How much is too much?

David Prosser discusses how much you can withdraw from your investment without running out of money. 


How much can you withdraw from your investments without fear of running out of money? It is a question that older people now routinely face as they draw an income directly from their pension funds in retirement; they need money to live on, but they also need to be sure their funds will last until the end of their lives. It is also a question for the growing number of people making withdrawals from their savings during the ongoing cost-of-living crisis.

Once upon a time, there was a simple rule you could use as at least a starting point for addressing this question. William Bengen, an American wealth manager, who conducted a series of academic studies during the 1980s and 1990s, devised the “Bengen rule”. Still followed by many financial advisers today, it suggests that savers who draw down no more than 4% of an investment fund each year stand a good chance of their money lasting. The idea is that over time, the average returns produced by such a fund will be sufficient to replace the money withdrawn so that you don’t run out.

The bad news is that Mr Bengen is no longer convinced about his own rule. Global investment markets have become so volatile that 4% might just be too much, he worries. Now retired, he is adjusting his own financial strategies accordingly, he recently told the Wall Street Journal. It also pointed to recent research from the investment analyst Morningstar, which suggests 3.3% might be a safer option.

What does that mean in practice? Well, if you have a pension fund worth £200,000, you might previously have felt very comfortable taking an income of £8,000 each year. In the current market environment, you might need to reduce that income to £6,600 if you want to feel the same sense of security.

It is important to say there are no guarantees either way. Mr Bengen’s original research was based on tracking the past performance of investments – but past performance is not necessarily a guide to the future. The same principle continues to apply – the fact that 3.3% looks reasonable in the context of what markets are doing right now does not mean it will definitely work out that way.

In any case, this kind of analysis always focuses on average returns. If you invest in assets that don’t match up the average, it will be harder to make sure that your savings do not dwindle away to nothing.

There is another factor to consider too, particularly right now. Inflation erodes the value of your money over time, and does so more quickly when inflation rates are higher. For this reason, it may not be enough to focus on making sure your money does not run out; if you can generate sufficient investment growth, you’ll also be able to protect the real value of your savings.

Where, then, to turn to achieve such objectives? There is no single right answer – everyone has different financial objectives and attitudes to risk, so you need to settle on a strategy that is appropriate for you.

However, investment companies could be one good option. Not only do they have a strong long-term performance record – typically outperforming other types of collective funds – they are also reliable income generators. They bank dividend income in good times to support pay-outs in tougher markets.

In this context, the investment companies analyst Stifel has just published research identifying 25 funds that currently offer a yield of 4% or more – that is, they’ll pay you an annual income worth at least 4% of the current value of your investment in the fund. That’s more than enough to cover the 3.3% withdrawal rate. These might not be the right funds for you, but they could be an interesting place to start looking.

You can use the Income Finder tool on the AIC’s website to identify companies with attractive yields and start to build an income portfolio.