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ARTICLE: Reducing Volatility Can Increase a Retirees Savings
During our lifetime, investing is essentially
divided into two phases. The accumulation phase - when we are
working and saving money for retirement, and the distribution
phase - when we begin withdrawing income from our savings during
retirement. The objective of most individuals saving for retirement
during their working years primarily focuses on one thing, increasing
they're investment returns. They have been accustomed to hearing
advice about thinking long-term, and to avoid worrying about volatility
and losses in the financial markets over the short term. However
when the time comes to begin withdrawing money in retirement,
the rules of investing are no longer the same. Taking the long-term
approach to investing is no longer an option. Volatility and losses,
even over the short term are a very real threat to retirees. To
illustrate the powerful impact that volatility can have on a portfolio
during the distribution phase of investing, lets look at the following
two hypothetical examples
In the first example, imagine you're saving
$10,000 every year over the next twenty years for retirement and
are offered the choice between two portfolios, Portfolio A with
an average return of 10%, or Portfolio B with an average return
of 9%. Like most investors, I'm sure the vast majority (except
for a few skeptics) would not even think twice before choosing
portfolio A. If you chose Portfolio A, after 20 years you would
have had $800,700 in savings, while $10,000 invested every year
in Portfolio B would have been worth only $619,675 at the end
of year twenty.
In the second example, you're now retired
with $500,000 in savings and plan on withdrawing $40,000 (8%)
of income for living expenses in year one, and $40,000 each year
thereafter. Your goal is to have your retirement savings last
a minimum of 20 years, and are again offered the choice of investing
your retirement savings in either portfolio A or B. If you again
answered portfolio A, you would have been much less fortunate
this time around as you would have run out of money after only
nineteen years, while Portfolio B was still worth $432,000 at
the end of twenty years. (See Chart)
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Portfolio
A
10%
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Portfolio
B
9.0%
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Yr.
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Avg.
Return
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Ending
Balance
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Avg.
return
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Ending
Balance
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1
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6%
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$
490,000
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5%
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$
485,000
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2
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14
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518,
600
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12
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503,200
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3
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-6
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447,484
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2
|
473,264
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4
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-19
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322,462
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-5
|
409,600
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5
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11
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317,932
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10
|
410,560
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6
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9
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306,546
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8
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403,405
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7
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2
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272,677
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11
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407,780
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8
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11
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265,399
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10
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408,558
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9
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14
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262,554
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13
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421,671
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10
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7
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240,933
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5
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402,754
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11
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14
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234,664
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12
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411,085
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12
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-5
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182,930
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5
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391,639
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13
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-6
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131.954
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0
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351,639
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14
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18
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115,706
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17
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371,418
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15
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27
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106,946
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16
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390,844
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16
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14
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81,918
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13
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401,654
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17
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30
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41,788
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12
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409,583
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18
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23
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11,400
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11
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414,937
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19
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26
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Broke!
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14
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433,028
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20
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10
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9
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432,000
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What makes this outcome even
more amazing is the fact that Portfolio A;
- Had a higher average return than Portfolio
B
- Had the same amount of money withdrawn
each year as Portfolio B
- Outperformed Portfolio B in 15 of the
20 years
- Ran out of money in year 19, while
Portfolio B was still worth $432,000 at the end of year 20
The primary objective for most individuals
in retirement is not about trying to become rich, but to avoid
ever having to worry about becoming poor. Unfortunately, far too
many retirees are still under the assumption that as long as their
portfolios rate of return is higher than rate of withdrawal rate,
they will never have to worry about running out of money. And
as we have seen, reaching for higher investment returns increases
volatility, which can increase a retiree's chances of running
out of money. That's why it is critical for retirees and those
approaching retirement to realize that managing money during retirement,
is completely different than managing money for retirement.
The goal now is no longer about achieving the highest returns,
but developing a portfolio with the right mix of assets that can
provide them with the "returns they need", with as "little
volatility" as possible.
Copyright (c) 2006, Capital
Wealth Management. All Rights Reserved.
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