If there is a "secret" to retirement, it consists of
more than just having a lot of savings. A 2002 study of American
retirees found that the single biggest factor in satisfaction was
not total assets, but financial preparedness—the knowledge that a
person's resources and plans for drawing on them would sustain the
lifestyle that person wanted over the long-term.*
Regardless of wealth, the most satisfied retirees were those who
had been saving for the longest (24 years or more) and were using a
variety of different investment classes and vehicles.
By saving for long periods, these retirees had demonstrated a
willingness and ability to think about their later years. And
continuing to trade off the use of assets even when in retirement,
remains important.
With that in mind, here are three tips to consider now to ensure
satisfaction with your financial portfolios in the years to come.
No. 1: Withdraw Less
Until recently, many people based their projections for
investment returns on the high equity returns realized from 1982 to
2000. Many assumed they could look forward to drawing out 8% a year
or even more and count on rising stock prices to keep the total
value of their portfolios unchanged.
The severity of the most recent market correction has exposed
this fallacy. But even substituting lower average return rates isn't
a solution. The truth is that market returns don't go up and down in
steady, predictable averages. The ups and downs can be large,
unforeseen, and can last for years.
A more realistic way to estimate how long assets may last is to
use past returns to project the probabilities for different future
scenarios. The chart below uses this method to show the effect of
different withdrawal rates on the number of years a portfolio may
last.
As you can see, there is a 90% probability that the portfolio of
50% stocks, 40% bonds, and 10% short-investments would be exhausted
in just over a decade at a 10% withdrawal rate. However, at a 4%
withdrawal rate, the portfolio would last for 33 years.
For a healthy couple aged 65 today, the chances that at least one
of them will live to age 85 are about 80%. And there's almost a 60%
chance that at least one of them will live to 90.**
Withdrawing too much early can be a mistake that's very hard to
recover from later. Ask yourself who will really enjoy retirement
more—a couple that lives more modestly, withdraws less and
maintains a large cushion. Or one who withdraws more early, only to
see their portfolio shrink to the point where they might have to
significantly downsize their lifestyle?
No 2: Live With Risk
As we've just seen, playing it safe by withdrawing less
from your accounts in retirement may be a good strategy. But when it
comes to choosing the investments in those accounts, opting only for
"safe" investments like high-grade bonds, U.S. Treasury
securities or money market funds can actually pose a significant
long-term risk.
There is a real danger that over-anxious investors may overreact
to the market downturn that has marked much of the last three years
by selling most or all of their equity funds or individual equity
holdings. Unless you have huge cash resources, adopting such an
ultra-conservative strategy can seriously raise the risk of
outliving your assets.
As an example, let's compare three hypothetical portfolios***.
The first consists entirely of short-term, money-market type
investments. The second consists of 30% short-term, 50% bonds, and
20% stocks. The third consists of 10% short-term, 40% bond, and 50%
stocks.
Assuming an inflation-adjusted annual withdrawal rate of 5%, all
three portfolios are likely to provide reliable income flows for the
first 15 years. After that, the risk of running out of assets begins
to increase.
After 25 years, the first and second portfolios are at severe
risk of running out of money. In fact, the first portfolio has
nearly a 100% chance of being exhausted while the second has roughly
a 60% chance. Meanwhile, the third portfolio, with a greater
percentage invested in stocks, has an 80% chance of remaining intact
after 25 years.
Bottom line: longer lifespans mean that many retirees have time
to wait out equity market volatility, and doing so may be a key
ingredient in pursuing long-term wealth preservation.
No. 3: Be a Working Investor
Retirement isn't a time to relax your attention to
investments. We've touched on the importance of managing withdrawal
rates and balancing asset allocation to pay for a long retirement.
Changing plans, changing markets, and changing stages of life
will probably always mean that the most satisfied retirees will have
one thing in common: that they never truly retire from keeping an
eye on their investments.
By withdrawing your retirement assets at a conservative rate,
maintaining a balanced mix of assets well into your retirement
years, and actively monitoring your investments as you age, you can
improve the odds that your savings will last as long as you do.
* Source: 2002 Study of American retirees
by gerontologist Ken Dykwald.
** Source: Probability of survival based
on Annuity 2000 Mortality Table from Society of Actuaries.
*** Source: Fidelity Investments.
Hypothetical value of assets held in the portfolios is based on
untaxed stocks, bonds and short-term investments. Historical data
used for the asset classes is from Ibbotson Associates; stocks,
bonds and cash are represented by S&P 500, US Intermediate
Government Bonds and US 30-day T-Bill. Average 3% inflation rate
assumed (historical average from 1926 through March 2003 was 3.06%).
Actual inflation rates may be more or less. Past
performance is no guarantee of future results.
