In response to my recent article “Q&A: Should I Pull Out of the Stock Market Now?,” I received the following question from a close friend:

Great article, and very timely! Could you elaborate on this point: if you have withdrawal needs “Investors should have at least five to seven years of their withdrawal rate allocated to stability (short money, U.S. bonds, and foreign bonds).” How do you calculate 5-7 years of withdrawal rate?

Thanks for reading!

A withdrawal rate is the amount of money that you are net withdrawing across all of your investment accounts. In contrast, a savings rate is the amount of money that you are net contributing across all of your investment accounts.

Each of us either has a withdrawal rate or a savings rate, as we are each either contributing to or withdrawing from our investment accounts.

Your savings or withdrawal rate is most easily calculated by looking at 12-month statements for all your investment accounts (your employer retirement plan, IRAs, taxable accounts, savings accounts, etc.) and summing the net contributions/withdrawals.

If the resulting number is positive, then you are net contributing to your accounts and the result is your savings rate. If the resulting number is negative, then you are net withdrawing from your accounts and the result is your withdrawal rate.

If you are net withdrawing from your investment accounts, then you should consider having a stability allocation.

To calculate your 5-7 year withdrawal rate, you simply take your calculated annual withdrawal rate and multiply by 5, 6, or 7 depending on how conservative you want to be. Seven years of withdrawals would be the most conservative selection.

Some young investors are contributing to some accounts, such as their Roth 401(k) or IRA, while at the same time they are withdrawing from other accounts, such as their taxable savings. However, if your net contributions/withdrawals across all your investment accounts is positive, you are contributing and do not have a withdrawal rate. Instead, the withdrawal on your taxable account is better thought of as a tax planning strategy, similar to a Roth conversion.

If you are on track for your retirement, then you can afford to have a more conservative asset allocation than only 5-7 years of withdrawals if you desire one. However, if you are behind on your savings, you may not be able to afford moving more conservative as you might need a higher expected return to meet your financial goals.

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