Conversation about... Discretionary Funds

As a follow-up to our phone conversation, I hope this email will clarify our advice regarding an appropriate spending level. As we explained, due to your age and likely longevity, we are comfortable when your average spending is between 4.5% and 5.0% of the account annually.

How do we come up with spending 4.5% to 5.0% of the account?

If historical returns are a fair indicator of what is to come, we expect your portfolio should return about 8% per year on average over the long term, which is defined as the rest of your life. It may lose 18% in a terrible year, and it may make 25% in a great year, but on average, we hope it will earn about 8%. If it earns 8% and you spend 5%, that leaves 3% in the account to keep up with inflation. So earn 8%, spend 5% and leave 3%. That allows you to keep your purchasing power. When the account increases by 3% annually, it looks like the account is growing, but really, it is just keeping up with inflation.

In the last couple of years, your spending was between 5.5% and 8.5%. I know you had the house project and so forth, but as you well know, expenses will always come up: a new car, a great travel opportunity, a new roof, helping family, etc. For the money to last, and for you to not go back to work, you should really try to spend no more than 4.5% to 5.0% of the balance annually. Were you 85 years old with a decidedly shorter life expectancy, we might be less concerned. Also, our advice to you takes into consideration your goal of preserving some capital for your heirs.

You are the boss, and we will send the amount you tell us to send. It's a good idea, though, to review the sustainability of the portfolio as it relates to your spending. Keep an eye on it, and you can maintain your standard of living.

Thanks for listening and please do not see me as the Grinch, but rather as the guy who wants you to be comfortable for the rest of your days.