Excess Withdrawal Risk results in the fear of running out of money as
assets deplete at a much higher rate than planned. When people do run
out of money during retirement, it is not uncommon for them to suffer
emotionally as they lose their identity, sense of well-being and sense of
independence. Add to that embarrassment and the stress of being
forced into difficult choices for self and family, it is no wonder that the
fear associated with this risk comes as no surprise.
Imagine this: you and your partner are stranded on a desert island
with a bottle of water and two cups. You stumble on a magic lantern
during your search for food. Upon rubbing the magic lantern, a genie
appears! He tells you that he will come on a regular schedule to refill
your water bottle, however he has certain rules:
- You drink two cups of water a day, enough to sustain yourselves
- He will only add two cups of water to your supply each time he
- If there is no more water in the bottle he will not add any water at all.
- If you want, you may drink more than two cups of water, but if the
bottle is empty, he will no longer come.
You and your partner follow the genie’s directions and drink only two
cups of water a day. You find that you live well and the genie appears
every day to refill the two cups of water. Life is good and you always
have a full bottle of water.
Soon, however, a rare heat wave arrives at the island and it gets
much hotter than you can bear. The heat is so unbearable your heads
throb and sweat begins to pour out of each of you like an open faucet.
As your thirst goes through the roof, you realize that you can no longer
sustain yourselves sharing two cups of water. You need to drink more to
survive, and you do. Now, every time the Genie appears, despite the
refill, you see the level of water in the bottle slowly diminishing.
Then one day your partner falls ill and his temperature skyrockets.
He needs to drink even more water to hydrate and to keep the fever
down. Without realizing it, and with no other choice, you give your
partner the last drops of water from the bottle. Then it hits you both—
no more water. And, no more Genie!
Imagine if that were you and your loved one on the island. How
would you feel at the moment of realization that things are not going to
work out too well for you? It would probably be devastating, wouldn’t it?
Excess withdrawal risk works the same way as our desert friends’
water. In a perfect world, each time you withdraw funds from your
investments for income, your money will replenish itself and grow back
to its original level.
Unfortunately, if you begin taking larger withdrawals due to inflation
or an emergency, your money will not have the time necessary to fully
replenish. Like the bottle of water in the desert, your money will eventually
run dry. When that happens, your income (your two cups of water)
will run dry as well.
Excess withdrawals can hide under your financial radar, until one day
you wake up and realize you are about to run out of money. By then, of
course, it’s too late to fix the problem. Running out of money due to
excess withdrawals from your investments will not end as badly as the
story, but it will change your life, always for the worse.
In the illustration below, look at how quickly assets deplete as the
withdrawal percentage increases.
Excess Withdrawal and Rates of Asset Depletion
Again, it’s your turn.