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Make the most of what you've got
How to maximize your nest egg.
March 30, 2005: 4:54 PM EST
By Walter Updegrave, CNN/Money contributing columnist

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NEW YORK (CNN/Money) - I've just retired. How should I be managing and investing my money so that I'll have enough to live comfortably on throughout my retirement?

—Anonymous

How sweet it is! After all those years of working, saving and investing, you're on the verge of actually living your retirement dream. The hard work's done, now it's time to kick back and reap the rewards of the retirement planning you did throughout your career, right?

Well, yes, up to a point.

You should enjoy retirement and whatever activities that may involve these days (gardening, fishing, mountain climbing, launching a post-career career).

But it's not as if retiring completely frees you from retirement planning.

You still have to monitor your finances to make sure that your money doesn't give out before you do. Indeed managing your assets after you retire is so important that I devote an entire chapter to this topic in my new book, "We're Not In Kansas Anymore: Strategies for Retiring Rich" In a Totally Changed World." (To read that chapter, click here.)

Essentially, there are two main tasks you've got to get a handle on: first, how to invest your nest egg now that you're drawing on it rather than building it; and, second, how to make those withdrawals so you don't deplete your nest egg too soon.

Invest it...

Let's take the investing issue first. Many retirees assume that they've got to play it extremely safe and limit themselves almost entirely to bonds with perhaps a smidgen of dividend-paying stocks.

That's a mistake.

Fact is, many of us are going to spend 30, 35 or even more years in retirement. So while you certainly want to protect your assets, you also need long-term growth. Otherwise, the purchasing power of your nest egg will decline as you age, perhaps forcing you to downsize your living standard in the later years of retirement.

There's no single "correct" mix of stocks and bonds that's right for every retiree. The blend that's right for you will depend largely on your age and how comfortable you are with seeing your portfolio's value jump up and down in response to market conditions.

But a good place to start is with a 40/60 mix: 40 percent stocks and 60 percent bonds.

The 40 percent in stocks should be spread among a diversified group of stocks or stock funds that include large and small companies, growth and value shares (including dividend-paying stocks) and, ideally, even a bit of international exposure.

The 60 percent in bonds should also be spread among different types of bonds: Treasuries, high-grade corporates and, depending on your tax bracket, municipals to determine whether munis are right for you.)

Depending on your appetite for risk, you may even want to consider a small position in high-yield, or junk, bonds. As for maturities, most retirees will want to stick to the short-to-intermediate end of the spectrum.

As you age, you'll want to tilt your mix away from stocks and more toward bonds so that the volatility of your overall holdings decreases as you grow older.

The reason for this is simple: the older you are, the less time you have to recoup any losses your portfolio might sustain. You don't have to shift your mix every year. But by the time you're, say, 75, you might want to take your stock position down to 30 percent or so and when you hit 80, reduce it to 25 percent and then down to 20 percent by 85 or so.

I'd be wary of going below 20 percent since even when you hit your mid-80s, you could easily live another decade or longer, which means you still need some growth.

If you're not comfortable putting together a portfolio of stocks or stock funds and bonds or bond funds on your own, you might consider a breed of funds known as target funds. Essentially, you pick a fund with a target date that matches the year you intend to retire, say, 2005 or 2010.

Or if you're already retired, you can choose the target fund designated for retirees. (It's usually called The Retirement Income Fund or something similarly clever.)

Whichever you choose gives you a diversified mix of stocks and bonds that's appropriate to someone your age, and in most cases that mix morphs to a more conservative stance as you age.) For more on how these funds work, click here.

...withdrawing it

Now we get to the issue of withdrawing money from your portfolio. Here, the idea is to set a withdrawal rate that provides a reasonable stream of cash but also provides a good level of assurance that your portfolio will last a good 30 years or more.

Many people have unrealistic expectations on this score. Indeed, when the MetLife Mature Institute asked pre-retirees last year what percentage of their portfolio they thought they could withdraw each year and still have the assets last a lifetime, two thirds said 7 percent or more.

That might seem plausible given historical rates of return.

But if you want reasonable assurance your portfolio will last at least 30 years, you should probably go with a withdrawal rate more like 4 percent. That may seem low, but it's a prudent guideline for a couple of reasons.

First, you've got to consider the effects of inflation over a long retirement. As you age, you'll have to draw larger sums from your portfolio to maintain your purchasing power.

That's why it's important to think of a withdrawal rate in inflation-adjusted terms.

So, if you have, say, a $500,000 nest egg and you choose a 4 percent withdrawal rate, that would mean you draw $20,000 from your portfolio your first year of retirement and then increase that dollar amount each year for inflation.

If inflation moved along at a 3 percent annual rate -- a bit higher than it's been doing lately, but about the pace of the last 75 or so years -- that would mean your initial $20,000 draw would increase to more than $36,000 in 20 years and nearly $49,000 in 30 years.

Keeping the withdrawal rate down will increase the odds that your portfolio can meet the strain of those ever rising withdrawals.

The second reason you ought to limit your withdrawal rate to 4 percent or so is that a downturn in the market wreaks much more havoc on your portfolio during retirement than when you're accumulating assets during your career.

Essentially, investment losses have a double-whammy effect: Your portfolio loses value because of the negative returns, and then shrinks more because of your withdrawals. The result is that you have less capital to recoup losses in a market rebound. A market slump that occurs early in retirement can be especially dangerous since the combination of losses and withdrawals may deplete your portfolio to the point where it never really recovers.

Of course, a higher withdrawal rate could work out perfectly fine if you earn a higher return by investing more aggressively and if the market doesn't deliver significant setbacks.

But higher withdrawal rates definitely increase the odds of running through your assets sooner.

If you'd like to see how the odds of your portfolio lasting throughout retirement change based on different ages, levels of withdrawals and different investment strategies, I suggest you check out the T. Rowe Price Retirement Income Calculator.

Fidelity has also recently introduced a new Web-based service that addresses the issue of investing and managing withdrawals in retirement.

To see what I've had to say about it, click here.

There are other ways to manage the risk of outliving your assets. In many cases, devoting a portion of your assets to an immediate, or "payout" annuity -- essentially, an investment that guarantees income for life -- can significantly increase the odds that your portfolio will last a lifetime (although, as I discuss here you've got to be careful to avoid annuities with bloated fees that undermine their effectiveness).

Similarly, developing a tax-smart withdrawal strategy can help you squeeze more spendable income out of your retirement assets, which can make those assets last longer.

Fortunately, once you've laid out a long-term strategy for investing your retirement assets and withdrawing them in a reasonable manner, the hard work is pretty much done. After that, it's mostly a matter of monitoring your progress, and making occasional adjustments to reflect any significant changes in the markets or your financial situation. Which should leave plenty of time for more important things, like actually enjoying the retirement you so richly deserve.


Walter Updegrave is a senior editor at MONEY Magazine and is the author of "We're Not in Kansas Anymore: Strategies for Retiring Rich in a Totally Changed World."  Top of page

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