Getting Going

Playing the Right Retirement Cards

By Jonathan Clements
The Wall Street Journal
(Copyright (c) 1999, Dow Jones & Company, Inc.)

Retirement is like a long vacation in Vegas.
The goal is to enjoy these years to the fullest, but not so fully that you run out of money. It is a dicey endeavor, involving tricky issues of longevity and investment returns.

As you try to figure out how much you can spend once retired, take a cue from the accompanying tables, which were put together by T. Rowe Price Associates, the Baltimore mutual-fund company.

To use the tables, you have to decide how long your retirement might last, what stock-bond mix you will hold and what percentage of your portfolio's value you might withdraw in the first year of retirement. After the first year, you are assumed to step up the amount you withdraw, along with inflation.

The tables don't provide definitive answers. Instead, like a gambler, you have to play the percentages. The answer you pluck from the tables is the chance that you will make it through retirement, without running out of money.

The probabilities are generated by considering hundreds of possible market scenarios. These scenarios take into account not only the historical volatility of returns, but also the diversification benefits that can come from combining stocks with bonds or mixing U.S. shares with foreign securities.

T. Rowe Price's focus on different market scenarios reflects a recent change in the way investment advisers think about retirement spending. Before, advisers would often simply project likely average returns for a retiree's portfolio, make some allowances for inflation and then figure out how much the retiree could withdraw so that the portfolio would last, say, 25 years.

The problem was, even if advisers guessed right about the average returns, they could still come up with the wrong answer. "It's the sequence of returns that are critical, not the average rate of return," says Todd Cleary, a vice president at T. Rowe Price.

To understand how important the pattern of returns is, imagine you held a mix of 60% stocks, 30% bonds and 10% Treasury bills over the 30 years ended 1998. That mix generated a spectacular 11.7% annual rate of return, far above the historical averages.

But despite that sizzling performance, the sustainable withdrawal rate was just 5.8%. Why so little? Unfortunately, the early returns were so miserable that, by the time the good results rolled around, a lot of your retirement money would already have been spent and thus you didn't reap the full benefit of this healthy performance.

For comparison, imagine you lived the 30 years in reverse, so that you began with 1998's generous returns, then moved on to 1997 and so on, finishing with 1969. Result? T. Rowe Price calculates that your portfolio could have sustained a 10.7% withdrawal rate.

In truth, most retirees would be lucky to enjoy a 5.8% withdrawal rate, yet alone 10.7%. As the tables suggest, a 6% withdrawal rate is possible for those looking at a 20-year retirement, but it's a dodgy proposition for anybody contemplating a longer retirement.

Mr. Cleary says he wouldn't adopt a strategy that had less than a 70% chance of success. That means folks who expect a 25-year retirement should probably stick with a 5% withdrawal rate, while those looking at a 30-year retirement ought to opt for just 4%.

For the legions of wage slaves who dream of early retirement, this isn't good news. To generate $40,000 in annual income, you would need $1 million. And that $40,000 is pretax.

Moreover, a 70% chance of success means there is a 30% chance of failure. The tables were generated by T. Rowe Price as part of a new program, which -- for a $500 fee -- will help retirees figure out how much income their portfolios can generate. T. Rowe Price has found that most folks want at least an 85% chance of success.

On the other hand, you do have only one shot at retirement, and you don't want to pinch pennies unnecessarily. The best approach may be to adopt a riskier strategy, knowing you will throttle back your spending if the markets turn against you.

In fact, many retirees do this instinctively. "If people's portfolios are doing poorly, they tend to cut their spending, because they're scared that they'll run out of money," says Minneapolis financial planner Ross Levin.

(See related letter: "Letters to the Editor: Retirement Funds For the Risk-Averse" -- WSJ Dec. 6, 1999)

Do You Feel Lucky?
To get a handle on how much you can spend in retirement without running out of money, check out the table below. For instance, the table suggests there is a 58% chance that a mix of 60% stocks and 40% bonds will sustain a 5% withdrawal rate all the way through a 30-year retirement.

20-Year Retirement Withdrawal

           -------------- STOCK/BOND MIX --------------  
RATE       100/0   80/20   60/40   40/60   15/85   5/95
 4%          97%     99%    100%    100%    100%   100%   
 5           91      93      95      96      97     93
 6           76      78      77      70      48     19
 7           56      53      46      28       2      0

25-Year Retirement Withdrawal

           -------------- STOCK/BOND MIX --------------
RATE       100/0   80/20   60/40   40/60   15/85   5/95
 4%          93%     95%     96%     97%     98%    93%
 5           78      79      79      66      46     14
 6           59      56      48      27       2      0
 7           38      31      18       3       0      0

30-Year Retirement Withdrawal

           -------------- STOCK/BOND MIX --------------  
RATE       100/0   80/20   60/40   40/60   15/85   5/95    
 4%          85%     88%     86%     85%     71%    37%
 5           68      66      58      42       8       0
 6           47      41      28      10       0       0
 7           24      18       7       1       0       0

Source: T. Rowe Price


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