Getting Going
Playing the Right Retirement Cards
By Jonathan Clements
11/16/1999
The Wall Street Journal
(Copyright (c) 1999, Dow Jones & Company, Inc.)
Retirement is like a long vacation in Vegas.
The goal is to enjoy these years to the fullest, but not so fully that
you run out of money. It is a dicey endeavor, involving tricky issues of
longevity and investment returns.
As you try to figure out how much you can spend once retired, take a
cue from the accompanying tables, which were put together by T. Rowe Price
Associates, the Baltimore mutual-fund company.
To use the tables, you have to decide how long your retirement might
last, what stock-bond mix you will hold and what percentage of your
portfolio's
value you might withdraw in the first year of retirement. After the first
year, you are assumed to step up the amount you withdraw, along with
inflation.
The tables don't provide definitive answers. Instead, like a gambler,
you have to play the percentages. The answer you pluck from the tables
is the chance that you will make it through retirement, without running
out of money.
The probabilities are generated by considering hundreds of possible
market scenarios. These scenarios take into account not only the
historical
volatility of returns, but also the diversification benefits that can come
from combining stocks with bonds or mixing U.S. shares with foreign
securities.
T. Rowe Price's focus on different market scenarios reflects a recent
change in the way investment advisers think about retirement spending.
Before, advisers would often simply project likely average returns for
a retiree's portfolio, make some allowances for inflation and then figure
out how much the retiree could withdraw so that the portfolio would last,
say, 25 years.
The problem was, even if advisers guessed right about the average
returns,
they could still come up with the wrong answer. "It's the sequence of
returns
that are critical, not the average rate of return," says Todd Cleary, a
vice president at T. Rowe Price.
To understand how important the pattern of returns is, imagine you held
a mix of 60% stocks, 30% bonds and 10% Treasury bills over the 30 years
ended 1998. That mix generated a spectacular 11.7% annual rate of return,
far above the historical averages.
But despite that sizzling performance, the sustainable withdrawal rate
was just 5.8%. Why so little? Unfortunately, the early returns were so
miserable that, by the time the good results rolled around, a lot of your
retirement money would already have been spent and thus you didn't reap
the full benefit of this healthy performance.
For comparison, imagine you lived the 30 years in reverse, so that you
began with 1998's generous returns, then moved on to 1997 and so on,
finishing
with 1969. Result? T. Rowe Price calculates that your portfolio could have
sustained a 10.7% withdrawal rate.
In truth, most retirees would be lucky to enjoy a 5.8% withdrawal rate,
yet alone 10.7%. As the tables suggest, a 6% withdrawal rate is possible
for those looking at a 20-year retirement, but it's a dodgy proposition
for anybody contemplating a longer retirement.
Mr. Cleary says he wouldn't adopt a strategy that had less than a 70%
chance of success. That means folks who expect a 25-year retirement should
probably stick with a 5% withdrawal rate, while those looking at a 30-year
retirement ought to opt for just 4%.
For the legions of wage slaves who dream of early retirement, this
isn't
good news. To generate $40,000 in annual income, you would need $1
million.
And that $40,000 is pretax.
Moreover, a 70% chance of success means there is a 30% chance of
failure.
The tables were generated by T. Rowe Price as part of a new program, which
-- for a $500 fee -- will help retirees figure out how much income their
portfolios can generate. T. Rowe Price has found that most folks want at
least an 85% chance of success.
On the other hand, you do have only one shot at retirement, and you
don't want to pinch pennies unnecessarily. The best approach may be to
adopt a riskier strategy, knowing you will throttle back your spending
if the markets turn against you.
In fact, many retirees do this instinctively. "If people's portfolios
are doing poorly, they tend to cut their spending, because they're scared
that they'll run out of money," says Minneapolis financial planner Ross
Levin.
(See related letter: "Letters to the Editor: Retirement Funds For the
Risk-Averse" -- WSJ Dec. 6, 1999)
Do You Feel Lucky?
To get a handle on how much you
can spend in retirement without running out of money, check out the table
below. For instance, the table suggests there is a 58% chance that a mix
of 60% stocks and 40% bonds will sustain a 5% withdrawal rate all the way
through a 30-year retirement.
20-Year Retirement Withdrawal
-------------- STOCK/BOND MIX --------------
RATE 100/0 80/20 60/40 40/60 15/85 5/95
4% 97% 99% 100% 100% 100% 100%
5 91 93 95 96 97 93
6 76 78 77 70 48 19
7 56 53 46 28 2 0
25-Year Retirement Withdrawal
-------------- STOCK/BOND MIX --------------
RATE 100/0 80/20 60/40 40/60 15/85 5/95
4% 93% 95% 96% 97% 98% 93%
5 78 79 79 66 46 14
6 59 56 48 27 2 0
7 38 31 18 3 0 0
30-Year Retirement Withdrawal
-------------- STOCK/BOND MIX --------------
RATE 100/0 80/20 60/40 40/60 15/85 5/95
4% 85% 88% 86% 85% 71% 37%
5 68 66 58 42 8 0
6 47 41 28 10 0 0
7 24 18 7 1 0 0
Source: T. Rowe Price
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