Ma Mana nagi ging ng You Your Mon r Money ey Dur urin ing Re g Reti tire reme ment nt Maria Crawford Scott Former Editor, AAII Journal 1 1
Th The Re e Retir ireme ement nt Sa Savings ngs Di Dilem emma: ma: Co Comp mpeting ing Goals Ensuring your savings last throughout your lifetime Withdrawing as much as possible each year 2 2
Di Discussi scussion on To Topi pics cs Your Withdrawal Rate: How to determine the amount of money you can safely withdraw each year. The key to your portfolio’s long -term survival. Asset Allocation: What is a prudent approach? Maintaining Your Portfolio: Steps you can take to ensure you remain on course, especially during challenging times. 3 3
One Popular ar Wi Withd hdra rawal wal Approach: ch: Th The D e Dow owns nsid ide Each year, withdraw only the income generated from your portfolio. Downside : Encourages heavy allocation to high-income but low-growth investments such as bonds. 4 4
An Anot other her Po Possible ible Wi Withdr hdrawa awal l Approach: ch: Th The Do Down wnside ide Each year, withdraw only the real rate of return from your portfolio. Downside: Does not produce a stable annual source of income. 5 5
The “Withdrawal Rate” Approach Create your own immediate annuity based on your total investment assets. First, determine a “first - year withdrawal rate” (a percentage of your portfolio). Use your life expectancy as the time period and the estimated real return (return AFTER inflation) for your portfolio over your life expectancy as the assumed return rate. Second, translate the first-year withdrawal rate into a dollar amount, which is your first- year “income”— the actual dollar amount that you can withdraw from the portfolio the first year. The next year, you are allowed to withdraw your prior-year dollar amount, but increased by the rate of inflation. 6 6
An Ex n Example ample $1 million portfolio 4% first-year withdrawal rate 3% inflation First-year withdrawal amount: $40,000 (4% of $1 million) Second-yr. withdrawal amount: $41,200 [$40,000 + (3% x $40,000)] 7 7
Wi Withdr hdrawal awal Ra Rate e Ap Appr proac oach Cl Clarifie ified The withdrawal “rate” is a percentage that applies only to your first-year withdrawal. The withdrawal amount is a “gross” figure that, along with any other sources of income, is used to pay annual living expenses, including taxes. The withdrawal amount does not take into consideration taxes that may be due based on the source of the withdrawal. The withdrawal rate has nothing to do with “required” withdrawals from retirement accounts. 8 8
Th The W e Withdr hdrawa awal l Ra Rate e Ap Appr proa oach ch Advantage tage The point of this approach is to separate your asset allocation decision from your immediate withdrawal needs so that they do not drive your allocation decision. Encourages you to invest for the long term, since the withdrawal rate does NOT depend on any income component. 9 9
Adaptin apting g th the e With thdrawal drawal Rate te Approac proach h to to th the Real al Wo World ld Annuity tables assume unvarying return rates each year, but in the real world, your return rates will vary significantly year-to-year. For portfolios in which there are NO additions and NO withdrawals, the return sequence has NO IMPACT on the ending value. For portfolios in which there ARE withdrawals each year, return sequences matter: For two portfolios with the SAME long-term average return, the one with higher returns at the beginning will have a higher end value than the one with higher returns toward the end. 10 10
Adaptin apting g th the e With thdrawal drawal Rate te Approach to the Real World (con’t) Base your withdrawal rate on studies of portfolio “success” (or “survival”) rates. The “success” rate is the percentage of times a portfolio is able to sustain the given payout over the entire time period without running out of assets prematurely. 11 11
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Po Portfo folio lio Su Succes cess s Ra Rates es: : Up Upda dated ed 13 13
Shortf rtfall l Risk k (Runout t Percentag centage) ) at Various s Withdra rawa wal Rates Source: “Guidelines for Withdrawal Rates and Portfolio Safety During Retirement,” by John J. Spitzer, Jeffrey C. Streiter and Sandeep Singh, Journal of Financial Planning, October 2007. 14 14
Th The K e Key ey to Po o Portfo folio lio Su Survival ival Use a realistic withdrawal rate: not more than 4% of the initial portfolio value. In subsequent years the annual dollar amount can be increased by your assumed inflation rate. Maintain a prudent asset allocation. 15 15
What Is a “Prudent” Asset Allocat cation ion? Based on your personal investment profile: your return needs (income vs. growth), your tolerance for risk and your time horizon. No single asset class will match all of your requirements. Diversifying your portfolio among the major market segments allows you to meet various needs while reducing various risks. 16 16
Maj ajor or Marke arket t Segm egments ents Stocks: Higher growth potential, lower and unsteady income, ability to outpace inflation, liquid markets but high risk of selling at a loss Bonds: Low growth potential, steadier income, unable to outpace inflation, liquid markets but high risk of selling at a loss Cash: No growth, unable to outpace inflation, use to reduce liquidity risk of total portfolio 17 17
St Stoc ocks ks, , Bo Bond nds an and Ca d Cash: h: 1926 Th Through 2012 Total Annual After Average Average Inflation Growth (%) (%) (%) Large Co. Stocks 9.8 6.7 5.6 Long- Term Gov’t Bonds 5.7 2.6 0.4 T-Bills 3.5 0.5 0.0 Inflation 3.0 na na Source: “Stocks, Bonds, Bills and Inflation—2013 Yearbook,” Ibbotson Associates, Chicago. 18 18
Hi Highest st and Lowe west st Re Return rns (19 1926 26 thr hrough ough 20 2012 12) Highest Lowest Annual Returns (%) Large Co. Stocks 53.9 (1933) -43.3 (1931) Long- Term Gov’t Bonds 40.3 (1982) -14.9 (2009) Balanced (50/50 Stocks/Bonds) 34.7 (1995) -24.7 (1931) T-Bills 14.7 (1981) 0.0 (1938) Inflation 18.1 (1946) -10.3 (1932) 5-Year Rolling Returns (%) Large Co. Stocks 28.6 (1995-99) -12.4 (1928-32) Long- Term Gov’t Bonds 21.6 (1982-86) -2.1 (1965-69) Balanced (50/50 Stocks/Bonds) 20.9 (1982-86) -2.8 (1928-32) T-Bills 11.1 (1979-83) 0.1 (1938-42) Inflation 10.0 (1977-81) -5.4 (1928-32) Source: “Stocks, Bonds, Bills and Inflation—2013 Yearbook,” Ibbotson Associates, Chicago. 19 19
Hi High ghes est t an and Low d Lowes est t Re Return urns (1926 through 2012) (cont’d) Highest Lowest 10-Year Rolling Returns (%) Large Co. Stocks 20.0 (1949-58) -1.4 (1999-08) Long- Term Gov’t Bonds 15.5 (1982-91) -0.1 (1950-59) Balanced (50/50 Stocks/Bonds) 17.0 (1982-91) 2.0 (1965-74) T-Bills 9.2 (1978-87) 0.1 (1933-42) Inflation 8.7 (1973-82) -2.6 (1926-35) 20-Year Rolling Returns (%) Large Co. Stocks 17.9 (1980-99) 3.1 (1929-48) Long- Term Gov’t Bonds 12.1 (1982-01) 0.7 (1950-69) Balanced (50/50 Stocks/Bonds) 14.7 (1979-98) 4.6 (1929-48) T-Bills 7.7 (1972-91) 0.4 (1931-50) Inflation 6.4 (1966-85) 0.1 (1926-45) Source: “Stocks, Bonds, Bills and Inflation—2013 Yearbook,” Ibbotson Associates, Chicago. 20 20
On One St e Star artin ting g Po Point nt: : Cash for Liquid Ca idity ity Provides liquidity, particularly during extreme market conditions when you do not want to sell any stock holdings. Helps protect stock holdings during bad times — provides a cushion so you are less likely to panic and sell at a market low, the worst possible time. Recommendations: 3 to 5 years’ living expenses. A 4% withdrawal rate, combined with cash totaling 5 years, implies at least a 20% cash component. 21 21
St Stoc ocks ks for or Po Portfo folio lio Su Survival ival Ov Over er Long-Te Long Term rm Wi Withdr drawal awal Periods ds The longer your payout period, the greater the stock exposure required to ensure a portfolio’s survival. For 30-year time horizons you need roughly a 50% stock commitment to ensure portfolio survival if you use a 4% initial withdrawal rate. Stock portfolios must be diversified . One suggested rule of thumb: 120 – your age = stock % 22 22
Bon onds ds fo for r Sta tability bility an and Yi d Yield eld Your bond allocation depends on your risk tolerance (stock allocation) — whatever percentage remains after allocating to cash and stocks. Keep maturities short- to medium-term (5 to 7 years) to reduce downside risk. 23 23
Asset et Allocat catio ion n Amo mong the he Ma Market et Se Segm gmen ents ts The least volatile segment should be used as the core (at least 50% of that asset class). More volatile segments can be added to varying degrees, but at least 10% is needed to have a meaningful diversification effect. Make sure you understand the risks of the non- core segments. 24 24
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