NEW YORK (Money) -- My spouse and I plan to retire within a year when we'll be 64 and 60, respectively. We've got 50% of our retirement savings in stock funds, 45% in bond funds and 5% in cash. Initially, we expect to tap our savings at a pretty low withdrawal rate -- maybe 2% or so. Is our portfolio mix reasonable or should we be more conservative to protect ourselves against the risk of another 2008 meltdown? -- Ed Higgins
Given the Dow's more than 500-point loss Thursday and reports of economic upheaval around the globe, it's understandable you want to protect your retirement savings. It's unsettling to see your nest egg get whacked, especially when you're on the verge of retirement.
That said, you and your wife likely have a long life ahead of you. So it would be a mistake to concentrate solely on what's happening now --or even on what might happen months from now. Rather, you should focus on coming up with a spending and investing plan that assures you have the money you need to live comfortably for the next 25 to 30 years, if not longer.
To meet that challenge, you've got to do two things: set a reasonable withdrawal rate that gives you the spending cash you need but won't exhaust your nest egg too soon; and create a mix of stocks and bonds that provides enough growth to maintain your purchasing power long-term, while also offering enough short-term protection that you're not living under a constant cloud of anxiety.
Let's start with the first issue, setting your withdrawal rate. There are no guarantees, of course, but generally the lower your withdrawal rate, the greater the odds are that your money will last throughout a long retirement no matter what asset allocation you choose.
This chart, which shows withdrawal rates ranging from 3% to 8% and portfolio allocations from 100% stocks to 100% bonds, illustrates that point. Start by looking at the top of the table, which shows the odds of savings lasting 30 years at a 3% withdrawal rate that is adjusted for 3% inflation annually.
In other words, that would mean a $30,000 initial withdrawal on a $1 million portfolio, followed by a withdrawal of $30,900 the second year, $31,800 the next year, $32,800 the year after that, etc.
You can see that by putting 50% in stocks and 50% in bonds -- which is very similar to your portfolio -- the odds of your savings lasting at least 30 years is 98%. Even with a much more conservative allocation -- say, 25% stocks and 75% bonds -- the odds are still 98%.
And though I want to be clear that I'm not recommending it, even if you were to take the incredibly aggressive stance of putting 100% of your savings into stocks, the odds would still be a relatively high 92%.
There's something else worth noticing, however. Your odds of success fall as you start to increase the withdrawal rate to 4%, 5% and higher. Also note that, as the withdrawal rate rises, the chances of your money lasting drop off more quickly at the more conservative allocations.
For example, at a 5% withdrawal rate and a 50% stocks-50% bonds allocation, the chances of getting the income you'll need for at least 30 years falls to 69%. Those odds drop to 56% for a 25% stocks-75% bonds portfolio and to 30% for all bonds.
These odds are hardly etched in stone. They'll change based on how the financial markets do and what your portfolio actually earns. But what this table does show is just how forgiving a low withdrawal rate can be.
If you start withdrawing a small amount from your portfolio, and adjust it for inflation, odds are good that your money will last a long time whether you invest relatively conservatively or aggressively.
If you're going to withdraw money at a higher withdrawal rate, it's much harder to pull off at very conservative allocations for the simple reason that a bonds-heavy portfolio isn't likely to generate a high enough return to compensate for the higher withdrawal rate.
At the same time, though, a very aggressive allocation doesn't offer very reassuring odds of being able to sustain a high withdrawal rate. In other words, you can't simply ratchet up portfolio returns to get a higher income, which is why it pays to hold the line on withdrawals, to the extent possible.
Now to the second issue: protection from market setbacks in the short-term.
You don't need any fancy tables to know that the more you have in stocks, the bigger the hit your savings stash is likely to take when the market swoons.
In 2008, stocks overall dropped roughly 37%, while a diversified portfolio of bonds gained about 5%. So a portfolio consisting of 50% stocks and 50% bonds lost 16% or so. That's hardly a pleasant experience, especially for a retiree, but it's a lot better than losing double that amount.
Fortunately, market cataclysms like 2008 don't come along very frequently. But they've happened often enough that safety-conscious investors should factor the possibility of a significant setback into their investing strategy. And that's certainly true given the shaky economic outlook today.
So what does all of this mean for your investing and withdrawal strategy?
The combination of a low withdrawal rate and a relatively conservative stocks-bonds mix offers you the best shot at getting both types of security you seek: protection from market setbacks and good odds of your savings supporting you throughout retirement.
That said, it's not as if you can set an allocation and withdrawal rate and go on autopilot for the next 30 years. Things happen (as we saw this week) and your need for short-term market protection may increase as you age.
A 15% drop in the value of your savings can be a lot more frightening at age 75 than it is in your early '60s. So it's important that you monitor your progress along the way.
You can do that by using this retirement income calculator. Plug in your savings, your portfolio mix, how much you're spending each month and how long you would like your savings to last, and it will estimate the odds you'll be able to sustain those withdrawals. If the markets do well, you may even want to increase your spending so you don't end up with lots of dough in your dotage when you're less able to enjoy it.
Just remember that no tool or calculator (or any forecast, for that matter) generates ironclad projections. Due to this lack of certainty, retirees and near retirees might want to at least consider devoting a portion of their savings to an immediate annuity or perhaps to an investing service designed to generate stable sustainable income -- although at this point, such services are limited mostly to a relative handful of 401(k)s.
You and your wife appear to be preparing for the transition to your post-career lives in a sensible, thoughtful way. If you continue that approach throughout retirement, you'll be doing all that you can reasonably do.
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