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Investing During Retirement During the accumulation phase it is completely rational and consistent to take a full measure of global equity risk in return for the probable higher returns. The emphasis is correctly placed on attaining the highest possible accumulation. At retirement the objectives change to: Generating income, and Not running out of money! An entirely different strategy is called for. Retirees have several key concerns: Decision-making is complicated by uncertainty. Most of the factors that determine success or failure are beyond our direct control. Retirees cannot control or predict market returns, interest rates, or even their own mortality. So, we must focus on the things that we can control, and devise a conservative investment strategy that will yield the highest probability of success. Sustainable Withdrawal Rates Old Assumptions Are Hazardous To Your Wealth The fatal problem with the traditional assumption is that it does not account for the variability of returns in the real world facing the retiree. We know from past experience that projecting average returns forward straight line is totally inappropriate. Average returns count for nothing if your retirement precedes a period like the Depression or 1973-1974. The real world that you face is much more complicated and risky than an “average” return might indicate. A Pioneering Study New and more powerful modeling tools confirm these principles and add additional insight, but do not replace the need for very conservative assumptions if the retiree wishes to have a high probability of success. The fact remains that the highest risk factor a retiree faces, and the only decision directly under his control, is the withdrawal rate. Recognizing the Effect of Volatility Totally Skewed With volatility, outcomes become skewed. Even though we obtain the expected rate of return across the sample, the median return is less than the average. The higher the volatility, the greater the sample becomes skewed at any time horizon. So, while we get the average return we expect, the average result is less than what we expect. As the number of failures goes up, the number of extraordinary results also goes up. A small number of players obtain much higher than expected results, while a large number of players’ portfolios either fail or obtain lower than expected results. Now that we have reviewed the biggest problem facing retiree’s, we can now move on to things the retiree can do to minimize the risk of outliving his portfolio. Constructing the Investment Policy Bucket One - Adequate Liquid Reserves Bucket Two – World Equity Market Basket Most advisors have been content to treat retirement assets as a single portfolio. For instance, many would advocate a “life style” portfolio comprised of 60% stocks and 40% bonds. However this leads to withdrawals on a pro rata basis from both equity and fixed assets regardless of market experience. It does nothing to protect volatile assets during down markets. A far superior alternative strategy would treat the equity and bond portfolios separately, then impose a rule for withdrawals that protects equity capital during down markets by liquidating only bonds during “bad” years. During “good” years withdrawals are funded by sales of equity shares and any excess accumulation is used to re-balance the portfolio back to the desired asset allocation. Again, using spreadsheet models with Monte Carlo simulation we find substantial incremental improvement by imposing this simple rule. Implementation Evaluation of Alternative Strategies Transition Planning Here's a suggestion that you can modify to meet your needs: Mid Course Corrections and Inflation Adjustments Alternative Withdrawal Plans Additional Considerations Lifetime Distribution Planning Estate planning
Be Prepared for Midcourse Corrections |