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Proper Planning Eases Retirement Worries

February 29, 2016 Mickey Roth, For the Express-News: April 4, 2014
The Subjective Science of Happiness

SAN ANTONIO — I have begun to see commercials for a major financial services company that are focused on retirement. The tagline of these commercials is, “How long will your retirement portfolio last?” 

The idea being sold is that you will likely use up all of the assets you've set aside for retirement in just a few years and then you'll have little, if any, financial support. Therefore, you need to engage this company to address the misfortune of living too long.

This is a situation I have addressed for decades; that is, how can you manage your investment portfolio so that it can support you in your retirement and actually grow while it does that? This question has become extremely important because of a significant event in retirement planning:

Pension plans have gone away. Instead, employers are locked on 401(k)s and IRAs. These plans can address employee retirement at a much lower cost to the employer than pensions. And they throw onto each employee the decisions about how they are to be invested and how much is to be withdrawn.

From that last point comes the concern: How long will your retirement portfolio last?

There is no way to answer that because you cannot know how long you will live in retirement. And because of that, it makes no sense to even make an assumption.

You could die at 70, or at 102 or anywhere in between. So basing the management of your retirement account (401(k) or IRA on a specific number of years is nonsense. But there is a logical way to plan for retirement given that pensions are a thing of the past.

Basically, you must build up your 401(k) and IRA so that they contain substantial sums when you retire. And the definition of “substantial” can be determined by using the methodology to which I referred in the opening paragraph. This methodology is something which I have, over the years, come to refer to as Roth's Inequality. “Roth's Inequality” is expressed thusly:

The Expected Return (ER) of your retirement portfolio must be greater than the Annual Distribution (D) which you will take (expressed as a percentage of your market value) plus the Rate of Inflation (I). This can be shown in a rather simple mathematical way: ER > D + I

Expected Return could prudently be around 8 percent to 10 percent. Common stocks, over time, have produced 10 percent to 12 percent APR. Obviously these numbers can vary, as in 2008, but over time the ER is around 9 percent. Bonds, (intermediate and long) today, show what are historically very low rates, but these are likely to climb to a 6-8 percent range. The situation in money market accounts is similar to what we now see in bonds.

If you manage your 401(k) and IRA accounts with reasonable asset allocation using competent managers whom you trust, you could create something like this:

  • Stocks 50 percent of your portfolio.
  • Bonds 40 percent of your portfolio.
  • Money markets 10 percent of your portfolio.

You could reasonably have an expected return near 9 percent. And if you took an annual distribution of 5 percent of your year-end market value, that would leave 4 percent of your return to offset inflation.

So, with this model you would take from your retirement portfolio annually just over half of its expected return.

There are, in this methodology, a number of key concepts anyone using it must understand:

Perhaps most important, your annual distribution must be a percentage of the market value of your portfolio. So, after a year like 2008 you'll have to tighten your belt.

Over time, however, your portfolio will have the capability to provide distributions whose purchasing power will grow.

And, this will be capable of supporting you no matter how long your retirement lasts. Therefore, you would not have to worry, about outliving your retirement account.

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