How much can you withdraw from a portfolio and still have your savings last throughout your lifetime? This is an important question because the answer can mean running out of money too soon or not having enough cash flow to meet day-to-day expenses.
In fact, as life expectancies lengthen, the threat of running out money is becoming a bigger concern. On average, the baby boom generation will spend more years in retirement than previous generations did. More years means more spending—something Ponce de Leon probably wasn’t considering when he went looking for the fountain of youth.
One solution to the problem is to buy an immediate annuity. The upside is that you are guaranteed a stream of income. As insurance expert Peter Katt states in his article about insurance products (click here), “You cannot outlive annuity income.” The downsides of annuities include the costs, less wealth creation, and the loss of flexibility over your portfolio.
The other effective option is to set an appropriate withdrawal rate. Studies show that withdrawing 4% of your initial portfolio value at retirement and then adjusting that amount by the rate of inflation is a strategy with a high probability of ensuring that savings last a lifetime. My predecessor as the editor of the AAII Journal, Maria Crawford Scott, also points out that this allows you to separate your allocation decisions from your withdrawal needs. Maria elaborates starting here.
Those of you who are fortunate to have more savings than are necessary to fund retirement have an additional challenge, allocating for financial goals you would like to accomplish before or at death. In the latest Retired Investor column, I give guidelines on incorporating plans for these goals. The column appears on page 16.
Adequate cash flow isn’t just important for retirees, it is also important for companies. Positive cash flow allows a company to reinvest in itself, pay dividends, and pursue growth opportunities. The cash flow statement (which I consider to be the most important financial statement) shows you just how much cash a company is generating. Joe Lan shows you how to read and analyze a cash flow statement here.
Another important part of financial planning is limiting investing mistakes. Steven Sears, a columnist with Barron’s, says most individual investors overemphasize making money at the expense of focusing on not losing money. Sears explains, and gives strategies for avoiding losses here.
This month’s issue includes interviews with three experts I spoke with at this year’s CFA Institute Conference.
The first is with Mike Mayo, a banking and finance sell-side analyst with CLSA. Mike explains how companies put pressure on analysts to be positive. He also gives warning signs on what to watch for when reviewing an earnings call transcript and reading the annual shareholder’s letters. A transcript of our conservation can be found here.
The second interview is with Daniel Kahneman. Daniel won a Nobel Prize for his work in behavioral economics. He believes investors hurt themselves by trading stocks and funds instead of simply investing in index funds and working with a financial adviser who is a realist. We discuss his rationale and talk about other behavioral errors, as you will see here.
The third interview is with macroeconomist David Hale. David believes investors should allocate to emerging markets to take advantage of their stronger growth rates and diversification benefits. We spoke not only about the reward potential, but also about the risks of investing in these newer markets. You can see David’s comments here.
Finally, AAII founder and Chairman James Cloonan gives his latest commentary on the Model Shadow Stock Portfolio. Global and domestic uncertainty dragged the performance of the markets and the portfolio down in May. Nonetheless, the portfolio’s year-to-date performance remains firmly in positive territory. Click here for more information about the portfolio.
Wishing you prosperity
Charles Rotblut, CFA
Editor, AAII Journal