Low-risk retirement

May 13, 2011: 7:58 AM ET

NEW YORK (Money) -- I'm retired and don't want to take chances. What's the best way to draw income from my money? -- T.V., Los Angeles

We all have to take some chances in life, but I agree: It's important that you understand the risks you face and decide how to manage them in an acceptable way.

Someone looking to turn retirement savings into regular income faces two main types of risk: investment risk and what I'll call "spending" risk.

You're no doubt familiar with one facet of investing risk -- the chance that a stock-market meltdown could wipe out a big chunk of your savings, and future income.

Limiting your stock holdings and increasing your stake in bonds and cash will protect you from that risk. ("Busted: Your bank is profiling you")

But the lower returns on bonds and cash will also increase your exposure to another risk: that you won't be able to maintain your purchasing power throughout retirement and that you'll run through your savings too soon.

The way to balance those two risks is to build a portfolio that includes enough bonds to provide ballast against market setbacks and enough stocks to provide at least some growth potential.

The right blend will depend a variety of factors: your age, stomach for risk, the size of your portfolio and what other resources you may have to fall back on (home equity, a pension, etc).

But starting somewhere between 35% and 50% in stocks at 65 and gradually reducing your stock holdings so that you're at, say, 25% to 35% stocks by age 75 and 20% to 30% in your 80s is a reasonable guideline.

If you'd like to see how different combos of stocks and bonds have fared in the past, you can check out this historical returns calculator. For a look at how different mixes might (emphasis on might) do in the future, rev up Morningstar's Asset Allocator tool.

But when it comes to creating retirement income, investing risk doesn't exist in a vacuum. It's inextricably entwined with spending risk.

You're no doubt aware of one aspect of spending risk, namely, the peril of spending too much too soon and depleting savings. What might surprise you, though, is how much that risk can increase the more you spend.

For example, if you have $500,000 in a 50-50 mix of stocks and bonds and withdraw $20,000 (4% of $500,000) the first year of retirement and increase that amount by inflation each year, there's a roughly 80% chance your savings will last 30 years.

Boost that initial draw to $30,000 (6% of $500,000) and the odds drop to about 25%.

However, there's a whole other dimension to spending risk that sometimes gets lost. That's the risk of spending too little. ("100 best money moves")

That may not seem like a risk at all. But if you're overly cautious about pulling money from savings early in retirement and the financial markets deliver good returns, you could end up with a big pile of savings late in retirement. Which would mean that you could have loosened your purse strings more early on and enjoyed yourself more in retirement.

To see how different spending rates affect the longevity of your savings, you can check out this retirement income calculator. One of the features I like about it is that it not only allows you to try out different levels of spending; it also lets you experiment with different combos of stocks and bonds. So it combines the effects of investing risk and spending risk.

Of course, you can't just set a path of spending at one point in retirement and expect to follow it faithfully year after year. Neither life nor the financial markets are that predictable. But by checking in with a calculator like this one periodically, you can see whether the odds of your money lasting throughout retirement are rising or falling. Based on that info, you can then decide whether to spend a bit more (if things are going well) or spend a little less (if your savings are running low).

Finally, one thing you may not want to take a chance on is the possibility of falling below at least a minimum standard of living. Or to put it another way, you may want to take extra care that you'll have at least enough income to meet your basic living needs the rest of your life.

Social Security can help on that score, as it provides guaranteed income that's adjusted for inflation each year (although due to a combination of low inflation and the way Social Security's cost-of-living adjustment is calculated, retirees received no payment boost in 2010 or 2011 and it's still unclear whether they'll get one in 2012).

But if Social Security doesn't cover enough of your essentials -- or you just want more assured income as a safety cushion -- you might consider putting some (not all) of your money into an immediate annuity, which can provide a monthly check for life. (To see how large a check, go to our Income for Life calculator.)

Buying an immediate annuity involves tradeoffs as well. But I think combining such an annuity with conventional investments like stock and bond mutual funds (plus a year or so's worth of living expenses in cash) can be an effective way to get a reasonable level of safety, assured income and potential for inflation-beating growth.

Bottom line: Don't be afraid to take chances. That's unavoidable. But do make sure you're taking them the right way. To top of page

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