By John Yetman & Adam Goddard

In our practice, our clients often ask us: “How do I get the most out of my retirement?” After doing over 2,000 financial plans and working with hundreds of retirees, these are our observations.

Although a good retirement is a matter of balancing many aspects, this article will focus on just one--how to live a good retirement and not run out of money.

The best way to not worry about money is to plan to not run out of money. The average person works 90,000 hours in his lifetime and spends fewer than 10 hours planning for retirement. Here are some steps to help ensure that your clients are on the right track.

First, make sure they know how much they need to live on during retirement. The average retiree lives on 70 percent to 80 percent of his pre-retirement income. This is because some expenses decrease during retirement while others may go up.

To live a good retirement life, your client will need to have a portfolio with low risk.

Second, have them answer the question: “How much money do I need to retire?” A T. Rowe Price study that was published in The Wall Street Journal in November 1999 showed that if a person lives 25 years in retirement, had a portfolio that was 60 percent stocks and 40 percent bonds, and took an annual distribution from his portfolio that was 6 percent, he would have a greater than 50 percent chance of running out of money. Many retirees today will live much longer than 25 years in retirement. In fact, today many people will live one third of their lives in retirement.

Many may think that if they can earn 8 percent a year and withdraw 8 percent from their funds each year, they will never invade the principal. However, this is not the case because we must take inflation into consideration. For our clients, we do not recommend taking more than a 5 percent distribution from their portfolios. This way, if inflation averages 2.5 percent and they withdraw 5 percent, they need to earn 7.5 percent on their money to keep their nest eggs intact.

One major problem with the above example is that it does not take into account the sequence of returns. If the early years of their retirement happen to be in a bear market, your clients’ distribution rate could balloon. Consider, for instance, if one had retired in March 2000 with $1 million and started to take out 8 percent each year. Assume that he was aggressively invested and over the first three years, he lost 40 percent.

As you can see, the person in the above example now has less than 50 percent of his original capital remaining. Now his 8 percent distribution rate is over 16 percent, based on the current balance--a plan destined to fail. You don’t need an extreme example like this one to cause your clients’ plan to fail. Once the distribution rate starts moving up, it can be a vicious cycle. Even worse, these distributions don’t even take inflation into account. As this example shows, setting the proper distribution rate from the portfolio is critical.

Key steps
The first step is to determine how much money a client will need to live on in retirement. We then divide that amount of money by his portfolio value to determine the distribution rate. Make sure that number is 5 percent or less. The third step is, in effect, recreating his paycheck. We need to construct the portfolio so that there is the greatest chance that he will get the 5 percent, inflation-adjusted, income distribution he needs. Where will he get that income? What income can he count on during retirement?

We like to look at predictable income sources during retirement. We refer to this strategy as “Building Income from the Bottom Up.” These predictable sources would include Social Security and any pension benefits. According to the Social Security Administration, the average monthly payment for an individual was $895, and $1,483 for a couple. A 1996 study by the Social Security Administration showed that the average retiree receives only 44 percent of his income during retirement from a combination of Social Security and pension income. The remainder comes from investment income and working.

The other two “predictable” income streams are interest income from bonds or other similar instruments like preferred stocks, and dividends from common stocks. Also included in this category is rental income from real estate.

As a rule of thumb, these predictable income sources should equal 60 percent to 80 percent of one’s retirement income in total. Thus, the fluctuation from stock market volatility is not as critical to the year-to-year cash flow for the retiree.

Now that we know what the client needs to retire, what steps do we take to make sure that, as a retiree, he is receiving the remaining portion of his retirement income from investments rather than from working? The answer is to preserve the capital. It is important for a retiree to shift his mindset from capital accumulation to capital preservation. We like to say that losses are twice as cruel as gains. This is because if you lose 50 percent in year one and gain 50 percent in year two, you are not back to a 0 percent return. You are still down 25 percent.

To live a good retirement life, your client will need to have a portfolio with low risk. To reduce the risk in our clients’ portfolios, we use what we call our five defensive investment strategies. In addition to the “Building Income from the Bottom Up” strategy, we use the following strategies to help protect our clients’ principal:

• Dollar cost averaging of a lump-sum pension
  
• Overweight value stocks
  
• Noncorrelating assets--asset allocation
  
• Bond ladders

We also use a living benefit rider on a tax-deferred annuity to help further reduce the risk of the stock market for some of our clients. None of these strategies can guarantee that your clients won’t suffer from a loss, but they will go a long way in helping to manage risk.

Once the portfolio is set up properly, it is important to meet with your clients on a periodic basis to make sure they are on track for meeting their retirement goals. Having a plan and knowing you are on track to achieve the goals of that plan provide a great deal of satisfaction and peace of mind. A good retirement cannot be had without peace of mind.

John Yetman and Adam Goddard are senior vice presidents-investment officers with the Goddard and Yetman Retirement Investment Group of Wachovia Securities in Washington, D.C. For more information, call them at 202-828-8193. (Wachovia Securities, Inc. member NYSE & SIPC)

Web Exclusive Articles

Selling Stability

Eight Tips to Help You Prepare for a Media Interview

Transitioning to a Fee-Based Financial Planning Practice

Do I Really Need an Upgrade?

Reverse Mortgages

Tough Times Call for Drastic Action

Top     LEGAL NOTICES     Contact Webmaster    

Change/Renew NAIFA Membership     Get Advisor Today: Join NAIFA

© Advisor Today 2003. All Rights Reserved.