Retirement Strategies

The new math of Retirement: Building better distribution portfolios

  • Do you have enough money to retire?
  • Will your retirement portfolio enable you to maintain your current lifestyle?
  • What is a sustainable withdrawal rate that won’t deplete your savings over your lifetime?

These are difficult questions to answer. When it comes to developing models to solve for the challenges of retirement planning, even the most sophisticated algorithms, spreadsheets and planning software cannot perfectly capture every uncertainty and unexpected event.

Real-life dynamics exceed the limits of conventional models. The complex combination of your life events and capital markets assumptions lies at the heart of this challenge. Success is not only defined as sustaining your current standard of living in retirement, but may also include secondary goals such as bequests, charitable giving and planning for future generations.

To meet these goals, your advisor must blend the science of planning and portfolio management with the art of applying his knowledge and judgment to client specific, inherently unknowable variables.

Added complexity and opportunity

As we manage your assets in the distribution phase, there are a number of challenges that are different than in the accumulation phase. Numerous variables are introduced to the portfolio equation, requiring additional education and discipline. A small shift in withdrawal rates, adjustments in asset allocation policy or changes to investment managers can all lead to major differences in long-term outcomes.

So while retirement portfolio modeling may be a scientific exercise, the inputs into the model are not exact. Experience and judgment are our best assets in planning for the distribution phase. Here are some of the variables you must consider in portfolio planning, both before and during retirement:

  • Time horizon. This may include multiple horizons tied to specific goals, such as retirement income solutions, property purchases or assisting with educational costs for grandchildren, as well as potentially early retirements and longer life spans.
  • Risk tolerance and investor behavior. Our natural risk aversion may be deepened in difficult markets, and the tendency to get too conservative too early can undermine the ability to fund a long retirement.
  • Expected or required rate of return. This includes your accumulated wealth, retirement goals and future income needs.
  • Asset class preferences. We must consider your investment history and biases.
  • Tax situation. Reducing the impact of taxes increases long term sustainability.

Now consider broader variables as you enter retirement:

  • Capital markets. The sequence of returns now becomes critically important. Analyzing the impact of investment results becomes more complex than just average returns and average standard deviations.
  • Inflation rates and economic uncertainty. Inflation can have a disproportionate effect on retirees due to the growing costs of health care and other factors.
  • Other income sources. The sustainability of Social Security and pension sources, as well as any part-time work you may engage in, is uncertain.
  • Income needs. Changes in retirement living, such as travel or charitable work, require a detailed review of income needs.
  • How, when and from which accounts to take withdrawals. Establishing the order of withdrawals from qualified and non-qualified accounts, along with setting optimal withdrawal rates, requires skill, vigilance and ongoing effort.

And finally, considering your unexpected cash flow needs which are essentially unknowable.  You may need a new roof or a surgical procedure, or may face the prospect of needing expensive long-term health care. You may also have variable monthly spending needs and patterns.

Given all these factors, it becomes apparent that retirement planning models cannot account for everything. Small changes in inputs can lead to significant changes in outputs — resulting in risk.

Despite the challenges involved in retirement income planning, the shift to the distribution phase also represents a profound opportunity for you. This opportunity is compounded by the sheer number of baby boomers on the cusp of entering retirement and possible outcomes of the current economic crisis.

Withdrawal Rate


* See Note Below
What portfolio withdrawal rate should advisors recommend during the retirement years – and how can they make the resulting income flows last as long as possible.  The withdrawal rate is defined as the amount of the investment portfolio that can safely be liquidated each year to provide income in retirement without depleting the assets during your lifetime.

Perhaps the single biggest criterion for success in the distribution phase is creating a sustainable income stream while preserving your desired lifestyle. Despite all the academic research on the optimal withdrawal rate, asset allocation or glide path for retirement portfolios, definitive answers are elusive. Clearly, you need to hire an advisor that specializes in this area to evaluate your retirement goals, income stream requirements and overall financial situation to develop and implement an appropriate withdrawal rate combined with an appropriate investment allocation.  To this end I am committed to delivering you the best and newest ideas and practices in this highly specialized area of retirement planning.

Sequence Matters

American Funds recently completed a study called the “new math” of retirement.  The sequence of investment returns, which affects the timing of wealth generation during the accumulation years, can have a dramatic effect when retirement distributions are being taken.   In chart 5, Portfolio A shows actual returns for Standard & Poor’s 500 Composite Index from 1966 through 2005.  The hypothetical Portfolio B earned the same results in inverse order. 


Inverting the sequence of returns has no effect on the ending value of a $10,000 investment during this 40 year accumulation phase (see Chart 6).  But taking annual withdrawals makes a significant difference.  Portfolio A begins the distribution phase with a negative annual return and suffers three more negative years in the first 10 years of retirement.  Struggling to maintain a 5% inflation-adjusted withdrawal plan, and damaged further by the 2000 stock market decline, this portfolio runs out of money in 2002.

Surprisingly, Portfolio B endures three consecutive negative years in the first decade and still comes out ahead – 12.7 times its original investment – while easily meeting its distribution requirements.  In this case; sequence matters.  Over different periods of time or with different withdrawal rates, the sequence of returns has a variable effect – there may be a dramatic difference, or very little.  As this illustration points out, despite having identical average annual returns and standard deviations for the period, the two portfolios’ results are not symmetric.  Investors in the distribution phase are more vulnerable to unfortunate timing.  While there is no way to control the sequence of returns; investors can choose an investment manager that aims to limit downside risk.


* See Note Below
American Funds: The sequence of return matters. Lit. No. MFCPFL-066-0508P Litho in USA CGD/ICI/8265-S17417 © 2008 American Funds Distributors, Inc.

* See Notes Below

Both portfolios have the same average rate of return over the twenty years and the same standard deviation.  However, the end result in the distribution phase is very different.  It could be that the standard measurements of average rate of return and standard deviation are incomplete measures.  We need to look into alternative measures of a portfolio such as capture ratio.

Fixed Income

Fixed income or bond investments can provide an important component to stabilize the income stream during retirement.  However while the strategy can provide a reliable stream of income from a stable and “safe” platform of investments, there can be a number of problems with this line of thinking.  It is important to understand that bond investments have a number of risks including but not limited to: credit risk, low returns, and call features.

Also the marketing claims of the mutual fund industry assert that bond funds are superior to individual bonds because they provide total return that includes income as well as capital appreciation has a significant flaw.   In retirement, appreciation becomes a secondary goal as compared to consistent income.

Bond funds do not have the same characteristics as individual bonds.  Individual bonds pay the same amount of interest every six months (or quarterly) through maturity, at which point they pay the face amount of the bond.  If you hold individual bonds to maturity, you do not have to bet on the direction of interest rates because you will get back the face amount of the bonds when the bonds come due.  You can also choose the quality of the bonds you purchase.  If you decide to sell an individual bond before its due date, you may get more or less than you originally paid, depending on the level of interest rates at that time.  This may not be true with bond funds.

Buying an individual bond is fairly straightforward.  Using our partnership with LPL Financial we are able to search for high quality bonds that will allow us to design and implement a fixed income portfolio to meet your financial retirement goals. 

Though individual bonds may have the same market volatility as bond funds, as they approach maturity their price will move closer to their face value and its volatility (duration) will decrease.  Therefore holding individual bonds can be an important component to establishing a reliable income stream.

Whatever your goals for the future may be; your needs always come first

The shift from accumulation to retirement distribution strategies requires an entire specialized skill set.  With such an overwhelming number of investment options, one of the most important decisions you can make is to seek the advice of a trusted, qualified advisor. For this important partnership, you need a highly trained and experienced professional who sees your total financial picture—someone who can help you define your life goals, establish the right financial plan, provide strategies focused on your needs, and help you stay on track.  To this end I have dedicated myself to seeking the expertise, knowledge and education to provide a blend of the science of planning and portfolio management to pursuing your retirement goals.

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* Past results are not predictive of results in future periods.  Investors should carefully consider the investment objectives, risks, charges and expenses of investments.  Investments are not FDIC – insured, nor are they deposits of or guaranteed by a bank or any other entity, so investors may lose money.

* Bonds are subject to market and interst rate risk if sold prior to maturity.  Bond values will decline as interest rates rise and are subject to availability and change in price.

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