Make your retirement savings last into your 90's

  @Money March 15, 2013: 2:57 PM ET
NEW YORK (Money Magazine)

What's the best asset allocation strategy in retirement in order to have a good chance of having savings left even if I live into my 90s? -- Dan M., Richland, Wash.

How you divide your nest egg between stocks and bonds is certainly an important factor in determining how long your savings will last in retirement.

But it's not the only one, nor is it the most crucial. The bigger issue is how much you withdraw from your retirement portfolio each year.

To see what I mean, let's look at a couple of examples I came up with by running figures through a retirement income calculator for a hypothetical 65-year-old retiree who has a $500,000 nest egg and wants reasonable assurance that it will be able to support him for at least 30 years, or until he hits age 95.

If this retiree starts with a reasonable 4% initial withdrawal that he subsequently increases each year for inflation -- $20,000 the first year, $20,500 the second, etc., assuming 2.5% annual inflation -- pretty much any allocation with 20% or more in stocks will provide a 75% to 80% chance that his nest egg will last 30 or more years. That's because you don't need an especially high level of capital growth to support that level of withdrawals.

Surprisingly enough, the allocation that provides the highest probability in this scenario isn't 100% stocks, which offers a 76% chance. It's a 50-50 stocks-bonds blend, which yields an 80% probability. The reason is that the greater volatility that comes with increasing stock exposure can eventually work against you, as it raises the possibility of severe setbacks that can devastate a portfolio.

Related: 'Help! I'm in my late 40s, with no retirement savings'

If our fictive retiree opts for a more conservative withdrawal rate, say 3%, then virtually any stocks-bonds mix offers a 90% or better chance that the nest egg will last three decades or longer. Even a 100% stocks portfolio comes in with a probability of 91%.

This isn't exactly a shock, since withdrawing 25% less each year puts a lot less strain on a nest egg, dramatically reducing the return needed to prevent it from going dry. Again, though, our retiree would get the most favorable odds by sticking with an allocation somewhere between 60% stocks-40% bonds and 30% stocks-70% bonds.

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Were our retiree to move up to higher withdrawal rates -- say, 5% or higher -- he would find two things.

First, that more stock-intensive allocations tend to do better. Higher returns are necessary to sustain those bigger withdrawals.

Second, and more importantly, he would also see that the chances even for the best-performing allocations aren't very good. At a 7% withdrawal rate, for example, even a 100% stock portfolio has less than a 30% chance of making it 30 years.

Related: Don't let a fear of stocks cost you in retirement

Of course, higher stock allocations still have more upside potential. For example, even though a 50-50 stocks-bonds mix has a greater chance of lasting 30 years than, say, a 90-10 mix at a 4% withdrawal rate, you could end up with a lot more money later in retirement with the 90-10 mix if the stock market generates outsize returns. That stands to reason since a portfolio with more stocks will benefit a lot more from a bull market.

The caveat, though, is that if the market tanks, especially early in retirement, a portfolio with a high concentration of stocks will take a bigger hit -- and run a greater risk of running dry.

So what's the lesson in all this?

The big takeaway is that if you want reasonable assurance your savings will support you at least 30 years, the single most important thing you can do is to start with a modest withdrawal rate -- say, 4% or, given today's low interest rates, perhaps even less. The lower the withdrawal rate, the more leeway you have to pick an allocation that jibes with your tolerance for risk.

If you're a Nervous Nellie who cringes when your portfolio's value drops even 10%, you can dial up the percentage of your portfolio that goes into bonds, giving you more downside protection. If you're more a no-risk-no-glory type, you can lean more toward stocks.

Personally, I think most retirees are probably emotionally or psychologically suited for more modest stock allocations of, say, 50% or less. But that's a matter of personal taste. The point is that by holding the reins on withdrawals, you increase the odds of your portfolio lasting -- whatever allocation you choose.

Keep in mind that all the probability figures I've mentioned -- and that you see advisers and retirement researchers cite -- are estimates, not guarantees.

Given the inherent uncertainty in making forecasts about the economy and financial markets, I think it pays to err on the conservative side when deciding how much to withdraw and how to invest. I think it also makes sense to at least consider devoting a portion of your retirement savings to an immediate annuity that can provide lifetime income regardless of how your investments perform.

Related: 10 tips for planning your retirement

Finally, remember that your retirement spending isn't something you can put on autopilot, starting with an initial withdrawal rate and blithely increasing it by inflation without regard to how your nest egg is faring. To avoid running out of money too soon -- or ending up with a big stash late in retirement, along with regrets you hadn't spent more freely early on -- you've got to remain flexible, cutting back when returns are lean and perhaps spending more if your portfolio's done especially well.

So I recommend you do your own version of what I did: Go to a good retirement calculator, plug in how much you have saved and then run a variety of scenarios with different withdrawal rates and stocks-bonds allocations until you find a spending level and asset mix that gives you the assurance you need. Then go through that process again every year, so you can make adjustments as your spending needs, nest egg's value and market conditions change. To top of page



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