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Dispatches

Many Retirees May Benefit From Non-Traditional Strategies

A brief from the American Institute for Economic Research challenges two primary guidelines for retirement investing that are considered conventional wisdom.

Conventional wisdom suggests two primary guidelines for retirement investing.

The first is that allocations should become more conservative as a person ages. A common rule of thumb calls for an investor’s equity allocation to equal 100 or 110 minus his or her age. For example, a 65 year-old’s equity allocation should be no higher than 45% under this guideline.

The second guideline calls for a preset, inflation-adjusted withdrawal rate. The most commonly suggested method calls for a retiree to withdrawal 4% of savings during the first year of retirement and then only increase the amount to account for annual inflation. Several studies have confirmed 4%, or percentage amounts close to it, as a maximum withdrawal amount that prevents savings from being exhausted over a 30-year period.

A brief from the American Institute for Economic Research challenges these guidelines. The brief’s author argues that the guidelines do not work for the typical person who has saved far less than $1 million. The guidelines also may not work for retirees who will not see a significant improvement in the quality of their life from withdrawals, those who intend (or want) to set aside a sizeable amount of savings to bequeath or those who have planned spending patterns that don’t mesh well with a set withdrawal amount (such as remodeling a house early in retirement). Rather, such retirees may be served by following an alternative approach.

The alternative approach can start by splitting savings between what is needed in the short term and what can be set aside for the long term. Short-term savings should be allocated to safe investments such as cash or money market accounts. Long-term dollars (not needed for 20 or more years) should be allocated mostly to stocks.

Those retiring with $200,000 or less may also want to choose an aggressive allocation consisting mostly of stocks. The rationale is that withdrawing 4% out of a $200,000 balance will likely contribute only a small portion to retirement income ($8,000 per year on a pretax basis). Plus, no matter what allocation is followed, the savings are not large enough to likely have a big impact on the retiree’s lifestyle.

Source: “Rethinking Retirement Guidelines,” by Luke F. Delorme, American Institute for Economic Research, January 2015.

Discussion

Carl Kendall from OH posted over 11 years ago:

One thing I do that no one else seems to do is us the equity in my home to replace bonds. My wife and I are retired with two small government pensions and 100,000 in our IRA's. I have found that putting all my money in the Vanguard small cap and total market funds works best for us. For many years I have tried everything from playing the date lines to buying single bonds, something always seems to go wrong. What do you think of my investment approach? Carl


Eric from WV posted over 11 years ago:

Carl, I am not clear on your strategy as you describe and I am not retired yet so take my comments as not expert. I removed equity from my home by a HEL when the bond rates returned more than the HELine and I was in my 30's - early 1990's after reading of this strategy. I feel that all this did was extend the banks ownership of my home. Since the crisis I have removed my home from my investment portfolio - this is a mental move, but in reality I feel that it does not belong in my investment portfolio. Having your home viewed as the roof over your head and paid for is my recommendation going into retirement - no house, vehicle or any debit payments is my rule number 1. This opens up all of your income to do what you want to do, not what you have to do to meet the obligations of others. I am sticking to the plan of a 4% siphon off of my 40/60 bond to stock portfolio and retirement at 58. You are fortunate to have a pension and I recommend Ramsey's books and literature (FPU) on no debt and building a portfolio that provides you with peace of mind and solid returns. I like your choice of Vanguard which is one of my favorite fund families due to their low cost from ownership structure and I have read Jack Bogles books many times over. I am in Vanguards Wellington Fund only as a personal rule due to its stable cash flow and equity to bond mix. Good luck, Eric


Eric from WV posted over 11 years ago:

My only comment is the example of remodeling your house in retirement? Money to Remodel your house, purchase of a vehicle or other big ticket items need to or should come from your portfolio income stream not the portfolio (it is as simple as the Goose and the Golden Egg story). If you find yourself removing capital from your portfolio in addition to your income stream, maybe you are not ready to stop working. You need to give thought to a simple savings vehicle building from your income stream for emergent items, but this still needs to remain outside of your cash generating portion of the portfolio to insure the sustainability of thet income stream. Thanks Eric


Daniel Bozza from FL posted over 11 years ago:

My wife and I have three accounts! The largest is a Roth Acct which we funded by rolling over an IRA account 11 years ago. We have tried to keep growth stocks there because of the tax free withdrawal feature of that vehicle. I frequently use option calls to help boost the growth! No bonds, treasures, funds here! My wife's account (2nd largest) has two high dividend, monthly paying stocks which pay all the bills we can't pay with my SS. (VNR, a Vanguard Fund, yes with a very nice monthly dividend! And the other is ARP) BTW both are very moderately priced so you don't need a bundle of money to get the dividends rolling! I also use options here to boost the dividend income. I only have options on VNR at the present time. "My" account is the smallest and I have just started to use it exclusively for options. It's taken a long time to finally get it all where we want it and are comfortable with. I just checked to see where I am compared to last year for this response and I am up 19.3% Yr over Yr. on the core account which of course does not include the dividend draw downs each month to help pay the bills as I mentioned above, which amounts to a little over $1,000/month!


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