Bear Market Retiree IncomeSubmitted by Larry Frank Sr. on Thu, 08/02/2012 - 3:00pmMany retirees’ biggest fear is losing their money in a bear market. Howmuch can you afford to withdraw from your retirement portfolio when themarket shrinks the principal?Some retirees structure their portfolios so they won´t lose principal, andthey live off the interest. But interest income usually goes down ineconomic hard times because the Federal Reserve cuts interest rates tostimulate the economy. For example, if the retiree starts with 5%interest, each $100,000 generates $5,000 per year (before taxes). Ifinterest rates drop from 5% to 4%, income drops to $4,000.Other retirees reaching for yield, meaning they invest in risky securitieslike junk bonds. That does not protect their principal very well.For a prudent balanced approach for income, consider a totalreturn strategy, which recognizes that income can come from manysources – and also recognizes that inflation is a factor in a retirementplan. That’s because retirement spans many years, and inflation eatsaway at your money.Portfolio values go up and down. The question for the retiree is: Howmuch up and down are you comfortable with?Beyond all that is the issue of how to manage your portfolio prudentlyduring retirement so that you live comfortably. During good economictimes, portfolio balances grow and, during poor ones, they decline. Inboth, you need to withdraw money from the principal to live on, and don’twant to take out too much.The figure below lists sustainable withdrawal percentages at variousages. As I showed in a previous article using this table, Withdraw 4% inRetirement, the upper segment is labeled POF 10%. POF meansProbability of Failure, and it measures the odds that your money won’t
last through retirement. The lower segment covers a 30% chance offailure.This figure and its conclusions come from research by me and mycollaborators, published in the November 2011 edition of the Journal ofFinancial Planning.Let’s look at a sustainable withdrawal percentage for a 65-year-old, whois concerned with passing on his money to heirs, so his inthe bequest category. His safest withdrawal rate is 4.11%. Thattranslates to spending, for each $100,000 in his portfolio, $4,110 for thecurrent year, regardless of interest rates or market actions.What if markets go down during the year? At what point should youconsider reducing spending just a little to improve future portfoliobalances for retirement needs? When the economy is poor, the naturaltendency is to reduce spending.The lower panel in the figure, with its 30% probability of failure, hasa higher drawdown rate. That rate rises in retirement due to a decline inportfolio value.Pardon me while we do a little math so you can see where the numberscome from. Let’s take our $4,110 amount from the example above.An annual drawdown rate (DR%) equals the annual dollar amountwithdrawn ($Y) divided by the total portfolio value ($X), or $Y / $X =DR%. What value would $X need to be in this example using $4,110from above so that DR% reaches the higher drawdown rate (5.21%) inthe lower panel?Thus, $4,110 divided by 5.21% in the lower panel = $78,887, which is theportfolio value at which we should reduce our spending. Of course,reducing spending prior to this point is more prudent because this meansyou are taking fewer dollars off of a declining balance earlier. That’s agood thing.Okay, but what do we need to reduce spending to? We want to get backto a lower drawdown rate, which is 4.11% in this example. Now we usethe lower portfolio value $78,887 we just calculated in the basic formula$X times DR% = $Y: $78,887 times 4.11% = our new annual retirementincome, $3242.
You also may use the above method to monitor your retirement. Simplysubstitute 4.52% or 5.29% for initial values respectively (upper panel), andfor poor market values substitute 5.69% and 6.53% respectively (lowerpanel) if you are age 65, for example.The 30% panel shows it is increasingly more likely you will run out ofmoney withdrawing from your retirement fund as compared to the 10%panel values. As your drawdown rate goes up, your portfolio values godown. The opposite happens when portfolio values go up, which is goodbecause this signals an ability to spend a bit more to replace that old car,repair the roof, visit the grandkids, etc.It really does not matter what the markets do on any given day since theyalways are noisy. That noise is what makes people nervous. But if peopleknow what portfolio balances really matter, then they can simply ignorethe daily noise.The value of this exercise is twofold: first, you now have a portfolio valuein mind ahead of time, WHEN you should reduce spending; second, younow have a drawdown value in mind ahead of time, WHAT you wouldreduce spending to. This last point is useful because you can evaluateyour expenses during worrisome times to see where you might cut back,rather than waiting.The art here is having a sense to distinguish between market declines thatare cyclical based on normal investor perceptions, and market declinesthat are a result of systemic stresses such as those experienced in 2008.This is where an experienced advisor may come in handy.This strategy to measure and manage your portfolio during marketdeclines does not prevent loss of portfolio value. Rather, it is a methodprecisely for such occasions and recognizes that markets, and portfoliovalues, go up and down.Follow AdviceIQ on Twitter at @adviceiqLarry R Frank Sr., CFP, is a Registered Investment Adviser (California) inRoseville, Calif. He is the author of the book, Wealth Odyssey. He has anMBA with a finance concentration and B.S. cum laude in physics withwhich he views the world of money dynamically. He has peer-reviewedresearch published in the Journal of FinancialPlanning. www.blog.BetterFinancialEducation.com.AdviceIQ delivers quality personal finance articles by both financialadvisors and AdviceIQ editors. It ranks advisors in your area by specialty.For instance, the rankings this week measure the number of clients whoseincome is between $250,000 and $500,000 with that advisor. AdviceIQalso vets ranked advisors so only those with pristine regulatory historiescan participate. AdviceIQ was launched Jan. 9, 2012, by veteranWall Street executives, editors and technologists. Right now, investorsmay see many advisor rankings, although in some areas only a few areranked. Check back often as thousands of advisors are undergoingAdviceIQ screening. New advisors appear in rankings daily.
Topic:BondsRetirement PlanningWithdrawals from 401Ks