Avoid running out of money when you need it most

Will your money last as long as you do? How about your spouse? Many retirees plan for too short a time horizon and misjudge how much money they can safely withdraw during retirement.

Carefully consider your time horizon. You may live a lot longer than you think

Life expectancies have been steadily increasing. According to the National Institutes of Health (NIH), average life expectancy has risen about nine years since 1952. Today, the average life expectancy for a 65-year-old is 83.4 years, as shown in the following table.¹ And that’s just the average—half could live even longer.

Source: Internal Revenue Service

Given rapid advances in modern medicine and health care, you simply must plan for a longer investment time horizon than your parents or grandparents did. And don’t forget about your spouse’s time horizon! Longer life expectancies present a challenge to today’s investors not faced by previous generations.

To learn more about retirement considerations, click here.

How much can you withdraw from your portfolio each year?

Investors often have unrealistic expectations about how much money they will be able to safely withdraw annually from their portfolios.

A common but incorrect assumption is that since equities have historically returned nearly an annualized 10% over long time periods,² then it is safe to withdraw 10% per year without ever drawing down the principal.

Nothing could be further from the truth!

While equities have historically returned 9.7% annualized,² because of inflation (approximately 3.0% annualized)³ the real return on investment is 6.49% annualized.

The following table demonstrates the potential impact of taking annual withdrawals equal to 10% of the beginning portfolio value from a $1,000,000 portfolio over 30 years (adjusting for inflation). In this example, the probability the assets survive the entire period is low, as is the probability of growing the assets—no matter the asset allocation.

Market volatility can play a role

Another important factor: Markets are volatile, and taking a 10% withdrawal in a year when the market declines could substantially decrease the probability of meeting your financial objectives. For example, if your portfolio is down 20% and you take a 10% distribution the same year, you will need about a 39% gain the following year just to get back to even!

Don’t forget about inflation

Inflation will also affect the size of the withdrawals over time. Due to the compounding effects of inflation, a person who needs $50,000 in 2009 to cover annual living expenses would need approximately $92,000 in 2029 and $125,000 in 2039 to maintain the same purchasing power.³

To learn more about retirement investing issues, click here.

¹ The US Total Population Life Table 2003 (revised as of March 28, 2007) National Vital Statistics Reports, Volume 54, Number 14

² S&P 500 Total Return; Global Financial Data, Inc. 1926-2009 = 9.70%

³ Global Financial Data, Inc.; based on US Bureau of Labor Statistics Consumer Price Index 1926-2009 = 3.0% inflation rate

How to Better Protect Your Financial Assets:

Do you know how well your future financial needs will be met? Are the decisions you are making today going to help or hurt your portfolio in the coming years?

Today’s investor faces a changing economic landscape, and having a financial plan that keeps pace with the changes can be critical to achieving long-term financial goals.

Making sure an adequate nest egg will still be there for you in the years ahead takes discipline, knowledge, and a deep understanding of portfolio management. Fisher Investments can help explain some potential risks and walk you through some tough decisions that could impact whether your portfolio will meet your future needs.

Click here to download the full version of How to Better Protect Your Financial Assets.

How big does your portfolio have to be to reach your financial goals?

A new reality has arrived. The pension plan era is over. Social Security is no longer backed by a solid guarantee, and healthcare costs are rising above the historical pace of inflation.* This means your portfolio may need to provide more money than you previously thought in order for you to enjoy a comfortable retirement.

So how much of your peak pre-retirement income will you need to keep your lifestyle constant in retirement? And with your annual withdrawals, how much money will remain in your portfolio at the end of your time horizon?

There is no simple answer to these questions. They involve numerous variables including time horizon, cash flow needs, and estate-planning goals.

Let’s examine a hypothetical retired 65-year-old investor who wants to spend $50,000 per year for living expenses and adjust that amount for inflation in the future. Say he also wants to leave $2 million to his heirs and estimates his time horizon at 25 years.

The table below illustrates the probability of the portfolio ending with at least $2 million while providing the required cash flow over 25 years given several different initial investment values and asset allocations.

This table is based on a Monte Carlo simulation, a sophisticated statistical technique which allows for random sampling of historical stock, bond, and cash returns while taking into account historical inflation to determine the probability of investment outcomes.

The simulation shows a high degree of sensitivity to the initial investment. In the $1 million scenario, even the optimal asset allocation yields a low probability of success, whereas when starting with $4 million, the probabilities of success are excellent regardless of asset allocation.

To continue reading Fisher Investments’ guide to making investment decisions, click here.

*Keehan, S. et al. "Health Spending Projections Through 2017," Health Affairs Web Exclusive W146, 2/21/2008.