawal Rate calculator. Thank you
The guy never sent it. Not sure why.