Dur urin ing Re g Reti tire reme ment nt Maria Crawford Scott - - PowerPoint PPT Presentation

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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

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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

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Di Discussi scussion

• n 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.

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One Popular ar Wi Withd hdra rawal wal Approach: ch: Th The D e Dow

• wns

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.

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An Anot

• ther

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.

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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.

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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)]

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Wi Withdr hdrawal awal Ra Rate e Ap Appr proac

• ach

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.

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Th The W e Withdr hdrawa awal l Ra Rate e Ap Appr proa

• ach

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.

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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.

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 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.

Adaptin apting g th the e With thdrawal drawal Rate te Approach to the Real World (con’t)

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Po Portfo folio lio Su Succes cess s Ra Rates es: : Up Upda dated ed

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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.

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Th The K e Key ey to Po

• 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.

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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.

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Maj ajor

• r 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

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St Stoc

• cks

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.

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Hi Highest st and Lowe west st Re Return rns (19 1926 26 thr hrough

• ugh 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.

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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.

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On One St e Star artin ting g Po Point nt: : Ca Cash for Liquid 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.

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St Stoc

• cks

ks for

• r Po

Portfo folio lio Su Survival ival Ov Over er Long Long-Te 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 %

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Bon

• nds

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.

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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.

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On One Ap e Appr proa

• ach

ch to Al

• Alloc
• cating

ating Am Amon

• ng

g Ma Market t Segme ments ts

Stock Market Segment Large Co. Core: 80% to 50% Small Co. Non-Core: 10% to 40% International Non-Core: 10% to 40% Bond Market Segment High-Quality Core: 80% to 50% High-Yield Non-Core 10% to 40% International Non-Core: 10% to 40%

The percentages range from conservative to aggressive and are based on the concept of effective diversification within the asset classes, with variations based on your investor profile. However, final allocation decisions should be based on a thorough understanding of the investment categories. Never invest in a segment if you don’t understand it or are uncomfortable with the risks.

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Mai aintaining ntaining You

• ur

r Por

• rtfolio

tfolio

 Portfolio Management Rules  Inflation Rules  Withdrawal Rules  Capital Preservation Rules  Midcourse Adjustments

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Po Portfo folio lio Ma Mana nage gemen ment t Ru Rules es

Portfolio management rules add only minimal benefits to the withdrawal rate:

1)

In a year when performance causes an asset class to become overweighted, sell excess and invest in cash.

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Po Portfo folio lio Ma Mana nage gemen ment t Ru Rules es (cont’d)

2)

Withdrawals each year are funded in the following order: Stock overweightings; fixed- income overweightings; cash; withdrawals from fixed income; withdrawals from stock segments based on prior year’s performance.

3)

No withdrawals from any stock segment following a year in which it had negative returns if cash or fixed-income assets can fund the required withdrawal.

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Inf nflation lation Ru Rules es

Inflation Rules add slight benefits to the withdrawal rate:

1)

Maximum annual inflation increase is 6%.

2)

There is no “make-up” for a capped year.

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Wi Withdr hdrawal awal Ru Rules es: : Mo Modest t Benefits its

Withdrawal Rules add modest benefits to the withdrawal rate:

1)

No increase in withdrawal amount for inflation if prior year’s investment return is negative.

2)

No “make-up” for a missed year.

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Ca Capital pital Pres reservation ervation Ru Rules les

Capital Preservation Rules do benefit the withdrawal rate:

1)

If current year’s withdrawal rate rises more than 20% above the initial withdrawal rate, then the current year’s withdrawal is reduced by 10%.

2)

Decreased withdrawal rate becomes basis for determining next year’s withdrawal amount.

3)

Rule expires 15 years before maximum planning age.

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Capital Preservation Rules (Cont’d)

 Drawback: Lost purchasing power each

time rule is triggered.

 “Prosperity rule” (increases the withdrawal

rate when current withdrawal rate is 20% below the initial withdrawal rate) can be applied; drops the benefits to the withdrawal rate by about 0.5%.

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Ca Capi pita tal l Pr Pres eser ervat vatio ion n Ru Rule e Ex Exam ampl ple

Initial Portfolio Value: $1 million; First-Year Spending Rate: 5.5%; Trigger Rate: 6.1% New New Annual Actual Current New Current New Current Spending Annual Savings at Spending Spending Savings Spending Spending Savings Spending Year Amount Return Year-End Rate Amount Year-End Rate Amount Year-End Rate ($) (%) ($) (%) ($) ($) (%) ($) ($) (%) 1 55,000 8.3 1,022,963 5.5% 2 56,650

• 3.1

936,840 5.5% 3 56,650 14.0 1,003,417 6.0% 4 58,350 7.6 1,016,420 5.8% 5 60,100

• 2.3

934,802 5.9% 6 60,100 4.0 909,691 6.4% 54,090 915,941 5.8% 7 61,903 9.2 925,360 6.8% 55,713 938,939 6.1% 50,141 945,020 5.5% 8 63,760 11.5 960,684 6.9% 51,646 996,113 5.5% 9 65,673

• 5.4

847,128 6.8% 53,195 892,471 5.3% 10 65,673

• 11.3

693,541 7.8% 53,195 744,858 6.0% 11 65,673 20.6 757,209 9.5% 53,195 834,145 7.1% 50% Stock/50% Bond Portfolio

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De Decisio ision n Ru Rules es an and th d the e Wi Withdr hdrawal awal Ra Rate

90% 0% Succes ess Rate 95% 5% Succes ess Rate Max ax Amt Max ax Amt Initia nitial

• f Init

itia ial

• f
• f

W/D Rate e Inc ncre reas ase e W/D Rate e Inc ncre reas ase (%) ) (%) %) (%) %) (%) (%) No Decis ision ion Rules es Port rtfolio lio w/50% 50% Stoc

• ck

3.6 na na 3.3 na na Port rtfolio lio w/80% 80% Stoc

• ck

3.6 na na 3.0 na na Port rtfolio lio Manage nagemen ent Rules les Port rtfolio lio w/50% 50% Stoc

• ck

3.6 3.3 Port rtfolio lio w/80% 80% Stoc

• ck

3.6 3.2 7 Inf nflat lation ion Rules les Port rtfolio lio w/50% 50% Stoc

• ck

4.1 14 14 3.7 12 12 Port rtfolio lio w/80% 80% Stoc

• ck

4.0 11 11 3.4 13 13 Withdr hdraw awal al Rules es Port rtfolio lio w/50% 50% Stoc

• ck

4.3 19 19 3.9 18 18 Port rtfolio lio w/80% 80% Stoc

• ck

4.4 22 22 3.9 30 30 (Cont

• ntin

inue ued d on nex ext slide ide)

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De Decisio ision n Ru Rules es an and th d the e Withdrawal Rate (Cont’d)

90%

% Success Rate 95% % Success Rate Max ax Amt Max ax Amt Init nitial ial of Ini nitia ial l of W/D Rate e Inc ncre reas ase e W/D Rate e Inc ncre reas ase (%) (%) (%) (%) (%) (%) (%) (%) All Three ree Rules les Port rtfolio lio w/50% 50% Stoc

• ck

4.7 31 31 4.3 30 30 Port rtfolio lio w/80% 80% Stoc

• ck

4.8 33 33 4.3 43 43 Add d Cap p Pres eser erve e Rule* e* Port rtfolio lio w/50% 50% Stoc

• ck

5.1 42 42 4.8 45 45 Port rtfolio lio w/80% 80% Stoc

• ck

6.3 75 75 6.2 106 106 Assumes es a 40-year ear horiz rizon.

• n.

*Inf nflat lation ion Rule le was dropp

• pped

ed for

• r this

is scena enario rio. Source: “Decision Rules and Maximum Initial Withdrawal Rates,” by Jonathan T. Guyton and Willia iam J. Klinge nger, r, Jour urnal nal of Financ nancial ial Planning anning, Marc rch h 2006 06.

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Po Portfo folio lio Ma Maint ntena enance: nce: Th The e Mi Midcourse urse Adjust stme ment nt Strategy tegy

Every 5 years, re-evaluate and re-adjust withdrawal amounts based on size of portfolio and shorter time horizon. The results of the study indicated this strategy was:



Less likely to run out of money early in retirement.



More likely to provide larger total withdrawals over the retirement span.



Not designed to provide a large estate.



Likely to produce more variability in withdrawal amounts, with the possibility of some being much lower than average.

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Midc idcourse

• urse Adj

djustment ustment Study udy

Fix ixed ed Withdr hdraw awal al Stra rategy egy* Mid-Cour Course se Correct rrectio ion Stra rategy* egy**

Maximum Sustainable Withdrawal Rate (%) 3.8 17.17 Average Withdrawal Rate (%) 3.8 8.4 Shortfall (% out of 10,000 sequences) 4.5 4.8 Earliest Runout Year 14 29 Balance Remaining ($; start amount: $100) 206 23 Strate ategy gy compari ariso son: n: Withdraw hdrawal l amounts nts for 5% shortfall tfall risk k and a 50/50 0 stock/ ck/bon

• nd allocatio

ation

* * Fixe xed Strate rategy: y: Fixe xed with thdra rawa wal l and fixe xed allo loca catio tion (50/5 /50 stocks/b cks/bonds) s). ** Mid-Co Course se Corr rrectio ction: : Revise vised with thdrawa rawal l rate te eve very y 5 years rs and fixe xed alloca locatio tion (50/5 /50 stocks/b cks/bonds) s). Source: “Retirement Withdrawals: An Analysis of the Benefits of Periodic ‘Midcourse’ Adjustments,” by John J. Spitze itzer, r, Financia cial l Servi rvice ces s Revie view w 17 (2008). ).

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Ma Maximu mum m Wi Withdr hdrawa awal l Ra Rates es an and d Co Correspo spond nding ing Stock k Allocat catio ions ns

5% Short rtfal fall Risk 10% Short rtfal fall Risk Stock Max Stock Max Longevi gevity ty Alloc

• c.*

.* W/D Alloc

• c.*

.* W/D (Year ars) (%) (%) (%) (%) (%) (%) 5 5 20 20 18.6 18.6 25 25 19.3 19.3 10 10 20 20 9.5 9.5 35 35 10.1 10.1 15 15 25 25 6.6 6.6 35 35 7.1 7.1 20 20 35 35 5.3 5.3 40 40 5.7 5.7 25 25 35 35 4.4 4.4 55 55 4.9 4.9 30 30 30 30 3.9 3.9 50 50 4.4 4.4 35 35 40 40 3.5 3.5 45 45 4.0 4.0 *Remai ainder nder is in bonds ds Source: “Retirement Withdrawals: An Analysis of the Benefits of Periodic ‘Midcourse’ Adjustments,” by John J. Spitzer, Financial Services Review 17 (2008).

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St Strat ategy egy Co Comp mpar arison: son: Wi Withdr hdrawa awal l Amo mounts s for 5% Sh Shortf tfall ll Ri Risk

Mid-Cour

• urse/

e/ Mid-Cou Course rse Variabl able Fix Fixed ed Corr rrec ecti tion

• n

Alloc

• cati

ation

• n

St Strategy* rategy* St Strategy* rategy** Strategy tegy** *** Max Max Sus Sustai tain W n W/D /D Ra Rate te (%) %) 3.8 .8 17.2 17.2 11.3 11.3 Av Avg W g Withd thdra rawal wal R Rate ate (% (%) 3.8 .8 8.4 8.4 6.7 6.7 Shor Shortfal tfall (% o % of 10,000 f 10,000) 4.5 .5 4.8 4.8 5.2 5.2 Earl Earlies est t Runou Runout Yea t Year 14 14 29 29 29 29 Bal Balanc ance e ($; S ($; Star tart: t: $100 $100) 206 206 23 23 12 12 * * Fixed

d Strat rateg egy: Fixed ed withdr hdraw awal al and d fixed d alloc

• catio

ion n (50/ 0/50 50 stoc

• cks/bo

bonds nds). ** Mid-Cour

• urse

e Correc rrectio ion: n: Revis ised ed withd hdra rawal al rat ate e ever ery 5 years ears and d fixed ed alloc

• cat

ation ion (50/ 0/50 50 stoc

• cks/bon

bonds ds). ). *** Mid-Cou

• urs

rse/ e/Var Variable iable: Revis ised ed withdr hdraw awal al rate and nd variab ariable le alloc locatio ion n (dec ecre reas asing ing stoc

• cks).

Source: “Retirement Withdrawals: An Analysis of the Benefits of Periodic ‘Midcourse’ Adjustments,” by John J. Spitzer, Financial Services Review 17 (2008).

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Live ve Long ng and d Live ve We Well: ll: A Portfolio tfolio Surviv rvival al Gu Guide ide

 NUMBER 1: Use a ‘withdrawal rate’ approach to

separate rate your asset et allocatio ation n decisi sion n from

• m your

im immediat diate wi withdrawal rawal needs, s, and to encoura urage ge you to invest st for r the long term rm.

 NU

NUMBER R 2: Us Use a r realist stic c wi withdraw rawal al rate—not

• t more

re than 4% of the initial al portfo tfolio io value.

• e. In subsequ

quent ent years, s, the annual l doll llar r amount nt can be in increa eased sed by your assume umed d inflat ation n rate. e.

 NU

NUMBER R 3: Asset et allocati ation

• n helps you reduce

ce the risk, k,

• ver the lo

long term, rm, of unknown wn (in in advance) ce) adverse rse conditi itions.

• ns. Make

ke sure e your portfo tfolio lios s are we well-dive iversifi rsified d among g the major r market ket segments, ents, and do NO NOT make e any major r bets on any one market rket segment ent or any single styl yle e of invest sting. g.

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Live ve Long ng and d Live ve We Well: ll: A Portfolio tfolio Surviv rvival al Gu Guide ide

 NU

NUMBER R 4: Us Use your cash allocati ation n as a li life preserver erver for r extr treme eme market rket condit itions ions—ma main intain tain a cash exposure of 3 to 5 years’ living expenses for liquidity. And if you have a lo longer-te term rm horizon,

• n, maintai

tain n at least t a 50 50% exposure sure to stocks cks to provi vide e growt wth h and to protect tect the long-ter term m purcha hasing sing powe wer of your futur ture wi withdra drawal wals. s.

 NU

NUMBER R 5: Us Use rules regardi rding ng annual wi withdraw rawal al amount nt increa eases ses and decrea eases ses to help maintai tain your portfoli tfolio—and nd ensure re that at you stay y on course. se.

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AAII Journa nal Re Resources rces

ARTICLES (all are available at the AAII website: www.aaii.com)



“A Key to a Lasting Retirement Portfolio,” by John Sweeney, April 2013.



“Finding the Right Withdrawal Rate: One Key to Portfolio Sustainability,” by Maria Crawford Scott, July 2012.



“Portfolio Rebalancing: Diversification, Risk Control and Withdrawals,” by Charles Rotblut, March 2012.



“Getting Through Difficult Markets,” by Julie Jason, November 2011.



“Retirement Spending on Planet Vulcan: Longevity Risk and Withdrawal Rates,” by Moshe Milevsky and Huaxiong Huang, September 2011



“Repairing the Damage to Assure the Flow,” by Christine Fahlund, February 2009



“Will Your Savings Last? What the Withdrawal Rate Studies Show,” by William Reichenstein, July 2008



“Optimizing Your Retirement Income: What Works Best and Why,” by Christine Fahlund, August 2008



“Invest or Delay? Strategies for Taking Social Security Benefits,” by Christine Fahlund, February 2007



“Withdrawal Strategies to Make Your Nest Egg Last Longer,” by William Reichenstein, November 2006



“Tax-Efficient Investing: Picking the Right Pocket for Your Assets,” by William Reichenstein, November 2005



“Withdrawal Rules: Squeezing More From Your Retirement Portfolio,” by Jonathan Guyton, August 2005



“Allocation During Retirement: Adding Annuities to the Mix,” by William Reichenstein, November 2003



“Bear Market Strategies: Watch the Spending, Hold the Stocks,” by T. Rowe Price Associates, May 2003



“Retirement Savings: Choosing a Withdrawal Rate That Is Sustainable,” by Philip L. Cooley, Carl M. Hubbard, and Daniel T. Walz, February 1998