"If a person hasn't saved enough, it's the old guns and butter," says Keith Singer, a planner in Plantation, Fla. "You only have so many resources to do some things. You can either work longer, spend less or take more risk. Three choices. The risk is really running out of money because you spend too much." In some cases, that means that the client will get back on track if they defer retirement by a couple of years. In some cases, a guaranteed income from an annuity product will be in order, though planners are often careful when prescribing these since they are often sold inappropriately (at a high fee to the seller) to capture risk that the client doesn't have.
This argument eventually leads to a thornier debate about the optimal rates of withdrawal for a retirement portfolio, and that's where opinions start to diverge. According to figures in an oft-quoted study by the Department of Business Administration at Trinity University in the late 1990s, the conventional wisdom that a retiree can take a 7% annualized withdrawal from a portfolio with 50% equities and 50% bonds can be dicey if you're afraid of inflation eating away purchasing power. According to the study, Sustainable Withdrawal Rates From Your Retirement Portfolio by Philip L. Cooley, Carl M. Hubbard and Daniel T. Walz, the portfolio success rate of inflation-adjusted monthly withdrawals over 30-year rolling periods from 1926 to 1997 was just 19% for 7% annualized withdrawals.
"What I was struck by," says William Garrett referring to the Trinity research, "is at a 6% beginning withdrawal rate-this is the portfolio returns since World War II, taking the Depression out of the thing-at 6%, which is the pretty common amount of what people want to take out, 43% of those portfolios didn't make it 30 years. Some of them were substantially less than 30 years. ... We start off making some false assumptions-that since the S&P 500 has made 10% a year and inflation has been 3% a year, I can take 7% a year out of a portfolio and I can be okay. But the study points out that that's a myth."
Garrett went back and took his own look at underlying figures by Ibbotson Associates through 2004. He found that since 1925, large-caps and small-caps combined have lost money 31% of the time over one-year rolling periods; over five years they've lost money 13% of the time; and over ten-year periods they've lost money 3% of the time. (Only the rolling 20-year periods didn't lose money.)
He says that his research-not only these figures, but also the higher 3.4% inflation risk calculated for the elderly-have convinced him that it is hard for bonds to keep up, and so he has stretched out his bond ladders to ten years as part of a proprietary method he has developed for constructing model portfolios. That way, he says, the money that replenishes the ladder from the stock market is allowed to stay in the market longer. Rather than being a traditional ladder that consumes principal, Garrett's structure includes an income pool with interest-bearing obligations of staggered maturities, including bonds, money market CDs, fixed annuities, etc.-anything that provides a dependable income stream without risk of market loss.
"The biggest problem I see with bond ladders is that they require so much money to generate enough income," he explains. "For instance, if you make 5% and you want a $50,000-a-year retirement income-do the math. You've got to have a million in there. Most baby boomers don't have that."
He says he would rather keep that money in the market, because there's less risk in the ten-year holding period. "So if you look at it in historical terms, you've reduced risk from a one-year rolling period of 31% to a ten-year rolling period of 3%. You've reduced risk by 90%. And that's a lot more optimal holding period for a bond ladder, in my estimation."
Cooley, one of the authors of the research, says that these figures are correct. However, he thinks a 7% withdrawal rate still can be successful if the figures are not adjusted for inflation (the consumer price index).
"I don't like CPI-adjusted figures," Cooley says, "because if you do the math, you'll find that you're back-end-loading all the spending, when the [retirees] are not as vital and not likely to be spending as much. If the market is doing well, it is possible for a retiree to give himself a raise, and if the market is doing poorly, as it was in 2000, then it's time to scale back."
Familiar Mistakes
Besides stressing to their clients that they must use the engine of compounding, and judiciously allocate between tax-deferred and nontax-deferred accounts, planners also must illuminate the simple pitfalls and tripwires awaiting the unwary retiree navigating the ups and downs of the golden years. An oft-told story is the one about the retiree who, like a parolee newly sprung, fled his office without remembering to exercise incentive stock options.
"The maximum period of time you have to exercise an incentive stock option is three months," says Shapiro. "I heard one story about a guy who was so excited he went on a cruise for a month or six weeks, and it took him three or four months after retirement to get his financial affairs in order. So he went on his cruise and forfeited all the value he built up on those stock options."