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Msg 159 of 167 at 12/8/2011 11:36:42 PM by

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The following message was updated on 12/9/2011 8:33:54 AM.

Why I have concerns about a retirement built on Mutual Fund investments

This is off topic - but this board is as close to dead as a board can be. This message is posted as a link to a message board that is still alive - and I need the formatting allowed here at Investor Village to assist in highlighting the key points - and I want it away from other message boards that I currently use.

Why Your Nest Egg May Not Last

Tom Lauricella, WSJ 3-27-11

    In recent years, it has become a rule of thumb that many retirees can safely withdraw 4% or 5% a year from their investments and feel confident about their chances of having their savings last the rest of their lives. Lending credibility to these withdrawal rates are complex computer models that assess the odds of success based on thousands of possible market scenarios. But as powerful as those computers may be, retirees may be overlooking some basic variables -- such as current interest rates and stock valuations -- that will have a direct impact on how long their money lasts.
     The inexact science of withdrawal rates was featured in an analysis published by Vanguard Group in November. While a withdrawal strategy "is important, the key ingredient in a long-term spending plan is flexibility," the report said.
     If investors are relying on either gains in the stock market or bond-market yields to make their money last, "then investors must either accept continuous, relatively smaller changes in spending or else run the risk of having to make abrupt and significantly larger adjustments later," the report said. (The complete report can be found at: vanguard.com/pdf/icrmda.pdf)
     Rather than take out a steady 4% or 5%, the Vanguard report suggests many investors would generally stand a better chance of not running out of money were they to adopt a strategy where the percentage of withdrawals was designed to rise and fall between 2.5% and 5% of the prior year-end portfolio, depending on the market's ups and downs. In short: After a good year, take out more, and following a bad year, less. However, one challenge this approach presents is that a 2.5% to 5% band represents a huge amount of variability in income for a retiree relying on savings to help pay the bills.
     Ed Easterling, founder and president of Crestmont Holdings, an investment-management and research firm, says there are other problems with the standardized withdrawal-rate strategies. Mr. Easterling compares the models that the withdrawal rates are based on to a visitor to Chicago in December who gets a weather forecast based on what the weather can be like over the course of an entire year.
     Most important, he says, is that the models don't put enough weight on market conditions at the time an investor stops putting money away and starts withdrawals. "Most of the models just show the same thing this year as they did last year," he says.
     Overvalued markets, quite simply, are more likely to fall in value. For a retiree, that means a greater likelihood of running out of money thanks to the combination of falling prices on their investments, withdrawals and the corrosive damage of inflation over a period of many years.
     Mr. Easterling, who questions the conventional wisdom behind safe withdrawal rates in a new book, "Probable Outcomes," crunched the probabilities of not running out of money based on different starting valuations for the stock market using a price/earnings metric developed by Yale University professor Robert Shiller.
     Investors had an overall success rate of 95% at a 4% withdrawal rate adjusted over time for inflation. But that success rate fell to 76% for those who retired when stocks were in the top 20% of the historical valuation range. The numbers were starker for a 5% withdrawal rate. For retirees starting out when stocks are in the highest 20% of valuations, the probability of success plunged to 41%. Only when stocks were in the bottom 40% of their valuations did retirees stand a better-than-90% chance of not running out of money.
     The bad news for today's retirees: on this metric, stocks today are in the top 20% of their historical valuations. For retirees depending on bond yields to help meet their savings needs, interest rates at the time of retirement are another variable overlooked by the models, says Mr. Easterling.
     Historically, it has taken about a 6% or 7% bond yield to be able to withdraw 4% from a portfolio plus an upward adjustment to inflation, he says. U.S. Treasury 10-year notes, meanwhile, are yielding just 3.3%. "When you start out retirement today, with such low bond yields, a person that uses the 4% withdrawal rate is assuming that interest rates are going to go up," Mr. Easterling says.
     But if interest rates rise and your portfolio is loaded up with longer-term bonds, those bonds will fall in price. That makes it difficult to take advantage of investing at the new, higher level of rates. The flipside is that a retiree sitting in short-term bonds may be earning just 1% or 2% and taking out more money than is sustainable over the long run. "What happens if interest rates don't go back up?" asks Mr. Easterling. "Then you're really in a pinch."

Investors starting out retirement in adverse market conditions, such as those of the past few years, may only be able to safely withdraw smaller percentages than is now the conventional wisdom -- such as less than 3%, Mr. Easterling says. "Retirees, especially those that started in the recent past, have a relatively long period ahead of them," he says. "Over-assumed returns can empty savings more quickly than many expect."

Next in this series - can consumer staples stocks help build a portfolio with a near 5% withdrawal rate that never touches principal? [The key is their contribution to portfolio annual average distribution growth]

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