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about leaving behind nothing but a check for the undertaker -- and the
check, of course, bounces.
Don't want to
cut it so close? Unfortunately, if you follow one of the most commonly
advocated retirement-spending strategies, there's a real risk that you
will outlive your money.
strategy, you build a balanced portfolio of typically 60% stocks and 40%
bonds and settle on a withdrawal rate, often set at 5%. That is the
percentage of your portfolio that you withdraw in the first year of
retirement. Each year thereafter, you step up the dollar amount withdrawn
along with inflation.
if you adopted a 5% withdrawal rate, retired with $400,000 and inflation
ran at 3%, you would pull out $20,000 in the first year of retirement,
$20,600 in the second year, $21,218 in year three and so on. These amounts
include any dividends and interest paid by the portfolio.
surprisingly, retirees like the idea of getting the same
inflation-adjusted income every year. But there's a hitch: If you
slavishly follow the strategy, you could rapidly deplete your nest egg if
markets are unkind. With a balanced portfolio and a 5% withdrawal rate,
there is a 42% chance you would run out of money over a 30-year
What's the alternative? Here are three strategies that, while they also have their drawbacks, do at least eliminate the risk of outliving your portfolio:
continue to withdraw 5% of your beginning-of-year balance. If your
portfolio performed well the year before, you would get to spend more.
But if your holdings took it on the chin, you would be forced to cut back.
it's a safer method than withdrawing a fixed dollar amount, because you're
automatically withdrawing less when your assets are reduced by a bear
market. If you take a fixed
percentage, you will never, ever run out of money. But you can still go
In particular, you could find your annual income dwindling if you either mismanage your portfolio or you use too high a percentage. After all, to generate a stream of income that grows along with inflation, your portfolio's return has to be higher than the percentage you are withdrawing. Still, if you can adjust to the annual changes in income, the fixed-percentage strategy strikes me as a good option.
Life: Over the past few years, I
have become a fan of immediate-fixed annuities. These policies can come
with all kinds of bells and whistles. But in its simplest form, an
immediate annuity involves handing over a chunk of money to an insurance
company, in return for which you get a check every month for the rest of
your life. In essence, it is a way of creating your own company pension.
annuities are really good if you have no interest in finance.
But the big problem is inflation, which will gradually erode the
value of an annuity's fixed payments.
inflation and because of the risk that you don't live long enough to get
much benefit from an annuity, you might put just 25% or 30% of your
retirement nest egg in one of these products and then invest the rest in a
mix of stocks and bonds.
Clipping Your Coupons: An old financial rule of thumb says you can spend your dividends and interest income, but you should never touch your capital.
This is what
most people have done in the past and it's still used by the vast majority
of retirees, even those who are unable to articulate their spending
But is it a
good strategy? If you are heavily invested in stocks, you may find that
your portfolio generates scant spending money. Stock dividends have
generally gone down as a percent of stock price over the years, as
companies have put more emphasis on growth. That leaves less cash for the
You could, of
course, compensate by putting more in bonds. But that may leave you
vulnerable to inflation. If your interest income doesn't grow and
inflation runs at a modest 3% a year, the spending power of your interest
income will be cut in half after 23 years.
drawback: By refusing to dip into principal, you may force yourself to
scrimp unnecessarily. Still, while it wouldn't be my first choice, the
"never spend capital" strategy can work well.
With the right mix of stocks and bonds, you should generate a decent stream of income, enjoy some inflation protection and be confident you won't outlive your money. And the local undertakers will be happy. After all, they are likely to get paid.
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