(PUB) Investing 2016

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17 Morningstar FundInvestor September 2016
income-replacement rate. An accumulator who
assumes a middle ground—that a Social Security
benefit will be there but reduced by a pessimistic
one third—would need to save 12% of her annual
salary to achieve an 80% income-replacement rate.
2 | Taking a too-low withdrawal rate later
in retirement
Many retirees and pre-retirees have gotten the memo
about the risk of overspending in retirement, espe-
cially if we encounter a period of muted future market
returns. Retirees who encounter a bad market in
the early years of their retirements and overspend at
that time risk permanently impairing their portfolios’
sustainability, because too few assets will be in place
to recover when the market does. I’ve talked to
many retirees who withdraw a fixed percentage of
their portfolios year in and year out to help tether
their withdrawals to the performance of their portfo-
lios; others tell me they use an ultralow percentage,
like 2% or 3%, even well into their 70s and 80s.
Conservatism is their watchword when it comes to
portfolio withdrawals.
That’s fine for retirees whose portfolios are large
enough to afford a decent standard of living with a
modest percentage withdrawal rate. And as noted
earlier, some retirees may prioritize not spending all
of their assets so that they can leave something
to their children or heirs; they’d rather be frugal than
jeopardize their bequest intentions. But for other
retirees, especially those who are well past the danger
zone of encountering a weak market early in retire-
ment, a higher withdrawal rate is reasonable, especially
if it affords them expenditures that improve their
quality of life. While it’s decidedly unsafe for a 65-year-
old to take, say, an 8% withdrawal, it’s not at all
kooky for an 85-year-old to do so. “The 4% rule” for
retirement spending, while not perfect, does a
good job of scaling up spending as the years go by;
the initial dollar-amount withdrawal gets adjusted
upward year after year to keep pace with inflation.
3 | Gunning for a 100% probability of success
If you were to ask investors what probability of failure
in their retirement plan they might be comfy with,
chances are they’d say 0%. In other words, they want
a plan with 100% odds of being successful. The risk
of spending their later years destitute—or having
to rely on adult kids or other family members for finan-
cial support—is simply too terrible to ponder.
But retirement-planning experts say that unless inves-
tors are willing to accept some probability of failure,
their only option is to hunker down in very safe invest-
ments, such as cash and Treasuries, and put up with
an unpalatably low spending rate (or an exceptionally
high savings rate for accumulators). Instead, most
retirement-planning specialists believe probability-of-
success rates of 75% to 90% are acceptable. Venturing
into higher-risk investments takes the probability
of success below 100%, but it also allows for the
possibility of a higher return. If a retiree needs
to course-correct by reining in spending, that’s not
going to result in a catastrophic change in his or
her standard of living.
4 | Assuming too little help from the market if you
have a very long time horizon
Stock market valuations, while not ridiculously lofty,
aren’t cheap, either; that portends lackluster returns
from the asset class over the next decade. Meanwhile,
current yields have historically been a good predictor
of bond returns; the Barclays U.S. Aggregate Bond
Index is currently yielding less than 2%. For sure,
those ominous signals suggest knocking down your
return expectations for the next decade or so.
On the other hand, investors with longer time horizons
to retirement may experience muted results over the
next decade or more, but for them it’s safer to assume
that the returns they earn from their stock and bond
portfolios beyond that time frame will be more in line
with historical norms. Although U.S. stocks have
historically returned roughly 10% and bonds about 5% ,
investors with very long time horizons may want
to give those numbers a small haircut to account for
muted near-term expectations; 7% to 8% seems
reasonable for stocks, and 3% to 4% for bonds. Based
on those assumptions, if I were estimating the very
long-run return expectation for a portfolio with 60% in
equities and 40% in bonds, I’d use 5% to 6%. K
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