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Recipe for Retirement

Investment diversification is the key to a lengthy retirement

By James P. Ruth, CFP

How large a nest egg will it take to retire comfortably? Will your investment capital run out before you do? What is the right investment mix for a long retirement—maybe 20 or 30 years or more? An advisor who can answer these questions will be an invaluable resource to clients starved for answers.

Maybe this recipe-for-retirement cake will help answer some of the questions. First, grab a mixing bowl from the kitchen cupboard. Then, pull three mutual funds off the pantry shelf. Stir in one growth and income fund, one long-term growth fund and one international fund. Or, season to taste as your tolerance for risk will allow. Cooking with the best ingredients helps ensure the best result; so select funds that have lower expenses and risk. Mix the ingredients thoroughly, reinvesting all dividends and capital gains. Pour the contents into a baking pan and allow it to bake in the oven for 20 years.

All good chefs, of course, need to periodically taste their creations. So every year, reach in the oven with a big cooking spoon and scoop out 9 percent of the cake. Because your appetite grows, increase the size of your scoop by 3 percent each year.

Twenty years later, the timer rings, announcing that your cake is done. So you open the oven door and pull out the remaining cake. But something strange has happened! You pull out more cake than the original ingredients you put in 20 years ago—more cake than you tasted each year along the way. You have baked a retirement cake that will feed its owner for 20 years and there will still be plenty left over for seconds or thirds.

For those of you who are not into cooking, here is the English language translation. The recipe is an example of the power of investment diversification applied to a lengthy retirement. The Retirement Cake Chart illustrates the actual results of a hypothetical investment of $100,000 each in three different load mutual funds from the same family 20 years ago. Each year, dividends and capital gains were reinvested. Quarterly withdrawals equal to 9 percent of the annual value of the remaining portfolio were made to provide retirement income. Because of inflation, the amount withdrawn was increased by 3 percent each year. No attempt was made to show the effect of income taxes. During this period, the stock market has given us bulls and bears, and there has even been a market crash. In selecting a mutual fund, an advisor can control only two things that have any predictive capability: the fund's internal expenses and its risk relative to its peer group. So we have illustrated funds that have lower expenses and risk. The names of the three mutual funds illustrated are not important. The story they tell is.

Retirement Cake Chart
As you can see from the Retirement Cake Chart, after investing $300,000, paying $7,500 in front-end commissions and making 9 percent inflation-adjusted withdrawals for 20 years, the portfolio value at the end is more than $1.5 million. This is the best example I know of having your cake and eating it too.

James P. Ruth, CFP, is a registered representative and president of Potomac Financial Group in Gaithersburg, Md. He is a former Maryland state NAIFA president. He can be reached at 301-948-3900 or by email at pfgroup@erols.com.


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