Thu, 27 Dec 2012
Overspending and impatient selling are two moves that can prematurely drain retirees' portfolio income, warns financial columnist Gail MarksJarvis, who offers strategies to avoid these pitfalls.
Christine Benz: Hi, I am Christine Benz for Morningstar.com. Getting ready to retire involves assessing many moving parts. Joining me to discuss some of them is Gail MarksJarvis. She is a syndicated columnist. She is also the author of Saving for Retirement (without living like a pauper or winning the lottery).
Gail, thank you so much for being here.
Gail MarksJarvis: It's good to be here.
Benz: Gail, one group I'd like to talk to you about is people who are just getting ready to retire. This is a scary time for a lot of investors. They are attempting to sort of jump off their own cliff and see whether what they've managed to save is going to last them through what they hope will be a very long retirement. What are some of the key steps that you would suggest investors take when they hit that threshold and they think they're about ready to retire? How do you do that analysis to see if you're actually ready?
MarksJarvis: What's been troubling to me is when I've looked at some of the statistics, so many people just retire. They look at a number. They look at a 401(k) or an IRA and they see the most money they've ever seen. It looks huge. Maybe they have $300,000, maybe it's $500,000. "Oh, that's a giant amount!"
Benz: Sounds like enough.
MarksJarvis: So, they just assume they can use it and that everything will be fine. I am troubled by the number of calls that I get at my office from people who have been retired for a while, sometimes literally crying to me because the money is running out. They never realized that it would happen, and it's too late to go find a job.
So, what people need to do is up front before just looking at the number and saying, "It looks OK; I think I can make it," they need to sit down. They need to actually work a budget. There are many calculators on the Internet that are called like retirement income calculators where you can look and see if what you have is going to cover your needs. I know some people don't like the idea of budgeting. But again, on the Internet you could do a Google search for "retirement budget." All kinds of things; you don't have to do any math. You just insert the numbers and it turns out OK.
People often think they'll live with less in retirement than they lived before they retired. But I have talked to a lot of people that in which that was a surprise too. They thought they'd sell the big house and move somewhere else. But when they moved somewhere else, the condo they bought was as expensive as the house.
Benz: Hard to sell the house.
MarksJarvis: Yeah, hard to sell the house, if you can even do that right now. I found people who have simple hobbies like growing wildflowers, but it turns out that those costs a lot. Retirees like to go out to eat; that costs something. They forget they might want to travel to see grandchildren. Traveling costs a lot, even if they have modest needs. So, these things all need to be considered up front.
Benz: One key thing I know that you talk about in the book is this idea of setting your withdrawal rate. So, what is a safe withdrawal rate that you can extract from your investments without risking running out of money? How would you suggest that pre-retirees approach that question?
MarksJarvis: Well, there is a rule of thumb. If you look at what you've saved, you can take out 4% to 5% of that a year, assuming that you have your money invested in like a balanced-type approach, maybe half stocks, half bonds; you're getting a return of maybe about 6% a year. Then you can take out 4% to 5% the first year of retirement. So, if you had $1 million that would mean you took out $40,000 to $50,000, combine that with your Social Security. And maybe you'd have say $40,000 plus your Social Security, maybe you'd have $65,000 to live on.
You have to look at that. Will that work for me? But don't play games. Because if that doesn't work for you and you think you're going to be able to take more out, you're taking a huge risk that you'll run out of money prematurely. Now, the other thing that people get confused about when you talk about pulling this money out, people say, "Well, when I get to age 70 1/2, I have my required minimum distribution."
Benz: From my IRAs and company retirement plans.
MarksJarvis: The government requires that you take a certain amount of money out a year because that money was protected from taxes before, and the government has this set up, so that you have to take a certain amount out at a certain point so that you pay your taxes. Uncle Sam wants your money. Now, people say, well, I have to take out my minimum distribution. . .
Benz: That takes me way over 4%. I get that question too.
MarksJarvis: Way over 4%. And I say that doesn't mean you have to spend that minimum distribution. If you know that all you can take out is 4%, after you've taken your distribution, put more money back into savings so you don't run out of money.
Benz: One thing I want to cover with you in terms of withdrawal rates, too, is what happens if you are using that 4% rule, and it includes a little inflation adjustment that you get every year, right? So 4% for year one and inflation adjustment thereafter. What happens if you hit a really terrible market? So, we're back in sort of a 2008-type environment where stocks are down 35%-plus. What is my strategy then for my withdrawal rate?
MarksJarvis: And this is a really scary possibility for retirees. There has been some research done that if you hit a bad market very early in retirement and you just keep taking out the money you assumed you'd take out, you can run out of money very early in retirement while you are still lively and you want to have an active life. You don't want to see that happen.
Benz: So, the portfolio values weigh down, but you're still taking your same dollar amount out, that's a problem.
MarksJarvis: And you're not giving that money a chance to heal. We know that cycles improve. We see that in this last cycle, if you would have had say half of your money in stocks and half of your money in bonds, the market went down 57%.
Let's just take a real easy number, let's say you had $10,000, that's all you had. Then with that loss that $10,000 would have turned into $7,700. But if you had let it sit there and heal, in a little over a year you would have gained back your original $10,000, and three years later that $10,000 that turned into just $7,700 would have been worth $13,000.
So the key is in a bad market to try to leave us much money still invested so that it can heal, and that can be hard for people to do. We just talked about taking 4% or 5% out a year. One of the things you can do to let your money heal is just stay with the previous year's income. Stay with what you were taking out the previous year rather than tweaking it up for inflation. That will help leave more money behind to heal. Ideally, you would cut back even further. You wouldn't take 4% out, maybe you would take 3.5% out. Anything you can leave there allows the money to heal and for you to come through cycles.
Regardless, it's going to be scary during a bad cycle like we went through. But the proof is I think the last few years in some ways are encouraging for people because it shows that despite the people who were on the phone to me, yelling in 2009, Gail, I have lost everything. They did not lose everything, and they gained it all back if they were cautious. And I am talking about when I say a 50-50 portfolio. I am talking about half in the S&P 500 and half in U.S. government long-term bonds. That might not be your exact portfolio; that's what I used through the illustration.
Benz: Really bad equity markets are one concern for a lot of retirees or pre-retirees. It seems like the big thing on investors' minds, pre-retired investors, right now is the bond market and what they might expect from bonds and what could happen to their portfolios in a period of rising rates. Not to mention that the interest rates that they're earning on their bonds are really, really low right now. What's your counsel to investors on that front in terms of their bond portfolios?
MarksJarvis: So, people have become very risk-averse after what they've gone through.
Benz: We're seeing it, right?
MarksJarvis: "Let's just hold onto my money. Let's just hold onto my money. I don't care if I am getting 1.5% in a certificate of deposit. I don't care if I am getting 1.5% in a U.S. government bond. At least it's there." But that's not going to look as encouraging at the point--and we still can't see this point coming and the Federal Reserve has just said they're probably going to keep rates low for another year or so--but at a certain point, bond yields are going to start to tick up. That means if you have a Treasury bond that's only paying 1.5%, and you say "I'd like to do better," you're not going to be able to sell that bond and take the money and get a higher-paying bond later because no one is going to want your low-interest bond.
In other words at that point, you lose money if you want to sell it. But if you hold on, you don't lose money. But the interest you're making may not keep up with inflation. We see no sign of inflation now, but the expectations are two, three, or four years out. Maybe at that point you'll see inflation and then your money from your interest might not stretch as far to buy the things you want.
Benz: So, does that mean that bonds should play a reduced role in retirees' portfolios, or do you still favor sort of a balanced mix regardless of what the challenges are for the bond market?
MarksJarvis: I think that everyone should always have a balanced mix. But I think in this kind of environment, you have to be careful about getting yourself locked into bonds that are like long-term bonds. You want to stay shorter-term, maybe five years or less. You want to have a combination of high-quality corporate bonds. I would say in the kind of environment we're in to beware of high-yield bonds because what you're being paid for high-yield bonds now is not extraordinary. And if we see a downturn in the economy, especially with the threats of the fiscal cliff coming, you could take a loss on high-yield bonds just like you could in stocks.
As far as stocks are concerned, you can get some income from stocks. And I have been encouraging people even with the possibility of taxes going up on dividends, to look at high-quality stocks, the very highest-quality stocks that pay dividends. And think of getting some income there, not just from your bonds. And the higher-quality stocks if we do get inflation or a stronger economy that could take your bonds down, those higher-quality stocks might appreciate at that point in time.
Benz: Gail, thank you for this very helpful guidance on this important topic.
MarksJarvis: Thank you.
Benz: Thanks for watching. I am Christine Benz for Morningstar.com.