Older readers are still uneasy about outliving their money
Gordon Powers The Globe & Mail Saturday, February 20, 1999

Judging from the nervous tone of more than a few older readers' E-mails, my writing about the perils of underestimating life expectancy seems to have hit a nerve.

Despite planning ahead, contributing regularly to a registered retirement savings plan, adjusting their asset allocation slightly every five years, and estimating retirement living costs reasonably well, they're still uneasy, they report.

The source of their worries? Longevity, or more specifically, the fear of outliving their money despite everything they've done.

So, how much can reasonably affluent investors afford to nibble from their retirement portfolios before they run dry? The answer, of course, depends on how much you've got, what you're going to need, and how much you want to leave behind.

Still, if you're one of those approaching retirement, there are some rules of thumb you can use.

While no one can say with complete certainty how long any portfolio will survive a particular annual withdrawal rate, researchers at San Antonio's Trinity University have calculated how likely it is that various model asset mixes might survive before being depleted.

Using a data base that stretches back to 1926, they gauged the probabilities of whether five different asset mixes would last 15, 20, 25 or even 30 years at rates of withdrawal ranging from 3 to 12 per cent of the original portfolio amount. The asset mixes ranged from all stocks, to half bonds/half stocks, through to all bonds.

According to their findings, except for relatively short periods of time, withdrawal rates much beyond 6 to 7 per cent a year are somewhat perilous. In the postwar era, there is a 100-per-cent chance that an all-stock portfolio would survive 15, 20, 25 or even 30 years at up to a 7-per-cent withdrawal rate, as would most mixes ranging down as far as 50-per-cent stocks and 50-per- cent bonds.

But withdrawal rates over that threshold sharply reduce the likelihood of success. Even a 100-per-cent stock portfolio, for instance, has only a 77-per- cent chance of surviving a 9-per-cent withdrawal rate for 25 years, and the chances that the same portfolio would survive a 10-per-cent withdrawal rate over the same period are 46 per cent.

Interestingly, over the shorter term, anyone looking to withdraw at greater than 6 per cent annually would stand an equally good chance of success with a lower-risk portfolio composed of 75-per-cent stocks and 25-per-cent bonds, the study found. In fact, over 15 years, a 75/25 mix actually yielded slightly more certainty at rates of up to 9 per cent a year.

Don't assume, however, that the ideal retiree's portfolio is brimming with bonds. Because they post lower returns than stocks, bonds' stability only improves a portfolio's odds of success at the lower withdrawal rates. At withdrawal rates of up to 6 per cent a year for 25 years, a portfolio consisting of 25-per-cent stocks and 75-per-cent bonds had a 100-per-cent success rate in every period under scrutiny. Factor in higher withdrawals and there's a big drop off, however.

So much so that an all-bond portfolio has a success rate of only 15 per cent at a withdrawal rate of 7 per cent over 25 years, dropping to zero as the withdrawal rate approaches 9 per cent.

In other words, the best investment strategy for older retirees who want more income for longer is not to invest in bonds alone but to construct a portfolio that's closer to at least 50-per-cent stocks, depending on the planned rate of withdrawal from the portfolio.

Reinforcing the conclusions of the Trinity researchers is a similar study using Canadian performance data from three professors at Toronto's York University. In order to determine the optimum asset mix for retirees, they developed what they call the wealth/consumption ratio, combining the amount available on retirement with expected annual income. The lower the ratio, the greater the possibility of a shortfall.

A person who has $500,000 in retirement funds and requires $36,000 annually would have a ratio of 14, for instance. Couple that with those average life expectancy figures, they suggest, and you'll discover that a healthy 65-year-old female has a two-in-three chance of outliving her money if it's all invested in bonds. Those odds improve sharply though, dropping to 28 per cent, with an all-stock portfolio.

Why the difference between the two studies? Canada's lacklustre stock market, of course. Substitute U.S. returns for Canadian stocks and the two papers match up rather well.

The message for young retirees is clear: In a balanced portfolio, you're probably safe to maintain a 5- to 6-per-cent withdrawal rate -- perhaps even a bit more during a high-return period like we've been enjoying. But, unless your wealth/consumption ratio is a lot higher than the norm, withdrawing at an 8- or 9-per-cent clip could crimp both your purchasing power and your estate plans.

Gordon Powers heads up Affinity Group, an Ottawa financial services consulting firm.


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