There's Just No Rest
For the Retired Investor

By JONATHAN CLEMENTS

Retirees often write to me, complaining that there aren't enough articles devoted to the issues they face. And they're right.

Investing in retirement? Who cares about that? Most of us ink-stained wretches are years from retirement, so the subject doesn't much interest us.

But there's another reason for this neglect by personal finance writers. Investing in retirement is so tricky that it just doesn't lend itself to journalistic generalizations.

The fact is, once you give up that paycheck, your everyday life may be a lot more fun, but your financial life becomes infinitely more complicated. Here are just some of the uncertainties that retirees face:

Living Long

If you are saving for retirement or your kid's college education, you have a pretty good idea of what your time horizon is. By contrast, once you retire, you don't know whether you need to make your money last a few years or a few decades.

For proof, consider some statistics from William Huff, an actuary with Seattle's Safeco Corp. Mr. Huff looked at the life expectancy for folks age 65.

He threw out the extremes, the 10% of 65 year olds who will die the most quickly and the 10% who will live the longest, leaving only the middle 80%. Even then, the range was huge. Men in this middle 80% might live as little as seven years or as long as 32 years. For women, the range was 10 to 33 years.

Clearly, how you manage your finances will vary enormously, depending on where in that range you think you will fall. As you try to get a handle on your life expectancy, consider your health, family longevity and whether you smoke.

Such factors are built into an intriguing quiz that is available at www.livingto100.com. But no matter what life expectancy the Web site suggests for you, you should plan for a somewhat longer retirement, just in case the doctors and the actuaries turn out to be wrong.

Rising Costs

The dollar's spending power was slashed by 51% in the 1970s, 39% in the 1980s and 25% in the 1990s, according to Chicago's Ibbotson Associates. In other words, even in the low inflation 1990s, folks living off a fixed income would have seen their standard of living cut by a quarter.

Moreover, older Americans were hit even harder than the statistics suggest. "Retirees have a much higher inflation rate than the general population, largely because of medical costs," says Henry Hebeler, a retired engineer and author of "J.K. Lasser's Your Winning Retirement Plan." "My wife and I visit widows in their 70s and 80s who spend over $1,000 a month on prescription drugs."

The implication: As you confront the prospect of spending 20 years or more in retirement, you can't simply plunk your savings in bonds or certificates of deposit and then spend all the interest.

Instead, you need to ensure that your portfolio continues to grow in the first 10 or 15 years of retirement, thus partly offsetting the corrosive impact of inflation. That means not only reinvesting a sliver of the interest from your CDs and bonds back into your portfolio, but also stashing maybe half your money in stocks.

Performance Perils

Fending off inflation is a lot easier if the markets are kind. On that score, the 18 years through year end 1999 were a bonanza for retirees. The Standard & Poor's 500 stock index clocked 18.5% a year and long term government bonds garnered 12.1%, while inflation shuffled along at 3.3% annually.

But the prior 16 years, through year end 1981, weren't nearly so generous. According to Ibbotson, the S&P 500 gained just 5.9% a year and long term government bonds returned 2.5%, less than the 7% inflation rate.

Will today's retirees get lucky or unlucky? With long term government bonds yielding less than 6% and stocks still at nosebleed valuations, my hunch is that the decade ahead will deliver lackluster returns.

But even if the next 10 years eventually offer up healthy gains, you need to pay attention to the "sequence of returns." This is especially critical in the first few years after you quit the work force.

Suppose you retire and immediately get hit with a vicious bear market. If you are not careful, the combination of market losses and your own withdrawals could devastate your portfolio.

Indeed, even if the market later rebounds strongly and fares well through the rest of your retirement, you may still find yourself pinching pennies. The reason: Your portfolio was so depleted in those initial years that you don't benefit much from the subsequent strong returns.

Self-Inflicted Wounds

You can't control how the market performs. But you can limit the damage done, by investing and spending prudently.

No matter what your age, you will likely get in a heap of financial trouble if you roll the dice on risky stocks, rack up hefty investment costs, hire an unscrupulous financial adviser or spend too much. But such missteps are especially devastating once you quit the work force, because you can't use your next paycheck to paper over your mistakes.

"We live in a golf course community, and you see people dropping their membership all the time," Mr. Hebeler says. "People often overspend in their early retirement years, and then they have to cut back."

Keeping the Cash
Flowing in Retirement

By JONATHAN CLEMENTS
Staff Reporter of THE WALL STREET JOURNAL

You need a fork. What you've got is a knife and spoon.

Once retired, your goal is to generate a generous stream of income that grows along with inflation and isn't threatened by market turmoil. But it's tough to find that magical combination in a single investment.

Sure, stocks may provide long run inflation protection. But they usually don't kick off much income and they can suffer wild share price swings.

Bonds, on the other hand, do yield a fair amount of income. But with the exception of inflation indexed Treasury bonds, they don't generate rising income, so they leave you vulnerable to inflation.

So how are you going to garner that generous, growing stream of income? You need to settle on the right mix of stocks and conservative investments. But that sure isn't easy.

Playing the Percentages

To understand how tricky all of this is, suppose you retire with $400,000 and pull out 5%, or $20,000, in the first year of retirement. That $20,000 would include any dividends and interest you receive.

In subsequent years, you step up your annual withdrawals along with inflation. For instance, if consumer prices rose at 3% annually, you would pull out $20,600 in the second year, $21,218 in year three and so on.

Doesn't sound like much income? True, if you withdraw 5% in the first year of retirement and your portfolio returns, say, 6% or 7%, it might seem like you are being overly conservative, because your portfolio will finish the year 1% or 2% larger.

But in fact, if consumer prices are rising at 3%, the inflation adjusted "real" value of your portfolio is shrinking. Meanwhile, with every passing year, your withdrawals are climbing along with inflation. The one-two punch of rising withdrawals and shrinking real portfolio values will eventually deplete your portfolio -- if you live too long.

Still, you should be able to sustain a 5% withdrawal rate through a lengthy retirement, provided your portfolio clocks around 7% a year over the long haul.

"There's no way you can get that 7% from a bond portfolio, unless you own the riskiest bonds," says Minneapolis financial planner Ross Levin. "You've got to own some stocks. But that introduces a whole new set of headaches."

Resting on a Cash Cushion

Make no mistake: Stocks are a mixed blessing. You need to keep maybe half your portfolio in stocks to sustain a 5% withdrawal rate. But if you are not careful, your nest egg could be devastated by a stock market plunge, as the combination of your own spending and slumping share prices rapidly drains your portfolio.

What to do? If you get hit with big investment losses, immediately cut back your spending until the market recovers. But even then, you will have a problem.

The reason: If you own 50% stocks and 50% bonds, your portfolio's yield will probably be around 3%, after costs, far less than the sum you are looking to withdraw.

In most years, you could garner extra spending money by selling stocks. But if you did that during a bear market, you would be unloading shares at fire sale prices. What's the alternative? Give yourself room to maneuver, by building a cash reserve.

Based on a 5% withdrawal rate, you will consume roughly a quarter of your portfolio's current value over the next five years. As a precaution, take that quarter of your portfolio and stash it in short term bonds, money market funds, inflation indexed Treasury bonds and certificates of deposit.

With this cash reserve in place, you are now free to invest the rest of your portfolio for long run growth, by buying stocks and riskier bonds. Each year, tap your cash reserve to pay your living expenses. Meanwhile, look to replenish this reserve by regularly selling some of your growth investments.

What if your growth investments are underwater? Don't do any selling until these investments recover. With five years of living expenses in your cash reserve, you should be able to ride out even a vicious bear market.

Buying a Monthly Check

Want even more room for maneuver? Consider buying yourself a hefty stream of annual income, by investing a portion of your bond portfolio in an immediate fixed annuity. Thanks to that extra income, you will have even less need to sell investments each year.

With an immediate fixed annuity, you hand over a chunk of money to an insurance company, in return for which you typically get the same sized check every month for the rest of your life. As with bonds, immediate annuities leave you vulnerable to inflation, unless you opt for an annuity where the payments climb each year.

But annuities do help with other risks. Even if you mismanage or outlive your other savings, you know you will get that annuity check every month.

Consider putting between 25% and 50% of your nest egg in an immediate annuity, suggests Brian Birmingham, vice president of guaranteed products at Prudential Financial in Florham Park, N.J. "There's a lot of peace of mind and downside protection that comes from that," he says. "It allows you to live through the stock market's ups and downs."

Six Tough Retirement Questions
To Mull Before Taking the Plunge

By JONATHAN CLEMENTS
Staff Reporter of THE WALL STREET JOURNAL

It's time to ponder the unpalatable.

Looking ahead to retirement? You will have lots of free time -- and at least a few agonizing decisions. The fact is, quitting the work force brings with it a fistful of thorny personal finance questions.

Here are six of the toughest:

Am I Retiring Too Soon?

Between Social Security, personal savings and pension income, typical retirees are quitting the work force with enough income to replicate maybe half of their pre-retirement income, figures Scott Sleyster, president of retirement services and guaranteed products at Prudential Financial in Florham Park, N.J.

That's just not enough money. "The vast majority of people are setting themselves up for disappointment in retirement," Mr. Sleyster argues.

One option is to work a few years longer. Those extra years will give you more time to save and more time for your portfolio to grow. You will also delay Social Security and any company pension, making you eligible for a bigger monthly check.

Still, this strategy has its limits. "It's easy to extend from 55 to 60 or from 60 to 67," Mr. Sleyster says. "But people shouldn't kid themselves that they'll be working at 73 or 75."

Should I Move?

Your home may seem perfectly manageable now. But will you be able to maintain the house and garden as you grow older? And what if you can't drive? How will you get groceries?

If you will need to move, don't delay too long. As folks age, they tend to feel they are losing control. Throw in the prospect of moving to a new home, with all the accompanying turmoil, and many retirees will feel overwhelmed.

If you do bite the bullet and trade down to a smaller place, there is a silver lining. You should be able to reduce your monthly expenses and possibly free up home equity that can then be spent.

"You could also save yourself a ton in state income taxes," says Minneapolis financial planner Ross Levin. "If you move from a high-tax state to a low-tax state, you might see your state tax rate drop by four or five percentage points."

Who Will Help?

At age 65, you might find it easy to stay on top of your financial affairs. At age 85, it will be a lot tougher.

What to do? Build a portfolio now that will be easy to manage later. To that end, favor mutual funds over individual securities and look to house all your investments at one brokerage firm or fund company.

Also, consider investing a portion of your portfolio in an immediate fixed annuity. Today, annuities might seem like pedestrian investments. But once you get into your 80s, receiving that check every month will be enormously comforting.

Meanwhile, line up one of your children, a friend or a financial planner to help you with your finances. Even if you can't imagine ever needing help, maybe your spouse will, should you die first.

"Becoming retired is one thing," says Richard Van Der Noord, a financial planner in Greenville, S.C. "Staying retired is immensely more challenging. Surrounding yourself with good help is nothing to be ashamed of."

Can I Afford Nursing Care?

If you are over age 65, there is a 43% chance you will spend time in a nursing home at some point, according to the U.S. Department of Health and Human Services. For many folks, the stay will be relatively brief. But what if you need years of nursing home care?

A year's stay might cost $50,000. If you and your spouse both need care, you could be forking over $100,000 a year.

Those with few assets should qualify for Medicaid. What about everybody else? You can pay at least part of the annual bill with Social Security and any pension and investment income. To cover the remaining cost, you may need long-term care insurance.

Who Gets What?

Parents shouldn't feel any obligation to leave money to their children. Need every last penny to ensure a comfortable retirement? Want to bequeath your assets to charity? It's your money. Use it as you see fit.

I do, however, believe we all have two obligations. First, if family members expect to inherit your estate but you have other plans, it is only fair you let them know. Second, do your best not to bequeath a mess.

If your financial records are in disarray, straighten them out. If you don't have a will, get one. If your insurance policies and retirement accounts don't have the correct beneficiary designations, fix them. If you own property in another state, stick it in a living trust. If your executors don't know where key documents are located, tell them.

Will I Get the Final Say?

As you sort out your estate, don't just consider the distribution of your assets. Also, give some thought to your final days. Want to specify your wishes concerning life prolonging medical procedures? Draw up a living will. Do you want somebody to make medical decisions on your behalf, if it becomes necessary? Consider a medical power of attorney.

You might also draw up burial instructions and write a last letter to your family. Got some final thoughts you want to pass on to your children? This is one opportunity you don't want to let slip away.