The Debate Over Retirement Income Strategies
Thursday, June 23, 2016

As millions of baby boomers are either retiring or nearing retirement, there is an ongoing debate on how to manage one’s portfolio heading into and once in retirement. Here’s a glimpse into it: While at last week’s Morningstar Investment Conference, I tweeted a comment made by Morningstar’s David Blanchett about the likelihood of success for a 50% stock/50% bond allocation with a 4% inflation-adjusted withdrawal rate (the so-called 4% rule) in the current low rate market environment. David described the odds of success as being no better than a coin toss. (Success being defined, in this context, as not outliving one’s savings.) Moshe Milevsky quickly responded by tweeting “Hopefully somebody asks him whether ‘probability of success’ or failure is a proper risk metric.”

While it can be hard to judge emotions from written words, especially a tweet, neither David nor I thought Moshe was trying to be cheeky. Rather, Moshe’s comment was reflective of the different camps or—if you prefer—schools of thought about how investors should allocate their portfolios in retirement. (Both David and Moshe have published research about retirement portfolios.) One camp calls for maintaining an allocation to stocks with systematic withdrawals (e.g., the 4% rule). The other camp calls for annuitizing an amount large enough to cover anticipated living expenses.

The systematic withdrawal camp focuses on using the portfolio to fund consumption. They suggest withdrawing a small amount from your portfolio in the first year of retirement (e.g., 4% of total retirement savings) and then increasing it each year in accordance with inflation. The actual amount that can be safely withdrawn depends on assumptions about future market returns, how big or small of an equity allocation is used and the existence of other forms of income (e.g., a pension). This can be thought of as more of a growth approach, especially since if the portfolio does well, the amount available for withdrawals will increase.

The big focus of the annuitizing camp is preservation of income. Those in this camp believe that the cash flow required for living expenses in retirement should be funded by guaranteed income sources. They do not think investors should risk a sequence of bad market returns and/or bad investment decisions with money needed to live on. Rather, they argue for transferring these risks to an insurance company through the purchase of annuities.

Ask which method is best and you’re likely to get a lengthy discussion. Systematic withdrawals give you more upside, while annuitizing offers more downside protection. In between the two is a big gray area. Social Security provides guaranteed income, as do pensions. Reverse mortgages can add to the stream of income for as long as the house is lived in (costs are an issue, though). Bond ladders can provide income. Allocating four years’ worth of living expenses to cash and short-term bonds will generally prevent you from having to sell stocks during market downturns. Allowing your withdrawal rate to move up or down gives you flexibility to deal with volatile portfolio returns.

Having spoken to both camps, I don’t think the decision on how to allocate one’s retirement portfolio is one size fits all. Very affluent people don’t need to annuitize so long as their spending habits aren’t out of control. Those who have saved little for retirement won’t be helped by annuities. Those in the large group in between are in a gray area where systematic withdrawals or annuities may work.

When trying to decide what to do (a decision that ideally is made before you retire), consider your long-term record managing your portfolio, your tolerance for risk and your ability to cut back on expenditures during tough market conditions. This information will help guide you in determining which camp is better for you. While doing this, keep in mind that you don’t have to pick one side or the other; you can pick and choose what works best for your own personal situation (e.g., following the 4% rule and purchasing a longevity annuity).

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Highlights from the AAII Journal

The Week Ahead

Results from the second-quarter’s early reporters will continue to be released, with 10 members of the S&P 500 on the calendar. They are NIKE (NKE) on Tuesday; Acuity Brands (AYI), General Mills (GIS) and Monsanto (MON) on Wednesday; and ConAgra Foods (CAG), Constellation Brands (STZ), Darden Restaurants (DRI), McCormick & Co. (MKC), Micron Technology (MU) and Paychex (PAYX) on Thursday.

The week’s first economic report will be April international trade, which will be released on Monday. Tuesday will feature the second revision to first quarter GDP, the April Case-Shiller Home Price Index and June consumer confidence. May personal income and May pending home sales will be released on Wednesday. Thursday will feature the June Chicago Purchasing Managers’ Index (PMI). Finally, June motor vehicle sales, the June PMI Manufacturing Index, the June ISM Manufacturing Index and May construction spending will be released on Friday.

Three Federal Reserve officials will make public appearances this week: Chair Janet Yellen on Wednesday, St. Louis president James Bullard on Thursday and Cleveland president Loretta Mester on Friday.

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AAII Sentiment Survey

The number of individual investors expecting stock prices to rise over the short term is at a four-week low, according to the latest AAII Sentiment Survey. Neutral sentiment rebounded strongly, while pessimism pulled back slightly.

Bullish sentiment, expectations that stock prices will rise over the next six months, fell 3.4 percentage points to 22.0%. Optimism was last lower on May 25, 2016 (17.8%).  The drop makes this the eighth time in nine weeks that fewer than three out of 10 survey respondents are optimistic. It is also the 33rd consecutive week and the 66th out of the past 68 weeks with bullish sentiment below its historical average of 38.5%.

Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, rebounded by 5.7 percentage points to 42.8%. The rise follows last week’s four-month low. The increase keeps neutral sentiment above its historical average of 31.0% for the 21st consecutive week.

Bearish sentiment, expectations that stock prices will fall over the next six months, declined 2.3 percentage points to 35.2%. The drop follows last week’s four-month high, but is small enough to keep pessimism above its historical average of 30.5% on consecutive weeks for just the second time since February.

Uncertainty and lack of optimism continue to be trends suggested by our weekly survey. More than four out of 10 individual investors have described their short-term market outlook as "neutral" during 14 out of the first 25 weeks of this year. (Neutral sentiment readings above 40% are unusually high, meaning more than one standard deviation above the long-term average.) At the same time, optimism has only exceeded 30% just seven times this year.

Giving individual investors cause for concern is the slow pace of U.S. economic growth and uncertain pace of global economic growth, terrorism and global unrest, lackluster corporate earnings, the prevailing level of valuations, the forthcoming November elections and monetary policy. Some AAII members, however, are encouraged by sustained domestic economic growth, corporate earnings and the proximity of stock prices to their record highs.

This week’s special question asked AAII members whether the Federal Open Market Committee was correct in keeping interest rates unchanged at its June meeting. More than half of respondents (56%) said the Fed was correct not to raise rates. Slow domestic economic growth and global uncertainty—including today’s Brexit vote—were the primary reasons given why. About one-third of respondents (34%) disagreed, saying the Fed should have raised rates. Many of these members think rates should be moved back to more normal levels and/or that ongoing monetary policy is hurting savers.

Here is a sampling of the responses:

  • “They are correct because the economy is fragile and the rates increases will slow down everything.”
  • “They are right because of world conditions and uncertainty.”
  • “Even a small increase, like 0.25%, is better than getting nothing on money market accounts.”
  • “Incorrect. They should have normalized rates long ago.”
  • “No change is correct now, but the Fed erred in failing to raise rates 18 months ago.”


This week’s Sentiment Survey results:

Bullish: 22.0%, down 3.4 points
Neutral: 42.8%, up 5.7 points
Bearish: 35.2%, down 2.3 points

Historical averages:

Bullish: 38.5%
Neutral: 31.0%
Bearish: 30.5%
Take the Sentiment Survey.

Local Chapter Meetings
AAII Local Chapter Meetings offer you a variety of presentations from expert speakers who will give you their view on the world of investing. A bonus of attending a Chapter Meeting near you is the opportunity to meet other AAII members who share your interest and enthusiasm for investing. You can even share the Chapter experience with your family and friends by inviting them to attend Chapter Meetings with you!