Tuesday, June 11, 2013

Planning for Retirement in a Low Return World

The "Bucks" blog at the New York Times continued the discussion it started last weekend about saving for retirement.

Here's an excerpt:

Today, there are almost 10 million millionaire households in the United States (excluding the value of a home), according to Professor Wolff’s calculations. In short, $1 million is a great deal of money, yet it is not so absurdly large a sum as to be beyond the comprehension — and, perhaps, the aspirations — of many people. 

That may be why the calculations for the $1 million portfolio were so startling. 

They started with a 65-year-old couple, retiring this year and using the 4 percent withdrawal rate that is a commonly used rule-of-thumb draw-down. The calculations provided by Bernstein Global Wealth Management showed that at a 4 percent withdrawal rate, adjusted for inflation, if they had invested the $1 million entirely in municipal bonds, there is a 72 percent probability that they will exhaust all of that money before they die. 

One important factor for this disturbing outcome is the highly unusual state of the markets more than five years after the onset of a global financial crisis. Bond yields remain very low, and central bank intervention in the economy remains very high. This won’t persist forever, but it has caused many investors to rethink the rules of investing and retirement.


As I wrote yesterday, it used to be that being a millionaire was a threshold that most assumed meant you were set for life.  However, the combination of low investment returns and increased longevity has called this into question.

One possible solution that several financial planners have suggested is for new retirees to scale back spending in the first years after they have stopped work.

For example, advisors often suggest a 4% withdrawal rate from retirement assets. This figure is based on a number of different studies done mostly in the 1990's, when the subject was becoming more broadly important to workers.

Given today's low yield environment, if a new retiree only takes, say, 2% of his retirement savings in the first years of his retirement, the odds grow much better than he will not outlive his money.

Problem is, this flies in the face of common sense.

If someone has worked for most of their adult life, and managed to stash a nest egg worth more than $1 million, scrimping by on $20,000 or $30,000 year at age 65 so they can be rich at 85 seems silly to most people.

In my experience, someone who has just retired and is in reasonably good health wants to enjoy the fruits of their labors. Travel is often a popular pursuit, or taking up a new hobby.  Giving these up so that they can live in a nicer nursing home doesn't resonate with most, including me.

Still, there is no denying the math:  savers either have to take more near-term risks in order to achieve superior longer term returns (i.e., stocks) or hope that bond yields rise above inflation fairly soon.