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Retirement Withdrawal Strategies — Research Review

Monday, June 8th, 2009

I just returned from the NAFPA National Conference which was held near Washington, DC.  I’m still sorting through all of my session notes and handouts but I wanted to share a great session by Jonathan Guyton, CFP® who reviewed all of the recent research on retirement withdrawal strategies.

·    If you want to withdraw a steady amount each year from your portfolio (adjusted for inflation) you can have an initial withdrawal rate of 4-4.5% per year.

·    If you are willing to freeze your withdrawal in the year after your portfolio value declines then you can have an initial withdrawal rate of 5-5.5% per year.

·    If you are willing to reduce your withdrawal by 10% the year after your portfolio declines then you can have an initial withdrawal rate of 5.5-6.5%.

The most interesting part of the presentation was a “stress test” of a client who retired in 1973 (our current worst case historical scenario).  We had a big market decline in 1974 along with high inflation (which according to Guyton’s research is more dangerous to a retirement portfolio than market declines).

In all three cases the client had enough money to last until at least 2009 but in the first couple of cases the ride was very scary and most clients and advisors would likely abandon the policy.  The third scenario (which allows for reductions in withdrawals) would be a lot easier to adhere to without the client or advisor having sleepless nights.

Although in the first scenario the withdrawal rate starts out low, the combination of a big market decline in the second year and high inflation mean that the withdrawal rate quickly reaches double digits if the client increases their withdrawals to keep pace with inflation.  Although the withdrawal rate rises in the third scenario it is much less dramatic due to the ability to adjust the withdrawals based on the portfolio performance.

Posted in Investing, Retirement Plans | No Comments »

How do you who your Financial Advisor is really working for?

Saturday, March 28th, 2009

Jason Zweig of the Wall Street Journal wrote a nice piece in today’s paper about the arcane world regulating Financial Advisors.

Most advisors are not required to work in your best interests. That includes any advisor at a bank (e.g. Chase, Bank of America, Citibank) or brokerage company (Merrill Lynch, Smith Barney).

Despite the nice ads stating how they really help you out, their approach is similar to a car salesperson that explains the feature of a car and sells you one that is “suitable” for you needs but not necessarily what he things would be best with you. Most people understand that about a car salesperson but not their financial advisor.

The National Association of Personal Financial Advisors NAPFA) has a great series of videos that you can watch at www.focusonfiduciary.com .

Posted in Fee-Only, Investing | No Comments »

Higher Income makes it hard to Invest Enough for Retirement

Tuesday, March 24th, 2009

It seems counterintuitive but having a higher income could make it harder for you to save enough to retire. Let’s look at two couples.

Couple 1:

Age: 45

Retirement Age: 65

Income: $400,000/year

Savings To Date: $500,000

Retirement Income Goal: $300,000/year (today’s dollars)

Less: Estimated Social Security $50,000/year*

Amount Needed from Investments: $250,000/year (today’s dollars)

Investment Income Needed 1st Year of Retirement: $547,866**

Annual Investment Needed***: $177,000

% of income to invest to meet Retirement Goal: 44%

Couple 2:

Age: 45

Retirement Age: 65

Income: $80,000/year

Savings To Date: $100,000

Retirement Income Goal: $64,000/year (today’s dollars)

Less: Estimated Social Security $40,000/year*

Amount Needed from Investments: $24,000/year (today’s dollars)

Investment Income Needed 1st Year of Retirement: $52,587**

Annual Investment Needed***: $13,000

% of income to invest to meet Retirement Goal: 16%

*Social Security could be reduced for higher income taxpayers in the future

** Assumes Inflation of 4%/year and Investment Return of 8% per year

***Increased by inflation rate each year.

The high income Couple needs to save 44% of their income vs. 16% for the moderate-income couple. Why? For the moderate-income couple Social Security will pay a much greater percentage of their retirement income. The Social Security tax is almost like forced retirement savings. The higher income couple is on their own to invest for retirement.

The message: If you have an income in this range or higher, it is even more important to invest a substantial portion of your income for retirement and not to let the fact that you can “afford” things now lead you to establish a lifestyle that will be unsustainable in retirement.

Posted in Budgeting, Families, Investing | No Comments »

Index Funds Still Winners

Wednesday, February 25th, 2009

I read an interesting analysis in the New York Times that compared a hypothetical stock index fund, with an actively managed stock fund, and a hedge fund. Because of higher fees and taxes the actively managed stock fund would have to outperform the index fund before taxes by an average of 4.3 percentage points per year to be a better long-term investment. The hedge fund would have to do 10 percentage points better over a 20 year period.

How many actively managed funds have pull off that feat – 13! You would have to be very lucky to figure out which 13 funds (out of several thousand) would be the ones to outperform over the next 20 years.

Read the whole article at http://www.nytimes.com/2009/02/22/your-money/stocks-and-bonds/22stra.html?scp=1&sq=index%20funds&st=cse

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Time to Harvest

Wednesday, December 17th, 2008

No, this is not about crops. It’s time to harvest your tax losses after the big declines in the stock market. Tax loss harvesting is a silver lining in a terrible year for stocks.

Here’s how it works:

On January 1, 2008 you had mutual funds worth $400,000.

Now they are worth $250,000 for a paper loss of $150,000

To harvest this loss you do the following:

  • Sell your mutual funds – now you have a loss for tax purposes of $150,000
  • Buy very similar mutual funds with the $150,000 proceeds – your investment strategy is still essentially the same
  • After 31 days, sell the new mutual funds and buy back your original funds

With your loss of $150,000 you can do the following:

  • Offset any gains you have (one client had substantial from earlier this year from selling individual stock holdings. This strategy will save her over $20,000 in capital gains tax.)
  • Offset up to $3,000 per year in income each year until your losses are used up.
  • Offset future gains you may have in the future.

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Expect more volatility

Friday, October 24th, 2008

The stock market has had some crazy gyrations of the past month, sometimes swinging wildly up and down during the course of a single day. These gyrations are normal during times of economic transitions. During the period after the great crash of 1929, the stock market did not go straight down but swung wildly with big rallies and big drops. Some of the biggest up days were in late 1929 and again in 1931. However, the overall trend was down. Our recent experience has been similar although the timeframe has been greatly compressed.

Until we understand the full extent of our economic situation expect the market to overreact to any news whether good or bad.

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The Financial Meltdown Continues . . .

Friday, September 19th, 2008

Lehman Brothers an investment bank files for Chapter 11 Bankruptcy, Bank of America buys Merrill Lynch at a fire sale price, and insurance giant AIG needs a huge loan from the Fed to avoid bankruptcy. All of these problems are the result of the mortgage excess with its roots in greed that have now spread across the financial sector. Banks no longer want to lend to each other because they don’t trust that the bank they are lending to is actually solvent or ready to implode.

The Fed and the Treasury Dept. have now developed a plan to address the financial sector meltdown and the stock market shot up yesterday and today, but there is likely more bad news ahead.

Despite the bad not all is not lost. You should not move all of your retirement money to cash. The S&P 500 (the best measurement of “the market”) is still over 50% higher than it was 6 years ago. If you are having trouble sleeping or you are worrying a lot about your investments, I recommend you do the following:

  1. Check your retirement account balances and calculate how much your portfolio has declined.It may have declined less than you thought because most investors are invested more broadly then the Dow or S&P 500 indices which are often used to represent the stock market.
  2. Review your results with the downside risk inherent in your asset allocation.Your financial advisor should have reviewed this with you when he or she wrote your investment policy statement and reviewed it with you.If your advisor did not do this or if you need an advisor who can develop a good investment strategy for you go to www.napfa.org
  3. If your losses are within the range the advisor projected as possible but you still are uncomfortable then you may want to review your overall risk tolerance.You may be less risk tolerant than your thought.
  4. If your risk tolerance has changed, you may want to consider changing your asset allocation strategy.Understand that moving to a more conservative allocation may mean that you need to save more or be prepared to work longer.
  5. Understand that investing is for the long-term and that almost no long-term strategy that provides a reasonable long-term rate of return can protect you completely from short-term losses
  6. Also understand as humans we are wired to respond to short-term changes (positive or negative) and discount long-term changes that are more significant

For example, only a short-term increase in gas prices got us to reduce our gas consumption, not the possible larger but longer term effects of global warming.

Next blog, what to expect in the future.

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