Two advisors believe he can, but that may be the last thing they agree on.
After a 30-year banking career, a good bit of it
spent launching branch operations in far-flung locales like Hawaii and
Germany, not much is going to deter Mike Kelly from his looming
retirement. Not even the distressed bond market, which has hobbled
yields and made predictable income streams a wistful memory. After
years of diligent investing and careful spending, Kelly is ready to
take the retirement plunge. In fact, he's already told the financial
institution where he's worked for some three decades that he's retiring
December 1, at age 62. He believes the $1 million portfolio he's
diligently built should be enough to provide him with the lifestyle
he's known and loved for years.
"I'm fearful of the same things everyone fears-running out of money-but I'm not that nervous, because among other things, I have a paid-off home," says Kelly, whose sleek Periwinkle blue rambler in Rehobeth, Del., is just five blocks from the beach.
Can this world traveler, who is due to start collecting $1,300 a month from Social Security come December, really retire comfortably on his cool $1 million? On his side, Kelly has only two hard and fast financial requirements: He doesn't want to leave the money sitting in his workplace pension, despite the $2,600 per month it would guarantee him for life. The reason he will take a lump sum rollover of $397,900 from his pension, and bet on the markets himself, is clear: He believes, based on family history, that he is unlikely to live much past age 75, and he wants to leave the funds to his beneficiaries. His second requirement? He needs $3,500 a month after taxes to live. The $1,300 a month Social Security will pay him brings his remaining cash flow needs to about $2,200 a month.
To find out if Kelly's assets will allow him to retire early in the current economic environment, we asked two senior investment advisors to create portfolios, which they say should generate the income Kelly needs to live on over the next 25 or even 35 years.
Patricia Powell, president and founder of The Powell Financial Group in Martinsville, N.J., built a low-cost, 14-mutual-fund portfolio for Kelly using T. Rowe Price and Vanguard funds (see sidebar). "He needs to withdraw about 2.8% of his total portfolio each year, which is an enviable position to be in compared to many retirees," says Powell. "I ran a miniplan on him and I'm comfortable that even with a 4% inflation rate, the equities will still be able to appreciate and be his hedge against inflation. If they grow, say from 44% to 60%, he'll be able to redistribute the difference back into his bond funds. Over time I would expect inflation to erode the income earned on the bonds and cash equivalents, but this is a plan based on cash flow and total return." Her plan would return a total of at least $2,200 a month after taxes, she says-the exact income Kelly requested.
Mark Cortazzo, who manages $250 million as a senior partner and founder of Macro Consulting Group in Parsippany, N.J., says Kelly doesn't have to settle for $2,200 a month. He advises that Kelly replicate his pension with a $500,000 investment in the Equitable Accumulator Variable Annuity, a contract designed to net the annuitant the upside of the stock market in addition to a guaranteed $30,000 in income for Kelly annually, while providing a death benefit guarantee for his beneficiaries. Cortazzo advises that Kelly invest the other $500,000 in Treasury securities to generate $23,500 a year, and buy ten-year Treasuries with the remaining $64,000 to gross another $3,000 a year. That, says Cortazzo, gets Kelly $56,500 in annual income, before taxes and Social Security.
"For someone who has been an accumulator, volatility in the early years of a plan is a profitable proposition," says Cortazzo. "But Kelly's switching to a very different kind of sport now, and it could have a devastating effect. If I had given him the average large-cap growth portfolio over the last five or six years and he was drawing down 6% a year, his million would be worth about $100,000 today. Long-term averages are wonderful, but they're meaningless. Because if the bad years come first, it won't matter what the average is," Cortazzo says. "If the market were hit that hard, they'd be equally hard hit at T. Rowe Price and Vanguard, but with no income guarantee."
While the annuity is expensive, costing 2% over the expenses of the mutual funds he selected for the contract, Cortazzo says the net income guarantee of 6% annually for life is well worth it. Both Kelly and his heirs are entitled to any market increases in his portfolio. Because of the death benefit guarantee on the contract, Kelly's beneficiaries will get the remaining portion of his portfolio or any unused portion of ten years' of his annuity payments, should he choose to annuitize. (With this Equitable contract, the annuitant would only need to annuitize once his or her portfolio is depleted.)
The saving grace for both portfolios is Kelly's own
habits. He's a judicious spender and a budget traveler. "I don't expect
things to change much," says the gourmet cook, who usually stays with
friends in England and Germany, enjoys cut-rate theater tickets and is
not averse to taking a consulting job. "I think of retirement as a gift
that will give me the time to travel, work on my beach house and spend
time with friends, some of whom are aging and could probably use my
What the long-time mortgage banker won't get is any gifts from the mercurial bond market. Thanks to Treasury bill and bond rates, which ranged from about 4.65% for the shortest maturities (two months) to just 4.9% for ten-year notes in early April, the margin for error can be pretty slim for retirees these days. And if interest rates continue their ascent after years of historic lows, bond prices could fall dramatically.
Lackluster bond performance is taking its toll on many retirees. "I keep a box of tissues in my conference room," says Powell, who says that many retirees are not as prepared as Kelly. "The average guy spends more time picking the color of his next car."
And without meaningful bond yields, retirement gets much harder, especially for people on the margin. "Twenty years ago, we could get very nice rates of returns with guarantees, even 8%, 9% or 10% with Treasuries," Powell says. "Today we're lucky to get 4.7%. And don't forget that's up from 1% or less back in 2004."
While at some point improving bond rates could definitely entice Powell to change her allocation and consider bond ladders, for right now "the yield curve is just too flat. What would I get going out ten years and locking in? A half-percent more?"
Instead, she says, her low-cost fund portfolio should provide Kelly with the income he needs and reduce redundancies. (He originally held four different S&P 500 index funds, which Powell would reduce to one.) "We're assuming Michael can average 4% on his cash and cash equivalents and bond funds, and 1% on the balanced and equity mutual funds, so this portfolio should return about 2.5%, which is what he needs." To keep Kelly from having to worry too much about market fluctuations, she's advising that he keep two years of income in money markets.
Cortazzo says that as opposed to a pension, which Kelly would leave on the table if he died prematurely, the annuity he's proposing will guarantee income and a lump-sum payment or payment stream to Kelly's beneficiaries. At the same time, the annuity is 100% liquid and carries no early-withdrawal penalties. "If you decide after a year you can do better elsewhere, you can take your portfolio and any upside performance you get and simply walk away."
For the risk averse, Cortazzo says, he can use ten-year Treasuries to cover their basic needs. "But you'll have no hedge against inflation. And you'll have no potential for meaningful appreciation or niceties. This risk assessment, and how a retiree wants to live, is the line investors and advisors have to walk right now, thanks to the bond market."
Still, Kelly has high hopes for the future. He is not opposed to downsizing his half-million dollar home if the need arises. And he may even start dabbling in politics. "I'm tempted to volunteer for the 2008 presidential campaign," he says. "Retirement will give me the opportunity to take advantage of any number of opportunities that come up, whether it's buying last-minute bargain airfare or taking on an enticing consulting job. If I can preserve this million, I'll be set."